Increasing credit card defaults has lenders reducing credit lines and adding fees
September 2, 2008
(Reuters)—U.S. credit card delinquencies are rising and the credit card issuers could be in for a lot of agony.
Expectations that cash-strapped consumers and businesses will default on their credit card balances in greater numbers are forcing lenders to reduce consumer credit lines, cut back on signing up new customers and raise fees.
But even these, in some cases drastic moves, are likely to be too late to save the credit card issuers from substantial credit losses.
“The bottom line is consumers have too much debt, they’re going to have to scale it back and that’s a painful process that will take time,” said Walter Todd, portfolio manager at Greenwood Capital Associates.
Hardest hit are likely to be Discover Financial Services and American Express, given their greater reliance on the credit card industry and limited access to funds, in comparison with big banks such as Citigroup or Bank of America Corp., said James Ellman, president at hedge fund Seacliff Capital.
Less affected will be Visa Inc. and MasterCard Inc. because they only process transactions and do not lend money. Furthermore, the world’s two biggest credit card issuers have continued benefiting from the growth of payments transactions, particularly outside the United States.
What is certain is that any pullback in the availability of credit will only further strain an economy already hurt by the slide in home prices and wider credit crisis.
“If consumers aren’t spending as much, it’s hard to have economic growth. Credit is like oxygen for the economy,” said Sung Won Sohn, professor of economics at California State University-Channel Islands.
Just how painful this deleveraging of the consumer will be is difficult to forecast, in part because this economic slowdown does not fit the standard mold.
Usually, consumers first default on their credit card and then stop paying their mortgages only after the economy has slowed for some time, because giving up a home is such a wrenching experience.
But in this recession, many homeowners refinanced their mortgages to pay down their credit card debt, ran their credit card debt back up over time, and then defaulted on their mortgages.
There is early evidence that credit card defaults are rising. Banks wrote off their credit card loans in July at a rate that would amount to about 6.6% of their total loans if annualized, according to Fitch Ratings.
The levels of unemployment and write-offs tend to move together and, if joblessness doubles, write-off rates will also roughly double, Fitch said in a recent report. The U.S. jobless rate has increased to a four-year high of 5.7% in July from 5.5% in June.
Bank of America, the largest U.S. retail bank, said its managed credit card loan losses rate jumped to 5.96% in the second quarter from 4.75% in the same period of 2007.
J.P. Morgan Chase, the third largest U.S. bank by assets, reported its net credit cards charge-off rate jumped to 4.98% in the second quarter from 3.62% in the same period last year.
American Express shocked investors last month after giving up its earnings per share growth forecast amid a significant worsening of the economic environment since January, particularly during the month of June.
“If we in fact do have a tough recession … credit cards loss rates will move from 6% or 7% to 10%, 11% in 2009, meaning a 50% increase in loss rates,” said Mr. Ellman.
Seacliff Capital’s president called those estimates “conservative.” He said loss estimates rates were low at the beginning of the subprime crisis, but now banks have recorded close to $500 billion of write-downs and credit losses.
ECONOMIC OUTLOOK
The U.S. economy grew faster than expected in the second quarter, boosted by strong exports and consumer spending.
But many analysts fear these factors will taper off in the second half of the year as the impact of a tax rebate program dries up and as weakening global growth and a stronger U.S. dollar crimps demand for U.S. exports.
Regulatory and legal pressures could hurt too. A bill pending in Congress seeks to protect credit card users from sudden rate increases and changes on fees and could put bank revenues under further pressure.
Given this kind of constraint, banks are making credit harder to get. About 65% of domestic banks said they had tightened lending standards on credit card loans over the past three months, according to the July Federal Reserve survey released earlier this month.
Certainly, some consumers may even begin to wistfully look back on the times when their mail included several credit card offers a day.
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