JPMorgan Chase (JPM 0.50%), the largest U.S. bank by assets and a top credit card lender, expects card loan losses to rise significantly this year as credit quality returns to historical norms.

For much of the past three years, consumers have had excess savings buoyed by federal stimulus payments and as a result of reduced spending when people were hunkering down to prevent the spread of COVID-19. But as inflation soared this year and people drew down their savings, there have been signs that consumer finances are weakening.

In 2023, JPMorgan expects this trend to continue, although it still doesn't see credit quality rising to levels that it would deem alarming. Here's why.

Loan losses are still historically low

Credit card lending tends to experience higher loss rates than a lot of other lending categories because if the consumer runs into financial issues and has trouble covering their expenses, a lot of those might be on their credit cards.

Person looking at large screen.

Image source: Getty Images.

It's not uncommon -- even in fairly healthy economic times -- to see credit card losses of 3% or more of the loans outstanding, although it varies from bank to bank and really depends on the composition of the customer base.

JPMorgan Chase ended the year with a net credit card charge-off rate, which looks at debt unlikely to be collected and is a good indicator of loan losses, of just 1.47%. That number came in below management's expectations heading into 2022.

That is also a historically low loss rate and likely not sustainable, especially as excess savings dwindle and Americans take on credit card debt.

JPMorgan Chase Chief Financial Officer Jeremy Barnum on the bank's fourth-quarter earnings call said the bank expects "consumer cash buffers" for lower-income customers to hit pre-pandemic levels in the second half of the year. He also said that card balances outstanding in Q4 were up 19% year over year and have returned to pre-pandemic levels. All of this supports the idea of credit normalization.

But it will take time before an loan balance becomes a charge-off, a process that typically begins when an account is delinquent for at least 90 days. JPMorgan expects credit card charge-offs to climb from 1.47% of total credit card loans at the end of 2022 to 2.6% at the end of 2023, which would represent roughly a 113 percentage point jump.

But in 2020 JPMorgan's credit card charge-off rate at the bank was 2.93% and even higher in 2019 at 3.10%, which is why a 2.6% credit card loss rate would still be healthy.

A few considerations

When you hear these numbers, understand that management has modeled them based on several assumptions.

Currently, JPMorgan Chase's central case is factoring in a mild recession in 2023 in which unemployment peaks at about 5%. If this doesn't end up playing out, credit card charge-offs could end the year better or worse than the bank's initial projection. Analysts have really never seen interest rates rise as quickly and or as much as they did in 2022, so there are still a lot of unknowns.

I also found it interesting that in the bank's net interest income projections, management expects to see two more interest rate hikes by the Federal Reserve followed by two rate cuts later this year. That would essentially leave the Fed's benchmark lending rate, the federal funds rate, unchanged from today. The federal funds rate affects borrowing costs, which flow through to charge-offs, so where it ends up will be key.

Ultimately, management teams usually try to be conservative and few are more experienced than JPMorgan Chase's, so the 2.6% estimate is likely a good target, despite all of the unknowns. If this scenario ends up playing out I do believe JPMorgan's stock will benefit.