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Sunday, October 12, 2008

The Next Meltdown: Credit-Card Debt

Not a new topic, not a new issue, but a nice chart, and an interesting article for future reference:

Full article here - http://www.businessweek.com/magazine/content/08_42/b4104024799703.htm

Some interesting extracts:

* "The next horror for beaten-down financial firms is the $950 billion worth of outstanding credit-card debt—much of it toxic."

* "That's bad news for players like JPMorgan Chase (JPM) and Bank of America (BAC) that have largely sidestepped—and even benefited from—the mortgage mess but have major credit-card operations."

* "We still haven't hit the post-recessionary peaks [in credit-card losses], so things will get worse before they get better." What's more, the U.S. Treasury Dept.'s $700 billion mortgage bailout won't be a lifeline for credit-card issuers. "

* "But some banks and credit-card companies may be exacerbating their problems. To boost profits and get ahead of coming regulation, they're hiking interest rates. But that's making it harder for consumers to keep up."

* "Innovest estimates that credit-card issuers will take a $41 billion hit from rotten debt this year and a $96 billion blow in 2009. "

* "Those losses, in turn, will wend their way through the $365 billion market for securities backed by credit-card debt. As with mortgages, banks bundle groups of so-called credit-card receivables, essentially consumers' outstanding balances, and sell them to big investors such as hedge funds and pension funds. "

* "Big issuers offload roughly 70% of their credit-card debt. But it's getting harder for banks to find buyers for that debt. "

* "Sure, the credit-card market is just a fraction of the $11.9 trillion mortgage market. But sometimes the losses can be more painful. That's because most credit-card debt is unsecured, meaning consumers don't have to make down payments when opening up their accounts. If they stop making monthly payments and the account goes bad, there are no underlying assets for credit-card companies to recoup. With mortgages, in contrast, some banks are protected both by down payments and by the ability to recover at least some of the money by selling the property. "

* "Making matters worse, the subprime threat is also greater in credit-card land. Risky borrowers with low credit scores account for roughly 30% of outstanding credit-card debt, compared with 11% of mortgage debt."

* "Credit-card losses are already taking a bite out of lenders' balance sheets. Bank of America, the nation's second-largest issuer behind JPMorgan, revealed on Oct. 6 that roughly $3 billion of its $184 billion credit-card portfolio has soured, a 50% increase from a year ago."

* "Likewise, American Express (AXP), which caters to wealthier borrowers, upped its provisions for credit-card losses from $810 million to $1.5 billion in the latest quarter, a sign that even upscale consumers are having trouble. "

* "The industry's practices during the lending boom are coming back to haunt many credit-card lenders now. Cate Colombo, a former call center staffer at MBNA, the big issuer bought by Bank of America in 2005, says her job was to develop a rapport with credit-card customers and advise them to use more of their available credit."

* "Now regulators and politicians are trying to curb some of the industry's abusive practices by limiting interest rate hikes, abolishing certain fees, and cracking down on questionable billing practices. Under rules proposed by the Federal Reserve, a borrower would have a 21-day grace period before being hit with a late fee, instead of the few days offered by some firms now. A similar plan working its way through Congress would allow banks to increase rates only on consumers' future purchases—not existing balances. And under both proposals, credit-card companies would have to allocate account holders' payments equally to balances with different interest rates. Currently, firms first apply payments to the debt with the lowest rate, which means it takes longer and makes it costlier for consumers to pay off their debt."

* "The Senate isn't expected to vote on the matter until early next year. "

* "Even consumers like Michael Polemeni, who miss only a single payment, can find themselves in the crosshairs of credit-card companies. ... Polemeni generally made more than the minimum payment each month, carrying a $2,000-or-so balance. But in July he missed a payment, and Providian, owned by Washington Mutual, jacked up his rate from 9% to 30%."

* "Not everyone will be able to pay down their debts like Polemeni. And that could make for a vicious cycle: As credit-card companies raise rates, more consumers fall behind on their payments, which then hurts the issuers. Says Innovest's Larkin: "We are going to see the banks massively hit." "

* "Consumers in Latin America, South America, and Eastern Europe are filling their wallets with credit cards. The number of cardholders in Brazil and Mexico has more than doubled in the past three years. But rapidly rising credit-card debt can wreak havoc on emerging-market economies, according to Oxford Analytica. Take South Korea. Consumers there went overboard on credit in 2003 and defaulted on a large percentage of those loans—which seriously crimped the country's growth."

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