Credit card defaults seen peaking this year

An employee of Kyobo bookstore holds a customer's credit card after swiping it to pay for purchases in Seoul February 5, 2009.

NEW YORK (Reuters) - Credit card loan defaults, which have risen sharply in recent months and which many analysts feared could rival mortgages as a headache for banks, could peak sooner than widely expected.

Guarded optimism that the worst would soon pass for the credit card industry increased by better-than-forecast default rates for July reported by several big credit card lenders on Monday.

More investors are now betting that the industry, battered by losses, could pull into the black next year, confounding those who expect the industry might not turn the corner until 2011.

The average rate of chargeoffs -- loans credit card issuers do not expect to be repaid -- declined in July for the first time in nine months, according to Jefferies analyst Richard Shane.

While many analysts expected a decline, the improvement was bigger than anticipated and even Bank of America Corp (BAC.N), one of the industry's most troubled players, showed its first drop in defaults in almost a year.

In addition, credit card delinquencies, or late payments, which are a measure of future defaults, eased at a time of year when they usually rise, suggesting chargeoffs could abate further in coming months.

"We are cautiously optimistic that it (the peak in credit losses) is this year. The trends that we have seen seem to be pointing toward that," said Sanjay Sakhrani, an analyst at KBW. "You've seen some abatement on a weekly basis on the jobless claims and that's constructive."

American Express Co (AXP.N), which earlier this month bolstered confidence in credit card issuers after reporting a steep decline in defaults, said delinquencies fell for fifth straight month in July. JPMorgan Chase & Co (JPM.N) posted its third consecutive fall in late payments.

"While delinquencies came in worse than seasonality would suggest during the first four months of the year, May, June and now July have been better," said Jason Goldberg, an analyst at Barclays Capital.

The change in the trend, seen by some analysts as a sign of a turning point, reinforced the idea that bad loans would bottom out sooner than expected.

Jefferies' Shane said in a note to clients that he expected credit deterioration this winter to be less than is typical.

Credit card defaults usually track unemployment, which is expected to peak at more than 10 percent by year-end. It was at 9.4 percent in July.

BACK TO BLACK?

While early estimates forecast the charge-off rate could spike at an average of between 12 percent to 14 percent, some analysts now say defaults could top out at around 11 percent and 12 percent on average.

Bank of America is already well above that level, with a July charge-off rate of 13.81 percent, but most of its rivals' stand at around 9 percent or 10 percent.

July's data broke a streak of record monthly credit card default records. The average default rate climbed to 10.76 percent in June, according to rating agency Moody's Investors Service.

A lower-than-anticipated peak in credit losses could decrease by $15 billion to $20 billion, and help release reserves for bad loans, improving the outlook for the banks and specialty finance companies that issue credit cards, analysts said.

For instance, Sandler O'Neill analysts this week raised Capital One Financial Corp's (COF.N) earnings estimates for 2010 to a profit of $1.09 per share from a loss of 10 cents per share.

"Our estimates reflect our view that unemployment peaks at around 10 percent by year end, but remains at elevated levels through 2010 rather than continuing to rise through the first half of the year," Sandler O'Neill analysts said in a note.

Capital One last month posted its third straight quarterly loss. JPMorgan, Citigroup Inc (C.N), and Bank of America have also been posting losses on their credit card businesses in recent quarters.

Even if the industry leaves the record losses behind, it will face the biggest regulatory overhaul in at least 20 years.

A new credit card law that goes into effect in February limits interest rates and fees and is expected to hurt the highly concentrated business' revenue.

(Reporting by Juan Lagorio; editing by Leslie Gevirtz)