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Monday, January 14, 2008 11:11 AM

Credit Card Time Bomb Is Ticking Away

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Cash strapped consumers are increasingly turning to charge cards and home equity lines to support consumption. Some Debt Trends Are Good. This Isn’t One of Them.

American credit card debt is growing at the fastest rate in years, a fact that may signal coming trouble for the banks that issue them.

The Federal Reserve reported this week that the amount of revolving consumer credit that is outstanding hit $937.5 billion in November, seasonally adjusted, up 7.4 percent from a year earlier. The annual growth rate has now been over 7 percent for three months running, the first such stretch since 2001, when a recession was driving up borrowing by hard-pressed consumers.

Home equity loans are very troubling given they are occurring at a time when home prices are falling practically everywhere, including places thought to be immune, like Will County, Illinois and Portland, Oregon.

Will County, Illinois is about an hour from where I live. I wrote about Will County on Sunday in Housing gridlock: Trapped in Suburbia.

How can home equity lines be soaring when home prices are falling?

The Times article explains it this way: "Home equity loans typically give consumers the right to borrow up to a certain amount of money. It seems likely that the latest increases reflect borrowing by consumers with pre-existing lines of credit that they are now tapping, rather than newly approved loans. The holiday sales data indicated that consumers cut back in late 2007. But the consumer credit numbers would seem to indicate that they wound up further in debt anyway. Those are not good signs for the economy as 2008 begins."

Grim Credit Card Facts
  • Credit card debt rose at an annual rate 8.5 percent October.
  • Credit card debt rose at an 11.3 percent annual rate in November..
  • Credit card debt rose at an annual rate between 2 percent and 4 percent from 2003 to 2005.
Grim Housing Equity Facts
  • The ratio of homeowners’ equity is currently 50.4 percent
  • The ratio of homeowners’ equity at the end of 2005 54.2 percent
  • The ratio of homeowners’ equity at the end of 2001 57.3 percent
The numbers are worse than they look. More than 1/3 of homeowners have no mortgages. It is those already deep in debt that are running up the bills.

Credit Card Party Will Soon Be Over

The trend towards treating credit card like ATMs is not going to end well for either the consumer or the lender. Defaults are rising rapidly. Professor Depew has been ahead of the pack by watching Capital One for months. Please consider point 4 of Thursday's Five Things.
Capital One Financial (COF), the largest independent U.S. credit-card issuer, reduced its full-year profit forecast by nearly 20% due to increasing loan losses.
  • What a difference 30 days makes.
  • Last time we heard from Capital One, the company was sticking to its assumptions about the pace of degradation in the housing market, and the "return to normalization" of credit performance.
  • As expected, those assumptions are proving a little too rosy.
  • The company had anticipated full-year charge-offs to stay in a range of $4.59 to $5.5 billion.
  • The top end of that range has now expanded to $5.9 bln.
  • The rate of loans at COF that were 30 days or more overdue in December rose to 3.87%, the company said, compared to 3.68% reported a month earlier.
  • Charge-offs in the U.S. credit-card segment rose to 5.74% from 5.34%
    a month earlier.
  • The stock is now back down to April 2003 levels.
Upscale Cards Go Soft

Increasing defaults are not just a subprime thing. Here is proof: American Express Warns About Earnings.
American Express (AXP) forecast first-quarter earnings below analysts’ estimates on Thursday and adopted a “cautious view” for 2008 because of a slowing economy. The company will take a $275 million fourth-quarter charge as more cardholders fail to repay their debts, the company, based in New York, said in a statement. Its stock fell 7 percent in extended trading.

American Express said its first-quarter 2008 earnings from continuing operations would be less than the 90 cents a share in the period in 2007, missing the 93-cent average estimate of 12 analysts surveyed by Bloomberg.
The Next Subprime

While searching for information on securitizations I came across this article from October 30 2007: The $915B bomb in consumers' wallets.
This past summer's subprime meltdown involved about $900 billion in now-suspect securitized debt, reckless lending, and consumers who buckled under the weight of loans they couldn't afford. Now another link in the consumer debt chain - credit cards - is starting to show signs of strain. And the fear that the $915 billion in U.S. credit card debt (an uncannily similar figure) may blow up has major financial institutions like Citigroup, American Express, and Bank of America strapping on their Kevlar vests.

"This is absolutely not the next one to blow," says Meredith Whitney, banking analyst at CIBC. Christopher Marshall, CFO of Fifth Third Bancorp in Cincinnati, points out that the U.S. has a long history of credit card securitization, "so it's fairly well understood." The securitization of the subprime sector, by comparison, "got blurry, and people didn't focus on what it meant."

[My Comment: Anyone care to revise that forecast?]

Credit agencies that monitor credit cards in the asset-backed securities market share that confidence. "The performance in the core consumer [asset-backed securities] sectors is expected to deteriorate modestly, but not enough to cause substantial downgrades," says Kevin Duignan, managing director at Fitch.

[My comment: Is Fitch ever right?]

But credit card debt is different from subprime debt in another way: Unlike mortgages, credit card debt is unsecured, so a default means a total loss. And while missed payments are at a historical low, they show signs of an uptick: The quarterly delinquency rate for Capital One, Washington Mutual, Citigroup, J.P. Morgan Chase, and Bank of America rose an average of 13% in the third quarter, compared with a 2% drop in the previous quarter.

If there is an international precedent the U.S. should be watching, it's actually that of the U.K. British consumers are just as overstretched as Americans, but since the real estate market there rose faster and fell earlier, they're about 18 months ahead in the credit cycle. Since the last quarter of 2005, credit card delinquencies and charge-off rates in Britain have risen as much as 50%, forcing banks to take huge write-offs.

It's a sign of the times that, according to one survey last month, 6% of British homeowners have been using their credit cards to pay their mortgages. That's suicidal, of course, given that credit card interest rates are more than double even the heftiest mortgage. Keep your fingers crossed that it's not a trend that crosses the Atlantic.
Is MasterCard Immune?

Minyan Peter addressed both Mastercard (MA) and American Express in Minyan Mailbag: Is Mastercard Immune?

Capital One (COF) Weekly Chart

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American Express (AXP) Weekly Chart

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Citigroup (C) Weekly Chart

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The market is not taking too kindly rapidly rising charge offs. Rising unemployment is going to make matters far worse.

Please don't carry a balance. If you "have to", be sure to Read the Fine Print. It's also best to avoid 2-cycle billing processors if you sometimes carry a balance.

Mike "Mish" Shedlock
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