Low Card Delinquencies Presage Pre-Recession Chargeoff Levels

Credit card chargeoff rates are on track to finish the year below the levels at which they entered the recession.

At Bank of America Corp., whose loss rates outran those of the other five largest domestic issuers during the downturn, chargeoffs on securitized receivables are headed toward a drop of 1.6 percentage points from the second quarter to an average of 6.1% for the fourth quarter, if the pace at which late accounts have been written off as uncollectible holds steady (see charts).

Second-quarter chargeoffs of about 3.3% on American Express Co.'s domestic loans were already less than one third of their cyclical peak in the second quarter of 2009, and delinquency trends suggest they will drop further, to about 2.5% in the fourth quarter.

Moody's Investors Service said this month that its index of securitized card loans that are between 30 days and 59 days overdue hit an all-time low in July at 83 basis points. Early-stage delinquencies, and the proportions in which they have been moving into more severe phases of distress, are chief determinants of ultimate loss rates, and Moody's forecast that its index of chargeoff rates would fall below 4% by the end of next year. That would be the lowest level since June 2006.

The forecasts for individual issuers presented here are based on early-stage delinquencies reported for securitization trusts in July, and assume that these delinquencies will translate into chargeoffs five months later at the same ratio that has prevailed for each company during the past five months.

Weighted according to the size of the issuers' portfolios, the group's chargeoff rate would average about 4.7% in December, below the 5% posted by Moody's chargeoff index for November 2007, the last month before the recession officially began.

To be sure, the past can be a poor indicator of the future, and while credit card performance has been improving despite the dismal employment picture, the industry of course remains vulnerable to the broader economic environment.

Moreover, statistics for loans backing bonds are an imperfect read on total portfolios — chargeoff rates have generally been higher for total portfolios for each of the big six issuers aside from Amex and B of A.

Still, card lenders aggressively tightened underwriting during the downturn, laying the groundwork for a sharp turn in credit performance. During Citigroup Inc.'s earnings call in July, Chief Financial Officer John Gerspach said the chargeoff rate for the company's core North American portfolio — 6.8% in the second quarter — might ultimately bottom out at 4%.

A necessary factor would be an increasing denominator as growth in lending begins to fill portfolios with "unseasoned" accounts — it takes time for new loans to charge off, and the lag suppresses loss rates.

In any event, credit performance appears near the point at which it can improve no further. In an August note, analysts with FBR Capital Markets predicted draw-downs of loan-loss allowances would begin to taper, though "there may be another quarter or two of relatively large reserve release for select issuers."

Lower chargeoffs bode well for receivables growth, they wrote, but demand for credit could be undercut by economic weakness, and, in the event of another recession, "we would expect reserve building to become a priority."