Banks Brace for Credit Card Pain
By: Staff

By Philip van Doorn


Credit card delinquencies are on the rise amid the weakening economy and lingering mortgage crisis, putting added pressure on bank issuers.


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Credit card delinquencies are on the rise amid the weakening economy and lingering mortgage crisis, putting added pressure on bank issuers already facing a bleak landscape.


Following our two-part discussion of large banks with high concentrations in nonperforming commercial real estate loans, a look at the largest credit card banks shows a significant increase in charge-offs which can only get worse, in light of last week's dismal unemployment figures.


According to the Federal Deposit Insurance Corp.'s quarterly banking profile for U.S. banks and thrifts for the third quarter, 4.85% of all credit card loans were delinquent 30 days or more, as of Sept. 30. This is an increase from 4.35% a year earlier.


While this might not appear to be an alarming increase, year-over-year net charge-offs (actual loan losses) grew much faster. Total industry net charge-offs for the first three quarters of 2008 were up 37.4% year-over-year, and the annualized percentage of net credit card charge-offs for all U.S. banks and thrifts for the first three quarters of 2008 was 5.24%, compared with 4.09% for the same period in 2007, according to the FDIC.


In its credit card asset quality review for the third quarter, Fitch Ratings listed falling home prices and rising unemployment, as well as tightening of credit standards as factors expected to lead to continued deterioration in the first half of 2009.


Fitch mentioned that its Prime Credit Card Index (used to help track asset-backed securities performance), which included about $292 billion in card receivables, mainly "associated with accounts having credit scores of 660 or above," had an annualized charge-off rate of 6.57% in September. This is quite a spike from the index's lowest charge-off rate of 3.1% in March 2006.


In Goldman Sachs' Dec. 8 report on banks, the firm's research team said the industry was only halfway through a three-year credit cycle. October saw the largest month-over-month increase for credit card delinquencies, of about 25 basis points, the Goldman analysts said.


The following table compares year-over-year numbers for the 10 U.S. banks with the largest credit card portfolios as of Sept. 30. We have used the consolidated credit card numbers, which include cards issued outside the U.S.


While we would prefer to provide net charge-off ratios based on average credit card portfolio balances, this proved impossible, because the average balance figures on bank call reports only include domestic balances, while charge-off numbers include cards issued outside the U.S. So our annualized ratios of net credit card charge-offs are calculated using quarter-end credit card balances.


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As you can see, most of the banks on the list showed significant year-over-year increases in credit card charge-offs, and several institutions on the list exceeded the 6.57% for Fitch's Prime Credit Card Index in September.


Capital One, AmEx Hit Hard


The bank with the highest annualized charge-off ratio of 7.86% was Capital One Bank (USA), NA, a subsidiary of Capital One Financial . A year earlier, the charge-off ratio was 4.71%.


In an effort to bolster its deposit base, Capital One Financial announced last Thursday a $520 million deal to purchase Chevy Chase Bank, FSB, a Virginia thrift with $15 billion in total assets and $11.5 billion in deposits. This came after the holding company received $3.56 billion in new capital through the Treasury's Troubled Asset Relief Program, or TARP, in October.


Of course it remains to be seen just how Chevy Chase Bank's branches and deposits will be allocated to Capital One Bank (USA) and its $111 billion big sister, Capital One, NA. The latter doesn't appear on the list because it has a very small credit card portfolio.


Regardless, the acquisition should help Capital One Bank (USA) continue to improve its net interest margin, relying more on retail deposits and less on more expensive brokered deposits and borrowings. In the wake of the Lehman Brothers bankruptcy, the three-month London interbank offered rate, or LIBOR, shot up from roughly 2.75% on Sept. 15 to 4.75% on Sept. 30.


On Monday, three-month LIBOR was at 2.16%. Still, beefing up core deposits is a key element for banks in weathering the economic storm, since news events have caused wild gyrations in wholesale borrowing rates.


The bank with the largest increase in charge-off activity was American Express Centurion (held by American Express ), which reported net card charge-offs of $320 million in the third quarter, or an annualized net charge-off ratio of 7.57%. This was the second-highest charge-off ratio on the list. Looking at charge-off figures from a year earlier, American Express Centurion had the second-lowest ratio: 3.08%.


Of course, American Express Centurion, with just $22.3 billion in total assets only represents a small portion of the holding company's $127 billion in assets. Still, the charge-off numbers reflected the company's aggressive growth strategy for its managed portfolio.


"American Express has gone from having the best loss rate in the industry in the first quarter of 2008 to the middle-of-the-pack in just two quarters," Fitch wrote, citing the company's rapid managed portfolio growth and "hefty exposure to California and Florida."


Asset Quality, Reserves and Capital


As we've analyzed banks throughout the mortgage crisis, we've constantly looked at nonperforming loans (those past due 90 days, or in nonaccrual status) as an indication of how high banks' loan losses will get. When looking at credit card banks, it's much easier to just cut to the chase and look at charge-offs, since bad credit card loans tend not to linger on banks' balance sheets for months and months like mortgage loans do, as banks try to modify or work out the loans, or go through an agonizingly-long foreclosure process.


We're still presenting asset quality figures for the group, along with the loan loss reserve ratio and capital ratios. The ratio for loans past due 30 to 89 days (but still considered "performing") is probably the most useful as a lead indicator to next quarter's charge-off activity.


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Credit card banks make higher interest-rate spreads than banks with more varied loan portfolios. Since loan losses are expected to be higher than they are for other lenders, these banks tend to hold much higher levels of capital. To be considered well-capitalized under regulatory guidelines, banks need to maintain leverage ratios of at least 5% and risk-based capital ratios of at least 10%.


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Of course, not all of the 10 banks with largest credit card portfolios are pure credit card banks. Citibank NA (a unit of Citigroup ), JPMorgan Chase Bank (held by JPMorgan Chase ), HSBC Bank, USA (a unit of HSBC and U.S. Bank (A unit of US Bancorp have diversified portfolios.


These capital ratios will be higher at the end of the fourth quarter for many of these banks, when capital infusions from TARP are factored in.


Chase Bank USA, Citibank South Dakota, Discover Bank (the main subsidiary of Discover Financial Services , American Express Centurion and Capital One Bank (USA), all had loan loss reserve ratios that were "behind" the annualized charge-off rate for the third quarter. This means that, assuming charge-off rates hold up or increase over the next few quarters, these banks will need to significantly boost their quarterly provisions for loan loss reserves.


In the case of Discover Bank -- even though its third-quarter charge-off ratio was not among the highest in our group of 10 -- its need for additional reserves would have been expected to have quite a large effect on earnings of parent Discover Financial Services, since the bank represents the bulk of the holding company's assets. However, Discover Financial expects to receive $862 million of its $2.75 billion settlement against Visa and MasterCard during the fourth quarter.


Discover filed suit in 2004, saying Visa and MasterCard's rules against issuer banks also issuing Discover cards violated federal antitrust laws. Discover expects to collect $472 million in settlement money each quarter during 2009. Now that's fantastic timing. The market apparently agrees, since Discover Financial's shares had a year-to-date total return of -26.96% as of last Friday's close, while the S&P 500 returned -54.71%.


American Express filed a similar suit against Visa and MasterCard, settling for $1.13 billion. The company expects to continue collecting $70 million per quarter through the second quarter of 2011, which will greatly mitigate credit losses. Still, the market has punished the company for its rapid slide in loan quality and (at least temporarily) the bleak prospect for loan securitization, with a year-to-date return of -57.41% at last Friday's close.


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