Get Ready for Credit Card Hell

So, the shadow banking system is blown to smithereens, mortgages have been gutted, and the credit default swap market is up in smoke. What's left to purge out of the financials system?

Easy. Credit cards.

And by purge, I really mean purge. Credit card companies aren't just sitting back and absorbing losses, but frantically slashing existing credit lines in a last-ditch effort to take the risk off their balance sheets.

Meredith Whitney -- who in December predicted existing credit lines would be cut by $2 trillion, or 45% of the total -- has already upped her estimate to $2.7 trillion. That essentially means 60% of all credit card lines could evaporate by the end of 2010. Bye-bye to 60% of the total dollar amount of extended credit.

The cuts mean two things for the industry. First, it's proof positive that lending standards were waaaay out of control in recent years. Card issuers offered credit at levels that could make some subprime mortgage shops look conservative. If you had a heartbeat and a mailbox, you qualified for about as much money as you could ask for.

But those glory days are coming back to haunt the industry in a big way. Charge-off rates are blowing through the roof. (Charge-offs are loans that banks write off because they don't think they'll be able to collect on them.) That isn't a shocker, but the speed at which things are deteriorating is.

For example, here's how net charge-offs at the biggest card companies looked over the past three years:

Company

2008

2007

2006

American Express (NYSE: AXP  )

5.5%

3.5%

3.3%

Citigroup (NYSE: C  )

6.9%

4.3%

4.0%

Capital One

6.3%

4.0%

3.1%

Bank of America (NYSE: BAC  )

6.7%

4.9%

3.8%

JPMorgan Chase (NYSE: JPM  )

5.0%

3.7%

3.3%

Discover Financial (NYSE: DFS  )

5.0%

3.8%

4.0%

A big increase from 2007 to 2008, which was to be expected. But look at how much worse the most recent numbers are for a couple of card giants we have data for:

Company

February 2009 Charge-off Rate (annualized)

American Express

8.70%

JPMorgan Chase

6.35%

Data from Capital IQ (a division of Standard & Poor's) and SEC filings.

The default rates at Citigroup and Capital One both steadily approached 10% in February as well. Things are getting ugly quickly. Some analysts think average charge-offs could hit 9% to 10% this year, meaning the increase in defaults that sent card stocks tumbling in the past several months could be just a taste of things to come.

But that isn't even the worst of it
The second, and most important, implication of slashing existing card lines is the impact it could have on card processors Visa (NYSE: V  ) and MasterCard (NYSE: MA  ) -- companies that don't take credit risk, but instead make money on each transaction.

The two have been riding a global shift of consumers switching to a cashless society. Their growth potential is huge, the story goes, and investors accordingly bid up shares to multiples that leave little room for error. Even in this market, Visa trades at more than 20 times the estimates for its 2009 earnings per share; MasterCard at about 16 times. While the shares of both have plunged since last summer, the companies are still valued on the assumption that plastic transactions will grow by leaps and bounds indefinitely.

But now that a full 60% of credit lines could go up in smoke, you have to ask how feasible those growth assumptions really are. No, a 60% cut in existing credit lines obviously won't translate to a 60% drop in credit transactions, and plenty of transactions could simply shift from credit to debit. But it will have an impact on the group of consumers whose credit card is their sole means of survival during an unemployment spell -- a group whose ranks are growing by the minute. Factor in a negative savings rate during the boom years, and the amount of consumers who thought a credit card counted as an emergency fund is probably larger than we'd like to think.

Bottom line
Full-service card companies like American Express and Discover already trade like the world is coming to an end -- which it may be -- but Visa and MasterCard are two that could really get creamed if the shift from paper to plastic starts to slow. These are both great companies that have a stranglehold on the industry, but it's dangerous to assume business will flourish indefinitely while the industry as a whole is being flipped on its head.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. JPMorgan Chase is a former Motley Fool Income Investor pick. American Express and Discover Financial Services are Inside Value recommendations. The Fool, which has a disclosure policy, owns shares of American Express. 


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  • Report this Comment On March 18, 2009, at 2:03 PM, sentinelbrit wrote:

    Is she serious? Credit card lines cut by 60%! That flies in the face of what the government is trying to do, namely stimulate the economy and encourage banks to lend. Furthermore, does she really think banks are going to curtail lending that much. America doesn't run on Dunkin' it runs on credit and it is still the life blood of the economy. There is no way, credit is going to be cut off by 60%. If that happens, we might as well all go home!

  • Report this Comment On March 18, 2009, at 2:18 PM, jerry20ct wrote:

    The Fools (sic) who gave out sub-prime mortgages to anyone who could breath are not the same folks who run the Bankcard divisions of our largest institutions. They know how to credit score and actually know what they are doing. These institutions have robust collection capacity in place. Current increasing delinquencies are no worse than prior downturns and have been forecast for several quarters-no new news. GAAP accounting policy reuqires Banks to reserve (i.e., reflect the loss in their P&L) in advance of the losses based on increasing delinquencies-most Banks have already taken the P&L charge in prior quareters. No way lines get cut by 60%. I bought 50,000 shares of C at $1.22-its a $10 stock in 6-10 quarters.

  • Report this Comment On March 18, 2009, at 3:12 PM, TMFKris wrote:

    Should I get new credit cards now, if I can, in case the one I have now gets canceled?

  • Report this Comment On March 18, 2009, at 6:51 PM, a65fc wrote:

    Jery20ct,

    The Fools (sic) who gave out sub-prime mortgages to anyone who could breath are not the same folks who run the Bankcard divisions of our largest institutions

    True, but they must have been under pressure to match the vaunted (inflated through leverage) returns.

    They know how to credit score and actually know what they are doing.

    Really? You posted Nov 7, 07 "You are spot on-Citi has no Risk Management." Then again, since then, other than a couple of kids graduating college (pre-paid for, no loans) my credit limit has tripled to mid-five figures. Because I pay it off every month?

    These institutions have robust collection capacity in place

    I sure hope so.

    Current increasing delinquencies are no worse than prior downturns and have been forecast for several quarters

    Please cite your source.

    GAAP accounting policy reuqires Banks to reserve (i.e., reflect the loss in their P&L) in advance of the losses based on increasing delinquencies-most Banks have already taken the P&L charge in prior quareters

    Got me on GAAP, I'm not an accountant, but I'd like to see a source.

    No way lines get cut by 60%

    Agreed. End of the world as we know it.

    I bought 50,000 shares of C at $1.22-its a $10 stock in 6-10 quarters.

    Nice timing on nailing the bottom. I tagged my Outlook for a pop-up at Sept '10 and Sept '11. If you've scored an eight bagger on either date I'll send you a utube link to me eating my hat.

  • Report this Comment On March 18, 2009, at 7:19 PM, Ozcutty wrote:

    This article is true, but the cc companies are closing a lot of inactive accounts. A simple way for then to cope will be to jack up rates back to 19% like the 90's which will probably happen.

    cc are not going away and fees will keep axp and dfs from going bust, not to mention tarp and litigation settlements.

  • Report this Comment On March 18, 2009, at 8:08 PM, xetn wrote:

    Perhaps it would not be a bad thing to eliminate a lot of credit card use and return to a cash basis of purchasing. The US consumer is up to their ears in debt and the stupid government is trying to get everyone to borrow money for purchases that they cannot afford. The biggest thing lacking in the US is real savings; we are actually doing negative savings. Compare that with China where the average saving rate is over 20% and some as high as 50%. The Chinese has virtually debt. Most pay cash for everything including cars and houses. And the Chinese government is actually trying to get them to be more like the US.

    But main issue with a lack of real saving in the US is there is no basis for capital investment in new equipment to spur real economic growth.

  • Report this Comment On March 18, 2009, at 8:41 PM, juliehowe wrote:

    January. I get a letter in the mail about my Chevron/Texaco gasoline credit card, which had a $1000 credit line and a $0 balance.

    Chevron decided that after assessing their risk, et. al, they were going to cut my credit limit down to $100. I called up to bitch about it, figuring they'd tell me to take a long walk off a short pier.

    I told the customer service rep 'Listen. A $100 credit line, that's an insult. It's useless.' She asked me what kind of credit limit I wanted, and I said that $200 would be just fine, enough to cover an emergency purchase of gas, but $100 was a joke.

    The rep puts me on hold and comes back five minutes later, telling me 'Congratulations. We've restored your credit to $2000.' I figured I didn't understand her accent right, until I got my next credit card statement. Yep. Now I have a $2000 credit line.

    Capital One sends me a letter telling me they're going to up my interest rate from 14.9 to 22 percent in May, giving me the option of closing my account and paying off the $300 balance at my current interest rate. So of course I opted to close the account. What do I get with my next statement? News that the credit fairies have lowered my interest rate from 14.9 to 11 percent.

    So these credit issuers don't know their a**es from a hole in the ground.

  • Report this Comment On March 18, 2009, at 9:15 PM, Seano67 wrote:

    "So these credit issuers don't know their a**es from a hole in the ground."

    juliehowe, what's your credit rating like? I'm assuming it's probably pretty good, as otherwise I'm not sure those card issuers would be giving you perks like that, at least I hope they wouldn't.

    I think the people that are perceived and rated as having 'good credit' will most likely continue to get the sugar and the love from their card issuers, in fact they may even get more love now that this credit crisis has unfolded. But it's the people with lesser credit, and the deadbeats, and younger people with little credit history who are really going to see some significant changes in the amount and the terms of credit offered to them. But people with good credit, I think they're all set, as they should be.

  • Report this Comment On March 18, 2009, at 9:47 PM, imsnilloc wrote:

    Banks are curtailing lending via cc. I have a credit score of 740. BOA closed one account due to inactivity. AE raised my interest rate and when I called them I asked them to drop it. They said they couldn't do it this month but try again next month. I told them I'd rather pay it off. They asked me to wait out the month and I agreed. I then figured out how much the month was going to cost me and paid it off. I applied for a 0% Chase card and I was denied due to open accounts ($0 balances) that I could draw from that exceeded my debt to income ratio. I'm in my 40's, stellar credit, but I have a teacher's income...modest but I guess not good enough. I'd close the accts with zero balances but I have had those credit cards and revolving accts for over 10 years. I use them once in awhile and pay off the balance immediately. I figured the length of time I have had the CC's contributes to my high score so I don't want to close them. Some say 60% is too high...I think it might be spot on.

  • Report this Comment On March 18, 2009, at 10:52 PM, theMovement wrote:

    It was surprising how long it took for credit cards to take the hit actually. Heloc loan defaults were increasing at a pace much faster than credit card defaults, this goes against what banks expected because of the collateral tied into helocs/home loans. A lot of management focus went towards that area, so it was just a matter of time until the cards crept up. I bet if they were paying more attention to the credit cards, they would have been lowering lines and doing all of the stuff they are doing now about a year ago. Instead they are reacting to bad stuff already happening. When you react to bad stuff that's already happening, it's already too late. Short those bank stocks because once all those extra credit card loans start going downhill, those bank stocks are going to lose all those gains they made the past week or two. They'll work their way back up eventually, but definitely the recent gains were a little too soon IMO.

    Yes jerry20ct, I agree that banks do reserve money to reflect losses in advance, but if I was to guess, I would say that it is very very unlikely that they were reserving at a loss rate of 10%!!! As for delinquency percentages not being any worse than prior downturns..... maybe the percentage is not worse, but I guarantee you that credit card outstandings are way way way way way higher than they were the last time there was a downturn and if you are considering the 2001 bubble burst a downturn, credit card delinquencies are going to be worse than they were at that time.

    Check this out............

    http://www.federalreserve.gov/releases/chargeoff/chgallnsa.h...

    http://www.federalreserve.gov/releases/chargeoff/delallnsa.h...

    2002 chargeoff was higher than 4Q2008, but 4Q2008 delinquency is the highest it's been since the numbers were tracked starting in 2001. The delinquency figure is what you want to look at because that is your pipeline for chargeoff, so actually we are pacing to have the worst chargeoff since the article tracked the data. THIS IS VERY VERY BAD FOR BANKS WITH A LARGE CREDIT CARD PORTFOLIO!!!!!

    You haven't heard about the credit card issue because banks were busy putting resources and brainpower towards band aiding the home loan related losses. The only reason you're hearing about credit card stuff now is that it's starting to get really bad. They are throwing out % numbers to the public now, wait until you hear the $'s that are represented by those %'s. Also if you've been tracking banks stocks............ good news for one bank seems to be making all bank stocks go up, so when more and more of this bad credit card news comes forward, expect those banks stocks to go down down down...... all of them! This is not news that will just hurt one bank........ most banks offer credit cards.

    I would say find what banks have a credit card portfolio that is managed/serviced by another bank, so they should be in a safer position, but unfortunately I don't think you can do that because the general public emotion will not decipher between those banks and will likely drive them (safe and non-safe banks) all back down. Way down back to where we were. That delinquency figure is a good one to watch on that link above. Once you see that going down, that means that chargeoffs will start to go down again and we should be in the clear for a recovery.

    Don't listen to people rambling on and on about what they think these stocks will do (I know a good bit about banks in particular, but I don't want you to listen to me either!). What everyone needs to learn to do is to find out what drives these businesses, find out what leading indicators are for losses, and then be responsible for finding this information from really reliable sources and then making their own judgments. Take the emotions and guesses out of it and look at the facts. Delinquencies are going up, so losses are going to go up. When delinquency starts to go down, chargeoff will go down.

    Bookmark these pages and you on your own can figure out pretty easily the future health of banks..........

    http://www.federalreserve.gov/releases/chargeoff/chgallnsa.h...

    http://www.federalreserve.gov/releases/chargeoff/delallnsa.h...

  • Report this Comment On March 19, 2009, at 7:56 AM, chopchop0 wrote:

    Visa has a huge moat of debit card business to fall back on.

    Long on Visa --- 2011+

  • Report this Comment On March 20, 2009, at 7:00 PM, holosys wrote:

    A friend in Vegas let his ego ride on his perfect FICO score which he loved rubbing everybody's noses in. The sweet whiff of a perfect FICO score turned sour in 2008 when out of the blue, his major credit cards (Visa, MasterCard, American Express, Discover, and various GE Money accounts) cut $200,000 in credit lines (from a box of credit cards that looked like a trading card collection) to less than $2,000. Many cards cut his lines to just above the balances.

    He didn't save a dime because he figured $200,000 in credit limits was sufficient for a "rainy day". Now the economy is in the eye of a hurricane, and like in a disaster movie he sees a wall of water from the storm surge.

    A tsunami of credit card mayhem has recently arrived in his mailbox. Some cards and GE Money have cut his credit limits way below his balances, and a few are attempting to stick overlimit fees they manufactured by lowering limits, in a sensitive place where the sun doesn't shine.

    Worse, his FICO score is no longer perfect, but has dropped to under 600. Credit card collection agents with weird names (mainly angry sounding women with male names, maybe it's a requirement for women employees to avoid sexual harassment when calling cardholders?) are filling his voice-mail and his cell phone is ringing off the hook.

    He paid off his home equity line with an inheritance, figuring it would act as a "savings account" while saving interest. That line was frozen even when his FICO score was still perfect.

    I've just described a friend who defines his self-esteem by a perfect FICO score, no late payments in over 30 years, and a "platinum" AMEX card with once "unlimited" charging capabilities that now declines charges under $100. This individual is as good as it gets.

    I figure if the credit card companies are killing the proverbial goose that laid the golden egg, then we're witnessing the total annihilation of the credit card industry as we know it, and possibly moving away from the "cashless society" foretold by futurist visionaries.

  • Report this Comment On March 20, 2009, at 7:12 PM, holosys wrote:

    EPILOGUE

    As an afterword to my previous message, my friend gave this advice to anyone with high credit card limits who may need the cash for a "rainy day" (or cold day in hell).

    His advice in a nutshell:

    (1) Take cash advances on all your credit cards TO THE LIMITS and deposit these funds in an FDIC insured money market fund (making sure not to exceed the $250,000 insured limit per account).

    (2) Use online banking to automatically transfer enough money to a checking account used for making monthly online payments to these credit cards.

    (3) Set up automatic payments online for each credit card (set to make the minimum payment from checking account in previously mentioned in (2) on the day after automatic transfer from money market fund.

    (4) Cut all consumer spending to ZERO (adopting a "bunker survival mentality" and transfer any excess cash regularly into same money market fund.

    (5) Monitor each credit card online regularly and be prepared to immediately pay it down if the limit is lowed to below the outstanding balance, using funds from the money market fund.

    DO THE SAME FOR HOME EQUITY LINE(S) WITH AVAILABLE CREDIT.

    And his final grim warning: Don't wait. The bottom could fall out any moment. It is too late for him, but he hopes others can learn from his misery.

  • Report this Comment On April 02, 2009, at 6:14 PM, Sandra1361 wrote:

    I too have had the same issue. I had 3 accounts in good standing with GE Moneybank, not missing one payment and one card was completely paid in full. Received letter that they are now closing all 3 cards due to Consumer Reporting Agency information, which I have no current deliquencies at all. Reason stated certain trade-lines close too limits. I guess paying bills every month on time means nothing any longer, you pay something off, gets closed. Yet we are bailing out everyone who took out bad loans, not paying credit at all, and banks that stole and gave bad loans. They should get NOTHING, all this has done is hurt all of the average middle class people that are paying bills on time suffer, while executives are partying at our expense. SOMETHING truly needs done with this. Pretty soon I guess credit score will have to be a perfect 850 to qualify for anything, meanwhile, those are the people who really do not need the credit anyway. What happened to freeing up credit, seems banks are closing credit lines to the people who have done everything right. HELP US ALL

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