The latest on credit card losses

[HognotinMemphis]

From today's WSJ:

Credit Card Losses May Scale New Peak

By DAVID REILLY

This financial crisis has shown that history is an unreliable guide for gauging future losses.

Banks relying on historical models were fooled when it came to potential mortgage hits. They similarly miscalculated with structured debt products.

Now, the same may hold true for credit cards. Banks and big card issuers have seen card losses climb and are projecting that things will worsen in 2009.

But their expectations, largely grounded in the experience of past downturns, might not be dour enough. Losses could easily overtake historic peaks, possibly spelling additional woe for the likes of Citigroup, J.P. Morgan Chase, Bank of America, American Express and Capital One.

A big reason: credit-card usage has changed so dramatically, even since the last downturn. A broader range of consumers now carry cards, and many run consistent credit balances to fund their lifestyles. This has led to successively higher peaks over the years in credit card charge-off rates.

The danger is that the current financial downturn results in a new, far-higher peak charge-off rate that leads to unexpectedly large losses at banks and other card issuers.

During the 1980s, charge-off rates averaged about 2.6%, according to Federal Deposit Insurance Corp. data. In the early 1990s recession, those rates peaked at 4.98%. Charge-offs rose to 5.39% in the late 1990s and then hit their most recent peak of 7.69% in the first quarter of 2002.

At the end of June, net charge-offs had risen to 5.52%, FDIC data show. Third-quarter data have yet to be released, but will undoubtedly be worse based on numbers already being reported by banks and card firms.

American Express said on its earnings call Monday that its loss rate had increased to 6.1% in September, compared with 5.9% for the quarter overall, and that it expected losses to grow to the end of the year. J.P. Morgan, meanwhile, forecast that its credit card loss rate could climb to 7% by the end of 2009, compared with about 5% in the third quarter.

And given that unemployment has only recently started to spike, the worst days may be still to come for charge-off rates. "Now we're at the point in the credit cycle where people really lose their jobs, and that's where you lose accounts so quickly," said Zach Gast, a financial analyst at RiskMetrics Group.

At the same time, funding is becoming more expensive for card issuers. That will only add to the pressure they are sure to feel as losses mount. Investors shouldn't be surprised if credit cards prove to be yet another underestimated threat.

Write to David Reilly at david.reilly@wsj.com

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I've been telling you about this. It's coming. Credit card loan losses are going to explode very soon and will be record-setting by a mile.