It looks as if the subprime contagion is
spreading into consumer credit, with the major US issuers all
sounding warning bells for their earnings outlooks for 2008. What,
if anything, can issuers do to avoid the ramifications of a
weakening US economy? Victoria Conroy reports.

The US card industry’s big hitters – American
Express, Capital One, Bank of America, JPMorgan Chase and Citi –
have all recently reported that their earnings are likely to take a
huge hit in 2008 due to higher levels of card charge-offs, consumer
delinquencies and slower economic growth. Fourth-quarter results
were down across the board, and issuers will now be wondering how
best to stave off the effects of a possible recession in the

Amex is not insulated

Perhaps the most surprising results were posted by Amex, which many
industry commentators had pointed to as being somewhat more
insulated from the fall-out of the subprime crisis due to its more
affluent cardmember base and prime card portfolios.

Amex reported on 10 January that it is seeing
signs of a weaker US economy, as cardmember spending began to slow
and delinquencies and loan write-offs trended upward during
December. Its fourth quarter income from continuing operations was
down 6 percent from the year-ago period to $839 million, while net
income dropped 10 percent to $831 million. The fourth quarter
results included a previously announced $438 million ($274 million
after-tax) credit-related charge in the US Card Services Segment,
reflecting the impact of the weakening economy during the latter
part of the fourth quarter. US Card Services reported fourth
quarter net income of $7 million, down from $473 million a year

Amex reported overall growth in worldwide
cardmember spending of 16 percent for the fourth quarter (13
percent on a foreign exchange adjusted basis). The growth rate,
however, trailed off to 13 percent in December with particular
weakness in US billings, which rose only 9 percent.

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Amex also reported that delinquencies in the
managed US lending portfolio increased to approximately 3.2 percent
in the fourth quarter of 2007, from 2.9 percent in the third
quarter, and that the write-off rate in this portfolio increased to
approximately 4.3 percent from 3.7 percent for the same periods.
Amex chairman and CEO Kenneth Chenault said that negative credit
trends were most apparent in California, Florida and other parts of
the US most affected by the housing downturn. Total provisions for
losses and benefits increased 70 percent compared with last year,
with lending provision increasing by 100 percent. Amex said that
the increase in the lending provision reflected the credit-related
charge, higher loan volumes and increased past-due and write-off
rates in the US portfolio.

Looking ahead to 2008, Amex said: “The company’s
2008 business plan currently assumes worldwide billed business
growth of approximately 8 to 10 percent for the full year. While
such growth would be higher than industry-wide levels during the
recent strong economy, it will still represent a decline from the
levels American Express has been generating in recent years. The
2008 business plan also assumes write-off levels in the managed US
lending portfolio will average 5.1 to 5.3 percent for the full

In a conference call with investors and analysts,
Dan Henry, executive vice-president and chief financial officer,
rebuffed concerns that Amex’s strong loan growth in such a short
space of time is a red flag for higher rates of delinquencies later
in the year. “On a managed basis, balances grew 22 percent on 23
percent growth in the US and a 15 percent increase in our non-US
portfolios,” he said. “In the US, some of this growth is also
related to a slowdown in payment rates, which we believe is
consistent with the weaker economic environment. While we know that
some have questioned the logic of such strong loan growth in this
environment, we are confident in the attractive underlying
economics of this business growth through the cycle.”

Amex insists it will fare better in a tougher
economic climate than its issuing rivals, with the company at pains
to emphasise that its business models are flexible and leave the
company well-positioned in a tougher economic climate. “We are less
weighted toward the travel and entertainment [T&E] sector and
have a larger presence in everyday categories where consumers don’t
typically reduce their spending during economic downturns to the
same extent as they do in T&E spending. Additionally, our focus
on the prime and affluent sectors should help us weather the
current conditions better than many competitors, although clearly
we are not immune from further deterioration in the overall economy
and credit environment,” said Chenault.

Sharp earnings fall at Capital One

Also adding to the bearish outlook for the US economy was Capital
One, which reported that its fourth-quarter earnings fell a
dramatic 42 percent due to rising credit card losses and charges
related to a shutdown of its subprime mortgage unit. Fourth-quarter
net income fell to $226.6 million from $390.7 million in the
year-earlier period. Capital One had previously announced its
fourth-quarter results would be dominated by a significantly higher
provision expense (around $1.92 billion) and a $92 million
litigation charge, both more than industry analysts had

Charge-offs rose in the fourth quarter of 2007 to
5.40 percent from 3.82 percent in the fourth quarter of 2006, and
delinquencies rose to 4.95 percent from 3.74 percent, resulting,
according to Capital One, from “continued normalisation of consumer
credit, pull-back from the prime revolver market throughout the
year, impacts of US Card’s pricing and fee policy changes made in
the second and third quarters, and economic weakening evidenced in
recently released economic indicators. The company expects the US
Card managed charge-off rate to be in the mid-6 percent range in
the first half of 2008.”

Capital One said it would apply lessons from
prior economic cyclical challenges to inform current actions,
including maintaining low lines and targeted product structures for
riskier parts of the credit spectrum; pulling back on growth with
prudent underwriting and marketing; ramping up collections
intensity early in cycle; and increasing process and operating
efficiency efforts.

Citi’s results reflect consumer stress

Citigroup posted a net loss of $9.83 billion in the fourth quarter
of 2007, with revenue falling 70 percent to $7.22 billion. Its
financial results were notable for highlighting the growing stress
on US consumers. Citigroup’s results, the first under new CEO
Vikram Pandit, were driven by $18 billion in write-downs and credit
costs in its fixed-income trading business, but Citi also suffered
a $5.41 billion increase in credit costs, with the bulk ($3.85
billion) set aside against credit deterioration in its US consumer
business. Similarly to Amex, Citi pointed out that credit card
weakness was most pronounced in the states where the housing slump
has hit the hardest, such as Arizona, California, Florida, Illinois
and Michigan.

Revenue in Citi’s US consumer business rose 6
percent in the fourth quarter, driven by higher business volumes
with average deposits and managed loans both up 10 percent, but
higher credit costs resulted in a net loss of $432 million compared
with net profit of $2.1 billion a year earlier.

Bank of America profits plummet

Bank of America is also feeling the first falterings of the
weakening US economy. It reported that fourth quarter profit
tumbled 95 percent, with more than $7 billion of losses tied to
poor trading decisions and mounting credit woes. Net income fell to
$268 million from $5.26 billion in the year-ago period. Bank of
America also set aside $1.74 billion for credit losses, including a
$1.33 billion addition to reserves.

Bank of America’s Card Services division managed
net revenue grew 4 percent to $25.53 billion due to growth in cash
advance fees and interchange income, while at $3.71 billion net
income was down 35 percent as credit costs rose. Card Services
average loans grew 10 percent over 2006, led by the US Consumer and
Business Card, Unsecured Lending and International units. In Card
Services, Bank of America added 3.3 million new accounts, helped by
a lower cost delivery strategy driving increased sales, with sales
through the bank’s Banking Centers increasing 8 percent from the
year-ago period. However, the managed consumer credit card net loss
rate increased to 4.75 percent as expected from 4.67 percent in the
third quarter of 2007. Thirty-day delinquencies increased to 5.45
percent from 5.24 percent in the year-ago period, while 90-day
delinquencies increased to 2.66 percent from 2.48 percent in the
year-ago period.

What was interesting to note in relation to Bank
of America’s credit card outstandings was that for 2007, managed
credit card outstandings for the period end of 2007 jumped to $183
billion, compared to $170 billion in 2006. In the second quarter of
2007, credit card outstandings stood at the $167 billion mark in
line with the previous quarter, but from the third quarter onwards,
outstandings have risen significantly. This indicates that Bank of
America credit card customers are putting more debt onto their
cards while reducing repayment amounts at the same time, a common
warning flag for increasing consumer indebtedness, and in tandem
with an increasing array of economic bad news from mid-2007 when
the credit crunch first took hold.

US Card Issuers Results

JPMorgan increases loss loan provision

JPMorgan Chase reported its quarterly profit fell 24 percent as the
bank lost $1.3 billion on subprime mortgages and set aside more
money for rising losses on home equity loans, resulting in it
setting aside $1.1 billion in loan loss provision. Credit card
spending also slowed in December, with CEO Jamie Dimon saying that
a worsening US economy would push consumer credit losses beyond
current levels. Net income at the bank’s credit card services unit
fell 15 percent to $609 million on a higher loss rate.

Revolving consumer credit jumps

The US Federal Reserve released its latest statistical update on
consumer credit levels on 10 January, revealing that total
revolving consumer credit had jumped from 8.5 percent in October
2007 to over 11 percent on an annual basis in November. This
indicates that consumers are turning to their credit cards in order
to pay everyday bills.

The strains on the US economy were not helped by
a surprising 0.4 percent fall in retail sales during the Christmas
holidays, indicating that consumers are already feeling the pinch
in addition to higher energy prices. At a time when consumers
typically spend more, the fact that people are reining in their
spending to such a degree could prove ominous for card issuers and
the wider economy.

On 22 January, the US Federal Reserve responded
to sustained falls in global stock markets by announcing an
emergency 75 basis point reduction in its base interest rate, the
largest single reduction since 1982. This was followed on 30
January by another reduction of 50 basis points.

Aside from lowering its federal funds rate, the
Fed also lowered the discount rate, or interbank borrowing rate, to
4 percent, which may help financial institutions that will be able
to borrow money cheaply on short-term rates and lend at higher
long-term rates. It remains to be seen whether the rate cuts will
be passed on to borrowers in the form of lower mortgage or credit
card interest rates. Issuers have to balance the effects of
lowering interest rates and reducing interest income against
keeping their rates as they are and risking greater levels of
delinquencies and charge-offs.

Gary Crittenden, the chief financial officer of
Citi, and formerly of Amex, told analysts during an investor
briefing following Citi’s results that Citi was raising rates on
credit cards and tightening the amount of credit it would extend.
Asked by an analyst whether credit card lending was an area where
Citi might want to pull back or increase pricing, he responded:
“All of the above.”

When announcing its rate cuts, the Fed said that
“incoming information indicates a deepening of the housing
contraction as well as some softening in labour markets”. So the
outlook for the US economy looks gloomy indeed, and issuers may
have to do some intensive re-evaluations of their business models
if they are to navigate the storm successfully. 

US Consumer Credit Outlook