Four months ago, when looking at the latest S&P/Bankcard data, we first reported that credit card defaults had surged the most since June 2013, a troubling development which ran fully counter to the narrative that the economy was recovering and the US consumer's balance sheet was improving.
The troubling deterioration prompted Moody's to pen its own report titled "Spike in Charge-off Rates Indicates a Slide in Underwriting Standards" and as Moody's analyst Warren Kornfelf wrote, the steep increase in credit card charge-off rates in 1Q’17 and 4Q’16 was the largest since 2009, and indicates that "strong underwriting standards in place since the financial crisis have deteriorated, potentially rapidly."
Then, following JPM's results earlier today, we showed that this concerning trend had persisted, with JPM reporting the second highest net credit card chargoffs in Q3 since the summer of 2013, and only a modest decline since the previous quarter.
It wasn't just the charge offs however: there was another red flag in JPM's results this morning in addition to the sharp 27% drop in the bank's FICC revenues: with charge-offs spiking, it was only a matter of time before both JPM and its peers was forced to provision substantially greater credit losses ahead of potential pain in the future, and as we showed first thing this morning, JPM did just that when it hiked its credit loss provision from $1.2 billion in Q2 to $1.45 billion in Q3.
This negative development was not lost on the broader investor and analyst community, either, and as Bloomberg reports, after enjoying years of declining losses from fewer consumers defaulting on debts, banks "appear to be preparing for a turn." And it wasn't just JPMorgan either, as both JPM and Citi "just boosted their reserves for consumer-loan losses by the most in more than four years" as "Both lenders set aside money in the third quarter because they expected write-offs for credit-card lending to climb in periods ahead, with Citigroup saying the increase is coming faster than it had anticipated." Ominously, Bloomberg picked up on what we said in June, noting that "the initial reports from JPMorgan and Citigroup signaled a shift in consumer credit quality."
Confirming the deterioration we had observed more than a quarter ago, Charles Peabody, a banking analyst at Compass Point said in an interview with Bloomberg Television that “We’re at an inflection point in credit" and that “you’re seeing in this quarter very aggressive reserve additions in the card portfolio for future losses, so the industry knows it’s coming.”
Other analyst piled on, and shares of both banks dropped after the “notably disappointing” trends in their credit-card units, Henry Coffey, an analyst at Wedbush Securities said in a note to clients. Citigroup fell 2.4% as of 1 p.m. in New York, while JPMorgan slipped 0.9%. Smaller credit card issuers, such as Synchrony Financial which partners with retailers including Amazon.com Inc. and Wal-Mart Stores Inc. to issue cards, also declined 1.8% .
Unfortunately, it appears that for the US consumer, the headaches are only just starting. And, by implication, for the banks too: In the years after the financial crisis, an improving U.S. economy with lower unemployment and less household debt allowed banks to claim back billions of dollars they had previously set aside for bad loans.
But by last year, working-class Americans were devoting a growing percentage of their income to paying debts, the first increase since 2010 and a shift that’s likely contributing to rising default rates, Moody’s Investors Service said this week.
That said, the consumer-led credit deterioration has a long way to go before becoming a full-blown crisis: So far, there are few signs of a dramatic reversal at big banks.
To be sure, JPMorgan did everything it could to calm investors that there is no need to panic (yet) by the adverse trend reversal. The bank’s non-performing consumer loans fell again in the quarter, and only 0.34% of the loans in Citigroup’s retail bank were more than 90 days delinquent, lower than a year earlier. JPMorgan also said its increase in reserves against credit-card lending was caused by a move it made in the last few years to give loans to riskier borrowers as a way to boost revenue.
The increase is “not about deterioration or normalization of credit, but is about being paid for the risk we’re taking and being able to reach a little deeper into the credit spectrum,” JPMorgan Chief Financial Officer Marianne Lake said in a call with reporters, shortly before commenting that the bank may trade bitcoin after all.
Citigroup was less optimistic: the bank's current delinquency rate of 2.84 percent in its North American branded credit-cards business will probably increase to 2.95% in 2018, CFO John Gerspach said during the bank's earnings call. It will ultimately rise to between 3% and 3.25% by 2020, which would be in line with historic norms, he added
Citigroup pointed to one trend: When people who hold cards issued in partnership with retailers fall behind, the lending relationship has a “higher propensity” to deteriorate so quickly that Citigroup has to write off their debts, Gerspach said, and noted that while the bank is still comfortable with the card business, it’s important to be vigilant.
“The last thing you want to do in any sort of consumer-credit business is take your eye off the ball or get complacent, and so we’re not getting complacent,” he said. “But as we look at all the statistics we see, we continue to think our branded-card clients remain very healthy.”
And while the trend is clearly not the banks' friend for now, judging by the modest decline in share prices, investors are willing to give banks the benefit of the doubt for now.
Unfortunately, there are other red clouds on the horizon, and as we showed yesterday, an even more troubling trend is what UBS showed overnight when it demonstrated, using the latest Fed data, that millennials - and poor Americans - have never been more in debt. In fact, as the right hand chart below shows, Americans youngers than 35 years old, now have a record 100% debt to assets ratio: up from 40% two decades ago.
In light of this disturbing trend which directly impacts the most populous American generation, we fail to see how as young America is encumbered with ever more debt, JPMorgan can hope for any optimistic reversal in trends in the coming years. In fact, if this trend persists, it virtually assures another major consumer-led crisis in the not too distant future.