The credit-card industry, which is already under fire from the Obama administration, is getting hit with a double-whammy these days: losses are growing even as fewer people use plastic.
In the last six months, record numbers of consumers have stopped paying their credit-card debt. On top of that, many other consumers are cutting back on their credit-card spending. Both trends are leaving banks that issue credit cards with huge losses.
"Revenues for issuers will be impacted not just by cardholders carrying smaller balances in the future, but even more by a decrease in transaction volume," says Greg McBride, chief economist with Bankrate.com. "Card issuers profit from interchange income every time a cardholder swipes the card."
Though the credit-card problem isn't nearly as big as the housing crisis, experts think it will continue to grow as long as the economy—especially employment—remains weak.
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"Credit card delinquencies mimic the unemployment rate," says McBride. "As jobs go away, as they have, so too does the ability of people to pay their debts."
Calls in Congress and the White House for stronger and tougher rules over how banks handle their credit-card business won't help, either.
"The banks don't need more regulation," says Karen Garrett, a counsel at Bryan Cave, a global business and litigation firm. "The Fed rules that go into effect next year should be enough to help. Banks have to make a profit and people don't have to take that extra credit card just because it's offered in the mail."
In the meantime, the losses are likely to get worse. Credit-card charge-offs by lenders rose to 8.4 percent in February, a record high according to Fitch Ratings. Those charge-offs are expected to reach 10 percent by this time next year.
Americans in total have some $955 billion in credit card debt. According to Fitch Ratings, delinquency rates for credit card payments rose to 4.33 percent in February, the third consecutive record number. The overall delinquency rate has increased 36 percent in the last six months.
The reason for the higher defaults can be traced to the crumbling job picture, say analysts.
"There's a tight relationship between employment and credit card losses," says Mark Sand, chief economist at Modes. "For every point rising in unemployment, there's about a point rise in the credit card charge-off rate."
As credit card delinquencies rise, the use of credit cards is going in the opposite direction, according to the Federal Reserve. The latest Fed data says credit card balances suffered their biggest percentage drop in more than 30 years in February, as consumers reduced their reliance on plastic.
The Fed's report showed revolving credit—a category of loans made up almost entirely of credit card debt—dropped by 9.7 percent in February, the largest decline since a 15.7 percent plunge in January 1978.
And overall, revolving debt fell to $955.7 billion from a total of $963.5 billion in January. Analysts say consumers are changing their habits in a bad economy.
"People are spending less and they are focusing on debt reduction" says Bankrate's McBride. "It's been going on for a while, as we see the economy slow down."
That's leaving banks with less revenues. "Consumers that play the rewards game tend to be high volume, very loyal customers," says McBride. They generate income that's almost risk free. If they stop using the cards, the banks will lose too."
Unlike some borrowers in housing, credit card users were a good risk, according to Sand.
"The quality of credit card borrower was not that bad," says Sand. "Because they had jobs, people thought they could handle their credit debt. Most gave up on their home mortgages first, not their credit cards."
Even as many consumers stop paying their debt, cut back on their credit card use and banks suffer losses, it doesn't mean the industry is in anywhere near as severe a crisis as housing, according to industry analysts.
"Ninety percent of people are paying their credit card bills," says Michael Dean, managing director of Fitch Ratings. "Those people are current in their payments. What's going on with credit cards is bad, but it's not like housing. It's not really a major concern."
The Federal Reserve has approved several rule changes to help consumers. The rules will take effect in July of 2010. They will:
- Forbid banks from imposing interest charges using the two cycle billing method
- Stop unexpected interest charges, including rate increases during first year
- Require that consumers have a reasonable time to make payments
- Prohibit use of payment allocation methods that maximize interest charges
- Keeping banks from increasing interest rates on closed accounts
Banks, even as they come under scrutiny By Congress and the Obama White House for their lending practices, won't be hurt all that much by the credit losses, says Sand.
"The debt is mostly concentrated in a few big lenders," Sand says. "These are the big banks, Citi, Bank of America, JP Morgan. The phrase 'too big to fail' applies in this case.
"Even if ten percent of the $955 billion in credit card debt defaults, it's not the same as what happened on the mortgage front," says Bankrate's McBride. "There won't be a big impact on the banks and the economy."
"I don't believe it's a crisis," says Garrett. "The concern is about the economy and the effect down to consumers who have to pay their credit card debt. But it's not a crisis."
But if anyone thinks a trend to cut down on credit card spending is permanent, they would be wrong says Fitch's Michael Dean. "Using credit cards has become a fabric of behavior," Dean says. "After all the economy returns we expect use to be about the same."
And that could be a problem, says Garrett.
"I think our entire economy has taken on too much debt, from consumers to the government," Garrett says. "I'm not being an apologist for easy credit but people spend the money when they probably shouldn't. We've stopped asking the question do I need this. Instead we ask do I want this."
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