Bucking convention, credit card lending is holding up better than expected, given the delinquencies plaguing other consumer products, such as mortgages and home equity lines.
Credit cards typically have served as the bellwether for deteriorating consumer credit, but analysts say the abnormal pattern is being driven by stronger bankruptcy laws, low unemployment, and tougher underwriting standards.
Delinquency and chargeoff rates for credit cards remain below historical averages and have yet to return to their levels before October 2005, when Congress passed legislation making it more difficult for borrowers to wipe out debt through bankruptcy.
The performance contrasts with the turmoil roiling the residential mortgage market, where foreclosure rates nearly doubled last month from a year earlier and a lingering liquidity crisis has sent dozens of originators into bankruptcy.
How long can the good news for issuers last?
"All the leading indicators point toward favorable conditions … with no significant deterioration," said Sanjay Sakhrani, an analyst at KBW Inc.'s Keefe, Bruyette & Woods Inc. "But the big question right now is whether the ongoing issues in the mortgage industry will eventually spill over into credit cards."
Not everything is rosy within the card business.
Credit quality clearly has worsened from a year earlier. Asset-backed securities, though still finding investors, are being sold in the secondary market at wider spreads, delivering thinner profits to the issuers.
Scott Valentin, an analyst at Friedman, Billings, Ramsey & Co. Inc., said in an interview last week that he is watching the third-quarter trends to see how asset quality within credit cards holds up.
"Will mortgage issues put more pressure on the consumer? Psychologically, that's also a negative," he said. "And you can't discount a liquidity crunch, but hopefully that will pass before credit quality significantly worsens" in the card market.
Asset quality through July remained solid, though credit metrics have climbed noticeably from last year, according to data from Fitch Inc. The July chargeoff rate for prime credit cards, for instance, rose 108 basis points from a year earlier, to 4.52%, though it remains well below the industry's 6% historical average. For subprime cards, the rate rose 45 basis points, to 8.85%, versus the historical average of 10%.
Cynthia Ullrich, a senior director in Fitch's asset-backed securities group, said in an interview Thursday that delinquencies for prime cards (which rose 21 basis points, to 2.51%) and subprime cards (which fell 29 basis points, to 4.66%) remain below their levels before bankruptcy reform.
James Chessen, the chief economist for the American Bankers Association, also cited bankruptcy reform and said typically 30% to 50% of chargeoffs can be attributed to bankruptcy filings.
Mr. Sakhrani also gave card companies credit for disciplined underwriting standards.
"Mortgage lenders changed their focus away from borrowers over to collateral," he said. "That obviously didn't happen with cards."
Banking companies contacted for this story cited comments made by executives during second-quarter earnings calls. The general message: Asset quality is slowly worsening, though not at a rate that threatens overall profitability.
Kerry Killinger, the chairman and chief executive of Washington Mutual Inc., pointed squarely to the economy — specifically to relatively low unemployment — during the Seattle company's second-quarter call last month.
"The principal driver of losses … is people's jobs," he said. "So with the unemployment rate relatively low … it's not surprising that credit card receivables would continue to perform quite well."
Mr. Valentin echoed those comments and predicted the unemployment rate would remain below 5% at least through the rest of the year.
"The key thing that I would keep an eye on are signs of an impending recession," he said.
Mr. Chessen also said the housing slump is making it harder for homeowners to get home equity loans, so they are using their credit cards more. "Those borrowers who make the shift could expose the credit card issuers to even more risk," he said.
Second-quarter revolving credit grew 1.8% from the first quarter and 7% from a year earlier, according to Federal Reserve Board data. Such data led several banking companies to increase their reserves for potential losses in their card portfolios.
Citigroup Inc. added $242 million of reserves during the second quarter directly as a result of its card operations, though Gary Crittenden, its chief financial officer said on the earnings call that "underlying credit metrics have remained largely stable."
Wamu, which entered the card business by acquiring Providian Financial Corp. in 2005, increased its card-related provision by 116% from a quarter earlier, to $229 million. The company said during its second-quarter call that a 4% increase in balance-sheet receivables, in addition to forecasts of future deterioration, led to the increase.
Analysts are also watching what bankers are doing to maintain profit levels in their card operations as credit quality metrics continue to slip.
James Dimon, the president and CEO of JPMorgan Chase & Co., said last month that the New York company is focusing less on teaser rates and balance transfers and relying more on transactional balances.
"That is affecting outstandings, which we would expect very slow growth in," he said during his company's earnings call last month. "But we don't expect to change profits that much, because some of that stuff wasn't as profitable. … People using their card to buy things is up 9% or 10%, and we hope that will continue."
Michael Rowan, a managing vice president of investor relations at Capital One Financial Corp., said the McLean, Va., company had stopped courting prime cardholders to focus on subprime ones.
"We have this love/hate relationship with the prime market," he said during an Aug. 14 presentation at a KBW conference in Kohler, Wis. Using 0% teaser rates "is bankrupt from a branding standpoint."
The shift is reducing Capital One's outstandings, which in turn likely will push its chargeoff rate to 5% by yearend, compared with 4.25% in the second quarter, Mr. Rowan said.
Mr. Sakhrani said bankers' moves may impact securitization activity. He noted that spreads on securities backed by card receivables have widened 15 to 20 basis points in recent weeks.
"They are as wide as they have been in the past three or four years, but they are by no means where they were during the last recession," he said.
Ms. Ullrich said that pricing may be under pressure, but securities volume is strong. Through July there have been more than 90 issuances this year worth $56 billion, and full-year volume could meet last year's total of about $70 billion, she said.
"We haven't seen a tremendous slowdown," she said. "There is a wide investor base for these securities."
But that receptiveness could be another thing to watch when companies report third-quarter earnings in October.
"From what I'm hearing, it is getting harder for anybody to sell credit cards in the secondary market at a reasonable price," Mr. Chessen said. "So the cost of funding is going up … though that could mean that the cost to consumers is also likely to go up among all risk levels."
Mr. Sakhrani said pricing "is causing some lenders to assess whether they want to wait it out or use alternative sources." Nevertheless, "deals are still getting done.
"Future appetite really depends on market perception and how bad credit gets."
