AmEx sees hope, but bad loans plague sector

American Express Co (AXP.N) raised hopes for a battered credit card industry after estimating that bad loans were easing, but analysts cautioned that the sector is not out of the woods yet.

The largest U.S. credit card company by sales said on Wednesday that credit card charge-offs, loans it does not expect to be repaid, fell for second straight month to 9.2 percent in July from 9.9 percent in June, in the first clear sign of improvement in 18 months.

While most credit card companies reported lower charge-offs in June, investors attributed the drop to a seasonal trend, as consumers used tax rebates to pay down their debts.

But American Express Chief Executive Kenneth Chenault said during an investor meeting that the decline in its case was not seasonal and forecast the company's defaults could end the year below 10 percent, lagging analysts' earlier estimates of 12 percent to 14 percent.

At the end of the day, the seasonality argument at least historically, I've been in the industry over 25 years, doesn't, last past May, Chenault said. We saw the improvements in June as we talked about July. That's not seasonality.

Shares of American Express rose to 10-month highs and helped boost the stock of rival Capital One Financial Corp (COF.N) to its best price since January.

But analysts said the Dow component was helped by the company's own actions to improve the recovery of past due loans and by its wealthy customer base, adding it was difficult to extrapolate a trend to the entire industry.

I wouldn't say it is going to be a broader trend, said Jason Arnold, an analyst at RBC Capital Markets. We are not entirely convinced that the economy is out of the woods.

Sanjay Sakhrani, an analyst at KBW, agreed.

There is definitely seasonality in the delinquency numbers, he said. In July and August you generally see a decline in chargeoffs ... and then it increases a little bit in November and December.

Both analysts forecast rising unemployment and higher bankruptcies will keep weighing on bad loans.

Investors that are thinking basically that the worst is behind us may be set for a disappointment ahead as we get more data, Arnold said.

SEPARATE WAYS

American Express was the fastest growing credit card company between 2003 and 2007, as it relaxed lending standards. But it paid a heavy price when the bubble burst and bad loans rose to record highs.

The company's portfolio remains the industry's least risky with 4 percent considered subprime, compared to about 30 percent of the credit card loans of Citigroup Inc (C.N) and Bank of America Corp (BAC.N).

American Express is better positioned (for a recovery) given their higher-end customer base, said Walter Todd, portfolio manager at Greenwood Capital Associates.

JPMorgan Chase & Co (JPM.N), and Discover Financial Services (DFS.N), whose conservative lending policy during the credit boom are paying off with lower-than-average default rates, could eventually start showing a more sustainable recovery.

But analysts estimated that defaults would remain high at Citigroup and Bank of America.

In June, Citigroup, the largest issuer of MasterCard branded cards, said chargeoffs inched up to 10.51 percent, while Bank of America Corp (BAC.N), the largest U.S. bank, said its default rate soared to 13.81 percent.

You start to see a differentiation on the way down given the customer bases that these companies have, Todd said.

MORE PAIN AHEAD

Last month, JPMorgan's (JPM.N) Chief Executive Jamie Dimon forecast the second largest U.S. bank would not make money from credit cards until 2011, and Bank of America's Chief Executive Kenneth Lewis predicted chargeoffs would keep rising for the rest of the year.

Credit card defaults usually track unemployment, which rose in June to a 26-year high of 9.5 percent and is expected to peak at more than 10 percent by year-end.

The industry's average charge-off rate rose to a record 10.76 percent in June, according to Moody's Investors Service, and defaults remain on track to peak around 12 percent in early 2010, analysts said.

We don't really buy into the economy getting a lot better any time soon. Arnold said.

Credit card firms are expected to release preliminary data about the performance of loan portfolios on August 17.