Consumer Credit Quality
To Slowly Improve By End of 2002

Despite the encouraging economic news in recent weeks, risk managers know that the worst is not yet over. Credit losses usually peak about six to nine months after a recovery begins. The financial distress for consumers caused by layoffs in 2001 will continue to impact lender portfolios well into 2002. David D. Gibbons, deputy comptroller for credit risk at the Office of the Comptroller of the Currency (OCC) expects problem loans to peak later this year. He told the American Banker, "We don't expect problem loans to decline soon, but hopefully they will peak this year."

Senior loan officers at major banks seem to agree with this assessment. In early February the Federal Reserve Board released its survey of senior loan officers and nearly 40 percent of respondents said their standard consumer loan was performing worse than the banks' scoring models predicted a year ago. About one-third said their standard credit card loans were performing worse than predicted by the models.

According to Fitch Ratings Ltd, the chargeoff rate on securitized credit card portfolios was 5.83 percent in January 2002, up 43 basis points from one year earlier. January marked the eleventh consecutive year-over-year increase in the chargeoff rate. Also in January, 3.41 percent of securitized credit card accounts were 60 or more days delinquent, up 23 basis points from a year earlier.

The good news is that many lenders appear to have adequately priced for the risk. Rui J. Pereira, a director at Fitch, commented, "asset-backed securities investors continue to benefit from record levels of excess spread, which provides ample cushion from higher chargeoffs and, by extension, early amortization." Declining interest rates over the past year have also helped cushion credit card profitability by lowering the cost of funds. That said, Fitch analysts also noted, "Excess spread may have little room for further improvement, as credit quality is expected to weaken over the short term and the margin benefits tied to interest rate easing dissipate." Certainly, it seems that the Federal Reserve Board has concluded its lengthy campaign to ease interest rates. The escalation in losses expected during the first two to three quarters of 2002 will shrink the margins on which current profitability rests.