Credit Card Defaults Set a New Record

A Moody’s report on Wednesday raised new concerns for the vulnerable economic recovery. Credit card defaults for August rose to a new record at 11.49% underscoring the difficulty consumers are facing in today’s market. Credit card defaults are typically highly correlated with unemployment which remains stubbornly high despite the recent strength in equity markets. The credit card news is likely to weigh on retail stocks as investors had been counting on consumers to increase spending as we approach the holiday season.

The report showed current weakness (as seen in the August defaults) but also points to future concerns which could lead to even higher defaults in the coming months. The number of loans delinquent at least 30 days also rose in August coming in at 5.80%. The “early stage” delinquencies (delinquent for 30 to 59 days) was especially hard hit which indicates that individuals are facing new issues when trying to keep up with credit card bills. The newly delinquent accounts have a good chance of working through the system and turning into realized defaults in the next 2 to 3 months.

As the unemployment rate continues to rise (estimates are for a peak near 10.5%), we should continue to see rises in credit card defaults. Moody’s currently estimates this peak to be mid-year 2010 with a high of 12% to 13% default rate. These defaults would be particularly challenging for the three largest US credit card lenders JPMorgan Chase (JPM), Citigroup (C), and Bank of America (BAC). But although lenders will have to write off these bad loans, I fear investors in retail stocks will actually bear the brunt of the weakness.

Recently we discussed how shares of Under Armour Inc. (UA) may face disappointment as spending for football season will likely be constrained. Additionally, our article on Tiffany & Co. (TIF) offered three reasons to avoid the luxury retailer. Consumers are running out of options for funding spending habits and even those who remain employed and financially secure may find themselves unwilling or unable to spend at the same rates seen previously.

When dealing with consumer spending, retailers are facing both fiscal and emotional challenges. In response to the rising default rates, credit card lenders are cutting back available balances in order to shore up their risks. Employed consumers no longer have a widespread ability to borrow against home equity as home prices have declined, and banks are less willing to offer additional lines of credit. These are the fiscal issues which are having a very real effect on spending.

Emotional decisions also come into play as workers who remain employed are reluctant to spend on items viewed as unnecessary. The savings rate has begun to climb as consumers realize the need for financial stability, and consumers who are not defaulting on their loans are usually using excess capital to pay down these balances in case their financial situation changes. The net result is that retailers are finding it more and more difficult to move merchandise out the door.

It will be interesting to see how the retail industry survives the holiday period. Last year consumers were certainly in shock after the collapse of many large financial institutions. But the prevailing sentiment seemed to be that consumers would continue to spend for the holidays in order to “count our blessings” or try to retain some sense of normalcy. This year consumers are much more entrenched in savings initiatives and I believe more likely to cut back on gifts. Spending will still pick up relative to the summer months, but I doubt it will be at a level which justifies the massive increase in share price for many of these stocks.

Smart investors should continue to remain vigilant and look for less traditional investment opportunities. Commodities, precious metals, alternative energy, and a few other niche areas offer investors true value with good growth opportunities. But traditional buy and hold investors should consider hedging positions in order to protect against losses coming into the end of the year.

Disclosure: Author does not have a position in any of the mentioned stocks.

Comments

[User 357705:]

But, but Helicopter Ben and CNBC said the recession is over.....

Sep 25 05:25 AM

[HORSE7786:]

YOU ARE RIGHT 357705 I WATCHED CNBC THEY SHOWED ME HOW GREAT THINGS ARE RECESSION IS OVER EVERYTHING IS BETTER THAN ITS EVER BEEN (ACCORDING TO CNBC NBC CBS ABC WEATHER CHANNEL CNN BLOOMBURG) SO I WENT AND BOUGHT A BUNCH OF STOCKS LAND PROPERTY 3 UPTOWN CONDOS(OF WHICH ALL 3 CONDO PROJECTS HAVE HALTED CONSTRUCTION BECAUSE OUT OF MONEY) THEN LOST MY JOB WHAT AM I GOING TO DO IM GOING TO APPLY AT CNBC

Sep 25 06:47 AM

[battman:]

Yeah, but think about how much all those defaulters "stimulated" the economy before they went bankrupt!

Good times my friend, good times.

Sep 25 08:02 AM

[lyingtoours...:]

People are living off credit cards, using them as a replacement for income. I'm going to be forced out of my job soon, I'm trying to sell my home, I might just have to join the living off credit crowd eventually myself. The only good thing about our economy is the dependence we have towards money, you cannot live without it.

Sep 25 08:12 AM

[Dan in mpls:]

Living off a credit card? Talk about moral hazard. I suppose the idiocy is somewhat encouraged fools on the street seeing the fools in Washington doing exactly the same thing for a lifetime.

Sep 25 08:56 AM

[Fund Insider:]

Grow up you people. Maybe you should have avoided purchasing/leasing that new car every 3 years, the flat panel TV, the cruise tickets and saved for a rainy day. Get used to it, you live in America, and there is no safety net for the little guy. You need to create your own. That, or start a bank and then have the govt rescue you.

Sep 25 09:23 AM

[battman:]

lying, as a small business owner, I sometimes find myself using credit cards to make ends meet, so I can sympathise with you. Hopefully things don't get bad for you. Good luck.


On Sep 25 08:12 AM lyingtoourselves wrote:

> People are living off credit cards, using them as a replacement for
> income. I'm going to be forced out of my job soon, I'm trying to
> sell my home, I might just have to join the living off credit crowd
> eventually myself. The only good thing about our economy is the dependence
> we have towards money, you cannot live without it.

Sep 25 09:25 AM

[Otternell:]

gee, I wonder if it has anything to do with the fact that they raised their rates right after getting bailed out? Knowing that Citi nearly doubled my rates (from 8% to 14.99%) right after they got a bail out makes me angry enough to default.

Sep 25 09:36 AM

[a. palmer jr.:]

Not to agree with CNBC or anything like that but stocks are still cheap, thanks to the recession and with the ups and downs in the market, there's some money to be made there. But a recovery, I don't think so.

Sep 25 10:17 AM

[AndrewBaker:]

Wow ... who would have guessed it?

Sep 25 12:22 PM

[Marc Rasmussen:]

Way too many people using their credit cards to keep up with the Joneses.

Sep 26 06:37 AM

[Anthony Har...:]

Credit card defaults have been one of the biggest concerns for the large US banks as unemployment levels are expected to reach 10%-11% over the next year. These will probably continue further up till 2011 as the Federal Government is not expected to reduce lending rates till then, sending alarms to credit card lenders. This is particularly true in case of JPM. Of the net charge-offs of $6.0 billion in 2Q09, credit cards and home equity charge-offs together accounted for 66%. Although Credit cards formed only 13.0% of the bank’s total loan portfolio, it accounted for almost 45% of total-charge-offs. Credit card charge offs rose at an uncomfortable 12.5% of loan portfolio compared to 8.9% in 1Q09 and 5.6% in 2Q08. With unemployment continuing to remain at elevated levels, credit cards charge offs are expected to peak to 20% while overall charge offs are expected to touch 4.4%. Details are available in the report:
boombustblog.com/index...

Sep 30 12:58 PM