Bankers' worst nightmare is the unemployment rate climbing toward 10%, a level at which credit losses could balloon unpredictably because of high defaults among people with previously strong credit histories.
Right now, bank balance sheets don't appear in a position to deal with unemployment moving sharply higher from its current 7.2% rate.
Building up bad-loan reserves to deal with a 9% to 10% rate could produce enormous losses and pulverize capital when banks are trying to preserve the thin cushions they have. And fear of rising unemployment could deter lending when the government wants banks to expand credit. True, the Obama administration's stimulus plan could reduce unemployment expectations. But right now, banks are hoisting their joblessness forecasts.
Last week, consumer lender Capital One Financial increased its unemployment forecast to 8.7% by the end of 2009, from its previous expectation of 7% by midyear. And Capital One added that it is building more-severe unemployment scenarios into lending decisions.
Also last week, Kelly King, chief executive of regional bank BB&T, said unemployment of 8% to 8.5% is "kind of manageable," but 9% to 10% would "have a dramatic impact on our scenarios."
Why the trepidation of going above 9%? Take a regular credit-card book. Past data show that a percentage-point increase in unemployment leads to roughly a percentage-point rise in the charge-off rate, the amount of defaulted loans written off at a loss.
But as unemployment exceeds 9%, bankers think charge-offs will start to increase by more than the increase in unemployment. The reason? A high rate could cause an unprecedented wave of defaults among prime borrowers, who tend to have bigger loan balances.
"The situation is so extreme and beyond what we've seen in past cycles that management teams are becoming reluctant to predict the relationship between unemployment and credit losses," said Kevin Fitzsimmons, analyst at Sandler O'Neill & Partners.
House of Cards
Even as the subprime mortgage fallout continues its ripple effect across the economy, fiscal storm-watchers have an eye on the next gathering cloud: nearly $1 trillion of consumer credit card debt. Defaults are up; in November, the percentage of charge-offs — money card issuers give up on ever collecting — rose to 5.62 percent. According to some economists, that percentage could double before this current downturn is over. The bearish RGE Monitor predicts the default rate could rise as high as 13 percent, eclipsing the previous high-water mark of a 7.85 percent in the first quarter of 2002.
This is bad news for the banks and third-party investors that hold this debt, as well as for consumers hit with the double-whammy of rising unemployment and restricted credit. Americans are relying on their credit cards to an ever-increasing degree. In 2008, the average credit card balance was $11,212, according to CardTrak.com. Compare this to 15 years ago, when the average credit card debt was a comparatively paltry $4,306. Factors like California’s plan to delay income tax refunds and long-jobless workers running out their unemployment benefits don’t help the situation, either. With no silver-bullet solution in sight, economists and analysts are nervous.
Credit card companies have already started to batten down the hatches by cutting cardholders credit limits and raising interest rates. “What institutions are doing now is circling the wagons,” said Dennis Moroney, research director, bank cards, at finance-industry research firm TowerGroup.
Additional retrenchment looks inevitable. Although about half of all credit card debt has been repackaged and sold as securities, it’s a much smaller pool of capital than the mortgage securities market, so a rise in default rates probably won’t cause the kind of systemic domino effect that the mortgage collapse triggered. It will, however, make third-party investors much more reluctant to purchase such debt — and risk getting burned — in the future. With mounting default losses on their own books, banks will have to raise more capital to meet their reserve obligations. Like a retailer trying to unload Christmas paraphernalia on December 26, they’ll have to slash prices if they want to attract buyers. As a result, consumers — especially those with blemished credit — are going to have difficulty securing loans or lines of credit.
In addition, the banking industry contends that new regulations passed by the Federal Reserve last month will give them no choice but to sharply curtail lending — putting at risk the consumer purchasing power that drives 70 percent of spending in the U.S.
Credit card issuers are using a host of measures to make sure customers make their payments and fees keep coming in, now that banks are feeling as squeezed as their financially pinched consumers.
Some card issuers are clamping down on late payments and grace periods as they near new, stricter credit card regulations that go into effect in July 2010, consumer advocates say. Some lenders also are working out payment plans and, in certain cases, lowering interest rates for delinquent customers who are having a hard time keeping up with their bills.
The industry also is bracing for sweeping changes approved last month by the Federal Reserve to revamp rules governing penalty fees and rates. Among other things, card issuers will be required to send a bill at least 21 days before the due date so consumers have time to make payment before getting slapped with a late fee. And bankers won't be able to raise rates on existing balances unless a payment is more than 30 days late.
"They see the writing on the wall, and when these rules take effect, their ability to impose penalty rates and penalty fees are going to be so greatly curtailed that in the interim period they'll be aggressive in trying to impose fees to the letter of the law that's in the account agreements," said Ben Woolsey, director of marketing and consumer research at creditcards.com.
With economic conditions deteriorating, card companies are stepping up their collection efforts in hopes of recouping what they can from consumers. They're also taking more telephone calls from cash-strapped customers.
Discover Financial Services has hired staff to respond to customers seeking help and launched a section on its Web site where cardholders can find more information on getting payment assistance.
American Express is calling card members in earlier stages of delinquency and offering payment plans that offer "flexibility around the interest rate, fees and plan length."
And Bank of America is waiving fees and reducing interest rates on monthly payment programs. Last year, the bank said, it modified nearly 700,000 credit card loans.
[Bankers' Worst Nightmare Materialize
HoweStreet.com, Canada ]