Q4 2014 Bank Review: Credit Card Charge-Off Rates

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An important factor behind the notable increase in profitability for the credit card industry over recent years has been the marked reduction in loan charge-off rates from the highs witnessed in late 2010. In the aftermath of the economic downturn, many cardholders defaulted on their obligations. The situation for card lenders was exacerbated by the restrictions imposed by the Credit CARD Act of 2009 as well as several Federal Reserve rules which capped interest rates and fees. But as economic conditions improved, the volume of bad loans began to shrink steadily – allowing card lenders to report credit card charge-off rates that are near historic lows over the recent quarters.

In this article, which is a part of our ongoing series detailing the country’s largest card lenders – JPMorgan Chase (NYSE:JPM), Bank of America (NYSE:BAC), Citigroup (NYSE:C), U.S. Bancorp (NYSE:USB), Wells Fargo (NYSE:WFC), American Express (NYSE:AXP), Discover (NYSE:DFS) and Capital One (NYSE:COF) – we discuss the trend in their credit card charge-off rates over the last twelve quarters and also detail what to expect in the near future.

See the full Trefis analysis for Capital OneJPMorganU.S. BancorpWells Fargo | Bank of AmericaCitigroupAmerican ExpressDiscover

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The charge-off rate is often used as a parameter to gauge the quality of a lender’s loan portfolio as it represents the proportion of loans which the lender is forced to write off for a given period. A lender with a higher charge-off rate historically is likely to see a larger hit in profitability in the event of weak economic conditions, as it usually indicates more relaxed lending standards. On the other hand, lenders that follow strict lending guidelines are expected to see lower loan charge-offs compared to their peers.

The table below summarizes the net charge-off rate for these eight lenders in each of the last twelve quarters. The data has been compiled using figures reported by individual institutions as a part of their quarterly announcements.

Q1’12 Q2’12 Q3’12 Q4’12 Q1’13 Q2’13 Q3’13 Q4’13 Q1’14 Q2’14 Q3’14 Q4’14
Citigroup 5.36% 4.82% 4.63% 4.37% 4.39% 4.24% 3.88% 3.76% 4.06% 4.04% 3.93% 3.78%
U.S. Bancorp 3.75% 3.81% 3.80% 3.67% 3.68% 4.02% 3.62% 3.61% 3.77% 3.78% 3.45% 3.46%
Wells Fargo 4.37% 4.35% 3.68% 3.72% 3.90% 3.90% 3.31% 3.40% 3.52% 3.19% 2.90% 3.00%
Capital One 4.14% 3.13% 3.22% 4.32% 4.45% 4.36% 3.78% 3.98% 4.02% 3.56% 2.88% 3.38%
Bank of America 5.45% 5.08% 4.51% 4.14% 4.12% 4.07% 3.49% 3.23% 3.14% 2.93% 2.75% 2.65%
JPMorgan 4.34% 4.30% 3.59% 3.52% 3.50% 3.30% 2.88% 2.87% 2.88% 2.86% 2.53% 2.69%
Discover 3.07% 2.79% 2.43% 2.31% 2.36% 2.34% 2.05% 2.09% 2.32% 2.33% 2.16% 2.26%
American Express 2.30% 2.20% 1.90% 2.00% 1.90% 2.00% 1.70% 1.60% 1.70% 1.60% 1.50% 1.40%

The trend of steadily falling charge-off rates across lenders over this period is evident from the table. What stands out here is the difference in these rates for Citigroup, which reported card loan charge-offs of 3.8% in Q4 2014, compared to American Express, which reported a figure of just 1.4%. The reason for this is fairly simple, as Citigroup’s geographically diversified credit card business is more prone to loan losses – especially in developing nations. This, coupled with the changes in dollar value of loan write-offs due to currency movements, explains the fluctuations in this figure for Citigroup over recent quarters. However, the steady decline in charge-offs has helped the banking giant set aside lower amount of cash as provisions to cover bad card loans since 2010 – something that is seen clearly in the chart below.

In sharp contrast to Citigroup, American Express’s focus on affluent clients acts as a protection against loan losses. This strategy allows American Express to notch the highest card payment volume among all U.S. card lenders even as its charge-off rates remain the lowest in the industry. The similar, selective nature of Discover’s card lending policy is also to thank for the card-focused financial organization’s low charge-off rates.

Bank of America stands out in the table as the lender to witness the largest improvement in its charge-off rates over the period. From being the lender with the worst card portfolio in the list in Q1 2012, Bank of America has seen this figure slashed by more than 50% over the period. An important reason for this improvement is the bank’s decision to get rid of its international credit card units in late 2011 and to focus on its U.S. operations. The bank’s sale of its MBNA Canada card unit helped it get rid of a large chunk of its poor-performing card loans.

In comparison, Capital One saw its charge-off rates jump in Q4 2012 as a result of its acquisition of HSBC’s card business in the U.S. The banking group warned investors at the time of the deal that its charge-off rates will be notably elevated from historical levels due to HSBC’s more relaxed card lending approach. Besides the steady economic improvement, Capital One’s decision to run-off certain non-core portfolios over 2012-2013 has also helped it reduce loan losses over recent quarters.

The graph below makes it easier to compare the relative changes in these lenders’ charge-off rates from early 2011. Notably, the relative position of the lenders with respect to each other has remained largely unchanged over the years – reinforcing the fact that charge-off rates are primarily dependent on how strict or lax a lender is about its card issuing criteria. We have already detailed why charge-off rates at Bank of America and Capital One have followed a more erratic trend over this period. Also, the fact that U.S. Bancorp’s charge-off rate has not changed much over the last two years leads us to believe that the regional banking player has been relaxing its card lending policies over the period to gain a larger share of the credit card market.

Nearly all lenders saw their card charge-off rates remain around the same level for each quarter of 2014, indicating that the lingering impact of the economic downturn is effectively gone. Given the steady economic growth in the U.S. as well as the positive outlook for the future, we expect card charge-offs to remain around current levels for the foreseeable future. However, it must be noted here that Q4 2014 marked the first time in at least four years when as many as five of the eight card lenders reported a sequential increase in card charge-off rates. While this could very well be a one-time event, it is also possible that the card lenders have begun relaxing their card lending criteria in response to improving market conditions. In case the latter is true, the impact will become evident in the form of gradually rising charge-off rates over subsequent quarters.

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