Since charge-offs typically lag unemployment changes, the first-quarter numbers may add up to big trouble for credit-card issuers
The jump in likely credit-card loan losses at Capital One Financial (COF) suggests that other major consumer lenders may be facing similar losses for the first quarter. On Apr. 15, the issuer of MasterCard and Visa credit cards reported a one-month spike of 1.27% in net charge-offs for U.S. cardholders, to 9.33%, in March, surpassing the increase in unemployment by a widening margin.
The unemployment rate rose to 8.5% in March, from 8.1% in February. Historically, the bad debt rate on credit cards has lagged unemployment, but deteriorating economic conditions have spurred growing concern that the rate would start to outpace climbing unemployment, which seems to be occurring now, according to Michael Taiano, an analyst at Sandler O'Neill & Partners in New York.
It's a much bigger concern, considering that some economists think unemployment might rise to 10%. "That would be mean a bigger drag on [issuers'] earnings in those quarters where that happens," says Taiano, who has a hold rating on Capital One's shares.
There are a few reasons for the spike in Capital One's charge-offs. First, fewer days in February meant that some of that month's charge-offs were recognized in March. When adjusted for this, the loss rates in February and March become 8.38% and 9.0%, respectively. "Still, a 60-plus basis-point increase in one month is a lot," says Taiano.
Loss Rates Climb For All Issuers
Another factor is the impact of Capital One having to adopt the minimum payment rule after it came under the regulatory oversight of the Office of Currency Comptroller about a year ago. That requires credit-card holders to make higher minimum monthly payments on their balances. Taiano expects the shift to boost Capital One's losses by 50 basis points in 2009 and says it could result in a slightly higher charge-off rate than its competitors suffer. The bright side, however, is that the company has already increased its reserves for this, so the adjustment should already be reflected in earnings. Capital One is scheduled to report first-quarter results on Apr. 21.
Loss rates for all credit-card issuers are climbing as their total loan portfolios—the denominator in the loss rate equation—shrink due to dramatically reduced originations of new loans and stricter underwriting standards.
Some analysts, including Taiano, say net charge-offs don't offer the most accurate picture of Capital One's credit-card losses. A more accurate picture, they say, can be found in the master trust data the company files each month with the Securities & Exchange Commission. Master trust numbers reflect pure credit-card losses, says Taiano, while the managed numbers include about $15 billion in closed-end personal loans—debt unsecured by collateral, much like credit cards, but not provided as a revolving line of credit to borrowers.
The master trust numbers show a rise in credit-card losses to 7.96% in March, from 6.89% in February, which means Capital One's losses are still lagging the unemployment rate.
But analyst Robert Napoli at Piper Jaffray in Chicago found even the master trust data disappointing and notes that the company is making less money on its loan portfolio (measured by a weaker portfolio yield) because of the higher charge-offs. "The drop in yield is concerning, especially since we understand Capital One, along with other credit-card issuers, has been increasing rates and fees," he wrote in an Apr. 15 note. "Discover (DFS) and JPMorgan Chase (JPM) card trusts had stable yield and less of an increase in credit losses."
While the month-to-month hike was higher for Capital One, the credit loss rate went up for all issuers between February and March, says Taiano.