Now is a good time to offer credit to Americans. Economic growth is solid, unemployment is low and wallets are open.
In July, retail sales rose 6% from a year earlier, faster than analysts had expected. The prosperity extends even to lackluster brick-and-mortar stores: Macy’s, the struggling department store chain, reported its third consecutive quarter of sales growth last week after several years of decline. walmart, the major discount retailer, recorded its best quarterly sales growth in 10 years. On the other end of the price spectrum, Nordstrom, the high-end department store chain, reported a surge in sales that pushed its stock up 13%.
The spending doesn’t seem particularly reckless either. When, at the beginning of last year, household debt exceeded its last peak in 2008, many experts speculated on the possibility of a new financial crisis. But US household debt – all $13.3 trillion, according to to the New York Fed – is much weaker, compared to the two GDP and disposable Incomethan it was before 2008.
The major card-issuing banks are satisfied. During second quarter calls with analysts, JP Morgan highlighted that consumer purchases using their cards increased by 11%; Bank of AmericaGrowth in purchases of was almost as high. Citigroup and Capital one pointed out that loan balances were growing nicely.
If card trading is a picnic, however, it is a late-summer picnic; the watermelon has already been served and the sky is showing the first signs of darkening. Card issuers recognize that as American consumers have regained their mojo, the competition for their business has become very competitive. Savvy Millennials are shuffling cards to maximize rewards and introductory interest rates. Big spenders with good credit scores are the prize in a “rewards war”.
At the same time, the current economic expansion, at the grand age of nine years, is the second longest on record. This gives no particular reason to think that it is coming to an end. But trees do not grow towards the sky.
Quarterly cancellation of bad debts on credit cards in 2018
The competitive heat and cycle length are felt in industry-wide data. The credit quality metric, while not flashing orange, is definitely going in the wrong direction.
Quarterly write-offs of credit card bad debt at U.S. banks peaked at nearly $19 billion in the first quarter of 2010 and bottomed out at less than $5 billion in 2015, according to the FDIC. Since then, they have fallen by more than $8 billion.
The delinquency rate of credit card holders, although still at a low level, has also increased since 2015. Bankers dismiss these trends as the natural “seasoning” of credit card loan portfolios that have been rebuilt since the recovery. But the numbers show it’s getting harder and harder to sell cards to quality customers.
Last month, the Federal Reserve Board of Governors released its annual report report the profitability of credit card banks. It showed declining return on assets in 2017, for the fourth consecutive year. At 3.4%, it is a third lower than it was in 2013. The Fed noted that a moderate increase in loss provisions was reducing profits. More importantly, non-interest revenue — which is made up of both merchant payments and annual fees and penalty fees charged to cardholders — is down.
This is partly due to large merchants making it harder to do business with banks and lowering fees. Costco, the major discount retailer, moved its branded cards from American Express at Citi last year, for example.
“Banks are giving traders more,” said Barclays analyst Jason Goldberg.
Generous rewards offers for new customers, which are recognized in revenue when the customer logs in, also contribute to the compression of fee revenue.
Finally, the squeeze on non-interest revenue is a long-term effect of the Credit Card Accountability Responsibility and Disclosure (CARD) Act of 2009, a law that prohibited many punitive charges and limited the ability to raise clients.
“Issuers have lost their ability to dynamically revalue and their ability to generate fee income,” said Brian Riley of Mercator Advisory Group.
The squeeze on fees and margins is even visible in the accounts of large banks with strong card portfolios: in JPMorgan Chase’s card business, for example, non-interest revenue fell $1.8 billion, to $4 billion, between 2013 and 2017, even as wallet card lending has grown. At the same time, Chase’s “net income rate” – all fee and interest income as a proportion of card loans – has tightened. A similar pattern of fixed or falling fees and margin compression is visible at Citi and Bank of America.
As spreads compress and credit measures ease, it becomes more difficult for banks to keep promises – made frequently in the wake of the financial crisis – to run disciplined businesses, even if it means accepting slower growth. If the industry starts chasing profit at the lower end of the credit spectrum, another crisis would become a matter of time.
There are signs that the banks are pulling back: Growth in the number of open card accounts has slowed to sub-single digits in recent quarters, according to the Federal Reserve. The Fed Loan Officer survey also shows that more big banks are tightening standards for card applications than relaxing them.
If the long cycle finally started to turn, the pressure on bankers to generate profits would increase further. Whether they maintain their discipline even then will determine the outlook for the industry for years to come.