As recession deepens, unemployment rises
and losses deteriorate, no one was expecting a miraculous
turnaround in the fortunes of the US credit card industry. As
results for 2008 show just how much the industry is being hit, the
scale of the crisis is now all too apparent. Charles Davis

US purchase volumeIn a surreal indication of the
growing sense of crisis enveloping the US cards industry, the
nation’s largest issuers are reeling as the finances undergirding
their operations free fall beneath them.

Analysts are openly discussing what even
weeks ago seemed unfathomable: that the nation’s largest issuer,
Citigroup, could sell off its consumer finance arm, including
portions of its credit card operations, as the troubled company
tries to raise cash and downsize its once-mighty operations.

Then again, no one could have foreseen
Citi executives gravely announcing a net loss of $8.29 billion in
the fourth quarter, or a loss of $18.72 billion for the full year.
It’s a loss so staggering in proportion that suddenly, all options
appear to be on the table for Citi, including the sale of card
assets once considered the envy of the industry.

End of the supermarket

As Citi downsizes, it may dismantle its
longtime financial supermarket model that has provided financial
services to consumer, investment and commercial clients around the

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Analysts said that could include Citi’s
private-label credit card operations, including cards offered by
such retailers as Home Depot and Office Depot – but the question
remains whether there are any with the size and balance sheet
strength to emerge as potential buyers. General Electric’s GE Money
unit last year failed to generate interest from buyers when it
tried to sell its own $30 billion retail card portfolio.

Citi’s global cards division reported a
fourth-quarter net loss of $610 million. Compare this to last year,
when Citi’s card operations earned $934 million in net income.

Card revenue during the fourth quarter,
which ended 31 December, was $4.6 billion, down 27 percent from
$6.3 billion during the same period in 2007. The bank increased the
card division’s provision for loan losses, benefits and claims to
nearly $3 billion during the quarter, up 67 percent from $1.8
billion a year earlier. The issuer lost 7.75 percent of its net
card receivables during the quarter, up 297 basis points from 4.78
percent year over year.

“It is unclear how closely credit loss
behaviour in the current recession will correlate with the 1990s
recession,” Gary Crittenden, the bank’s CFO, told analysts during a
conference call announcing the losses. “Loss rates in cards have
now surpassed their historic highs.”

Spending volumes

Average receivables dropped to $191.3
million during the quarter, down 2 percent from $195.1 million a
year earlier, and the bank reported 175.5 million open card
accounts as of the end of the quarter, down 7 percent from 188.6
million a year earlier. Even more troubling for the short term,
Citi reported that global purchase volume dropped 15 percent, to
$102.7 billion from $120.3 billion.

Companywide, the bank has lost about $18
billion in the past four quarters. It is also sitting on a
portfolio of toxic assets that have been marked down from their
original value by some $49 billion during the same time frame. In a
credit cycle that is expected to be more severe than any other in
the past, global credit ratings agency Standard & Poor’s
(S&P) anticipates that the bank will have another tough year
and possibly four more quarters of losses this year, according to a
new report issued on 8 January.

The report also underscores that potential
losses on other types of assets are not covered by any government
guarantee, including those in the credit card business, losses
which the report cites will likely surpass those recorded in
previous credit downturns. Some $166 billion in foreign consumer
loans are also outside any implicit US government guarantees.

Meanwhile, Bank of America’s (BofA)
decision to buy the brokerage Merrill Lynch – a deal lauded at its
inception at least in part for the cards-related opportunities
presented – looked increasingly shaky as the brokerage firm ran up
losses of $15.3 billion in its final quarter as an independent
institution. The US government was obliged to step in with aid of
$20 billion to persuade BofA to stick with its purchase.

BofA revealed that it had suffered a
quarterly loss of $2.3 billion but this was dwarfed by the
liabilities discovered at newly-acquired Merrill Lynch.

On a conference call, BofA CEO Ken Lewis
admitted that he had not anticipated a “significant deterioration”
in Merrill’s finances that occurred in mid-to-late December. He was
persuaded to stick with the transaction by the US Treasury and the
Federal Reserve, which are anxious to avert the failure of any more
Wall Street firms.

“The government was firmly of the view
that terminating or delaying the closing of the transaction could
lead to significant concerns and could result in significant
systemic harm,” said Lewis. “We just thought it was in the best
interest of our company and our shareholders and the country to
move forward.”

Charge-off rates

BofA’s card services segment reported a
net loss of $204 million for the fourth quarter ended 31 December.
Net cards-related income for the year fell 85.5 percent, to $521
million from $3.6 billion in 2007. More ominously, BofA reported a
net charge-off rate of 7.16 percent of credit card receivables for
the quarter, up 241 basis points from 4.75 percent a year earlier.
The bank’s net charge-off rate for the year was 6.18 percent, up
139 basis points from 4.79 percent in 2007. The company reported a
30-day delinquency rate of 6.68 percent of card loans outstanding
for the quarter, up 123 basis points from 5.45 percent during the
same period a year earlier.

“We’ve continued to see increased
delinquencies across our card portfolio, even more so in the states
most affected by housing problems,” Joe Price, BofA CFO, told
analysts during a teleconference. “California and Florida make up a
little less than a quarter of our domestic consumer card book but
represent about a third of the losses.”

Between them, Citi, BofA and Merrill lost
a sum in the quarter exceeding the annual gross domestic profit of
Ethiopia. The size and speed of the losses indicated that the
credit crunch is getting worse, rather than easing, with credit
cards joining mortgages and credit derivatives among firms’ most
troublesome operations.

The news from JPMorgan Chase was
dramatically more upbeat, as the bank reported a $702 million
profit for its fourth quarter, topping forecasts, although cards
represent a major area of losses.

The bank posted the profit despite
recording more than $2.9 billion in losses in a range of corporate
and consumer businesses, from trading to credit cards and mortgage
lending, as it confronted the worst housing and job markets in
decades. The profit was well short of the $2.97 billion JPMorgan
earned in the fourth quarter of 2007, but it surpassed analysts’
expectations of flat earnings, if not a loss.

JPMorgan nearly tripled its reserves
against potential loan losses, to $8.5 billion, and CEO Jamie Dimon
hinted that the bank might have to prepare for even more pain

“If the economic environment deteriorates
further, which is a distinct possibility,” he said, “it is
reasonable to expect additional negative impact on our
market-related businesses, continued higher loan losses and
increases to our credit reserves.”

Dimon made a point to stress that the
company was continuing to make new loans, issue new credit cards
and maintain existing lines of credit, even as the it tightens
underwriting standards and the appetite for credit remains

Despite the happier overall results,
JPMorgan reported a $371 million loss in net income for its card
services unit for the fourth quarter, down from net income of $609
million during the same period in 2007. Revenues for the unit were
$4.91 billion, up almost 23.7 percent from $3.97 billion, boosted
by Chase’s acquisition of Washington Mutual last year.

Contributing to the loss was a 121.8
percent increase in loan loss provisions, to $3.97 billion from
$1.79 billion. Average managed loans during the quarter totalled
$187.3 billion, up 23.5 percent from $151.7 billion a year earlier.
Net charge-offs for the quarter, including Washington Mutual’s card
portfolio, jumped to 5.56 percent of outstanding receivables
compared with 3.68 percent a year earlier.

Rising concerns over bad

On top of a meltdown in the mortgage
market, experts are becoming increasingly concerned about banks’
exposure to bad debt on credit cards. As the unemployment rate
rises, a surging number of jobless cardholders are struggling to
make repayments.

In yet another sign of mounting stress on
US consumers, Fitch Ratings said that retail credit card
charge-offs are poised to surge in the coming months as more
borrowers fall into delinquency. With consumers scaling back
purchases and lenders actively curtailing credit overall, retailers
are already navigating a difficult holiday season, and increased
borrower defaults on store cards will complicate matters further in
2009, according to Fitch managing director Mike Dean.

“Rising delinquencies will pressure card
issuers and their retail partners during the coming year as Fitch
expects a scenario akin to nearly one in eight cardholders
defaulting on their store cards,” said Dean. “Despite the worsening
credit quality, negative retail card asset-backed securities (ABS)
rating actions are not expected near term given the current robust
levels of excess spread available to cushion Fitch’s rising
charge-off expectations.”

According to the latest Fitch Retail
Credit Card Index results, 60+ day delinquencies have risen nearly
24 percent since August, reaching 4.8 percent in the most recent
period. As a result, Fitch expects charge-offs to exceed 12 percent
in first half 2009 from current levels of 9.1 percent. While in
line with historical averages, the current charge-off index is more
than 40 percent above 2007 levels.

Fitch said that despite the deteriorating
credit quality environment, excess spread levels for retail card
portfolios remain robust and should insulate against any negative
retail card ABS rating actions near term. Excess spread on retail
card trusts is bolstered by the relatively high portfolio yields on
those portfolios, reflecting the generally higher annual percentage
rates (APRs) charged to cardholders.

Another major US issuer, Capital One,
reported that its US card segment’s net charge-off rate increased
to 7.71 percent of card receivables in December, up 73 basis points
from 6.98 percent in November. Capital One’s 30-day delinquency
rate rose to 4.78 percent in December from 4.7 percent a month
earlier, according to a company filing with the US Securities and
Exchange Commission.

Ramifications for the

Not all the news is as grim. Despite
widely reported increases in credit card charge-offs, delinquencies
on those loans actually declined in the third quarter of last year,
according to American Bankers Association (ABA) data. The
percentage of card accounts more than 30 days delinquent fell 34
basis points from the previous quarter, to 4.2 percent, according
to the ABA, which marks the lowest the association has reported for
card delinquencies since the third quarter of 2007.

A major issue going forward is access to
capital, even as the federal lending rate drops to near-record
lows. Fund-raising through private sources has become virtually
impossible for the banking industry, which commands little
confidence among investors.

Recognition is growing among Washington’s
new Democratic administration that bad assets must somehow be
purged from banks’ balance-sheets before they will freely make new
loans. Citi has already had more than $300 billion of toxic assets
bailed out and guaranteed by the government; its apparent intention
to create a separate entity for its unwanted assets is a more
straightforward echo of the “good bank/bad bank” approach used in
Sweden’s much-vaunted bail-out of the 1990s.

If the universal banking model in the US
is indeed dying, the question of what happens to the massive card
portfolios inevitably follows. Sales of some parts of portfolios
long thought out of reach could find their way back on the block,
the ranks of issuers reconfigured and perhaps, an era of massive
consolidation undone, at least in part, by the economic

US Issuers: Fourth quarter 2008 results