Inflation Just Hit a 3-Year High. These Credit Card Stocks Will Show the Strain First.

Life's becoming increasingly expensive. That's the big takeaway from the U.S. Bureau of Labor Statistics' measure of May's inflation. Led by higher energy costs, consumer prices were up a hefty 4.2% year over year, rising at a pace last seen in April 2023. Prices are expected to remain similarly elevated for the foreseeable future too. And it's not just in the U.S. Inflation is up on worldwide as well.

It's a problem for the global economy, of course, and in particular, a risk to credit card lenders. Consumers here and abroad are racking up more and more credit card debt, not because rising income is giving them the confidence to splurge, but because they increasingly need to finance life's basic needs like groceries. For perspective, the Federal Reserve reports credit card debt among U.S. borrowers ended the first quarter at a near-record $1.25 trillion, up 5.9% from the year-earlier comparison.

Cracks are starting to show too -- some modest and some not. One of the not-modest red flags is the fact that an 18-year high 13.2% of credit card accounts are now at least 90 days delinquent on their payments.

And this raises the question: Which credit card stocks will be the first to show signs of this economic strain?

Unequal distribution of growing subprime loan risk

The knee-jerk answer might be names like Visa (NYSE: V) and Mastercard (NYSE: MA) simply because these two companies are so dominant in the industry. They aren't though. As operators of payment networks, they're simply intermediaries, charging merchants a small toll every time a consumer uses a card for a purchase. Indeed, Mastercard and Visa are arguably benefiting from increased use of credit cards to purchase more basic consumer goods.

The real risk stacking up here, rather, is borne by the underlying card issuers, who supply the money upfront to fund a purchase that's (hopefully) paid back later, with interest.

These issuers come in all shapes and sizes, and are often banks. Bank of America's (NYSE: BAC) total credit card balances outstanding as of the end of Q1, for instance, were up 3.1% year over year, while Wells Fargo's (NYSE: WFC) were up 6%. Neither of these banks is reporting a rise in delinquencies and charge-offs though, at least not yet. And they may not at all. In fact, both are showing some modest improvement of these measures.

Rather, the outfits most threatened by the impact of higher consumer prices are the so-called subprime lenders and the credit card issuers.

Capital One Financial (NYSE: COF) is arguably the biggest and best-known subprime credit card issuer. Although the lender doesn't officially designate itself as such, it does disclose that about a fourth of its cardholders have FICO scores of 660 or less, which indirectly indicates a less-than-perfect payment history and/or below-average incomes, and/or a limited credit history.

Like Wells Fargo and Bank of America, Capital One's credit delinquencies actually fell in Q1 ending in March, sequentially as well as year over year.

That was before the recent surge of inflation, however, which didn't start picking up until March and didn't explode until April and May. With a full quarter's worth of higher prices now in the books, Capital One's Q2 delinquencies and charge-offs could jump.

That's probable, in fact, given the anecdotal hints that subprime borrowers are suddenly starting to struggle. Standard & Poor's reports 60-day-plus delinquencies for subprime automobile loans rose 37 basis points in May to 6%, extending a trend that's been in place for several months within and outside of the car loan business.

Another name that's particularly vulnerable to the fallout from lingering inflation is lender Synchrony Financial (NYSE: SYF).

You could be a customer without even realizing it. Synchrony often is the lender behind store-issued credit cards, although it also issues its own plastic. Its loan portfolio also includes ordinary installment loans, often to support the purchase of bigger-ticket items like motorcycles, HVAC systems, and more. It's not a subprime lender per se, although it's a lender with a sizable portion of its customer base (more than a fourth) with credit scores of less than 650. If this swath of consumers is forced to shoulder any more financial burden, the payment delinquency cracks that aren't quite yet showing up in its loan portfolio could appear in a hurry.

Image source: Getty Images.

Census Bureau data analyzed by Goldman Sachs suggests that as of April, thanks to rising inflation, the bottom-earning quintile of U.S. households -- households that are more likely to be subprime borrowers -- are now forecast to have just a 0.8% increase in their 2026 disposable cash flow. That's down from an estimated gain of 3.2% as recently as January. For perspective on that figure, Goldman says disposable cash flows for U.S. households of all incomes are still expected to improve by an average of 3.7% this year.

This should be concerning to shareholders of lenders with significant exposure to the subprime credit market.

Serious enough to distinguish prospects from one another

These aren't the only lenders facing above-average risk of subprime borrowers' mounting struggles. Bread Financial (NYSE: BFH) could soon hit a wall as well. It's also worth noting that while Capital One and Synchrony's customer bases include more potentially distressed borrowers than those of conventional banks like BofA or Wells Fargo, all of these lenders have some exposure to such borrowers. And just because a borrower is considered prime or better doesn't necessarily mean they will be able to continue making payments on their loans balances. Everyone's in the same economic boat. It doesn't take too much delinquency trouble to do some serious damage to any lender's stock.

If you're looking for a credit card outfit with proven resiliency, consider a stake in American Express (NYSE: AXP), which tends to serve a more affluent customer base that can better withstand economic pressures. Its modest past-dues and charge-offs didn't budge in Q1. Moreover, as Chief Financial Officer Christophe Le Caillec commented during April's Q1 earnings conference call, "retail spending kept up its momentum, up 11% FX‑adjusted. And spending at luxury retail merchants was up 18%, reflecting the continued strength of our premium customer base."

Connect the dots. This contrast is real enough to merit picking one of these aforementioned names over another.

American Express is an advertising partner of Motley Fool Money. Synchrony Financial is an advertising partner of Motley Fool Money. Bank of America is an advertising partner of Motley Fool Money. Wells Fargo is an advertising partner of Motley Fool Money. James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends American Express, Goldman Sachs Group, Mastercard, and Visa. The Motley Fool recommends Bread Financial and Capital One Financial. The Motley Fool has a disclosure policy.