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 for the lenders from the highs they 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 free up some of their loan loss reserves over 2012-2013.
In this article, which is a part of our ongoing series detailing the country's largest card lenders - JPMorgan Chase ( JPM ), Bank of America ( BAC ), Citigroup ( C ), U.S. Bancorp ( USB ), Wells Fargo ( WFC ), American Express (AXP), Discover (DFS) and Capital One (COF) - we discuss the trend in their credit card charge-off rates over the last eleven quarters and also detail what to expect in the near future.
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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 eleven quarters. The data has been compiled using figures reported by individual institutions as a part of their quarterly announcements.
Bank of America
The 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 almost 4% in Q3 2014, compared to American Express, which reported a figure of just 1.5%. 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 up 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.
Diversified banking giant 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 cut in half 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 direct 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 have seen their card charge-off rates level off over the first three quarters of the year, 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.
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