Recovering Bad Card Debts Feeds Issuers’ Profits — For Now

Recoveries against bad loans have become a major source of cash for credit card issuers, and hence an increasingly important factor in the industry’s return to pre-recession loss rates.

This money, once written off as uncollectible, is salvaged through means like court judgments against debtors and sales of claims to collections agencies. But collections are a wasting resource: the massive reservoir of charged-off paper is aging, which will make it harder to make good on these claims. That’s not to mention the intensifying scrutiny of the collections industry from authorities concerned about potentially widespread documentation problems.

Recoveries have held steady or climbed at some of the largest issuers. At Discover Financial Services, the value of card loans written off as uncollectible fell by half to $550 million in the third quarter of last year from from about $1.1 billion in the second quarter of 2010, according to regulatory financial reports.

Meanwhile, recoveries jumped by about a quarter to $146 million over the same time. Thus, in the third quarter, recoveries offset about 26.5% of gross chargeoffs, or more than twice the figure in the second quarter of 2010.

The pattern was similar at American Express Co., where gross chargeoffs fell 48% from the second quarter of 2010 to $571 million in the third quarter last year, while recoveries edged up by 2% to $144 million.

Overall, Amex’s net chargeoff rate fell by 3.8 percentage points to 2.9%. (This rate is the amount of gross quarterly chargeoffs less recoveries at an annual rate, as a percentage of receivables outstanding at the end of the previous quarter.)

Recoveries have been strong generally, though the trends elsewhere among the nation’s six largest issuers have been lumpier — a worrisome sign.

At JPMorgan Chase & Co., recoveries surged to $390 million, or 16.1% of gross chargeoffs, in the first quarter last year, but then slid to $253 million, or 15.6% of gross chargeoffs, in the third quarter.

American Banker reported in January that JPMorgan Chase had halted collections lawsuits around the country and dismissed teams of lawyers in mid-2011, a development experts said could reflect legal issues.

Even without heightened resistance from judges and consumer advocates, recoveries of charged off debt are due to decline.

“Recoveries have been above normalized levels given the outsized pool of defaulted loans that resulted from the recession,” but should drop as “that pool continues to shrink,” analysts at KBW Inc.’s Keefe Bruyette & Woods Inc. wrote in a note in January.

Capital One Financial Corp. Chief Executive Richard Fairbank told analysts in January that the decline in recoveries at his company simply reflected “the math of a shrinking inventory of fresh charge-offs against which to recover.”

He acknowledged that there is “an incredible amount of noise about the collections area,” but asserted that Capital One had not changed its approach after doing “a huge amount of work over the years to make sure that we have very rigorous and buttoned-down, disciplined collections processes.”