A massive tidal wave of bad credit card debt is surging toward Wall Street, prompting more investor panic and pushing more consumers to the brink of financial devastation.
That’s according to Innovest Strategic Value Advisors, an international investment research and advisory firm. Its latest report, “Credit Cards at a Tipping Point,” forecasts that credit card charge-offs by financial institutions will reach near $100 billion by the end of 2009.
Charge-offs are when credit card accounts have been deemed irrecoverable or there has been no payment for 120 days, according to Innovest.
The economy already is shaky under the crushing weight of the mortgage crisis, and this will only add to that instability, said Gregory Larkin, senior analyst with Innovest.
“This is really going to start registering in the first quarter of 2009, when we’re looking at about $18.5 billion to $20 billion of charge-offs, and by probably the (end of) 2009 we’re probably looking at between $96 billion and $102 billion, and then after that we think it will start to taper off,” he said. “In our view, it’s at least a 12-month cycle. We’ve never seen credit cards default at this level before, so this is going to break the record.”
Evidence of increasing credit card charge-offs is mounting. Last week, Citigroup announced its fourth straight quarterly loss and said more of its credit card holders in North America became delinquent, and more had to be written off. Its credit card loss rate jumped to 7.3 percent from 6.46 percent in the second quarter and 4.37 percent a year ago.
A prolonged recession and accompanying job losses likely will precipitate more credit card defaults as consumers find themselves without the income necessary to stay afloat, said Dennis Hoffman, professor of economics in the W.P. Carey School of Business at Arizona State University.
“There is a fragile situation, but it is sustainable as long as the jobs are sustainable,” he said.
There will be additional defaults and losses to financial institutions if the economy continues to sour, but it won’t be anywhere near as severe as the mortgage debt crisis, said Ken Clayton, senior vice president/general counsel of the American Bankers Association Card Policy Council.
“What you’re seeing is the natural evolution where economic times have gotten harder and more people are going to have trouble,” he said. “But the numbers are still within historical norms. Delinquencies and 30-day late (accounts) are around 4 percent. They’re ticking up, but they’re still within historical norms.”
WE'LL ALL PAY
Most large lenders already have greatly tightened credit-card lending standards, and that’s likely to continue as charge-offs escalate, Larkin said.
Companies like Discover, American Express and Capital One rely on credit cards for the majority of their net revenue, according to Innovest. Large universal banks like Citibank, Bank of America and JP Morgan Chase are also vulnerable to credit cards losses, Larkin said.
“There’s this massive backlog of bad debt,” he said. “Is there going to be some sort of debt-forgiveness holiday? I don’t think so. I think there’s a lot less regulatory incentive for the government to step in and help anyone here just because they’ve got to focus on the mortgage mess right now.”
The practice used by some consumers for transferring their credit card balance from one card to another offering a lower interest rate is drying up and will likely disappear as charge-offs escalate, Larkin said.
“No bank wants to be the lender of last resort to someone who is severely indebted right now,” he said. “Every bank wants to prove that they can keep charge-offs and delinquencies down, that their borrowers are healthy and their customers are healthy. They don’t want to be seen how Washington Mutual is seen.”
There’s good reason to worry if you’re someone who lives beyond your income and depends on transferring debts to new, low-interest credit card accounts, Larkin said.
“If you’re one of those people, it’s going to be tough,” he said. “If they’re someone who lives within their means and doesn’t spend money on something they can’t afford, then they don’t need to worry.”
As soon as default rates jump, lenders will raise interest rates “on the rest of us,” Hoffman said.
“They have the power to do that,” he said. “They’re not going to lose. They’ll find somebody to sting, that’s for sure.”
The effect on heavily indebted consumers is going to be “very, very painful,” said Michael Sullivan, director of education at Take Charge America, a Valley-based, nonprofit credit counseling agency.
“A lot of people are going to be in trouble because ... credit cards were their last resort,” he said. “When you cut out credit cards, they don’t have home equity loans, they don’t have savings, they don’t have anyplace to go. I think we’re going to see some pretty horrendous and difficult stuff here in the next two years as this happens.”
ON THE EDGE
For the past decade, consumers have been taking on more debt while their savings and real wages have declined, Larkin said. Real wages have grown by only 4 percent since 1999 while outstanding credit card debt has risen by more than 75 percent during the same period, he said.
A rise in unemployment and a decrease in disposable income, coupled with record high food and gas prices, are squeezing household cash flows even further, he said.
Mortgages were the first part of this “deterioration of credit quality” and credit cards will be the next, Larkin said.
“From a timing perspective, we think that mortgage owners who aren’t able to repay their mortgages ... you’re going to see those same people start losing out on their credit cards,” he said. “It’s sort of a chapter two, and then it’s also a different movie altogether. There’s overlap and it’s also distinct to some extent.”
Many consumers are able to stay financially afloat and keep up with their monthly debt payments as long as their income isn’t interrupted, Hoffman said.
“That’s why the credit card business is so lucrative, because credit card interest rates are so high and these people just keep paying the minimum balances every month, and these lenders have made a lot of money and continue to make a lot of money off the interest,” he said. “Certainly people at low-income levels have far more amounts of credit today than they have ever had historically, and what all that depends upon is an economy that does not go into a severe recession.”
It’s not hard to see that more people are reaching a critical point with their credit card debt, Sullivan said.
“We have people who all they need is some advice,” he said. “We say to them 'you make enough ... you can do this, just hunker down.’ Then we have the second group where we say 'yeah, you do need some help, so we’ll put you on a debt-management plan ... and pay off this debt.’ And then there’s this third group that we indeed look at and say, 'there’s no way you could ever pay off this debt and we suggest you talk to an attorney.’ We’re seeing more and more of that third group, and less and less of that first group.”
Unlike the mountain of mortgage debt, credit card accounts are coveted by most lenders because they continue to provide a strong and reliable revenue stream, Hoffman said.
“These mortgage debt claims got passed from institution to institution,” he said. “These credit card accounts are held very preciously by these credit card companies, and they are streams of revenue that they covet and they maintain internally. They’ll do a lot to continue to allow that (delinquent) borrower increasing amounts of rope to continue that stream of payments coming in, even if they can make partial payments.”
The mortgage crisis is much deeper because the amount of bad debt involved is approaching $1 trillion, Larkin said. In comparison, $96 billion in credit card charge-offs looks small, he said.
“Having said that, the banks will absorb those losses,” he said. “But the market is very skittish right now, they’re panicked right now, and if banks announce an earnings surprise or if they come in under estimates, investors are going to panic and drive their stocks way down. So there’s sort of a fear multiplier that you need to take into account given the current market situation that we’re in.”
According to Innovest, the lenders that likely will suffer the largest losses will be:
• Those that aggressively loaned to demographic groups with questionable ability to repay.
• Those that have made it nearly impossible for consumers to repay their balances by piling on fees and penalties, and unexpected interest rate increases because of changes in their overall credit situation.
“What that means is you have a stockpile of customers who maybe were very lucrative when times were good, but now they’re going to have a broken back with all the debt that they have,” he said. “You’re not going to get anything, not $100, not $300, nothing.”
Credit card companies act prudently to reduce the level of risk to their portfolios, Clayton said.
“What we try to do is keep the price low for people who pose less risk and gradually increase that price for people who pose higher risk,” he said.
“Does it have an impact on people who get into trouble? Absolutely, and that’s why they should call their card company and see if they can work their way through it.”