The first quarter often brings relief to credit card issuers, as holiday shopping is over, New Year resolutions bring promises of financial soundness, and tax refunds start to come in. However, issuers not ranked in the top 100 should begin to shudder.
The increase in charge-offs for all commercial banks issuing credit cards, which rose 17 basis points in Q1 2024, from 4.23% to 4.40%, is a warning of real problems to come. This rate, not seen since Q1 2012, should be a cause for concern for all credit card issuers, particularly those not ranked in the top 100. In the same period, these issuers saw a slight increase, from 9.50% to 9.51%.
Charge-Off Causes Credit Card Companies to Lose Money
Consumer lenders are used to charging off accounts to bad debt, and well-run underwriting prices risk into interest rates. Charge-off occurs when the account is contractually overdue by 185 days and must be purged from the bank’s loan books as uncollectable.
Credit card issuers lose money on every charge-off account, and a $5,000 charge-off can negate the revenue generated by a dozen accounts. However, the business becomes unsustainable when the rate rises, as it has for small banks, from 4.23% in Q3 2021 to 9.51%.
What a 9.51% Charge-Off Means
The charge-off rate is compared to the lender’s annualized receivable, which is annualized to smooth out peaks and valleys in people’s purchasing and paying habits.
Charging off 9.51% means that for every $100 in loan value, the issuer will lose $9.51. Scale this up to a $100,000 portfolio for a small issuer or $1,000,000 for a middle-sized issue, and the losses make lending unsustainable.
Other payments expenses, like collection staff, fraud costs, salaries, telecommunications, and marketing, require funding. Unless you can cut these expense lines to fund the losses, you are in for an unprofitable situation. Sooner or later, the issuer will have other risks, like real estate or commercial lending, and then liquidity issues will begin.
Who is at Fault?
It is undoubtedly not the issuing banks. They put their money at risk every time they issue a card in good faith of repayment. It might not be the cardholder, although they incurred the debt. The core issue is inflation and record-high interest rates, which have disrupted household budgets. And, unless salaries surge, to cover it at $4.50, milk should be at the same price or even rent that households can afford.
But who pays? Investors who enable the lending process. Consumers that keep their accounts current. And, merchants, who will lose sales as lenders tighten underwriting.