What 2Q says about the outlook for consumer credit

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Bank of America on Monday issued such strong second-quarter consumer lending results, it was easy to forget that just a few days before its largest peers reported some underwhelming numbers.

Consumer loans (excluding mortgages, which are a special case in the current economic environment) rose 7% at BofA at June 30 compared with a year earlier, but only about 2.5% at both JPMorgan Chase and Citigroup. And they actually declined at Wells Fargo and PNC Financial Services Group.

There are many reasons for the variations in performance. JPMorgan’s ongoing ramp-up in credit cards was offset somewhat by a decline in auto lending. Wells Fargo is de-risking in auto lending and reining in growth in general, and PNC said education loans dipped.

But one of the big-picture questions to be answered as the year moves ahead is whether Bank of America shows there is plenty of growth opportunity out there, or if it will be headed back to earth like all the rest.

BofA executives are bullish that consumer banking will remain healthy.

“Our perspective is, customers are optimistic given tax reform, the economy is strong, and confidence feels high,” Chief Financial Officer Paul Donofrio said, adding that loan growth should remain in the mid single digits, excluding the runoff of noncore mortgages.

Yet BofA’s growth could be a double-edged sword—rapid growth carries the risk of a spike in bad loans. And that is the second big-picture question: Is there a credit quality problem brewing?

Some economic indicators offer little comfort. Consumers paid $104 billion in credit card interest and fees over the 12-month period that ended March 31, an 11% rise over the previous period, according to the consumer-advice site MagnifyMoney.com. The figure may rise another 10% in the coming 12 months, as the Fed keeps raising rates.

BofA’s rivals have struggled with consumer credit quality. The net charge-off rate in credit cards for JPMorgan rose 26 points in the second quarter, to 3.27%. And Citi recently experienced a surge in early-stage delinquencies with some of its cards.

Gerard Cassidy, an analyst at RBC Capital Markets, downplayed the concerns, saying that banks run into consumer-loan problems when unemployment rises. Instead, the U.S. employment rate dropped to 4% last month from 4.3% in the previous June, according to the U.S. Bureau of Labor Statistics.

“Credit quality, including consumer credit, in the U.S. banking system and at Bank of America is the strongest we have seen in over 15 years,” Cassidy said. “If you think unemployment will be 5% to 6% this time next year, then the credit players will have a problem.”

Credit cards set the pace in BofA's 7% increase in consumer loans and leases to $281 billion. That total excludes mortgage lending, which declined 22% year over year.

Donofrio said that BofA’s credit quality metrics are solid.

“When you look at all the metrics—nonperforming loans, 30-plus-day delinquencies—they are all going in the right direction,” he said.

Nonperforming consumer loans, as a percentage of all loans, dropped 15 basis points to 1.03%. And total consumer loans at least 30 days past due declined 16% to $7.2 billion.

Net charge-offs did rise in the second quarter, climbing 10% to $996 million. However, the second quarter “is the highest quarter in card [net charge-offs] usually,” Donofrio said.

It also makes sense that card charge-off rates increased, as U.S. consumers spent the last decade paying down debt, said David Fanger, an analyst at Moody’s.

“Only in the last few years has consumer debt growth accelerated,” Fanger said. Additionally, consumer debt levels relative to consumer income levels remain very low, he said.

At BofA, total combined spending for credit and debit cards rose 8% to $148 billion.

If charge-off rates keep rising at a steady pace, that may be a sign of serious credit quality issues, Fanger said. Moody’s has detected some deterioration of underwriting standards for credit cards throughout the banking sector.

But BofA is guarding against that, Donofrio said. It is keeping riskier customers at arm’s length and, for the time being, is peddling its cards to consumers who are the most likely to repay on time.

“We’re very focused and remain focused on prime and super-prime,” Donofrio said.

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