More U.S. consumers are defaulting on their credit cards, but banks may be holding onto the riskiest loans instead of passing them off to investors, according to a report from Barclays.
The credit card loans that banks bundle into bonds and sell to investors are outperforming the loans that lenders have held onto, Barclays analyst Alin Florea wrote in a report dated May 3. On average, losses on loans the biggest banks packaged into bonds known as asset-backed securities are 1 percentage point lower than lenders' broader portfolios. Banks are writing off bad card loans on their books at the highest rate since 2012, and losses are outpacing those for auto and home loans.
The discrepancy may be explained by the more stringent requirements for the quality of loans that banks place into asset-backed securities, Florea wrote. For example, most of the securities require borrowers to have higher minimum credit scores than a bank might demand.
The difference in standards underscores how any future consumer downturn may hit banks more than asset-backed investors. Though losses have been rising for banks and to a lesser extent bonds backed by credit card payments, Barclays isn't alarmed by the numbers now.
While card losses are growing, they're still near post-crisis lows and haven't crimped strong profits in banks' consumer lending divisions. Part of the deterioration can be explained by a surge of lending in the space, as many banks have prioritized growing their credit card businesses, which can generate the highest interest rates of any form of consumer debt, over other areas like auto lending.
"Charge-offs following the post-crisis period have been very low and it is only natural that they rise as the credit cycle matures," Florea wrote. "While they should certainly be monitored, we do not see current levels as posing a risk to credit card ABS."
The credit card accounts that get bundled into bonds can be different from banks' broader lending in several ways. Most accounts eligible for being bundled into asset-backeds have been open for awhile, and the majority of borrowers have high credit scores.
In an asset-backed security Bank of America Corp. issued last year, about two-thirds of borrowers had credit scores of 720 or higher, and all of the accounts had been open at least five years, according to S&P Global Ratings. (Consumer credit grades known as FICO scores usually range from 300 to 850, with the cutoff for subprime usually seen as somewhere around 620 or so.) The charge-off rate for that bond was 2.57% in April, according to data compiled by Bloomberg. In the broader Bank of America card portfolio, it was 3.18% for the first three months of 2019.
Most bonds backed by credit cards also perform better because they exclude cards tied to retailers, which tend to have the loosest underwriting standards. Among bonds backed by retail credit cards, charge-offs were 7.58% in March, according to Fitch Ratings.
