Credit Line Cuts: Less Pain Than We Feared

One rare bit of good news out of the credit card industry: The nearly yearlong fear that banks would arbitrarily slash credit lines has indeed come to pass, but it isn't having a big impact on consumers' credit scores.

A recent report released by FICO -- yep, the organization that assembles your credit score -- shows a few interesting trends:

• From October 2008 to April 2009, banks cut credit lines on 33 million credit card holders.
• Roughly 73% had no dings on their credit reports (like missed payments) that would indicate being a higher risk.
• Within this group, the average cut was $5,100, or about 14% of their total credit line.
• The average impact to credit scores for the group with no dings on their credit was trivial. Half actually saw their credit scores go up.

This is good news for consumers. Since late last year, it's been a given that credit card-issuing banks like American Express (NYSE:AXP) and Capital One (NYSE:COF) would hunker down and de-risk themselves, annihilating open lines of credit. And since one aspect of calculating FICO scores is a consumer's used balance as a proportion of their available balance (the "utilization rate"), a big fear was that dying lines of credit would wreak havoc on credit scores. That process could eventually feed on itself, with declining lines of credit leading to declining credit scores, leading to declining lines of credit ... and around we go.

Why hasn't that happened yet? FICO's general manager and vice president of scoring had this to say:

[M]any people whose limits were reduced lowered their balances on other revolving accounts and in general managed their credit conservatively. These practices resulted in their ability to sustain or improve their scores despite reductions in their credit card limits.

In other words, even though the denominator (available line of credit) shrank, the numerator (debt balances) declined as well.

The amount of extended credit was horrifyingly high to begin with, but the fear was that banks would slash indiscriminately, wiping out credit for even the most responsible spenders (they do exist, you know). Busts, like bubbles, find comfort in the extremes. A big slump in credit availability also bites into Visa (NYSE:V) and MasterCard (NYSE:MA), both of which rely on consumers' ability to swipe freely and frequently. This stuff ain't fun to deal with. It's credit card hell, really.

The question now is how much deeper banks will cut. Are more cuts coming? Are they done? No one really knows for sure. The rate at which the biggest players have been scaling back hasn't been uniform:

Sources: Company filings.

Earlier this year, one estimate predicted the amount of card lines that could vanish would hit 60% of the total, or about $2.7 trillion, by the end of 2010.                                              

If that actually happens, the line-of-credit massacre might just be warming up, and the self-fulfilling negative impact on credit scores could begin. Why? Because credit card companies can cut lines of credit more easily, quickly, and sustainably than consumers can counteract by paying off debt.

So, sure, this is good news for now. But we're hardly out of the woods just yet -- a general theme in the economy these days, if you haven't noticed.

What do you think? Have a personal story about the effects of a credit line cut? Feel free to share your thoughts in the comment section below.

For related Foolishness:

• Get Ready for Credit Card Hell
• American Express Just Can't Quit You
• An Inside Peek at Consumer Confidence