JPMorgan Chase (JPM) -3.00%)The largest US bank by assets and a leading credit card lender expects card loan losses to rise significantly this year as credit quality returns to historical norms.

For much of the last three years, consumers have been in excess of savings fueled by federal stimulus payments and as a result of reduced spending as people took shelter to avoid the spread of COVID-19. But as inflation has spiked this year and people cut back on savings, there have been signs that consumer finances are weakening.

In 2023, JPMorgan expects this trend to continue, although it doesn’t yet see credit quality rising to levels it would consider alarming. This is why.

Credit losses remain historically low

Credit card loans tend to experience higher loss rates than many other loan categories because if the consumer is in financial trouble and is having trouble meeting their expenses, a lot of it could be on their credit cards.

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

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

That’s also a historically low rate of loss and probably not sustainable, especially as excess savings dwindle and Americans get into credit card debt.

JPMorgan Chase Chief Financial Officer Jeremy Barnum, in the bank’s fourth-quarter earnings call, said the bank expects “consumer cash reserves” for low-income clients to reach pre-pandemic levels in the second half of the year. He also said outstanding card balances in the fourth quarter increased 19% year-over-year and are back to pre-pandemic levels. All of this supports the idea of ​​credit normalization.

But it will take time before a loan balance is turned into a payoff, a process that typically begins when an account is at least 90 days past due. JPMorgan expects credit card charge-offs to rise from 1.47% of total credit card loans at the end of 2022 to 2.6% at the end of 2023, which would represent a jump of about 113 percentage points.

But in 2020, JPMorgan’s credit card charge-off rate at the bank was 2.93% and even higher in 2019 at 3.10%, so a credit card loss rate of 2. 6% would still be healthy.

Some considerations

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

Currently, the core case for JPMorgan Chase is factoring in a mild recession in 2023 in which unemployment peaks at around 5%. If this is not met, credit card cancellations could end the year better or worse than the bank’s initial forecast. Analysts have never really seen interest rates rise as fast 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 from the Federal Reserve, followed by two rate cuts later this year. That would essentially leave the Federal Reserve’s benchmark lending rate, the fed funds rate, unchanged from today. The federal funds rate affects borrowing costs, which flow into charge-offs, so where it ends up will be key.

Ultimately, management teams tend to try to be conservative and few are more experienced than JPMorgan Chase’s, so the 2.6% estimate is probably a good target, despite all the unknowns. If this scenario does come to pass, I think JPMorgan stock will benefit.

JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Bram Berkowitz does not have a position in any of the mentioned stocks. The Motley Fool has positions at JPMorgan Chase and recommends it. The Motley Fool has a disclosure policy.