Are credit cards the next subprime catastrophe?

Although consumer rates of credit card delinquency are at record levels, credit card exposure will not be a problem on the scale of subprime mortgages. But that's not to say that credit cards are not in trouble, because they are.

Fitch's Prime Credit Card Delinquency Index measures credit card debt more than 60 days late. Through January 2009 that index surged to a record 4.04 percent, exceeding the 3.75 percent record set in December 2008. And in the previous three months, the index climbed 23 percent, putting the index 30 percent above historical averages.

So why won't bum credit card loans create a subprime-level catastrophe? There are three reasons.

  • The amount of securitization of credit card receivables is relatively modest. Of the $63 billion of maturing credit card Asset Backed Securities (ABS) in 2009, Moody's (MCO) said $46 billion is from Bank of America (BAC), JPMorgan Chase (JPM) and Citigroup, Inc. (C). The subprime market was much larger -- $1.5 trillion.
  • Most banks have a relatively low exposure to credit card loans -- although those three banks are most at risk. They represented over half of the estimated U.S. card outstandings as of September 30, 2008. Credit card lending has historically accounted for between 15 percent and 25 percent of pre-tax income at JPMorgan, Bank of America and Citigroup, according to Moody's. However, analysts expect these businesses to shrink as lenders tighten credit standards and cut credit lines.
  • Credit card receivables are not collateralized by hard assets. Unlike mortgages, there is no asset that needs to be thrown onto the market in order to raise cash to offset the loss from the bad loan. Throwing a house onto the market in foreclosure has the secondary economic effects of slamming the value of the entire housing market and damaging the construction and furnishings industries, among others. But with credit card receivables, there are no related assets for banks to sell so the related economic effects are more limited.

With consumers losing their jobs and/or taking pay cuts, credit card losses are likely to rise. Those losses will hurt these three banks more than their peers. But the problem will not be as severe as subprime was.

Peter Cohan is president of Peter S. Cohan & Associates. He also and is the author of You Can't Order Change: Lessons from Jim McNerney's Turnaround at Boeing. He owns Citi shares and has no financial interest in the other securities mentioned.

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