Credit-card delinquencies are likely to become the next flashpoint in the credit crisis, though the impact on the overall economy won't be as severe as the housing slump, analysts believe.
As the economy worsens and unemployment rises, more Americans are having trouble paying off their credit card balances. That has pushed up losses for credit card issuers, forcing them to tighten standards, which puts a further squeeze on cash-strapped consumers.
“After mortgages and home equity, credit cards are the next in line to feel the crunch,” says Marc DeCastro, an industry analyst with Financial Insights.
With job losses growing, credit cards delinquencies could rise to 7 percent by the first quarter of 2009, which would be a 20 year high, says Howard Shapiro, an industry analyst with Fox-Pitt Kelton.
And because consumers no longer have the equity in the house to fall back on, they're relying even more on credit cards to pay for living expenses.
“Now with their home equities getting shut off, people are going to start augmenting their income with their credit cards," DeCastro says. "They are going hit their limits and once they hit their limits, then they are probably going to walk away from their credit cards.”
Though consumer spending accounts for three-quarters of the US economy, the credit-card crunch isn't likely to be as big an economic blow as the housing crisis has been.
The reason is that credit card debt, while still large, is much smaller than the amount tied up in mortgages.
There is roughly $1 trillion of outstanding credit card debt—compared to $14 trillion worth of outstanding mortgages—and in the second quarter of 2008, $385 billion of this had been bundled into asset-based securities, according to the Securities Industry and Financial Markets Association
Another reason for the smaller fallout is that credit card issuers have been working over the past year to tighten standards and limit the damage.
“I don’t see the credit card industry facing the kind of stress that the mortgage industry has faced," says Shapiro. "They have had time to prepare, to tighten their underwriting standards which were not stretched to the same degree as they were in the mortgage industry."
Still, that doesn't mean the growing losses aren't going to hurt.
Credit card write-offs last year totaled $26.6 billion, and are on track to reach more than $41.4 billion this year. And that's just the beginning.
“We think 2009 is going to be a difficult year for the credit card industry," Shapiro says. "There’ll be higher charge offs, slower growth, people are cutting back on spending. That is going to mean pressure on earnings.”
Innovest Strategic Value Advisors forsees delinquencies rising through the next three quarters, peaking at 10 percent, with industry losses of close to $100 billion in 2009.
That’s higher than most estimates but that's because most models do not sufficiently account for the freezing of the transfer market, in which borrowers could rollover debt into new cards with a low (or zero) introductory annual percentage rate (APR), says the investment research firm.
That option is quickly disappearing, leaving a growing raft of people with more debt than they can repay and no place to turn. That essentially was the situation that burst the subprime mortgage bubble, when people could no longer just roll over into a new subprime or sell their house.
The pain for the industry comes at a particularly difficult time for banks, which have long relied on credit card operations as steady, and highly lucrative, profit centers, contributing significantly to total revenues.
American Express and Discover, which both have small bank subsidiaries, are better positioned to weather the storm because of tighter standards. Retailers are probably the most vulnerable, mainly because they are usually the last to get paid by strapped consumers. Target recently lowered its guidance because of higher than expected credit card write-offs.
Another problem for the industry is its exposure to borrowers with less-than-stellar credit, also known as sub-prime. That’s believed to be about 20 percent industry-wide (more than 30 percent at Bank of America and Capital One) but the scale of the problem is far smaller than in mortgages and much of that has been shifted off company balance sheets.
Tightened credit terms will help card issuers, but it also will mean fewer options for borrowers who have stumbled into trouble. Instead of transferring balances to a new card, often a new low introductory rate, they may end up defaulting.
This just makes a bad credit situation worse and is “unsustainable” argues Laura Nishikawa, an analyst with Innovest, who says issuers need to work with consumers to encourage "healthier use of credit," not the orgy of the past decade.
She says Discover is showing the way, by offering convenient loan calculators, allowing customers to choose payment days, and offering cash back rewards for being on time.
“There is some cause and effect here….but [as an issuer] you don’t want to the last one in the line” to get repaid, responds Dennis Moroney, research director for bank cards industry at TowerGroup, a wholly owned subsdiary of MasterCard which operates with editorail independence.
That’s precisely the risk retailers run by issuing store-specific credit cards, as he expects retailers will feel compelled to do to boost holiday shopping revenues.
Since these cards can only be used in the stores issuing them, they are typically the last to get repaid, raising the chances of charge-offs, especially as the economy weakens.
Even if consumer spending retains its holiday sparkle, the real test for the credit card industry, he says, will come in early summer, when families’ ability to stay current on bills rolled over from the holiday binge, and when delinquencies typically pick up.
If the recession we are sinking into proves deep and prolonged it will probably force painful consumer change.
"People are basically spending far more than they earn and that is just going to have to change, especially if banks are not willing to indulge that kind of behavior any more, that’s going to have big repercussions in the economy,” says Gregory Larkin, a senior Innovest analyst.
That may mean the days of carrying card balances of ten of thousands of dollars may be over if banks have doubts about your ability to catch up.
The new economic reality may bring some rude moments, cautions Larkin. “You may have that embarrassing moment when you are out with your wife and the guy says, ‘Sorry, you are maxed out’ – you are going to get a lot more of that happening, your card not letting you charge dinner tonight.”