You may have called me Chicken Little when I said in late 2022 that 2023 would be a rugged year for credit card issuers, and the risk will likely bleed into 2024.
But here is a news flash: credit card delinquency is deteriorating rapidly. Our expectation is on point.
Look at yesterday’s Financial Times, where the headline screams, “Big US banks to post the largest rise in loan losses since pandemic.”
- This week, the largest U.S. banks are set to report the biggest jump in loan losses since the onset of the coronavirus pandemic, as rising interest rates pile mounting pressure on borrowers across the economy.
- The publication of second-quarter results is set to show that banks have benefited from higher interest rates to some degree, by boosting lending and investment income. But after three years of relatively low defaults, partly fueled by pandemic-era stimulus cash and other government assistance, lenders are also starting to see the negative effects of higher rates and inflation on borrowers.
- The nation’s six largest banks—JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, and Morgan Stanley—are predicted to have written off a collective $5 billion tied to defaulted loans in the second quarter of this year, according to the average estimates of bank analysts, as compiled by Bloomberg.
- The six lenders will set aside an estimated additional $7.6 billion to cover loans that could go bad, analysts estimate.
Step Back a Moment: $5 Billion Loses + $7.6 Billion in Additional Reserves
No wonder Goldman Sachs (GS) is trying to drop the Apple Card like a hot potato. However, what top experienced credit card issuers like American Express, Bank of America, Citi, Capital One, Chase, Discover, and Wells Fargo are doing is playing the long game instead. Building loss reserves ahead of charge-off reduces current net income, making life much more palatable as delinquency surges in coming months. A little pain now will temper an upcoming storm.
Credit card issuers follow loan loss accounting rules under CECL, instead of waiting to realize that low FICO Scores lead to surging delinquency when the economy burps, strong credit policy groups squirrel loan loss reserves ahead of the ensuing risk. This way, credit card issuers can smooth out their losses.
Building up loan losses before a surge in charge-offs is as simple as good household budget management. If you do it right and save forward for the expense, replacing a roof is not as painful. Putting $2,000 or $3,000 into a household reserve every year makes it simple to reserve against the cost of a new roof. Similarly, building up loan loss reserves is just as practical. Rather than going through a crisis when the numbers explode, you have sufficient funds ready to cover the losses.
And that is one of the “safety and soundness” standards U.S. regulators have long established. Plan, and the storm can be no riskier than a little shower. When you know consumers cannot handle their household budgets, be ahead of the credit risk.
Overview by Brian Riley, Director of Credit /Co-Head of Payments at Javelin Strategy & Research.