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November 18, 2007 • By Leslie A. Pappas
The News Journal
The avalanche that began months ago with struggling homeowners missing mortgage payments rumbled through Wall Street again last week, dragging prices down in a volatile three-week skid.
"Right now, I think we're on the cusp," says Red Gillen, senior analyst at Celent, a Boston-based financial consulting firm. "The situation is ripe for a serious problem in the credit card industry. What you need is a recession to make it happen. When people start losing jobs, then you'll have a problem."
At first, the slide of subprime mortgage problems seemed destined to roll only over hapless homeowners and risk-taking lenders. Then investors in mortgage-backed securities began to realize that they, too, had planted stakes in risky ground.
In recent weeks, the credit crumble took billion-dollar swipes out of the nation's largest banks. A wrap-up of recent write-downs on mortgage-related businesses: Bank of America, $3.3 billion; Barclays, $2.7 billion; HSBC, $3.4 billion; Merrill Lynch, $8 billion; Citigroup Inc., a whopping $11 billion. Last week, even traditionally low-risk money market funds and municipal bonds found themselves ducking for cover.
Could the nation's credit card industry, which employs 15,498 people in Delaware, be the next victim in the downslide's path?
"Everybody's asking that question," said Ken Paterson, a credit card analyst at the Mercator Advisory Group. "Today's answer is that the only people who really know are people who are managing card portfolios."
There are many signs the answer to the question should be no, Paterson said.
In the first place, cardholders still seem to be managing their credit card debt pretty well and continuing to make payments each month.
In fact, aside from a one-time spike at the end of 2005 before new bankruptcy laws went into effect, credit card delinquencies and defaults at the nation's top 100 banks have been dropping since 2002.
Holding on to their cards
The new bankruptcy code, which made it more difficult for consumers to walk away from credit card debt, flushed many of the shakiest credit card customers out of the system when it took effect last year.
Those who were strong enough to remain now seem intent to hold on to their cards. In fact, recent studies show some people choosing their credit card over their home, letting properties go into foreclosure but paying the credit cards on time.
There is even reason to believe the problems in the nation's housing markets could help the credit card industry by bringing consumers back to cards after years of tapping into home equity.
"Home equity loans have been stealing market share that would have been credit card market share for the past four or five years," said Jim Stewart, a credit card industry veteran now running Epic Research LLC, a financial service direct marketing company in Wilmington. Formerly president of Barclays' Wilmington-based credit card operations and a top executive at Juniper, First USA, and Bank One, Stewart remembers closely monitoring the home equity markets.
"We looked at that every month: mortgage debt growth against the credit card business," Stewart said. "It was dramatic what was going on."
Today, as banks tighten up on lending and the value of homes begins to fall, it's getting much more difficult for consumers to use their home as an ATM. With consumers less able to tap into the equity of their home for quick cash, they may put more spending on credit cards.
Nevertheless, there is still a very real possibility that the subprime mortgage slide could drag the credit card industry down with it.
One of the big 'ifs' lies in the securitization market.
Like mortgages and auto loans, most credit card debt is packaged into securities that can be sold to investors. For years, securitization allowed banks and other lenders to take loans off the balance sheet and raise capital to grow their business. Home-grown MBNA Corp., now part of Bank of America, was an early pioneer of securitization in the late 1980s, packaging and selling billions in credit card loans.
Securitization is what ties struggling homeowners to high-flying Wall Street investors. For years, happy homeowners pulled Wall Street higher. Today, many of those homeowners have fallen into foreclosure, and they're pulling investors down with them.
Whole market 'shaken up'
Investors stung by losses in mortgage-backed securities are beginning to wonder if the other securities they hold are about to go soft. That means investors are scared to buy asset-backed securities and companies trying to raise capital can't sell them.
"All of Wall Street right now, there is a credit crunch going on," said A. Michael Mancini, vice president of investments at Ferris Baker Watts Inc., a brokerage in Wilmington. "The whole securitization market is shaken up."
The banks, too, have become skittish about all types of loans going bad.
"Credit card companies are setting aside larger reserves against default losses from people failing to pay their bills, a sign that they expect more non-payment," said Justin McHenry, research director at IndexCreditCards.com. "Also, I think subprime credit card borrowers are going to find it harder to get their hands on credit cards. Credit card companies make a ton of money in fees off of bad credit customers, but in today's market, the risk associated with the worst borrowers is becoming much greater."
Subprime problems could affect the credit card industry indirectly if it causes problems in the labor market, said Scott Hoyt, director of consumer economics at Moody's Economy.com.
Credit and the job market
If a slowdown in housing leads to layoffs, unemployed workers are likely to cut back on credit card spending. And since most Americans have little savings to fall back on, an increase in joblessness could lead to a spike in credit card defaults.
"The most important driver for the credit card market is the labor market," Hoyt said. "Do we keep adding jobs or don't we?"
Last week, 339,000 people filed new unemployment claims in the United States, an increase of 20,000 from the prior week — though unemployment remains low overall at 4.7 percent. In Delaware, unemployment rose in October to 3.4 percent, up from 3 percent in September.
Jose A. Garcia, senior research and policy associate for the economic opportunity program at Demos, a New York-based advocacy group, said the possibility that strapped consumers will be using credit cards more doesn't bode well for companies in the long run.
"They'll see an increase in lending," Garcia said of the credit card companies. "They won't necessarily see an increase in people paying back."
American homeowners cashed in $1.2 trillion in home equity over the last six years to pay off debts and cover living expenses, Garcia wrote in a recent Demos report, "Borrowing to Make Ends Meet."
Credit debt and foreclosures
Credit card debt may have even contributed to the foreclosure problems.
Close to half — 48 percent — of subprime loans taken out in the second half of 2006 were cash-out refinances, according to The Mortgage Bankers Association.
Gladys Brister Spikes, director of Housing Opportunities of Northern Delaware, said 70 percent to 80 percent of her clients facing foreclosure at one point refinanced to consolidate debt.
As home equity dries up, credit card issuers may see delinquencies go up, says Mary Monahan, partner and senior analyst at Javelin Strategy and Research.
"There will be a ripple-down effect," Monahan said. "If people can't get a home-equity loan, they're going to be squeezing their credit cards."
The biggest danger for credit card companies is that even their best customers might cut back on spending out of fears about recession.
A third of U.S. consumers plan to cut back on their spending in response to the subprime mortgage crisis, an October study from London-based market research firm TNS found.
And that has experts using the R-word. If the subprime avalanche pulls the economy into recession, experts agreed the credit card industry will be hard hit.
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