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March 26, 2009

Fitch warns of record defaults to come

With unemployment at a record high, US issuers are bracing themselves for an acceleration in credit card defaults and delinquencies in the months to come, and a combination of factors is also exerting pressure on gross yields As the US economy continues to deteriorate, the stress on cardholders is growing, with consumers falling further behind on their credit card bills, setting the stage for record default rates in the months ahead, according to global credit ratings agency Fitch.

By Verdict Staff

With unemployment at a record high, US issuers are bracing themselves for an acceleration in credit card defaults and delinquencies in the months to come, and a combination of factors is also exerting pressure on gross yields. But some issuers are taking a series of pre-emptive pricing steps, as Charles Davis reports.

As the US economy continues to deteriorate, the stress on cardholders is growing, with consumers falling further behind on their credit card bills, setting the stage for record default rates in the months ahead, according to global credit ratings agency Fitch.

January marked the second consecutive month that US credit card delinquencies recorded all-time highs, according to the latest Fitch Credit Card Index results. At January month-end, the 60-plus day delinquency rate was 4.04 percent. The index has surged more than 23 percent in the last three months and the latest figures are 30 percent above historical averages. The index measures the percentage of credit card receivables that were reported more than 60 days past due through January.

“Record credit card delinquencies are just the latest sign that US consumers are under considerable levels of stress,” said Michael Dean, managing director of US consumer asset-backed securities (ABS) for Fitch Ratings. Record delinquency rates are a harbinger of record default rates, according to the report.

“The latest numbers point to even higher default rates and worsening consumer credit quality measures in the coming months,” Dean said.

Near-term rise in charge-offs

Credit card issuers typically charge off receivables after 180 days of delinquency or within 60 days of a bankruptcy filing. This month’s rise in delinquencies indicates that gross charge-offs, at 7.40 percent as of the end of January, are likely to rise significantly in the near term.

“As the unemployment rate accelerates and consumers’ ability to service their debt weakens, Fitch anticipates that gross charge-offs will surpass 8.5 percent by mid-year and approach 9 percent by year-end,” said Cynthia Ullrich, Fitch’s US consumer ABS senior director.

Despite the trends, Fitch anticipates downgrades will be limited in credit card ABS, particularly at the ‘AAA’ level, given available credit enhancement levels and proactive efforts by issuers to stem the deterioration and preserve existing ratings.

Among other credit card ABS performance measures, the three-month average excess spread increased to 5.8 percent from 5.43 percent. Fitch expects an additional 100 to 200 basis points of compression in excess spread in the coming months as charge-offs mount.

Fitch said that the rising level of delinquent debt combined with seasonal effects is exerting incremental downward pressure on gross yield. Fitch’s gross yield index, currently at 16 percent, has trended into near-record low territory over the last year due to reductions in the prime lending rate, the index to which most credit card receivables are linked. The only lower reading of gross yield was 15.86 percent in February 2004.

At 17.15 percent, monthly payment rates continue to slow from the 20 percent levels experienced in 2006 and 2007 when delinquencies were lower, consumer spending was robust, and refinancing opportunities were plentiful.

Consumers rein in spending

Making matters worse, US consumers have been holding back on their spending as the recession grabs hold. With the unemployment rate at 8.1 percent, a 25-year high, Americans are hoarding cash for fear of losing their jobs. And with the Dow Jones Industrial average and the S&P 500 stock indexes bouncing off 12-year lows and home prices sinking across the nation, consumers have watched their wealth deteriorate.

Fitch expects credit card ABS performance to worsen further given recent delinquency and bankruptcy trends and the rise in unemployment levels. Nevertheless, negative rating actions are expected to be limited in the near term. Charge-offs and delinquencies are likely to rise for at least another year, Fitch said.

“US consumers continue to struggle in the face of mounting pressures on multiple fronts from employment to housing to net worth,” Dean said. “While we expect these issues to further impact credit card ABS performance going forward, available credit enhancement and structural features help reduce the risk of widespread downgrades.”

Anticipating that the worst is yet to come, US issuers are raising credit card fees, rolling out new fees and reining in card issuance to offset record delinquencies and rising charge-offs.

Wells Fargo recently increased late fees and cash advance fees, JPMorgan Chase instituted a $120 yearly fee on some cards with low interest rates, and American Express raised its late fee for some business cards.

Many US issuers have raised interest rates for borrowers even as the Federal Reserve has cut interest rates. The issuers are trying to get out in front of a federal regulation that takes effect next year, curtailing their ability to raise rates on existing credit card debt.

The new rules will largely prohibit price increases on existing balances unless the borrower has missed a payment to the issuer. The rules also will require lenders to apply payments to balances carrying the highest interest rates first. Proposed legislation would accelerate the implementation.

But raising prices on credit cards at such a moment in history is fraught with risk on multiple fronts. Those who increase fees first could push customers to other issuers – and risk toppling marginal borrowers into default, something that politicians and the regulators who developed the federal rules will surely notice. And some of the issuers raising rates and fees are the recipients of taxpayer-funded bail-outs, doubling the potential for a populist uprising.

With the US Congress already moving on several fronts to provide even tighter regulation of credit card pricing, issuers find themselves in quite a pinch. In a January letter to Senator Robert Menendez, a Democrat from New Jersey, who had urged issuers to adopt the new federal rules quickly, Ryan Schneider, the president of Capital One’s card business, wrote that, in view of the deterioration in the economy and credit quality, “it is imperative that credit card issuers maintain a reasonable degree of flexibility to reprice accounts to reflect the risk environment.”

It is only responsible for issuers to consider “changes to accounts whose terms do not appropriately reflect these increased risks or are simply misaligned with the new regulatory structure,” he added.

It may be responsible, but it is deeply unpopular. The Fitch delinquency data might help convince sceptical legislators that a price increase today is better than a default tomorrow.

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