The troubles sound familiar:
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.
That's bad news for players such as JPMorgan Chase and Bank of America that have largely sidestepped -- and even benefited from -- the mortgage mess but have major credit card operations. They're hardly alone. The consumer-debt bomb is already beginning to spray shrapnel throughout the financial markets, further weakening the U.S. economy.
"The next meltdown will be in credit cards," says Gregory Larkin, a senior analyst at research firm Innovest Strategic Value Advisors.
Adds William Black, the senior vice president of Moody's Investors Service's structured finance team: "We still haven't hit the post-recessionary peaks (in credit card losses), so things will get worse before they get better."
What's more, the Treasury Department's $700 billion mortgage bailout won't be a lifeline for credit card issuers.
The big companies say they're prepared for the storm. Early last year, JPMorgan started reaching out to troubled borrowers, setting up payment programs and making other adjustments to accounts.
"We have seen higher credit card losses," acknowledges JPMorgan spokeswoman Tanya Madison. "We are concerned about (it) but believe we are taking the right steps to help our customers and manage our risk."
How would raising interest rates help?Some banks and credit card companies may be exacerbating their problems. To boost profits and get ahead of coming regulation, they're increasing interest rates. But that's making it harder for consumers to keep up and will make tomorrow's pain worse.
Innovest estimates that credit card issuers will take a $41 billion hit from rotten debt this year and a $96 billion blow in 2009.
Those losses, in turn, will wend their way through the $365 billion market for securities backed by credit card debt. As with mortgages, banks bundle groups of so-called credit card receivables, essentially consumers' outstanding balances, and sell them to big investors such as hedge funds and pension funds. Big issuers offload roughly 70% of their credit card debt.
But it's getting harder for banks to find buyers for that debt. Interest rates have been rising on credit card securities, a sign that investor appetite is waning. To help entice buyers, credit card companies are having to put up more money as collateral, a guarantee in case something goes wrong with the securities. Mortgage lenders, in sharp contrast, typically aren't asked to do this -- at least not yet. With consumers so shaky, now isn't a good time to put more skin in the game.
"Costs will go up for issuers," warns Dennis Moroney of Tower Group, a consulting firm.
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.
Bad credit factors into subprime equationMaking matters worse, the subprime threat is also greater in credit card land. 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.