Financials May Face Credit Card Crisis

A white paper by Mathias Kruettli at RGE Monitor predicts total 2009 credit card write-downs by banks to be between $64 billion and $146 billion, compared with $50 billion in 2008. Already crippled by the subprime mortgage crisis and the ensuing recession and credit crisis, credit card defaults act like a landmine in the midst of U.S. commercial banks’ path to recovery. And if the write-downs themselves do not represent enough of a threat, then consider the fact that like mortgage-backed securities, credit card portfolios have been widely securitized.

Kruettli points out that, as of September 2008, total nominal outstanding revolving consumer debt, which mostly consists of credit card debt, has reached $970 billon. As layoffs continue to pile up in the U.S. economy, the default rate on credit card debt is likely to increase, forcing banks to charge-off portions of their portfolios. This situation could result in the failure of undercapitalized banks that heavily participate in the credit card market. However, because nearly half of the outstanding credit card debt in the U.S. has been packed into asset-backed securities and sold in the financial markets, it will, once again, be difficult to determine how much of the loss a particular bank would suffer.  Also, due to the securitization of the debt, the damage may not be limited to banks.

Using an econometric model and adjusting for certain variables, Kruettli determined a best-, average-, and worst-case scenario for 2009 credit card write-offs. The average scenario (credit card charge-offs of $100 billion) is twice the 2008 amount of approximately $50 billion.

This is an advance warning to investors that the credit crisis is not over. The crisis that began with subprime mortgage defaults will soon spread to subprime credit cards and probably auto loans as well. This will hit banks at a time when they are using federal funds to recover from the mortgage calamity. How long can the government continue to issue debt and print money to keep the financial industry afloat? I don’t know, but let us hope that it can until financial markets can function on their own, laid-off workers can get jobs, housing prices stabilize (simply stop going down, that is – there likely won’t be an increase for several years), and consumer spending returns (at a sustainable level allowing for household saving).

One final note: anyone considering buying stock in financials should be aware that the top 3 issuers of general purpose credit cards (based on outstanding debt) are not credit card companies, but banks. Those three, in order of outstanding credit card debt are JPMorgan Chase, Bank of America, and Citigroup (if the credit card crisis hits hard, I think Citigroup will be sold for its parts). The next three on the list are the credit card companies one would expect: American Express (Amex converted to a bank holding company); Capital One; and Discover Card.

[SOURCE: A Forecast of Write-Downs on U.S. Credit Card Debt in 2009, Mathias Kruettli, RGE Monitor, December 2008]