Charge-off rates in the US are approaching
their highest level in nearly three years, according to a new
report from credit ratings agency Moody’s. As Charles
Davis
reports, previous highs came during two economic
slowdowns in 1991 and 2001, and current metrics suggest charge-offs
will increase over the year. 

It’s always darkest before the dawn, and US issuers must be hopeful
that the economy might be touching bottom soon.

Credit card charge-off rates are on track to soon reach historic
highs of about 7 percent of total loans outstanding, according to a
recent Moody’s Investors Service report. The authors of the report,
which relies on Moody’s most recent credit card performance data,
did not speculate on when the historic high might occur, but
indicated that the threshold will be broken inevitably as the
dynamics fuelling the rise in charge-offs show little sign of
reversal any time soon.

The Moody’s report found that the credit card charge-off rate for
May rose to 6.41 percent, a startling increase of 173 basis points
from 4.68 percent a year earlier. The credit card charge-off rate
has reached the 7 percent level twice before, during the last two
economic slow-downs in 1991 and 2001, and all signs point to
similar charge-off rates to come, the report said.

Highest rate in three years

“The charge-off rate is now the highest it has been since December
2005, when charge-offs temporarily spiked due to a change in the
consumer bankruptcy law,” the report said. “The normalisation of
bankruptcy filings and economic headwinds will most certainly
continue to increase charge-off rates throughout the year and,
perhaps, into 2009.”

For February 2008, credit card performance deteriorated in three of
the five metrics tracked by Moody’s, which monitors more than $445
billion of US bank credit card loans backing securities rated by
Moody’s.

Performance of the card sector has historically been correlated to
broad economic factors like unemployment and income fundamentals.
After the 2001 recession, charge-off rates eventually reached 7.05
percent in May 2003. As in the 2001 recession, the rising trend in
charge-off rates following the 1991 recession significantly lagged
(by more than a year) the official periods of business-cycle
contraction. If the current economy significantly slows or
contracts, charge-off rates may not peak until sometime in
2009.

The delinquency rate, which can be an early indicator of future
charge-off rates, is also on the rise. Credit card delinquencies –
the proportion of account balances in which a monthly payment is
more than 30 days late – increased by 79 basis points, to 4.47
percent from 3.68 percent in May 2007.

Interestingly though, the early-stage delinquency rate (card
balances less than 30 days past due) has been relatively stable for
the past six months; however, the late-stage delinquency rate (card
balances 90 days or more past due) continues to rise. This apparent
dichotomy between the trends in early- and late-stage delinquencies
may be indicative of an ever more challenging collection
environment.

Other performance metrics remain relatively strong. Although the
payment rate has weakened somewhat in recent months, it remains, on
average, within the historically high range of 18 to 20
percent.

This rate typically rises in March due to tax refunds, and it may
rise again when, starting in May, the federal government mailed its
economic stimulus payments to more than 130 million
households.

Also, despite the significant drop in interest rates, the average
yield on credit cards through February has been
stable-to-improving.

“This positive trend is perhaps reflective of the discretion that
many card issuers have in the rates they charge cardholders,” the
report said. “Risk-based re-pricing and the presumed increase in
late fees collected on the increasing proportion of delinquent
borrowers have also bolstered the yield.”

Growth in financial obligations slowed again in the fourth quarter,
although it remains modestly above the pace of the first half of
the year. Growth in debt payments is very low by historic
standards. In fact, year-on-year growth was the slowest since the
start of 2004, although quarterly growth remained modestly above
the levels seen in the first half of last year.

Weakening economic environment

With creeping rises in joblessness and falling house prices, US
consumers have increasingly turned to credit cards to finance
consumption.

Moody’s highlighted figures from the US Federal Reserve for the
month of February, when total consumer credit rose by $5.2 billion
to $2.539 trillion, or an increase of 2.5 percent at an annualised
rate. February’s annualised pace of 2.5 percent stands well behind
the average pace of 5.8 percent in 2007. Moody’s said that increase
in total consumer credit was driven solely by revolving credit. In
February, revolving credit, largely credit cards, increased $4.7
billion or roughly 6 percent at an annualised rate

Overall, the report found that US household finances are eroding
fast, a result of rising debt and falling home prices, and
consumers are increasingly turning to their credit cards as a
short-term fix. Consumers are behind schedule in payments or have
walked away from nearly $800 billion in household debt of all
types, including credit cards, mortgages and car loans, said Mark
Zandi, Moody’s Economy.com’s chief economist.

Credit tightening increases pressure

Complicating matters is the fact that due to the inescapable
tightening of credit standards, it’s now far more difficult for
many consumers to find a way out of debt, since other options, such
as home equity lines of credit, aren’t as readily available and
it’s not as easy to refinance a home or take out a loan with a
lower interest rate than it was even a few months ago. The report
said that there is evidence that the overall tightening of credit
is spreading to credit cards, too, potentially reducing the
availability of new credit and already starting to lower credit
limits – moves that could slow consumer spending and overall
economic growth.

Another report from Fitch Ratings echoes Moody’s findings,
concluding that issuers in the coming months are likely to suffer
greater losses than first expected.

“The degree of deterioration will be dependent upon the duration
and severity of an economic downturn and an issuer’s ability to
manage portfolio growth, control exposure to unused credit lines
and collect delinquent accounts,” Fitch said.