Too much of a good thing in credit portfolio

Delinquency rates in Target’s credit card portfolio are now at their lowest level in three years as more people are paying their bills on time. It is an encouraging sign for the long-term health of the nation’s economy to know that people are increasingly using credit in a responsible manner, at least those who have a Target card anyway, and therefore more likely to honor their obligations.

Accounts 60 days past due sank to 3% of receivables in June, down slightly from the May figure of 3.1%, and well below the peak of 6.6% seen in November 2009. A similar drop was experienced with accounts 90 days past due where the June figure was down to 2.1% compared to 2.3% in May and well below the peak of 4.7% seen in November 2009 and January 2010.

While these trends are generally viewed as good because it reduces Target’s exposure to bad debt expense that results when people don’t pay at all, a certain level of delinquency isn’t entirely bad. Let’s face it, credit card issuers make most of their profits by collecting late fees and interest payments from folks who don’t pay off their balance in full each month and Target is no exception.

The company’s credit card division produced a $194 million first quarter operating profit compared with $111 million the prior year. However, the primary driver of that 75% increase was a huge reduction in bad debt expense, which fell to only $12 million compared with $197 million the prior year. Conversely, as the company has tightened its standards for account holders, revenues from finance charges declined to $292 million from $350 million and late fee revenue dropped to $42 million from $59 million.

Given trends in the delinquency rates, second quarter late fee and finance charge revenues would appear to be headed lower, while the big reductions in bad debt expense that drove profit growth are expected to diminish further.