The continuing economic slump in the US
is leading to rising unemployment and slowing consumer spending,
which is having a massive knock-on effect for card issuers. Rising
charge-off rates look set to get even higher even though issuers
are tightening lending criteria, as Charles Davis

The credit crunch has spread from mortgages to commercial
banking to investment banking to consumer lending, and now its icy
hands are on the credit card market.

Mounting credit card losses are causing even more pain for US
financial markets, as an already traumatised industry senses that
credit cards are an inevitable victim of the downturn. Banks are
cutting back on loans to consumers and small businesses as credit
card losses rise. That in turn is hitting bank earnings as well as
key engines of economic activity and job growth as the economic
slump deepens.

August charge-off rates spiked to 6.82 percent from 6.36 percent
in July, Moody’s Investors Service said. Moody’s added the rate
could rise to 7.5 percent by the end of 2009, above the peak of 7.1
percent in May 2003 after the last recession. The drop in August
marks the 13th consecutive month of year-over-year decreases in
repaid credit card debt.

Issuers reducing exposure

Leading issuers have responded with stricter loan terms, lower
credit card limits and reduced card issuance as part of steps to
reduce their exposure to risky loans. In what appears to be a
self-fulfilling prophecy, macroeconomic factors add fuel to the
fire, leaving issuers no choice but to rein in credit.

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The US jobless rate stands at a five-year high of 6.1 percent.
Many economists expect it to rise further, possibly to 7 percent or
higher as the economic slump deepens. While the $970 billion in
outstanding credit card debt is much smaller than the $14 trillion
tied up in mortgage loans, the sense of crisis is no less palpable,
at least in part because the credit card market reaches millions
more American wallets.

Unlike their counterparts in mortgage lending, credit card
issuers have been proactive in scaling back lines of credit,
raising minimum credit scores needed to qualify for loans and
intervening early when they start seeing borrowers slipping into

Capital One said in October it was restricting credit card
issuance after charge-off rates spiked to 6.34 percent in the third
quarter from 3.96 percent in the same period last year. American
Express said it would boost interest rates for higher-risk
customers after third-quarter profit fell as cardholders struggled
to repay debt. Citi, HSBC and Discover, among others, are also
trimming their credit card exposure, including closing inactive
accounts and requiring higher credit scores.

Target, the US retailer whose credit card portfolio totals $8.6
billion, recently said its charge-off rate in September was 10.1
percent. The company said it is tightening credit, even for some
good customers in high-risk areas such as California, which has
been hard hit by the housing slump.

Charge-off rates on the rise

JPMorgan Chase’s forecast that its charge-off rate would be 5
percent or higher was consistent with previous guidance, but now it
projects next year’s rate will range from 6 percent at the
beginning of the year to 7 percent by year-end. It had previously
forecast an average rate of 6 percent for next year.

Bank of America’s charge-off rate increased 44 basis points from
the previous quarter and 173 basis points from a year earlier, to
6.4 percent. The Charlotte, North Carolina-based issuer said the
rate would likely exceed 7 percent if the unemployment rate topped
7 percent.

Citi said most of the $309 million addition to its allowance for
North American credit card losses was associated with a move to
bring receivables back on the balance sheet in response to “rate
and liquidity disruptions in the securitisation market.”

Wells Fargo reported credit card loan charge-offs of $361
million for the third quarter ended 30 September, up 105.1 percent
from $176 million during the same period last year. Nevertheless,
Wells’ card interest income totaled $609 million, up 9.3 percent
from $557 million, and Wells earned $601 million during the quarter
from non-interest fees on credit and debit cards, up 7.1 percent
from $561 million.

The situation is so dire that US issuers have formed the most
unlikely of alliances – with the consumer advocates that do daily
battle with them in the halls of Congress – to urge the government
to allow huge portions of credit card debt to be forgiven, a
turnabout from recent years when the banking industry lobbied
strenuously to make it harder for consumers to erase their credit
card debts in bankruptcy.

Under the groups’ proposal to US Comptroller of the Currency
John Dugan, whose Treasury Department agency oversees national
banks, a new pilot programme – which the banks hope will become
permanent – could involve as many as 50,000 people struggling with
credit card debt. On an individual basis, the amount of debt to be
forgiven would rise according to the severity of the borrower’s
financial situation, up to a maximum of 40 percent.

The issuers may have little choice but to reach for a federal
bailout. The largest credit card issuers – Discover Financial
Services, Bank of America, Citigroup, JP Morgan Chase, Capital One,
American Express and HSBC Holdings – each set aside between $1
billion and $3.5 billion in the third quarter for losses on card
loans as their profits plummeted.

Lenders wrote off an estimated $21 billion in bad credit card
loans in the first half of 2008 as more borrowers defaulted on
payments. With companies laying off tens of thousands of workers in
the crisis, the industry stands to lose at least an additional $55
billion over the next year and a half, analysts say. Currently, the
total losses amount to 5.5 percent of credit card debt outstanding,
and could surpass the 7.9 percent level reached after the
technology bubble burst in 2001.

Moody’s said it expects the industry to remain under pressure
through the end of 2009 as a result of the worldwide economic
crisis and worsening underlying collateral performance as the
credit card asset-backed securities market shows signs of
increasing stress. Although the balance sheet strength and
liquidity of the sectors largest credit card issuers remains quite
strong, the uncertainty and tempo of the turmoil will test even the
industry’s giants’ ability to adapt.