Banks Prepare for Consumers Unable to Pay Back Loans
Banks are shoring up their provisions against credit losses on fears that consumers could be late paying, or default on, loans and credit card bills.
Fears of a recession continue to increase as interest rates have risen rapidly. The Federal Reserve, which has raised interest rates 3 percentage points since March, is expected to hike rates by 0.75 percentage point in November and possibly 0.5 or even another 0.75 point in December.
Banks are preparing as Main Street has been hammered by sharp inflation; coupled with the increasing interest rates, consumers could find paying back loans difficult.
Higher interest rates translate to a larger portion of a payment allocated to interest instead of the principal amount borrowed.
Consumers have returned to using their credit cards more often to make purchases. Delinquency rates increased to 1.57% and average balances per consumer increased to $5,270. That balance figure is up significantly from 2021, though it's still below prepandemic levels, according to data from credit scoring firm Transunion.
Delinquencies in credit card payments declined early on in the pandemic, but by the fourth quarter of 2021, consumers reverted to past habits.
The consumers in the study group made smaller and smaller payments, showing the "deterioration of the liquidity of those consumers who eventually fell 90+ days behind occurred as soon as 9 to 12 months prior to severe delinquency."
The study tracked 5.9 million consumers and their ability to fund their payments from third-quarter 2019 through fourth-quarter 2021.
American Express Sets Aside More
In its third-quarter-earnings report, American Express (AXP) - Get Free Report said it put aside more funds for bad loans than was expected, and the financial-services giant reported an increase in charge-off rates.
The company said its provision for credit losses was $778 million, including a $387 million build in its reserves, compared with a $393 million reserve release in 2021.
American Express said the increase in the reserve resulted from more spending in its card business, but also to prepare for slower growth in the economy globally.
"Our credit metrics also remained strong even as we steadily rebuild loan balances, with delinquencies and write-offs continuing to be low," CEO Stephen Squeri said in a statement.
"We have not seen changes in the spending behaviors of our customers, but we are mindful of the mixed signals in the broader economy and have plans in place to pivot should the operating environment change dramatically, as we have done in the past."
Car Lenders Expect Late Payments
Ally Financial (ALLY) - Get Free Report, an online-only bank and lender, reported both weaker earnings and higher charge-offs of bad loans than had been anticipated.
The bank reported its share of retail loans and net charge-offs doubled to 1.05% from 0.54% in the second quarter. The figure was 0.27% in the third quarter of 2021.
Ally on Oct. 19 said it expected its total loss rate over the cycle to range 1.4% to 1.6% and closer to the higher end.
During Ally's earnings call. CEO Jeffrey Brown described the macro situation as a “pretty fluid environment."
Auto loans are one metric financial analysts often use to assess the likelihood of consumers paying debt, since repossession of cars can occur within 90 days after a payment isn't made.
The steady rise of car prices, especially during the pandemic, have pushed monthly payments up to $700 because of consumers seeking "ever-larger and more expensive vehicles," Greg McBride, chief financial analyst for Bankrate, the New York financial data company, told TheStreet.
Consumers paying down the principal on their auto loans -- which these days are often six- to seven-year loans -- leads to "much less equity to be used as a down payment on the next vehicle," he said.
Ally’s average auto loan yielded 7.29% during the third quarter of 2022, up from 6.62% in the third quarter of 2021.
Another large auto lender is Capital One (COF) - Get Free Report, which reports earnings on Oct. 27.
Other Banks Added to Provisions
Some banks are faring better because their standards for approving consumers for loans are much stricter.
Bank of America (BAC) - Get Free Report has maintained its more conservative lending standards since its appetite is smaller than other Wall Street banks like Goldman Sachs or JPMorgan Chase.
Bank of America reported its percentage of nonperforming loans -- loans not earning interest -- at just 0.39%.
Consumers have reverted to their previous payment habits and have used credit cards more often to make purchases. Bank of America reported its loan balances rose 12% year over year from more commercial loans and consumers using their credit cards more.
Even though the bank is more disciplined in the aftermath of the Great Recession in 2007 to 2009, the bank added $900 million to its provision for credit losses.
“Our U.S. consumer clients remained resilient with strong, although slower growing, spending levels and still maintained elevated deposit amounts,” said Brian Moynihan, chief executive at Bank of America.
Goldman Sachs's Marcus consumer line of business, launched in 2016, has not contributed significantly to its bottom line.
The consumer business, meant to lure in Main Street, and its wealth-management operations will merge with its asset-management division as part of Goldman's plan to pare back to three units.
Goldman Sachs attracted around 13 million customers with Marcus and accumulated more than $100 billion in deposits, but its losses are expected to total at least $1.2 billion. Goldman Sachs hopes Marcus will be profitable from 2022.
Citigroup (C) - Get Free Report reported third-quarter earnings declined 25% as it ramped up its credit-loss provisions while investment banking profits weakened.
The profit decline stemmed partly from higher loan-loss reserves. Citigroup increased its allowance for credit losses by a net $370 million during the quarter, compared with a release of more than $1 billion in the year-earlier period. The total credit loss provision for the quarter was $1.37 billion.
