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Next challenge for banks: Credit card losses

It used to be easy to guess how many Americans would have problems paying their credit card bills. Banks just looked at unemployment: Fewer jobs meant more trouble ahead.
/ Source: The New York Times

It used to be easy to guess how many Americans would have problems paying their credit card bills. Banks just looked at unemployment: Fewer jobs meant more trouble ahead.

The unemployment rate has long mirrored banks’ loss rates on card balances. But Eddie Ward, 32 and jobless, may be one more reason that rule of thumb no longer holds. For many lenders, losses are now outpacing layoffs.

Mr. Ward lost his job at a retail warehouse in April and so far has managed to make minimum payments on his credit card debt, which he estimates at $15,000 to $20,000. Asked if he thinks he will be able to pay off his balance, he said, “Not unless I win the lottery.”

In the meantime, he said, “I’m just doing what I can.”

Even if Mr. Ward can pay off his debts, experts predict that tens of thousands of Americans will not be able to, leaving a gaping hole at ailing banks still trying to recover from the housing bust.

The bank stress test, released last Thursday, found that the nation’s 19 biggest banks could expect nearly $82.4 billion in credit card losses by the end of 2010 under what federal regulators called a “worst-case” economic situation.

But if unemployment breaches 10 percent, as many economists predict, the rate of uncollectible balances at some banks could far exceed that level. At American Express, Citigroup, and J.P. Morgan Chase, one-fifth of the credit card balances are expected to go bad over the next 20 months, according to stress test results. At Bank of America and Wells Fargo, about a quarter of card loans are expected to sour.

Even the government’s grim projections may vastly understate the size of the banks’ credit card troubles. According to estimates by Oliver Wyman, a management consulting firm, card losses at the nation’s biggest banks could exceed $141.5 billion by 2010 if the regulators’ loss rate was applied to their entire credit card business. It could reach $180 billion for the entire credit card industry.

Regulators only published losses on credit cards held on bank balance sheets in the official stress test results. The $82.4 billion figure did not reflect another element included in their analysis: tens of billions of dollars losses tied to credit card loans that the banks packaged into bonds and held their off-balance sheets.

What is more, the peak unemployment level that regulators used to drive their loss estimates was not much worse than what current rates are on track to reach. That suggests the test results could reflect actual losses, rather than the worst-case scenario that regulators projected.

And many economists expect the number of job losses to climb even higher. On Friday, the unemployment rate reached 8.9 percent as the economy lost 539,000 jobs. The unemployment rate and the rate of credit-card charge offs, bank lingo for uncollectible balances, are traditionally closely aligned because consumers that lose their jobs are more likely to miss their payments.

Banks wrote off an average of 5.5 percent of their credit card balances in 2008, while the average unemployment rate was 5.8 percent. By the end of the year, the rate of credit-card write-offs was 6.3 percent; more recent data was not available.

Experts predict that the rate of credit-card losses could eventually surpass the jobless rate because of the compounding effects of the housing crisis and lackluster consumer confidence. Shortly after the technology bubble burst in 2001, credit card loss rates peaked at 7.9 percent.

“We will blow right through it,” said Inderpreet Batra, a partner at Oliver Wyman, a consultancy specializing in financial services.

After writing-off about $45 billion in bad debts during 2008, credit card lenders are bracing for the worst year in the industry’s history. Not only are losses spiraling, but lawmakers are on the verge of passing a set of tough new consumer protections that could have a devastating effect on profits. This week, the Senate is expected to take up the so-called Credit Cardholders Bill of Rights after the measure passed in the House with a strong bipartisan vote of 357 to 70.

President Obama over the weekend pressed lawmakers to sign the credit-card reforms into law by Memorial Day, and he plans to push the cause again at a meeting this week in Albuquerque, N.M.

The legislation would curb the ability of card issuers to raise interest rates retroactively on consumers and reduce hidden fees and penalties.

For the banks, the economics of the credit-card business are increasingly troubling. As the recession has dragged on, existing cardholders have sharply reduced spending. New customers with strong credit rates are increasingly hard to find.

And the most troubled borrowers are so deeply mired in debt that card companies are willing to strike deals to remove late fees and reduce card loan balances. The average American household is saddled with nearly $8,400 of credit card and other revolving debt, according to Economy.com analysis of government data.

Every major credit card issuer has been approving fewer new applicants, reining in credit lines and canceling unused accounts. Lenders are also eliminating teaser rates and ratcheting up interest rates and penalties for existing borrowers. With the sweeping regulatory changes and relatively few signs that the economy stabilizing, the amount of credit available to consumers will continue to shrink.

Meredith A. Whitney, a prominent banking analyst, expects credit card lenders will cut the lines of credit they extend to borrowers by a total of $2.7 trillion through 2010. That is equivalent to a 57 percent reduction in the credit they made available two years ago at the height of the boom.

Within the card industry, all eyes are focused on a significant increase in unemployment. Capital One, for example, had a charge-off rate of 9.5 percent in its domestic card business for the first quarter. “We expect further increases in the U.S. card charge-off rate through 2009 as the economy continues to weaken,” Gary Perlin, the company’s finance chief, said on a conference call with investors in late April.

At Citigroup, executives noted that the company’s 10.2 percent credit card charge-off rate for the first quarter had broken “historic correlation with unemployment” and showed no sign so far of letting up.

American Express, whose first quarter credit card charge-off rate of 8.5 percent tracks roughly with current unemployment levels, said it expects higher losses in the coming months.

Cindy Schneider, a 53-year-old from Connecticut, is a long way from being confident about her finances.

She is not making any money from her job as a realtor and cannot find work elsewhere. Her husband’s pay was just cut 10 percent. And she worries about how they will pay off a $5,000 balance on their credit card.

When her credit card company recently raised her interest rates, saying she was three days late with a payment, she transferred the balance to another card with a lower rate.

“We are borrowing from Peter to pay Paul,” she said.

This article, "Rising Credit Card Losses Are Next Challenge for Banks," first appeared in The New York Times.