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Bank's Retail Credit Losses And Unemployment Rate

|Includes: DFS, JPMorgan Chase & Co. (JPM)

Bank's Retail Credit Losses and Unemployment Rate:

Bank's credit worthiness is dependent on number of factors. One of them is profits and profit itself is dependent on credit losses of its customers. Financial institutions have very sophisticated databases to forecast the losses for pricing of their products and reserving losses and performing stress testing.

Financial institutions use sophisticated statistical methods like logistic regression, VAR to compute the risks in their portfolios. These tools are available only to Financial institutions own management. For outside investors, there are other tools.

Some of the proxy data that can be used to forecast consumer credit losses. Investors can look at the job creation rates published monthly by Bureau of Labor studies (BLS). Conventional wisdom says there is a close relationship between the unemployment rate and delinquency. As people become unemployed they are unlikely to repay their loans. As can be seen in the accompanying data even though the unemployment rates have remained steady at 7-8%, delinquency rates have come down. The delinquency rates peaked with the monthly job losses and dropped as the job creation started. Most people focus on the unemployment rate, when describing the credit losses, but as can be seen from the graph the unemployment rate is not a good metric for forecasting credit losses at Financial Institutions.

There are other reasons for drop in delinquencies as credit losses increase, banks tighten their lending standards, consumers will restructure their loans. Restructuring of the loans helps both the consumer and the banks. Often in case of collateralized loans like house and cars, their is often the willingness of both the banks and customers to restructure the loans.

Source: JP Morgan

US Unemployment Rates

Source: BLS.gov

Job Creation/losses per month in thousands

Source: BLS.gov