As the pandemic took hold, U.S. credit card issuers took a cautious step by building loan loss reserves. A driving factor for reserve building was to comply with accounting changes relative to reserving against future credit losses. Current Expected Credit Loss Accounting required that financial institutions adopt a more conservative approach to preparing for credit card losses.
In 2020, Top issuers diminished earnings to fund their reserves. For example, JP Morgan Chase increased their allowance for credit losses by $4.3 billion, which caused a $2.7 billion decrease in earnings. At the same time, Citi increased their loan loss reserves by $4 billion.
Now, 4Q earnings suggest that several top issuers may have over reserved, which is a good thing for investors. Just as a charge to loan losses decreases income, unused funds can be recaptured and increase income. That is what happened at the 2020 year-end, as Charge-Off metrics and delinquency indicators performed better than expected.
COVID continues to take its toll, but top credit card banks are beginning to feel the worst may be behind us, as Bloomberg reports in 4Q20 earnings. In an article titled “Big Banks Unleash $5 billion from Loan Loss Reserves,” Bloomberg indicated:
- Wall Street’s worst fears about the fallout from Covid-19 are receding.
- Three of the biggest U.S. lenders — JPMorgan Chase & Co., Citigroup Inc., and Wells Fargo & Co. — cut their combined reserves for losses on loans by more than $5 billion, helping fourth-quarter profit top estimates even as they faced headwinds from low-interest rates. While posting results Friday, executives expressed guarded optimism about fiscal stimulus and rising vaccinations during a pandemic in which delinquencies have remained low.
- Still, the banks warned the economy isn’t out of the woods yet.
The earnings impact from reducing reserves is notable. At Discover, the most recent investor call indicated the provision for credit losses was $305 million lower than the prior year. The reserve helped the firm deliver substantial revenue, along with positive trends in net interest margin.
Do not feel overconfident. Credit card delinquency remains muted by forbearances, stimulus checks, and the promise of a vaccine.
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group