Card Issuers Start to See Credit Quality Diverge

First-quarter results represent a divergence among credit card issuers. All credit card issuers are at different stages of growth in this credit cycle and displaying mixed performance. On the basis of card issuer performance this quarter,

For credit cards, the best leading indicator of credit performance is a company’s delinquency rate, as one quarter’s delinquencies are highly correlated to credit losses in the following quarter. While the market is focused on a potential turn in the cycle, Capital One’s card delinquencies actually fell from the first quarter of 2017, and American Express’ delinquency rate was flat. Alliance Data Systems’ delinquencies were up 50 basis points year over year, which comes on top of March 2017’s increase of 50 basis points. The company attributes much of the increase to hurricane activity. However, neither Capital One nor Synchrony saw a similar rise in delinquencies, and neither mentioned hurricanes affecting payment behavior during the quarter.

Capital One’s portfolio is also less exposed to retailer bankruptcies than private-label issuers Alliance Data Systems and Synchrony--its recent growth has been more weighted toward its general-purpose and rewards cards. We anticipate Synchrony will follow Capital One and soon see fewer delinquencies and lower credit losses. At the end of the first quarter, Synchrony’s delinquency rate stood at 4.5%, a 20-basis-point increase from the previous year. Though its acquisition of the PayPal portfolio could affect this, Synchrony appears have slowed growth well ahead of the turn in the cycle. Alliance Data Systems is the most exposed to beleaguered mall retailers, which is the major reason we reduced our 2018 and 2019 loan growth forecast to 12% and 5%, respectively, from 14% and 10%. We also see Alliance Data Systems as the most aggressive issuer. Though some of the company’s growth has been through portfolio acquisitions, the company has no plans to slow loan growth, forecasting portfolio growth in the midteens in 2018. In comparison, Capital One and Synchrony increased card portfolios by 8% and 6.2% in the first quarter. We’re also somewhat cautious on American Express’ relatively late-cycle growth. Though the company targets a different customer segment, its heady first-quarter growth rate and past missteps in lending warrant close scrutiny in quarters to come.

Stabilization in credit quality will help some issuers benefit from operating leverage and margin expansion. Again, Capital One stands out as credit provisions declined 16% from the previous year while top-line interest income grew 4%. This resulted in pretax income growth of nearly 50% from the first quarter of last year. We think conservatism at Capital One will lead to a meaningful near-term catalyst as credit quality and margins improve.

We like that card issuers have been returning capital. Synchrony has the lowest leverage, with assets that are 6.7 times equity, and is well positioned to create value through share repurchases and modest increases in leverage. Capital One has modestly higher leverage at 7.3 times, and Alliance Data Systems has consolidated assets of 14.7 times equity. American Express’ capital ratios were hit by the late 2017 change in corporate tax rates, and the company has temporarily halted repurchases. That said, aggressive capital returns contributed to a 38% year-over-year increase in earnings per share in the first quarter.