Like the rest of the financial services sector, shares in credit card lenders have staged a spectacular rally since their March nadirs as investors look ahead to a decisive turn in the credit cycle and the ultimate bounty: releases of massive loan-loss reserves.
A number of forecasters have predicted that the industrywide chargeoff rate will peak in the middle of this year or sooner. But it is likely to be a bumpy ride with nearly universal expectations that unemployment will remain painfully high for a long time, uncertainty introduced by aggressive loan forbearance tactics, the possibility of additional shocks from further action by Washington, and a shrinking denominator. (Growth in receivables, conversely, typically suppresses chargeoff percentages, since it usually takes time for new accounts to sour.)
After hitting 11.49% in August — an all-time high — the chargeoff rate ranged between 10.04% and 10.72% in the subsequent four months, according to an index maintained by Moody's Investors Service Inc.
But delinquency rates traced their typical seasonal climb in the second half, ultimately setting chargeoffs up to follow. It typically takes several months for a lender to deem an overdue balance uncollectible. (Monthly performance data released Tuesday by large issuers showed that the pace of chargeoffs generally increased from the month prior in January, while delinquencies slowed a bit.)
Initial jobless claims, a powerful leading economic barometer, indicated that the industry would turn out of a nosedive in credit performance, even if it has not been a clean break. They peaked at 674,000 in March, but had trended down to an estimated 473,000 as of the most recent report, for the week that ended Feb. 13.
It is largely the loss of yet another job — and the financial wherewithal of another borrower to sustain monthly payments — that drives loan losses. But the persistence of unemployment is part of the equation — borrowers can stay afloat until they burn through savings, for example, or lean on credit card lines before defaulting on larger balances.
A rule of thumb is that a 1-percentage-point increase in the unemployment rate is roughly matched by a 1-percentage-point increase in the chargeoff rate. But increases in the chargeoff rate outstripped increases in the unemployment rate as the downturn set in and household financial woes multiplied. (See graphic below.)
Analysts have also cited unique factors during the current slump, including a lack of personal savings and, frequently, an inability to turn to borrowings against home equity. Some have speculated that card loss rates could freewheel if unemployment continued to surge.
Still, some in the industry have held that chargeoff rates can subside amid elevated levels of unemployment as bad accounts are written off and wash out of the system. Analysts have also argued that the chargeoff rate could peak before the unemployment rate, because some increases in the latter measure could be rooted in additional job seekers being drawn into the work force by a strengthening economy, as opposed to net job losses and increases in the number of cardholders finding themselves without a paycheck.
After the recession at the beginning of the 1990s, the chargeoff rate peaked at 6.4% in June 1992, according to the Moody's index, the same month that unemployment peaked at 7.8%.
Excluding a spike at the end of 2005 associated with a change in bankruptcy law, the chargeoff rate hit a high of 7.1% twice in the first half of this decade, in March 2002 and May 2003, while unemployment peaked at 6.3% in July 2003.