Dire times are coming for consumers who hold credit cards and the banks that issue them, according to a report released Tuesday.
The report by the research firm Innovest Strategic Value Advisors, titled "Credit Cards at the Tipping Point," predicts that fallout from the credit crunch will lead to a sharp increase in credit card defaults in the coming year, making $1 out of every $10 owed on credit cards impossible to collect. That will force banks to write off nearly $100 billion in credit card debt, it said.
"A long build-up in consumer indebtedness, deteriorating economic conditions and a potential 'sudden stop' in credit availability could cause charge-offs to rise dramatically into 2009," the report says.
Misleading practices by credit card issuers will come back to bite them, say report author Gregory Larkin and Laura Nishikawa, as uninformed consumers who wind up facing surprise interest rate hikes and fees will be more likely to default on their loans. The report concludes that Capital One is most at risk, due in part to its aggressive marketing and "fee-trapping" strategies.
"The data points to an unsustainable business model based on penalty pricing, and the company is worst-in-class by Innovest standards," the report said.
Innovest is an international research firm which analyzes companies based on environmental, social and corporate soundness; it was among the first to criticize the subprime mortgage lending business and downgraded now-defunct Bear Stearns in 2006, when its stock was still riding high.
'Credit card business is exceptionally resilient'
A spokeswoman for Capital One said she hadn't seen the report and was unable to comment on it, but pointed towards reassuring comments made by CEO Richard Fairbank at a recent equity analyst conference.
"In our U.S. card business, we're taking many actions to navigate the current downturn," he said. "The credit card business is exceptionally resilient, with high risk-adjusted margins and a business that doesn't suffer the issues of collateral value that currently plague in particular the mortgage industry."
But charge-offs at Capital One have already reached 6.3 percent and are climbing rapidly, according to the Innovest report.
Meanwhile, there are plenty of other indicators of looming trouble for other credit card issuers, according to the authors, who also analyzed Bank of America, JP Morgan Chase, Citigroup, Discover and American Express.
As previously reported, card issuers are lowering consumer credit limits and discontinuing balance transfer discounts in an attempt to reduce their risk from consumers who may be unable to pay their bills. Many consumers who may have considered tapping home equity to pay off their credit cards can no longer do so.
One obvious sign of coming distress for the credit card market: In a recent Federal Reserve survey cited by the report, 83 percent of major credit card issuers said they had tightened their lending standards, compared to 45 percent just three months earlier.
Borrowing more, paying less
But efforts to limit exposure may have come too late.
Data collected by Innovest shows that many borrowers are already running higher balances and making smaller monthly payments. Only 1 in 5 Citibank customers pays bills in full each month; fewer than 1 in 10 Bank of America customers do so, and rates of full payment are dropping at both firms. Meanwhile, the average balance at Citibank is up 20 percent compared to last year.
"This could be an early sign of borrower distress, which could lead to higher delinquencies in the next few quarters and higher loan losses moving forward," the report says.
Bank of America already has acknowledged trouble in its credit card business. On Oct. 6, the firm said in its earnings report that it would write off $1.24 billion in credit card losses in its third quarter, roughly 50 percent higher than the previous quarter.
"We've seen, even in the last 45 days, things worsen," CEO Ken Lewis said during a conference call with analysts.
Larkin and Nishikawa say that the worst of the credit card defaults may still be a year off, as credit card debt isn't discharged until 60 days after completion of a bankruptcy case, or 180 days after nonpayment.
"The high charge-off rates today are in part reflecting economic troubles from two quarters back, and that the full extent of the current pressure on borrowers will only be felt in 2009," the report said.
Other details from the report:
• Outstanding credit card debt has grown by more than 75 percent since 1999.
• Risky borrowers with low credit scores -- subprime borrowers -- account for roughly 30% of outstanding credit-card debt.
• Washington Mutual (now JP Morgan's headache) had the highest subprime exposure of major lenders, with 48 percent of receivables held by subprime borrowers. By comparison, about 30 percent of receivables at Capital One and Bank of America are owed by subprime customers.
• More than 50 percent of Capital One's cards are "low-limit" cards, which Innovest said are designed as fee traps -- consumers with low limits are more likely to surpass those limits and face penalty charges. (CEO Fairbank maintains that low-limit cards are simply a smart way to manage risk)
• Perhaps not coincidentally, Capital One received the most complaints during the last year among credit card issuers at the Better Business Bureau -- nearly 8,000. JP Morgan, by contrast, received only 273.
Despite its grim tone, the report notes that even a worst-case scenario collapse of the credit card market would not damage the overall economy the way the housing market meltdown has; it's simply a much smaller problem. The U.S. mortgage market, with about $11 trillion in outstanding loans, dwarfs the credit card market, with about $1 trillion in outstanding balances.