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Are You Ready for Credit Card Meltdown?

I think I’m gonna hurl. From MSN Money Central:

Borrowers falling behind on their payments. Defaults rising. Huge swaths of loans souring. Investors getting burned.

But forget the now-familiar tales of mortgages gone bad. The next horror for beaten-down financial companies is the $950 billion worth of outstanding credit card debt — much of it toxic.

Innovest estimates that credit card issuers will take a $41 billion hit from rotten debt this year and a $96 billion blow in 2009.

What’s more, the Treasury Department’s $700 billion mortgage bailout won’t be a lifeline for credit card issuers.

Sure, the credit card market is just a fraction of the $11.9 trillion mortgage market. But sometimes the losses can be more painful. That’s because most credit card debt is unsecured, meaning consumers don’t have to make down payments when opening their accounts. If they stop making monthly payments and the account goes bad, there are no underlying assets for credit card companies to recoup.

With mortgages, in contrast, some banks are protected both by down payments and by the ability to recover at least some of the money by selling the property.

Risky borrowers with low credit scores account for roughly 30% of outstanding credit card debt, compared with 11% of mortgage debt. More than 45% of Washington Mutual’s credit card portfolio is subprime, according to Innovest.

That could become a headache for JPMorgan, which agreed on Sept. 25 to buy the troubled thrift’s credit card business and other assets for $1.9 billion. Says a JPMorgan spokeswoman: “We are aware of the credit quality of (WaMu’s) portfolios and will manage risk appropriately.”

Credit card losses are already taking a bite out of lenders’ balance sheets. Bank of America, the nation’s second-largest issuer behind JPMorgan, revealed on Oct. 6 that roughly $3 billion of its $184 billion credit card portfolio had soured, a 50% increase from a year ago. At the same time, the bank, which is also dealing with the broader financial tumult, said it would have to cut its dividend by 50% and raise $10 billion in fresh capital. The stock stumbled more than 25% the next day when investors largely scoffed at the new shares B of A was offering.

American Express, which caters to wealthier borrowers, upped its provisions for credit card losses from $810 million to $1.5 billion in the latest quarter, a sign that even upscale consumers are having trouble.

The industry’s practices during the lending boom are coming back to haunt many credit card lenders. Cate Colombo, a former call center staffer at MBNA, a big issuer bought by Bank of America in 2005, says her job was to develop a rapport with credit card customers and advise them to use more of their available credit. Colleagues would often gather around her chair when she was on the phone with a consumer and chant: “Sell, sell.”

“It was like ‘Boiler Room,’” says Colombo, referring to a 2000 movie about unscrupulous stockbrokers. “I knew that they would probably be in debt for the rest of their lives.”

Unless, of course, they default. Responds Bank of America spokeswoman Betty Riess: “The allegations do not reflect our practices. The bank has nothing to gain by extending credit to people who do not have the ability to pay us back.”

Even consumers like Michael Polemeni, who miss only a single payment, can find themselves in the crosshairs of credit card companies. The independent computer specialist relied heavily on his credit cards for child-support payments and business expenses. Polemeni generally made more than the minimum payment each month, carrying a balance of about $2,000. But in July he missed a payment, and Providian, owned by Washington Mutual, jacked up his rate from 9% to 30%. “I was shocked because I am a very good customer,” say Polemeni, who paid off the full balance immediately. WaMu didn’t return calls for comment.

Not everyone will be able to pay down their debts like Polemeni. And that could make for a vicious cycle: As credit-card companies raise rates, more consumers fall behind on their payments, which then hurts the issuers. Says Innovest’s Larkin, “We are going to see the banks massively hit.”

Are you ready?

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Posted By: Ashkan Karbasfrooshan | Oct 28th

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