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

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

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.

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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

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

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

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

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

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

“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.).”

Capital One

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

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

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

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

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.