Are Credit Card Losses Finally About to Swell?

Here's Discover Financial Services Chief Executive Officer David Nelms in July 2012: "Credit performance continues to be exceptional, but we continue to expect that we must be at, or near, the bottom."

And here he is in an interview Wednesday, again addressing credit losses: "At some point, we do think the next moves will be in the upward direction. It just can't get any lower than it is today."

For more than two years, executives in the credit card industry have been predicting that their losses will rise, as more customers begin to fall behind on their payments. They keep being proven wrong. In the most recent industry-wide report from the American Bankers Association, 30-day delinquencies on bank-issued credit cards fell for the second straight quarter, and sat just a hair above their postcrisis low.

"It's like the boy that cried wolf. After a while, you don't believe it until it actually happens," said Mike Taiano, an analyst at Burke & Quick Partners.

In the fable, of course, the wolf eventually arrives. And surely the metaphorical wolf will someday show up at the doorstep of the credit card industry. But today signals are mixed about how soon that will happen.

On one hand, credit card loans are finally growing again after several years of stagnation. Revolving consumer credit grew at a seasonally adjusted annual rate of 6.3% in the second quarter, according to the Federal Reserve, a sharp uptick from 1% in the same period a year earlier. That is likely the result of both loosening credit standards and a stronger appetite by U.S. consumers to take on new debt after years of cleaning up their household balance sheets.

Loan growth should eventually result in higher losses for the card issuers, and those projections are now being baked into projections of companies' future earnings. The uptick in losses may arrive sooner at those card issuers that have been increasing their lending faster than the industry average.

On Wednesday, Discover announced that its third-quarter provision for loan losses was 17% higher than during the same period a year earlier. The company explained that some of its larger recent vintages of card loans are now moving into the stage in which their losses will be higher. And Nelms pointed out that low loss rates are not the company's main goal.

"You don't necessarily maximize your profits by having your chargeoffs too low, and not growing, and not booking new loans," he said.

Earlier this month Capital One Financial also announced a 17% boost in its loss provision, and said that it expects to keep building that buffer in coming quarters. The firm pointed to the effects of loan growth as a key factor.

"While the impact on the chargeoff rate will be modest at first, we expect that the impact will grow throughout 2015 and beyond," Capital One Chief Executive Officer Richard Fairbank told analysts during an Oct. 16 conference call.

Also in the third quarter, American Express boosted its loss provisions by 16% compared with the same period a year earlier. The firm's chief financial officer, Jeff Campbell, told analysts on Oct. 15 that writeoff rates will eventually increase from their current low level.

But there are other reasons to think that across the entire industry, losses may remain low for some time.

Historically, unemployment has been one of the leading indicators of credit card chargeoffs. The four-week moving average of initial jobless claims is currently at its lowest level in 14 years.

"They're continuing to trend down, and that's certainly helped," Taiano said.

There's also the fact that crisis-era reforms have altered the structure of the credit card industry. Issuers no longer have the ability to reprice existing debt, which has curbed the flow of credit to consumers with low credit scores.

In the second quarter of 2014, card loans originated to people with credit scores of below 620 were less than half their volume seven years earlier, according to data from Moody's Analytics and Equifax. In the last two years, those subprime loans have started to rebound, but only slowly.

And while Capital One and Discover have issued warnings that their credit losses will begin to rise, some of their competitors have a sunnier outlook.

Citigroup Chief Financial Officer John Gerspach spoke in an Oct. 14 conference call about the opportunity for improvements in credit performance in Citi's card businesses. "You might still see some reserve releases in the near quarters," he said.

Industry analysts said that overall, the credit outlook in the card industry still looks benign.

"It doesn't look like there are any signs as of today that the credit cycle is turning," Taiano said.

Mustafa Akcay, an economist at Moody's Analytics, noted that the growth rate in credit card borrowing is lower than it was before the recession. He acknowledged that loan standards have started to ease, but said that is in response to what has been a tight lending environment.

"I'm not expecting credit card losses to be a huge problem in the next several years," Akcay said.

For now, industry executives are largely repeating the same lines they have been using for quite some time.

"It's hard to imagine, as an industry, losses getting much better than this," Capital One's Fairbank told analysts on Oct. 16.

Then he added, "I've been wrong before on that."