Hugs

Source: Jesslee Cuizon

Ready for a shocker? I've found something banks and consumers can agree on! 

Being late or missing a credit card payment stinks. For you and the bank. And there's one bank that's seen its customers act a little differently than the rest of the industry.

Since 2000, the number of late-paying customers has fallen dramatically, as shown in the chart below:

Images

Source: Board of Governors of the Federal Reserve System/FRED.

The delinquency rate is a good indicator of the credit quality of borrowers. Since the provisions for credit losses (what a bank expects to lose on its loans) get directly subtracted out of its revenue, the fewer people the bank expects to pay late on their credit cards, the lower that number will be, which will lead to higher revenue (and more money to shareholders).

When we check in on five of the largest credit card issuers in the U.S., which at last count had more than $400 billion in credit card loans outstanding, we see their 30-day delinquency rates in the most recent quarter as follows:

Bank of America (NYSE:BAC)

2.4%

Capital One (NYSE:COF)

3.2%

Discover Financial Services (NYSE:DFS)

1.6%

JPMorgan Chase (NYSE:JPM)

1.7%

 American Express (NYSE:AXP)

1.1%

Source: Company earnings reports.

Yet one quarter in isolation doesn't tell us much of anything (besides that American Express continues to be a market leader in the category) and if we look at performance over the last year, we see something very interesting:

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Source: Company earnings reports.

Shown a little differently, we can see that Capital One not only has a higher delinquency rate when compared to its peers but the gap is widening as it gets worse while its peers all get better.

An even more striking example is the comparison between Bank of America and Capital One, which had relatively similar delinquency rates in the second quarter of 2012, but have seen their delinquency rates move in opposite directions over the past year:

 

2Q 2012

Q3 2012

Q4 2012

Q1 2013

Q2 2013

Bank of America

3.1%

3.1%

2.9%

2.8%

2.4%

Capital One

3%

3.7%

3.7%

3.5%

3.2%

Difference

0.2%

-0.6%

-0.8%

-0.7%

-0.8%

Source: Company earnings reports.

Are investors to think that Capital One's customers are getting worse at paying their bills on time while users of other cards are getting better? Have they stopped sending the Vikings?

The important thing to remember in all of this is the correlation between risk and returns. If a company is able to still generate income at a similar rate even in the face of rising delinquency rates, it should ease some concerns. And, in fact, that's where we see something rather interesting:

Q2 2013 Credit Card Yield

Capital One

15.9%

American Express

9.1%

Bank of America

9.8%

JPMorgan Chase

9.4%

Discover

12%

Source: Company earnings reports.

As seen in the table, in the face of greater risk, Capital One returns much more money on its credit card business than the others. Yet not only is it wringing out more than all of its peers, but it is seemingly the only one seeing those margins improve:

Images

Source: Company earnings reports.

Over the past year, Capital One's credit card profitability has gone up 20%, and its closest competition in that growth category is JPMorgan, whose profitability has only risen by 5%.

There is little discussion from Capital One detailing whether this trend is intentional and if it is seeking riskier loans for the sake of higher margins, but that certainly appears to be the case.

While the company has set 11% less allowance for loan losses compared to last year (its peers have all seen theirs fall at a greater rate), it's encouraging to see that even in the face of more late payments, it still thinks it will lose less.

With this strategy, Capital One is able to continue generating high returns on its portfolio -- yet it could signal trouble if a day comes when its delinquencies go up and its margins don't rise as well.

Fool contributor Patrick Morris owns shares of Bank of America and Discover Financial Services. The Motley Fool recommends and owns shares of Bank of America. It also owns shares of JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.