Credit Card Defaults Are Just Beginning

There's finally talk about credit card defaults. Business Week has a pretty good article on the subject here. Outstanding credit card debt amounts to around $950 billion. About $285 billion of it is subprime, and the defaults are just beginning. As the economy weakens and more people lose their jobs, credit card losses are likely to accelerate. Innovest, according to Business Week, estimates that losses could be higher than $75 billion by 2009.

As credit card debt starts to sour, companies are reducing lines of credit, issuing less cards, and raising their already usurious rates on balances even higher. All this will contribute to a decline in credit card use and profitability. With a lower effective credit limit (whether because their credit line was reduced or their balance is near the limit) consumers will have less purchasing power. This means less swipes at the register. It also means they'll borrow less money.

Banks, like Chase (JPM), Citigroup (C), and Bank of America (BAC), will suffer losses on defaults. Unlike defaulted mortgages, where some of the losses can be recouped through a foreclosure auction, credit card debt has no collateral. They will also lose potential profits because they will be lending out less money. This can become a self reinforcing cycle, as buyers of securitized credit card debt will demand higher yields to compensate for their risk.

American Express (AXP) and Discover (DFS) are in the same boat as the banks above. As they also make money from swipes, less swipes means lower earnings. While American Express has wealthier customers, the downturn in the economy is still having an effect. According to Business Week, the company's provision for losses was $1.5 billion in the latest quarter, up 85%. As almost 98% of Discover's US revenue comes from credit cards, its outlook is not very bright either.

Visa (V) and Mastercard (MA), which issue no debt, will almost certainly be affected too, because of less swipes. Although increased debit card use will likely offset this somewhat, less swipes mean lower earnings.

Disclosure: I don't have any positions in the stocks mentioned above. If the current rally continues, I'll be looking to buy puts on some or all of the following: AXP, BAC, C, DFS.

Comments

[Echo To All:]

simmer down on the credit card defaults... everyone keeps mentioning it, but credit card debt is known to be expremely risky and defaults see a big increase during times of economic downturns.

in other words, there will be no surprises with respect to risk here... this type of debt is far better understood by the banks.

2008 Oct 15 09:16 AM

[an occasion...:]

One positive: all those annoying Visa pumpers seem to have abandoned these forums.

The fact that credit card debt is "known" to be risky will not keep the stocks from falling further when issuers (COF) announce additional charge-offs, write-downs, and reserves and transaction processors (V, MA) announce diminished activity.

In fact, I think the surprise here is how little these stocks have fallen given the iceberg that they are headed toward.

Today the market is down in part because retail sales came in relatively weak. But certainly a weak consumer at this point is not a surprise. Evidently that knowledge was NOT already priced in...

2008 Oct 15 10:15 AM

[User 265729:]

There are so many idiots and idiot banks out there... I've seen people not cutting back one bit! They are just filling in the "deficit" with Mr. VIsa, Uncle MasterCard and brother American Express.

One of many shoes to drop. I guess banks don't think they need to reel in some of the irresponsible types with credit cards. After all, the American taxpayer will bail them all out.

2008 Oct 16 04:22 PM

[thedozer:]

curbs...
you said "irresponsible types with credit cards" hilarious!

why won't anyone in politics admit this utopian lifestyle we've... sorry, they've been living is OVER

What is wrong with buying a used 4k car? is the world going to end?

I saw something on a 'business' channel speaking about people not affording 'brand new' cars due to the lack of financing!!!

hint... if you make cars... and you need someone to finance you buyer
hmmm... finance them yourself!

if you can't... STOP MAKING CARS!

I was reading last night, that Herbert Hoover ordered 48 of the 50 states to 'dramatically increase it's number of public projects to maintain employment numbers"

sound a little like obama's recent call for "investing in infrastructure"...
yeah.... there may be a little 'depression' right around the corner

2008 Oct 16 04:32 PM

[User 265729:]

thedozer:

It is a bit disturbing,,, My wife just let me read an e-mail from the young daughter of a friend of ours in Michigan. She essentially made a statement to the effect, "I can't wait until things get back to the way they used to be."

Some young people out there, with a lack of understanding of economics and history will shortly be in for a big surprise. I guess rude awakening, is more like it...

I actually feel sorry for the total naivety of a lot of people. I guess one of the factors for stocks going up today was oil below $80.00 bbl, yet few really want to know exactly why that is happening. Things like... You won't have a job to drive to... They'll be repossessing that SUV with wide screen TV for the kids. Industry will not need the petroleum... This is all something to celebrate...

2008 Oct 16 07:34 PM

[Smarty_Pants:]

Let's not forget that bankruptcy laws were recently re-written to be more strict on the filer. Some will be surprised to find out that their unbacked credit card debt is in fact still backed by bankruptcy court imposed wage garnishings.

The fun is just getting started.

2008 Oct 17 12:06 PM

[Smarty_Pants:]

PS. dozer:

My car only cost me $3500 about 2 1/2 years ago. And that included the cost of a new radiator. I self-financed the purchase by going to my wallet and paying in full.

The only car payments I have are insurance and fuel. Well within my budget.

There are still some of us out here that live by the old rules.

2008 Oct 17 12:09 PM

[armchariQB:]

FEWER Devin. It's fewer swipes and fewer cards not LESS swipes and less cards. Fewer things and less of some (one) thing.

Don't the schools teach grammar anymore?

2008 Oct 17 02:26 PM

[Offgrid:]

Something's up. My gas station just posted a sign saying they no longer accept American Express.

2008 Oct 17 08:47 PM

[Bob168:]

I just read a good article on Invest18.com. The article mentioned that AXP may have problem raising capital from the credit market so it is cuting credit limits on its existing cardholders. The article gives me a different perspective.

2008 Oct 20 02:59 AM

[lilac:]

Visa you forget has its debit card transaction business growing 400 percent a year. It has no exposure to the Bank credit card debt as it makes its money only on a per transaction fee basis. Credit will be affected, but people like the convenience of debit cards and they will only increase, therefore Visa is FOOLPROOF MONEY IN THE BANK.

BACK THE TRUCK UP CHUCK!

2008 Oct 20 03:37 PM