Banks Hoard Cash as Credit Card Defaults Rise
Thursday, October 16, 2008
Consumers are increasingly unable to pay off their credit cards, forcing banks to hoard cash to protect against future losses and lend to fewer people, according to reports yesterday from several of the nation's largest banks.
These financial disclosures showed a spike in credit card loans going bad, putting further pressure on already-stressed balance sheets. J.P. Morgan Chase said the number of credit card loans in default rose 45 percent in the third quarter from the comparable period a year ago and predicted that default rates would sharply accelerate through 2009, with 7 percent of credit card loans going bad.
"We have to be prepared that it gets a lot worse," J.P. Morgan chief executive Jamie Dimon said about the overall economic outlook.
Capital One, a credit card lender and bank based in McLean, announced rising default rates and delinquencies in its portfolio of credit cards and auto finance loans yesterday. The company said 6.34 percent of credit card loans went into default last month, up from 5.96 percent of loans in August. The company has said it expects default rates to rise to 7 percent next year.
The deterioration in consumer credit, the latest downturn to whack Americans after the housing slump and mortgage meltdown, threatens one of the linchpins of the U.S. economy. Over the past 10 years, credit card debt has gone up 75 percent as Americans' real wages and savings rate have stayed flat. That means Americans have been spending beyond their means -- and fueling economic growth with borrowed money.
Now, the housing crash, financial downturn and contracting economy have made it more difficult for Americans to settle their bills, setting off a downward spiral. As people fail to pay off their credit card bills and other loans, banks must put away money to cover expected losses. So banks lend less. Americans who tended to rely on loans to fuel their spending must cut back, readjusting their spending habits to conform with what they earn.
"Given that the savings rate has been minuscule, there's no reserves in the tank for the consumer to tap his savings to support his spending," said Scott Valentin, a financial services analyst at Arlington investment bank Friedman Billings Ramsey. But consumers have been driving about two-thirds of the U.S. economy.
Overall, the rate of credit card loans going bad increased 54 percent in the second quarter of 2008 from the same period in 2007, according to Federal Reserve data, the latest available.
A report this week from Innovest, a research firm, said banks and other credit card lenders could record nearly $100 billion in losses because of bad loans through the end of next year. Innovest said financial firms could be reaching a "tipping point" at which years of growth in credit card debt starts to decline.
Traditionally, consumers having difficulty paying credit card bills could transfer balances to new credit cards with lower rates. But now that may be tougher. A recent Federal Reserve survey showed 65 percent of credit card issuers had tightened standards in the past three months, up from 5 percent from the comparable period a year ago. Credit card issuers are lowering credit limits on existing cardholders and issuing fewer cards.
"There's a complete freeze of lending to low-income, high-risk borrowers as banks try to stabilize their balance sheet. They're not going after anyone with moderately shaky credit. They're even being cautious with people who have great credit," said Gregory Larkin, a senior analyst with Innovest.
Credit card debt is not the only area showing weakness. Defaults on auto loans are also rising fast. "Even somebody with great credit is going to have an extremely difficult time getting a loan if they don't have a down payment," said Greg McBride, senior financial analyst at Bankrate.com.