Friday, November 13, 2009

Credit Card Companies Face a Grim Future

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By Josh Lipton

The past quarter century was a fun one for the American consumer. But after all that borrowing and spending, consumers have re-discovered the benefits of thrift and prudence. This is good news for personal balance sheets, but bad news for credit card companies.

In a recent report, Fitch Ratings forecast that US credit card issuers will continue suffering with respect to their earnings over the near term as a result of the lousy labor market, bankruptcies, and losses.

The report, as summarized here for us by the gang at Zacks Equity Research, notes that major credit card issuers are still dealing with tough losses as the US unemployment rate hurdled over 10%.

“Also, as it is expected that the rate will remain above 10% through 2010, consumers will increasingly fall behind on payments,” write the crew at Zacks. “As a result, the losses of the credit card issuers could worsen further.”

Fitch’s rating outlooks are negative on the less diversified credit card companies, which are at risk of a downgrade. That hit list includes: Capital One Financial Corporation (COF), American Express Company (AXP), and Discover Financial Services (DFS).

According to Fitch, prime credit card delinquencies of 60 days or more climbed 16 basis points to 4.22% in October. The rating agency forecasts higher loss rates in 2010.

Additionally, more trouble for these companies is coming in the form of the Credit Card Accountability, Responsibility, and Disclosure law signed by President Barack Obama in May 2009.

Key components of the act include an inability to raise rates on existing card balances, a requirement to maintain promotional rates for at least six months, and a restriction on fees for subprime, low limit cards. See also The Gall in Your Credit Card's Fine Print.

Most of the new requirements will take effect in February 2010.

At the same time, write the analysts at Zack’s, consumers have been transitioning from credit cards to debit cards (See Seven Ways to Avoid the Debit Card Blues). So the credit card companies don’t have much room for improvement until the economy starts to enjoy a sustainable recovery.

But there are more than just near-term speed bumps for these companies. Strategists say these shops are getting squeezed and that’s a headwind they could face for some time.

The models and analyses of these companies, so these market pros write, assumed that the borrowing-and-spending binge in the US would go on forever.

However, those go-go years came to a screeching halt as unemployment spiked higher. The unemployment rate jumped to 10.2% in October from 9.8% in September, and is now just 60 basis points shy of taking out the post-World War II high of 10.8%.

When will the unemployment picture begin to brighten?

According to our central bankers, we shouldn’t hold our collective breaths.

Dr. Janet Yellen, president of the Federal Reserve Bank of San Francisco, recently said that “unemployment could well stay high for several years to come… [and] our recovery is likely to feel like something well short of good times.”

Her colleague, Mr. Dennis Lockhart, the president of the Federal Reserve Bank of Atlanta, didn’t sound too much more optimistic, saying that he expects to see “very slow net job gains… sometime next year.”

Given that backdrop, it's thoroughly unsurprising that you and your neighbors are now more interested in saving rather than spending. No data captures that shift more clearly than the contraction in US consumer debt.

In September, total consumer credit fell $14.8 billion, making it the eighth month in a row of debt repayment. This, say economists, is an unprecedented string of declines. See also Could You Get Cut Off From Credit?

Dr. Gary Shilling, the noted economist, strategist, and founder of A. Gary Shilling & Company, recently told clients that he would steer far and wide of credit card companies.

“Recent developments are virtually all negative for the credit card business now and for years to come,” Dr. Shilling wrote in his most recent research note, adding, “With the switch from a quarter century consumer borrowing-and-spending binge to a long run saving spree, the credit card business has moved from a growth industry to a laggard.”

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