Credit card defaults could hit banks hard

Credit-card defaults may rise beyond 10 percent this year, breaking records and wiping out more than half of annual profit for lenders including Bank of America Corp. and JPMorgan Chase & Co., analysts said.

Loan failures are about to surpass a previous high of 7.53 percent as people losing jobs amid the U.S. recession can't repay debt, according to Fitch Ratings. The defaults may peak at 10 percent to 11 percent of loans by year-end, Goldman Sachs Group Inc. analyst Brian Foran said in an e-mail, reducing 2009 earnings for issuers including an almost 40 percent cut for American Express Co.

"The challenge is getting past the intensifying credit problems that will probably stay pretty rotten over the next six months or longer," said John Williams, an analyst at Macquarie Capital in New York, who rates American Express and Discover Financial Services "underperform."

Banks that already got cash from the U.S. Treasury after losses tied to mortgage securities may have to add billions to reserves for credit-card defaults, straining capital levels further. They are cutting credit lines, raising interest rates and scaling back on mail solicitations to brace for future losses. Citigroup Inc., Bank of America, JPMorgan, American Express, Capital One Financial Corp. and Discover are the biggest card lenders.

Charge-offs, or loans that banks deem uncollectable, reached 7.5 percent in December, according to Fitch Ratings analyst Cynthia Ullrich. The record of 7.53 percent was in 2005 after a change in bankruptcy law spurred a wave of filings, according to Fitch, which tracks a quarter of the $964 billion in U.S. credit card receivables. Unemployment worsened in January, rising to 7.6 percent, the highest rate since 1992.

"This is going to be an awful year for the credit card industry," Bank of America Chief Executive Officer Kenneth Lewis told lawmakers this month. "The more optimistic views are unemployment at 8 or 8.5 percent, and that would cause very high loss rates in the credit-card portfolios."

The rise in losses may outpace unemployment as credit-card debt from the past two years is defaulting more than older vintages, Goldman Sachs's Foran said in a Jan. 26 note. Assuming a U.S. unemployment rate of 9 percent by year-end, 2009 profit for Bank of America, JPMorgan and Capital One may be cut by more than half, he said. Discover's earnings may be totally wiped out, while American Express profits may be 38 percent lower. Citigroup posted a net loss in 2008, obviating a percentage comparison.

Charge-offs may reach the "midteens" in a worst-case scenario, Moody's Investors Service analysts led by William Black said in a Feb. 4 note. Issuers would have to bolster their securities to prevent them from hitting early payment-triggers and lower-rated securities could be downgraded, Moody's said.

Sustained defaults at 10 percent could force a major issuer to seek a rescue or sell its credit-card division, said David Robertson, president of the Nilson Report, the Carpinteria, California-based trade newsletter.

"There's never been a lender of that scale in this predicament," Robertson said in an interview. "Portfolios that have been required to sell themselves to a lender because they've gone underwater have been far smaller."