Credit Cards: The Next Subprime?

Last week the Fed said that credit card delinquencies hit 4.86% and credit debt increased by 7.9% to $957.2 in March. American Express (AXP) is experiencing mounting credit losses but today reassured investors that it still expects annual profit to increase by 4%-6%. Companies like Visa (V) and Mastercard (MA), which shoulder very little credit exposure, have been reporting excellent earnings growth.

This explosive growth in credit card spending seems intrinsically tied to the rising costs of bare necessities like food and oil and the diminishing financial resources that US consumers have to cover these costs. Basically, if they don’t have the money to buy these basic items, they put them on their credit card.

In the short-term, this added credit card spending will boost these credit card companies’ incomes, but what will happen when consumers get stretched too thin and can’t pay off these loans?

American Express has set aside $1.27 billion this quarter to cover the write-offs of debt defaults, the biggest chunk was set aside by the US division at $881 million, up 52%. Mastercard and Visa will have less to worry about as they have far less debt exposure. And in the end, a lot of the problem could fall on banks already struggling with the last big thing: subprime.

Lehman Brothers (LEH) continues to hog the headlines in its struggle to rid itself of its risky positions. It said it has already sold $100 million of these assets and is closing down some of its prop-trading divisions. Just as others before them, Lehman is saying it has enough capital and has not needed to access the Fed’s discount window. There is also speculation that Lehman may be buying back some of its own shares, although hedge funds with a short position are working hard to “break the bank”.

In the end what happens to banks like Lehman Brothers, Citibank (C), Bank of America (BAC), UBS (UBS) and  Merrill Lynch (MER) with major credit exposure will depend a lot on the economy, the consumer, and of course how much taxpayers’ money gets spent to keep them all making money.

Comments

[Echo To All:]

come on Grace... everyone working on the street knows debt from credit cards are higher risk, and understand that risk far better than they did subprime debt. Meaning, they will be taking these delinquencies into account.

not that I even have to spell it out for you (as i am sure u already know), but the difference between credit card debt and subprime debt is that a grossly incorrect assumption to risk was placed on subprime.

investors know very well in times of economic slowdown credit cards delinquencies go up. (especially when the consumer is squeezed with a higher cost of basic goods.)

so no... its not the next subprime, its just the normal increase in delinquencies from an economic slow down. Pending how severe the slow down and real inflation (not gov. reported inflation) stays high, prudent assumptions should be the delinquency rate goes higher.

2008 Jun 04 01:00 PM

[fatcat:]

Echo,it goes further than that.example cap one...it also has big exposure to helocs and auto loans. If they are suv loans,can you say "oops"..

2008 Jun 04 01:18 PM

[sugar:]

echotoall:

"Credit Cards: The Next Subprime?" It is just a title to catch your attention!

2008 Jun 04 02:12 PM

[Andy Singh:]

I hope visa makes it through. I bought some $95 sep call options which are down a fair bit already. I wrote about it here, www.savingtoinvest.com.... I think I bought into the hype for VISA. Should have gone with MA.

2008 Jun 04 03:08 PM

[Malkiel:]

In the 90's there was alarm because credit card debt per capita was skyrocketing as credit card middlemen Visa and Mastercard whipped up tons of new debt for their bank customers; then those customers got out from under their debt by using cash from mortgage refinancing, new debt that mortgage company middlemen whipped up for THEIR bank customers; now the consumers are getting out from under their mortgage debt by transferring debt back to their credit cards. There are two interesting points here: firstly, banks are suckers for the machinations of middlemen; second, all forms of debt are probably being shouldered by the same few dumb banks, so expect more writeoffs for credit card losses from the people who had to write off mortgage losses...

2008 Jun 04 03:20 PM

[Jared:]

So Americans no longer have any income? If they've resorted to putting groceries on the credit cards, where are their paychecks going? It seems to me that certain elements within the media are trying to create this extremely dire situation in America where a large portion of the population is on the verge of homelessness. I don't buy it.

2008 Jun 04 04:15 PM

[nrgre:]

The increase in credit card transactions is not a result of the increase in price of neccessities! It is a result of the fact that people don't want to carry large amounts of cash on them at all times. The use of credit cards will continue to grow and so will the debt associated with them. Its a matter of convenience.

2008 Jun 04 04:38 PM

[billddrummer:]

Convenience, strapped wallets, and debt transfers all play a part. The best investment option seems to be the issuers (MA, V), not the banks. There's no credit risk at the issuer level--in fact, you could say that credit card financing is a form of factoring, because the receivable is created by the issuer but serviced through payments from the end user to the bank.

Unless banks begin to tighten up credit card criteria (soon to come in my opinion) MA and V will continue to show healthy revenue and profit growth.

2008 Jun 04 06:46 PM

[mkreisel:]

I exclusively use credit cards for my purchases, and I always pay my balances in full.

Credit cards offer a convenient way to organize my bills, track my spendings, and a great protection from fraudulent merchants.

If you shop online, credit cards is pretty much the ONLY way to buy anything. If you travel to foreign countries, Visa and Mastercard offer way BETTER exchange rates than those rip-off banks.

It's actually far safer to make purchases with credit cards than with cash. They have become very good at detecting anomalies. Once I bought something in China, and I got a call from them a day later. Now if you give cash to the wrong person, it's gone forever.

2008 Jun 04 07:06 PM

[CLH:]

yes I agree that the increasing use of credit cards has more to do with convenience. We buy everything on credit cards and get back 300 to 400 dollars every year. Cash is trash. grin

2008 Jun 04 10:35 PM

[Vegasjoe:]

V and MA do not take credit risk; they simply process transactions. They collect toll charges. Most banks have cut back their teaser transfer competition. Most banks now financially underwrite loans for everything. Imagine that. AXP is a buy at these levels. Maybe MBIA and AMBAC will insure credit card defaults since they got into every other dumb business other than muni bonds.

2008 Jun 05 09:02 AM

[Kylan:]

Grace points out that “explosive growth in credit card spending seems intrinsically tied to rising costs of bare necessities like food and oil.” What is the strength of this correlation?

If it holds true, decreased food reserves paired with the natural disasters that have afflicted supplies in Asia should lead to higher food prices over the next two years. I’m paying $4 for a dozen eggs versus half that 6 months ago. Plus, despite the sell off in crude, oil is projected to hit $140 by the end of the year. This implies that credit card spending will increase, and so will V & MA earnings.

When consumers become stretched thin and start defaulting on debt, V and MA will not be the companies holding that debt.

2008 Jun 05 12:54 PM

[dapper dan:]

AMEX and others can reprice to risk fairly easily, it is not like they are stuck with no buttons to push when delinquencies rise. I wouldn't hold your breath waiting for any sort of credit card catastrophe.

2008 Jun 05 04:04 PM

[Diva:]

Life goes on ! And Visa is everywhere you want it to be . Let the games begin :)

2008 Jun 06 05:31 AM

[Diva:]

Visa is the new currency , I don't use cash and Visa is everywhere you want it to be . Let the Olympic games begin ,Visa Sponsor !

2008 Jun 06 05:37 AM

[DevKumar:]

Does this author ever write anything positive ? Anyone can come up with these articles with some basic research or analysis.
Why don't you start writing the solutions to fix these problems? or you leave it on luck or depend on next president to fix it.
Because of people like you , this once great country have turned into a land of losers from land of opportunity.
Here how we can fix this country...

1. Start Oil exploration in Alaska immediately . This will reduce the pressure on oil. Believe me environmentalist's say will not be able survive beyond 10 years when China takes over most of the property in this country.
2. Come out of Iraq immediately and tell them to continuously supply free oil for USA as IRAQ needs to pay for the cost of the war.
3. Open up immigration for those people willing to invest in USA housing stock - can have different ranges for different regions.
This will immediately put some life in housing market.
4. No tax upto $100,000 in income for next 5 years if a couple produces a kid.
5. Open up nuclear plants , run as semi govt entities on a non-profit basis, as many as we need to give cheapest supply of electricity to US people. Build new railway lines, trams if needed across the country to run everything of electricity .
6. Increase patent protection for drugs from 20 years to 40 years to give incentive to drug companies so that they can reduce the price of drugs by half. This will give them enough time to come up with new drugs as well.
7. Build govt sponsored education institutions to mass produce doctors, surgeons and dentists to bring down the cost of health care or open up easy immigration for medical professionals. These newly immigrated medical professionals will need to work for cheap and for atleast 5 years in govt owned hospitals.
I will post new stuff soon on seeking alpha. Today I couldn't resist to shut up these so called analysts who are bringing down this country for their own selfish reasons.

2008 Jun 07 02:55 PM