In the space of six months, global money markets have been turned upside down and profits at financial institutions worldwide have taken a severe hit following a downturn in the US housing market, which has led to rising levels of subprime mortgage defaults and the ensuing credit crunch that has fanned out into the global economy.
One domino effect from the subprime fallout that markets are already witnessing is a marked rise in bad credit card debt. As the holiday season approaches, there are fears that over $400 billion of US credit card debt could be dragged into the black hole of the credit squeeze, as American consumers resort to other forms of borrowing as their mortgage credit ultimately exhausts. This situation has only been aggravated by banks that pushed increased credit card borrowing with less than stringent lending standards as the mortgage market became less enticing.
Credit card delinquencies may rise
As American homeowners file for bankruptcy and lose their houses to foreclosure in droves, there is a growing fear that credit card delinquencies will begin to rise. Capital One, the largest independent credit card issuer in the US, has already reported a rise in delinquency rates and accordingly adjusted its forecast for 2008 credit losses up to $5.5 billion (see CI 391). Credit card companies across the board are setting aside larger reserves against default losses from people failing to pay their bills.
These concerns were articulated by HSBC, when the bank was forced to make an extra $700 million write-down in its third-quarter figures. The bank warned that this was a direct knock-on effect from its subprime mortgage business onto its consumer lending business, with most of these figures attributed to motor loans and bad credit card debt.
Much like the subprime mortgage loans, more than one-half of all US credit card debt – totalling over $920 billion – was bundled up and sold off across the globe to investors. Furthermore, the level of this securitised credit card debt has risen steeply in the past 12 months, according to ratings agency Standard & Poor’s, which reported a $40 billion increase during this period. It will remain difficult to gauge exactly how big the spill into the consumer arena has been while the housing crisis continues to unfurl. However, should delinquency rates start to shoot up, it will be the larger pension funds and mutual funds that primarily deal in this securitised credit card debt that will be affected, rather than the Wall Street banks.
“We haven’t seen problems in consumer loans outside of the mortgage arena. They still keep up their credit card payments and auto payments. If we see an increase in losses then there would be reason to worry,” according to David Wyss, the chief economist at Standard & Poor’s who compiled the data, speaking at a conference on banking organised by the credit rating agency.
Low credit card debt
So while it is clear that the problems faced in the housing market are beginning to seep into other areas of consumer finance, what remains unknown is the actual level of subprime debt within the US credit card market as a whole. Overall, the level of credit card debt is at a historically low level, but analysts fear that more increases in losses could gravely destabilise the market.
Before the credit squeeze this year, delinquency rates on cards had been dropping since 2002. While the new bankruptcy laws that came into force in 2005 caused a spike in delinquency rates at the end of that year, they appear to have flushed the most skittish credit cardholders out of the system. Some of the more optimistic observers believe that the mortgage meltdown may even help the industry by bringing back consumers who had previously used the equity of their homes as a means of accessing quick cash.
However, the securitisation market remains the albatross around the neck of the credit card industry. Investors caught out by mortgage-backed securities are now fearful that other securitised products are about to slide. Additionally, there is the risk that the subprime mortgage meltdown will have a backhanded effect on the credit card industry through the employment market. If a slowdown in the housing market leads to increased layoffs, unemployed workers are likely to cut back on credit card spending. And since the majority of Americans do not have a large savings cushion, an increase in unemployment could lead to a sharp rise in credit card defaults. According to a report recently published by research organisation Demos, US homeowners cashed in $1.2 trillion in home equity over the past six years to pay off debts and cover living expenses, further threatening their financial security.
As these problems continue to beleaguer the US and by extension the European markets (notably with Discover’s recent announcement that it intends to write down the value of its Goldfish credit card business in the UK by up to $422 million), consumer finance in other parts of the world is comparatively buoyant. In Latin America, the large under-banked population has gained access in recent years to a diverse range of products and services, as major financial players have begun to turn their attention to the region and its growing economies.
The two biggest players in global consumer finance – GE Money and Citi – are increasingly reliant on international markets as US growth flattens. GE Money is active in six Central American countries – Guatemala, Honduras, El Salvador, Nicaragua, Costa Rica and Panama – and in several Asian markets including the Philippines, South Korea and China.
While global profits for GE Money were healthy for the third quarter of 2007, figures for the Americas region were down by 4 percent. As a result of this, the company’s overall numbers dragged due to the increase in delinquency provisions for its US book. Unsurprisingly, this has caused GE Money to look abroad for further growth. It currently has plans to incorporate a subsidiary bank in Shanghai, and has a 43 percent stake in both Hyundai Capital and Hyundai Card in South Korea, offering consumers various loan products, mortgages and credit cards. The company is also targeting emerging banking markets such as Taiwan and Thailand, and is hoping to achieve a $100 million net income within five years.
In Europe, GE Money is involved in numerous projects, including a consumer finance venture with Turkey’s Garanti Bank, and has formed joint ventures with several Spanish savings banks to provide consumer loans and credit cards. The company is also very keen on the Russian consumer finance market, having begun operations there in 2004. GE Money revenues and net earnings increased 12 percent and 15 percent in 2006, respectively, with nearly $1 billion of revenue added in the form of acquisitions. However, a substantial part of these net earnings was from lower-taxed earnings from its global business.
Citi looks overseas
Likewise, Citi has been increasing its overseas operations as its US consumer base has begun to tail off as a major revenue driver. International card purchase sales have grown 6 percent between the second and third quarters of 2007. Year-on-year, its international consumer revenue growth has grown by 35 percent, while the year-to-date growth is an impressive 22 percent.
In particular, Citi has achieved impressive levels of growth from its Japanese consumer operations. Card purchase sales were up 37 percent in the third quarter of 2007 from the same time last year, while card loans also managed a 52 percent increase for this period. By comparison, card purchase sales in the US market were up by only 6 percent.
Citi’s international cards operations offer a variety of cards products to almost 21 million accounts in 42 countries outside of the US. Income rose by 17 percent by year-end 2006 from the year-ago period and US card income grew by 41 percent during this time. The credit crunch appears to have brought an end to these types of numbers for their domestic market.
Citi had made a concerted attempt to drive growth from business abroad recently. This month, the bank paid nearly $425 million for Taiwanese local lender Bank of Overseas Chinese, and sees the Taiwan market as one of great potential. Citi is divided into three major business groups: Global Consumer, Global Wealth Management and the newly formed Citi Institutional Clients group. Citifinancial, the group’s consumer finance arm, generated approximately 55 percent of the Global Consumer Group’s overall profits. Of this, its cards operations constitute nearly 40 percent. In Mexico, Citi operates under the Banamex brand; the country’s largest bank, it is now fully owned by the group.
Yet with the US standing on the edge of a recession, the buoyancy of these international markets will be sorely tested as the effects of the global credit crunch worsen. Should the price of oil continue to surge, the threat of corresponding rises in inflation, energy and fuel costs, and consumer goods will undoubtedly have a knock-on effect for consumer spending across the globe.