Another quarter, another dire set of results for US issuers as profits are wiped out by credit losses, government repayments and one-off charges. However, American Express and Capital One are taking opposing views as to where charge-off rates may be headed, as Victoria Conroy reports.
American Express (Amex) and Capital One have posted their latest quarterly results, and neither set makes particularly encouraging reading. Following on from Bank of America, Citi and JPMorgan Chase, Amex and Capital One are finding that rising credit losses and painful one-off charges are erasing any profit gains despite frantic efforts to cut costs, reduce funding costs, shed employees and rein back marketing expenses.
Charge-off rates in particular continue to be problematic for all US issuers, with JPMorgan Chase’s level of charge-offs closely tracking the US unemployment rate (which as of June was 9.5 percent) while those of Bank of America, Citi and American Express surpass it. This is particularly worrying given the historically close correlation between the US unemployment rate and charge-off rates.
Moody’s Investors Service stated that US credit card charge-offs rose to a record high of 10.76 percent in June and may keep climbing higher during the rest of this year and into the next.
With the official US unemployment rate rising to 9.5 percent in June, the highest since 1983, Moody’s said it expected the unemployment rate to reach as high as 10.5 percent in 2010, with charge-offs peaking at 12 percent to 13 percent in the same time period. Clearly, if charge-offs were to reach that level, the scale of credit losses would be disastrous.
The severity of rising charge-offs is being tempered by indications that delinquency rates are dropping from highs recorded in previous quarters, which may give issuers a glimmer of hope that the ‘green shoots’ of economic recovery are sprouting – although it will be roughly two years before issuers can expect to see anything approaching ‘normalised’ earnings even if the economic situation improves.
With crystal balls scarce, many issuers remain wary of giving earnings forecasts and where charge-offs may be headed, but based on their respective delinquency rate indicators, American Express and Capital One have come to very different views about the direction of charge-offs.
Cost-cutting not enough to halt profit drop
Amex’s second-quarter net income dropped 48 percent from the year-ago period to $337 million, with consolidated total revenues net of interest expense falling 18 percent to $6.1 billion, compared to $7.5 billion in the year-ago period. This quarter’s results included $182 million of net re-engineering charges as part of Amex’s drive to cut costs, primarily by reducing staff levels, and a $135 million net gain on the sale of a stake in Industrial and Commercial Bank of China (ICBC).
Provisions for credit losses amounted to $1.6 billion compared to $1.8 billion in the year-ago period, reflecting lower average cardmember receivables and loans and higher charge-offs and past due loans.
The US Card Services segment continues to be hammered by slowing consumer spending and rising credit losses, swinging to a loss of $200 million compared to a net income of $21 million in the year-ago period. Total revenues net of interest expense for the second quarter decreased 22 percent to $2.8 billion, driven by reduced cardmember spending, lower loan balances and lower securitisation income.
US billed business volumes fell 16 percent to $84.1 billion – with consumer and small business volumes falling 16 percent and 17 percent respectively, and total cardmember loans on an owned basis plunged 38 percent to $23.6 billion, while managed loans dropped 17 percent to $54 billion. However, Amex stated that while billed business in the first five months of 2009 was relatively flat, in June and July the year-over-year spending decline appeared to have moderated slightly with transaction numbers only down about 3 percent.
While consumer spending continues to slide in the US as a whole, Amex’s results were impacted by its decision to cut the number of its cards in force by 9 percent (or 2.7 million) to 40.2 million. Amex stated that it had cut inactive cards, defined as being inactive on both spend and balance for 24 months, to reduce its credit exposure, which helped to reduce the average spending decline to 15 percent in the second quarter, compared to 18 percent in the first quarter.
In a conference call, Amex CFO Dan Henry explained: “The concern was if someone was not using your product and then all of a sudden decided to activate after being dormant for 24 months, it could well be that it was driven by the fact that the customer had some credit issues and we wanted to really pull in the lines we had related to those customers because we viewed them as potentially risky.”
Amex continues to trim costs and expenses in line with its previously announced re-engineering initiatives, with consolidated expenses coming in at $4.1 billion, down 16 percent compared to the year-ago period. Marketing and promotion expenses were slashed by 47 percent, while cardmember rewards expenses were cut by 9 percent, reflecting overall rewards-related spending volumes. Salaries and employee expenses fell by 8 percent on the back of Amex eliminating 5,800 employees as part of its restructuring efforts.
It has also bolstered its capital strength, with its Tier One risk-based capital ratio coming in at 9.6 percent, higher than the regulatory benchmark of 4 percent laid down by the Federal Reserve as part of stress tests conducted earlier this year.
Amex hopeful about outlook
In the US, provisions for losses totalled $1.2 billion, a fall of 22 percent compared to the year-ago period. The managed net charge-off rate reached 10 percent in the second quarter, compared to 8.5 percent in the previous quarter and 5.3 percent in the year-ago period. Despite this, Amex said that loss rates were lower than expected and appeared to be stabilising, based on better-than-expected 30-day delinquency rates for the second quarter.
Amex CEO Kenneth Chenault said: “Although it is still too early to point to any sure signs of an economic recovery, the number of cardmembers who are falling behind in their payments, the volume of bankruptcy filings and the level of loan write-offs were better than we had expected. If these trends continue, we expect US lending write-off rates on a managed basis to be below 10 percent for the second half of the year, which is lower than the outlook we offered earlier this year.”
Dan Henry added that if loss rates improved in line with company expectations, Amex would use a significant portion of its provision reserves to selectively increase spending on marketing and promotions to grow its charge card business among other targeted areas such as bank relationships and co-branding efforts.
According to Sanjay Sakhrani, an analyst at Keefe, Bruyette & Woods, Amex is bucking the trend by giving a relatively optimistic outlook in comparison to its peers and expecting charge-offs to decline.
“While this could be viewed as opposing views on the economy and the credit cycle, we believe it’s more about Amex seeing relative improvement because of abatement in seasoning pressures and relatively harsh actions taken on account management over the past year,” Sakhrani told CI.
“Amex has seen much greater degradation in credit quality to date in the cycle and part of this is related to the seasoning implications of loan growth that occurred in the 2005-2007 time period (which take two to three years to season) as well as actions taken late last year and early this year to proactively reduce risk (for example, through line reductions, etc.).”
Revenues at Capital One increased by $418 million but again were wiped out by credit losses and the impact of the US government’s TARP scheme. Capital One’s second-quarter net income came in at $224.2 million compared to $452.9 million in the year-ago period, but taking into account the repayment of $499.7 million related to the US government’s TARP scheme, and a pre-tax charge of $80.5 million to bolster a federal deposit insurance fund, Capital One swung to a net loss of $275.5 million, its third consecutive quarterly loss.
Capital One also released $166.2 million from its reserves to partially offset a $4.5 billion reduction in reported loan balances. According to CFO Gary Perlin, its US cards division accounted for the entire allowance release. Provision for loan losses totalled $934 million, down from $1.27 billion in the previous quarter and $2.09 billion the fourth quarter of 2008.
US card net income was $168 million, compared with $340 million in the year-ago period, with the primary driver being lower provision expenses – the pre-tax allowance release, prompted by a drop in reported loan balances, more than offset rising charge-offs.
The net charge-off rate rose to 9.23 percent compared to 6.26 percent a year ago. As with Amex, the 30-day delinquency rate is declining steadily, from 5.08 percent in the previous quarter to 4.77 percent.
Purchase volumes in the second quarter came in at $23.61 billion compared to $26.73 billion in the year-ago period, and the number of cardholder accounts fell to 33.7 million, compared to 38.41 million in the year-ago period.
Capital One has also trimmed its marketing costs to $133.9 million, compared to $585.8 million in the year-ago period, while staff costs decreased to $633.8 million compared to $1.18 billion in the year-ago period.
However, in stark contrast to Amex, Capital One remains pessimistic about its earnings over the rest of the year, predicting that unemployment levels will continue to be a sore point. Capital One’s management is assuming that the unemployment rate will rise to 10.3 percent by the end of 2009, with charge-offs in its US cards division expected to increase as a result of increased bankruptcy levels.
According to Sakhrani, Capital One’s results suffered because the company did not build sufficient reserves, instead choosing to tap into reserves to offset a decline in on-balance sheet loans.
“We do believe that getting to normalised earnings for Capital One is probably more of a late 2011 or 2012 event,” he told CI.
Funding is easier to find – for now
A bright spot in both sets of results is that Amex and Capital One have made headway in securing funding for lending operations from a variety of sources, principally their deposit-taking operations and lower-cost interbank market funding.
Combined with much-improved capital Tier 1 positions, it would appear that Amex and Capital One may find it easier to navigate through ongoing economic turbulence than their bank-issuing peers.
Amex, which in 2008 transformed into a bank holding company allowing it to take deposits, reported that it expected direct retail deposits to be its primary funding source for the remainder of 2009. Amex also launched a direct deposit-taking programme, ‘Personal Savings’ during the second quarter.
As of 30 June, Amex had $22 billion of excess cash and readily marketable securities on its balance sheet, having accumulated $20.1 billion of funding through customer retail and institutional deposits, a net increase of $2 billion from the first quarter of this year. Amex also gained $11.8 billion through its brokered retail certificate of deposit (CD) programme launched in October 2008, a net increase of $2.5 billion from the first quarter.
Other funding sources include those utilised under the US Federal Government’s Term Asset-Backed Securities Loan Facility (TALF), under which securitised credit and charge card receivables are eligible collateral.
Amex stated that it during 2009 it would be able to issue up to $9.8 billion of securities backed by cardmember loans or receivables eligible under TALF.
Amex is also eligible, under the Fed’s Commercial Paper Financial Facility (CPFF), to have up to $14.7 billion of commercial paper outstanding through the CPFF.
Meanwhile, Capital One reported that its average funding mix, of which deposits comprised 64 percent as of the second quarter of 2009, had also become cheaper – Capital One’s weighted average cost of funds fell to 2.40 percent, compared to 2.76 percent in the previous quarter and 3.52 percent in the fourth quarter of 2008.
Unlike Amex, Capital One has not had to access TALF, and its acquisition of regional bank Chevy Chase increased average deposits by approximately $7 billion, although end of period deposits fell $4 billion due to higher-cost deposits running off in the face of its contracting loan book.