Since the pandemic, consumers across the board registered higher cash balances thanks to built-up savings from the pandemic and from stimulus checks. But in 2022, consumers started using up those savings, once again accumulated debt, and are now also dealing with inflation and higher interest rates. All this combined to increase borrowing costs, which cut into their savings.
Despite all that, most bank CEOs report noticing that lower- and some moderate-income populations are seeing their finances normalize faster than higher-income consumers. That theme is also playing out in recent bank earnings results. Here's what's going on.
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JPMorgan Chase vs. Discover Financial Services
Both JPMorgan Chase (JPM 0.28%) and Discover Financial Services (DFS -2.10%) are large credit card lenders that recently reported their fourth-quarter earnings results and provided early guidance for full-year 2023.
JPMorgan Chase reported that it expects its credit card net charge-off (NCO) rate to jump from 1.47% at the end of 2022 to about 2.6% by the end of 2023. The NCO looks at credit card debt unlikely to be collected as a percentage of the total credit card loan portfolio.
Keep in mind that at the beginning of 2022, JPMorgan expected its NCO rate to come in around 2%, and it came in below 1.5%. But even if the NCO rate did hit 2.6% that would still be below the bank's credit card NCO rate in 2019 prior to the pandemic.
In its earnings call, JPMorgan's CFO Jeremy Barnum said that cash buffers among lower-income segments are normalizing at a faster pace and that the bank expects cash buffers for this segment to return to pre-pandemic levels by the third quarter of the year.
If we move over to Discover (which has the bulk of its loans in credit cards), the bank's NCO rate ended 2022 at 1.82%. Management expects the credit card NCO rate to jump to a range of between 3.5% and 3.9%, a level that would be decently above pre-pandemic NCO levels. Discover's CFO John Greene said consumers with FICO scores below 660, which the bank classifies as near-prime, "are certainly feeling the impact from inflation."
If you look at JPMorgan Chase's third-quarter regulatory filing, more than 87% of the bank's customers had a FICO score above 660, and 12.6% of its customers were below a 660 FICO. Discover's split was wider, with 83% of its credit card borrowers above 660 and about 17% below.
What does it all mean?
Although the percentage breakdowns may not sound like a huge difference between JPMorgan and Discover, we don't actually know the weighted average FICO score in each of these companies' portfolios.
After all, above and below 660 can still mean many things. Also, bank credit portfolios can be heavily differentiated by just a fraction of a percentage point.
Ultimately, it's not the end of the world if Discover sees higher credit card loan losses than JPMorgan. That's supposed to happen, given the demographics of each credit card portfolio. It's all about how management manages credit through the cycle and whether they are appropriately reserving.
I like both JPMorgan and Discover as stocks, but Discover is more vulnerable right now because it serves a larger number of lower-income borrowers who are more affected by macroeconomic forces. A worse-than-expected economic scenario could lead to a bigger jump in loan losses among this demographic.
