We are all aware of the problems we have had with most of our largest banks. Not only did taxpayers have to bail them out for those toxic mortgages they wrote, but now it is almost impossible to get a first mortgage, or a refinance of an existing one unless you do not need the money anyway! That being said I expect some major earning surprises from Bank of America (BAC), JPMorgan Chase(JPM) and Citigroup (C), and now could be the time to reap the benefits.
Several of our largest banks have been "lending" however. As a matter of fact, they are begging everyone to borrow from them. As this report states:
"Want a troubling sign of how great the economy is doing? Banks are feeling confident enough to lend money to people with bad credit. What could possibly go wrong?"
Yesterday I heard a report on CNBC that basically said that the banks are sending out a new wave of pre-approved credit card applications to millions of the highest risk applicants. I believe this to be absolutely the case. This article gives a point blank description of who is getting the new credit cards.
Bank of America , JPMorgan Chase , and Citigroup are having a grand old time lending money this way, and as shareholders we can profit right along with them.
Why Are Banks Handing Out Credit Cards To Anyone?
The fact that banks are tight when it comes to approving mortgages and business loans becomes much clearer when we understand the type of debt they are taking on with these loans.
There is unsecured debt, and secured debt.
From this website, here is a the definition of unsecured debt:
Unsecured debt is debt that is not guaranteed or "backed" by any collateral. Essentially this means that if you default on an unsecured debt there is nothing that the creditor can take back to recover their costs for non-payment of the loan. Interest rates tend to be higher on unsecured debt because there is no collateral for the creditor to seize. Credit cards fall into the category of unsecured debt. A credit card company cannot seize any of your possessions if you do not pay off the balance. Creditors attempting to collect on a delinquent unsecured debt typically turn the account over to a collection agency.
From the same website, here is the definition of secured debt:
Secured debt is debt that is backed by some type of collateral such as assets or revenue from the borrower. Mortgages and vehicle loans are two examples of secured debts. If the borrower allows the loan to become delinquent, the lender can foreclose on a home or repossess the vehicle for non-payment. Because there are assets the lender can use to recoup their loss in the event of a loan default, interest rates are generally lower on secured loans.
To make it very simple, banks do not want to own any more homes and cars. If someone defaults on the mortgage or auto loan, the banks' only course of action is to foreclose or repossess. That has not been working out very well has it?
Not only will the banks get "stuck" with bad assets, but so will their balance sheets. That would not be great for them, or for investors.
Credit cards on the other hand, are unsecured and there are no assets behind them. When someone does not pay the bill, the credit gets shut down. Nothing is foreclosed or repossessed.
It also means that it will be a temporary "bad debt' on the balance sheet and be written off almost immediately. Some would say that it is ridiculous to think of these bad debts as actually being "good" debts for the banks and investors.
Not so fast.
The average interest rate on existing balances on credit cards is 14.96%, down from 15%. (Check this out)
Not only that, but the high end of the rates goes up to about 20.99%. That means that the banks are basically "covering" themselves by charging 8 times the going rate of a mortgage, and 2-3 times the going rate for an auto loan, to subsidize and offset the "breakage" from those who don't pay.
Plus, they can sell the debts after a period of time (I believe it is around 9 months) to offset even more of the "bad" debt.
On top of that, the banks are making ridiculous profits on those who DO pay, whether it is by annual fees, merchant fees, AND the high interest from the vast majority of credit card holders who pay the monthly minimum amounts.
What this says to me, is that investors will see the profits from all of these credit cards right on the banks' bottom line, and will obviously increase the overall value of our shares.
Ergo: Higher share prices for us.
What About Bankruptcy?
Prior to 2005, individuals could file for bankruptcy, and if they owed more than they had, all debts (unsecured) were wiped off. Poof. As if they never existed. The only ones left holding the bag were the credit card companies, banks and department stores. The could never sell the debts, and they just took their lumps. Interest rates were also not quite as high and they did get burned to the point that everyone stopped seeing those pre-approved junk mailings altogether.
Now, it is not that easy. To boil it down for everyone, if you file for bankruptcy and have a job, the courts and the IRS will not wipe off the debts anymore. A payment plan of 3-5 years will be established to pay down the debts (which would already have been sold) or paid off completely.
As duly noted in this CNN report:
Under the new law, fewer people will be allowed to file under Chapter 7; more will be forced to file under Chapter 13.
Lawmakers who favor the legislation argue that it will prevent consumers from abusing the bankruptcy laws - using them to clear debts that they can afford to pay.
It goes on to say:
But consumer advocates argue that the new law is a gift to creditors - particularly the credit card industry, which may receive $1 billion or more from repayment plans due to the expected increase in Chapter 13 filings, according to Robert McKinley, CEO of CardWeb.com.
"The bill simply doesn't balance responsibility between families in debt trouble and the creditors whose practices have contributed to the rise in bankruptcies," said Travis Plunkett of the Consumer Federation of America in a written statement.
They are very correct. The new law basically paved the way for what is going on today. Virtually risk free (or at least much less risk) lending for the banks and the credit card companies at extremely high interest rates!
Everyone hates the banks right? We bailed them out, and we cannot get loans. However, I believe as investors we stand to make a whole bunch of money as the value of the banks begin increasing the share prices, and maybe even dividends.
Are you ready for some big earning surprises?
Take your pick, I like them all.
Disclosure: I am long BAC.
Disclaimer: Please be sure to do your own research prior to making any investment decisions. This article is not a recommendation to buy or sell any security and is strictly the author's opinion.