US consumers are being battered with rising
living costs, and as a result credit losses are reaching historical
highs. With the bad news set to continue for the foreseeable
future, Fitch Ratings has released a report outlining the various
factors squeezing profitability for US issuers. Charles
The battered US economy continues to weaken,
and with its deterioration goes credit quality. Fitch Ratings, the
global credit ratings agency, has released a new report that does
little to encourage issuers. It found, as we reach the midpoint of
2008, the American consumer is under greater pressure than ever and
the squeeze is being felt in card portfolios large and small.
“Issuer credit losses have approached, and in
some cases surpassed, five-year historical averages and many
management teams are predicting worsening metrics for the latter
part of 2008 as home price depreciation, rising unemployment rates,
and higher energy prices continue to put pressure on consumer
wallets,” the report said.
“While Fitch believes card issuers have taken
steps to manage the near-term pain, we expect the credit quality
picture to get worse before it gets better.”
The report, Credit Cards: Asset Quality Review,
discusses current asset quality trends in the credit card market
and provides updated growth and asset-quality statistics for some
of the largest credit card issuers. The statistics are a depressing
drumbeat of reality, underscoring just how volatile the consumer
credit markets are, and likely will remain, for the foreseeable

Consumers under pressure

Credit card charge-offs and delinquencies rose rapidly in the
fourth quarter of 2007 and continue to deteriorate in 2008 as
highly leveraged consumers contend with falling home prices, rising
unemployment levels, and higher energy prices.

“Many issuers who had provided full-year credit
guidance in fourth-quarter earnings calls revised or withdrew
credit expectations at the end of the first quarter as portfolio
statistics worsened and economic indicators provide no clear
indication of stabilisation,” the report said.
“Fitch believes credit metrics will continue to
deteriorate over the balance of 2008 and potentially into 2009. The
degree of deterioration will be dependent upon the duration and
severity of an economic downturn and an issuers’ ability to manage
portfolio growth, control exposure to unused credit lines, and
collect delinquent accounts.”
Consumer leverage, as measured by the financial
obligations ratio, rose above 19 percent in the third quarter of
2005 for the first time since the metric’s inception in 1980, and
has remained above that level ever since; the rate currently is at
19.15 percent. According to the Federal Reserve, revolving consumer
credit outstanding amounted to approximately $957 billion at the
end of the first quarter of 2008, which is 7.8 percent above a year
Fitch believes revolving debt will continue to
grow as the availability of term-debt consolidation options, like
home equity loans or cash-out mortgage refinancing, have diminished
The report said falling home prices have
certainly had a negative impact on industry credit metrics, as
issuers have relatively large exposures to borrowers in those
states with the largest declines. According to the Office of
Federal Housing Enterprise Oversight, home price appreciation
declined 10.5 percent and 8.15 percent in California and Florida,
respectively, in the first quarter of 2008. These two states, in
aggregate, represent approximately 18 percent of the US population
according to 2007 census estimates and, on average, the large
credit card lenders have geographic portfolio exposures similar to
the population distribution.

Closer monitoring by issuers

Issuers have responded by slowing growth and exercising more
aggressive line management in those markets. Many have also begun
tracking borrowers by mortgage type (prime/non-prime, fixed
rate/adjustable rate) and risk rating mortgage lenders, when that
information is available, in order to control exposure to the
housing market.

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The unemployment rate is another economic
statistic that can signal deterioration in credit card asset
quality, as borrowers with a decline in household income may begin
to miss monthly credit card payments. The unemployment rate has
been steadily increasing in recent quarters and recorded the
largest monthly increase in 22 years in May, rising 50 basis points
to 5.5 percent.
Fitch has found charge-offs generally trend
with the unemployment rate, so this does not bode well for credit
metrics in the remaining months of 2008.
Credit card delinquencies began to tick up in
the latter half of 2007 and have continued to deteriorate in 2008,
although at a slower pace. Prime delinquencies of 60 days or more
amounted to 3.17 percent as of May 2008; 15 basis points above a
10-year monthly average of 3.02 percent.
Still, performance on US credit card
asset-backed securities remains well within long-term historical
trends and continues to resist the rapid deterioration seen in
certain mortgage-backed securities. Fitch believes underwriting
standards in the credit card space have been more consistent over
time, relative to the mortgage industry.
From a funding perspective, disruptions in the
capital markets combined with deteriorating asset quality
expectations have impacted issuers’ growth plans for 2008,
particularly for those who remain reliant on securitisations for
funding. Credit card asset-backed securities transactions completed
to date in 2008 exhibit higher spreads and shorter durations, the
report found.
The decline in base interest rates has offset a
portion of the wider spreads, but the all-in cost of issuance has
increased as issuers have largely retained notes rated below AAA,
which requires a higher capital commitment to account for the
higher-risk asset on the balance sheet. Additionally, refinancing
risk has increased as issuers have generally issued
shorter-duration paper, expecting funding costs to ‘rationalise’
somewhat before the notes mature.
Excess spread levels have declined for credit
card portfolios, however should still be sufficient to absorb
anticipated higher losses. The prime card index, for example,
reported excess spread levels at 7.5 percent as of May, a healthy
114 basis points above a ten-year monthly average of 6.36
As a result, while Fitch anticipates sector
performance to eventually return to long-term historical trends as
bankruptcy reform benefits continue to dissipate, ratings should
remain stable for the balance of 2008.