When Cate Colombo was hired by credit-card giant MBNA in 2001, she had no idea what she was letting herself in for. The advertisement called for a customer services representative, but within weeks she was expected to pressure-sell credit to the group’s customers. “It was like a boiler room,” she told ABC’s Nightline show recently – “we were offloading up to $25,000 an hour, with colleagues gathering to chant ‘sell, sell’.” In short, her job was to persuade elderly customers of the merits of taking out fresh $100,000 loans.
Credit-card groups weren’t the only firms to set aside all scruples during the credit binge, but their stocks have suffered less from the backlash that has hit banks and mortgage lenders. Now that’s about to change. As unemployment heads to 6.5% in America, credit-card firms are being hit with an acceleration in delinquencies. Losses on bad debts have risen to 6.6% of total balances, compared to 4.6% a year ago. In the coming months, these will pass the US historic high of 7.5%, says Sandra Ward in Barron’s. Financial research group Innovest estimates that credit-card issuers will have to deal with $96bn of rotten debt this year alone.
For big issuers such as Bank of America – the second-largest in the US – digesting bad debt will be an ugly task. If a mortgage goes bad, at least there is some collateral to reposses. Credit card issuers have nothing to recoup when a big spender stops paying. And subprime borrowers are a huge headache, says Jessica Silver-Greenberg in BusinessWeek. Risky borrowers with low credit scores account for roughly 30% of outstanding credit-card debt, compared with just 11% of mortgage debt. Even relatively prime American Express card holders are suffering. It’s had to raise provisions from $810m to $1.5bn in the last quarter.
Things are even turning sour for those card groups who don’t carry consumer debt. Visa and Mastercard, for example, make their money by typically charging merchants a 2% transaction fee every time someone uses a card they sponsor to make a payment. But as they fall behind on their monthly payments, Americans are taking the scissors to their credit cards. As banks continue to tighten access to credit, there will be a lot a lot less plastic being swiped in shops and on garage forecourts.
Consumers are not alone in turning against credit-card groups. In recent weeks, federal regulators have initiated the most sweeping changes to the industry in decades, slapping tough measures on issuers designed to curb the more abusive practices in the industry. So some of the most popular means of boosting revenue – hiking interest rates on outstanding balances and changing billing practices – are now banned. For example, customers must now be given 45 days’ notice before any changes are made to terms. These changes could cost the industry more than $10bn a year in interest payments, according to a study by law firm Morrison & Foerster.
Even more troubling, the industry remains cut off from its prime source of funding – the asset-backed securities (ABS) market. Just as they did with mortgages, banks bundled up consumer credit-card balances and sold them off to big investors, such as hedge funds and pension funds. The biggest issuers offloaded roughly 70% of their credit-card debt in this way. But since the ABS market froze up last September, nobody is buying these securities.
So with consumers, lenders and the government turning on credit-card groups, it can’t be long before investors do too. Their last recourse is Federal support, says Ward. American Express has sought bank-holding status, making it eligible for funding from the Fed’s Troubled Asset Relief Program (TARP). More may follow. We look at some of the credit-card groups in the biggest trouble below.
Investors should steer clear of credit card groups
Many card firms followed other financial stocks as they plunged last year. American Express was no exception, sinking 60% from its May peak. But banks that issue credit cards, such as Bank of America (NYSE:BAC) and JP Morgan Chase (NYSE:JPM), haven’t seen the worst yet. The bad news, says Sandra Ward in Barron’s, is that losses from bad card debt will rise from 6.6% now to more than 10% over the next two years. The same goes for Visa and Mastercard, who can in theory make money from card transactions in good times or bad, provided consumers keep spending. But as card transaction volumes fall, so will share prices. And both are expensive, with Mastercard on a forward p/e of 14.9 and Visa on 17.
That’s one reason why American Express – largely a transaction processer – is trying to convert to bank holding company status. That way it might qualify for federal money under the Treasury’s TARP plan. Discover, which saw first-quarter losses hit 6% of outstanding debts, up from 4.4% a year earlier, plans to do the same. Ward picks out Capital One (NYSE:COF) as the best-placed credit issuer to withstand the coming storm. Having recently snapped up Chevy Chase Bank, it has pretty secure funding, she says. But even Capital One could fall by as much as 24% in the next 12 months, according to Merrill Lynch analyst Kenneth Bruce. We’d steer clear of the lot.