Rising Reliance On Credit Cards Could Reflect Subprime Fallout
August 24, 2007: 08:05 PM EST
Aug. 24, 2007 (Investor's Business Daily delivered by Newstex) --
Rising credit card borrowing may be a sign of consumer distress spreading from the subprime mortgage market to other types of lending, some economists say.
While defaults among home buyers have spiked, the number of credit card loans in delinquency has been running steady.
One possible reason, analysts say, is that troubled first-time homebuyers have been choosing to stay current on credit card payments while walking away from homes on which they put down little upfront money.
Jumps in credit card delinquencies are usually tied to unemployment. And the job picture seems OK. In July, the nation's jobless rate ticked up to a still historically low 4.6% from 4.5%.
Charging Up Trouble?
But trouble may be brewing in the credit card industry, says Merrill Lynch. (NYSE:MER) (OOTC:MERIZ) It says balances on consumer credit cards jumped at an annual rate of 11% in May and June. With two exceptions, that's the highest rate since the last recession in 2001-02.
What's behind the jump in credit-card borrowing?
Consumers sometimes run up bigger credit card bills when feeling upbeat about the economy. But retail sales have been sluggish of late, reflecting a pullback in consumer spending.
Merrill Lynch says some distressed homeowners are now turning to credit cards, before being forced into foreclosure. It says a run-up in credit card delinquencies is likely in six to 12 months.
"Credit card balances are booming," said David Rosenberg, an economist at Merrill Lynch. "On Main Street, the lender of last resort as banks pull in their horns is the credit card.
"The next shoe to drop from this subprime mortgage fiasco, which has already fed into the asset-backed market, is probably going to be the credit card business."
Consumers usually can't charge mortgage payments directly to credit cards. But, they can use credit cards to buy everyday items, thereby stashing away some cash for mortgage payments. Some bank card or credit card accounts let consumers get cash advances.
"Certainly mortgage equity withdrawal has plummeted. So it's no surprise to see credit card lending going in the other direction," said Paul Ashworth, senior economist at Capital Economics.
Home Piggy Bank Empty
A few years ago, many Americans used "cash-out" mortgage refinancing to raise cash to pay off other debts, such as credit cards.
Mortgage equity withdrawal peaked in the fourth quarter of 2005, says a Goldman Sachs (NYSE:GS) report. The report says using credit card debt to sustain spending is a risky strategy for consumers, because credit card interest rates are about three times higher than mortgage rates.
Tony Hughes, managing director of credit risk analysis at Moody's Economy.com, says some consumers may be tapping credit cards in hope of refinancing mortgages at lower rates.
"It's a plausible short-term strategy -- to hold out hope that you can get a near-term re-rating and thus lower interest payments," said Hughes. "But it may not work longer than two or three months."
Interest payments have climbed sharply for homeowners with adjustable-rate mortgages over the past three years as the Federal Reserve has hiked rates.
The Fed last week lowered the rate it charges financial institutions in need of emergency funds, but it has yet to cut the federal funds rate, which affects mortgage payments.
Meanwhile, Wall Street has lost its appetite for mortgage debt, especially subprime. So banks, unable to sell their mortgages, are jacking up subprime and alt-A rates, or getting rid of various loans altogether.
Hughes says data on credit card borrowing and delinquencies may be harder to interpret in this business cycle, as distressed subprime borrowers may be acting differently than others have in the past.
He says when unemployment goes up during recessions, consumers typically make house payments first, then take care of auto loans and credit cards.
"We are in uncharted territories," Hughes said. "But the good news is that subprime borrowers haven't lost their jobs yet."
Credit card delinquencies fell to 4.41% in the first quarter of 2007, from 4.56% at the end of 2006, says the American Bankers Association.
"The improvement ... is somewhat remarkable, given that the economy was not operating on all cylinders," ABA chief economist James Chessen said in a statement.
But the delinquency rate on auto loans made through auto dealers hit a 10-year high of 2.73%. Those loans are more likely to involve subprime borrowers, analysts say.
Home equity late payments also climbed.
The overall delinquency rate rose to 2.42%, the highest in nearly six years, says the ABA.
"There are dozens of kinds of subprime loans, so folks that are having trouble servicing their mortgages will probably have problems in other areas of their finances," said Nouriel Roubini, an economist at New York University.
Rosenberg, the Merrill Lynch economist, says he isn't sure whether consumers tapping plastic to make mortgage payments are subprime borrowers or those with more solid credit histories.
"The house is not a stock. It's not a bond," he said. "A house is an investment, but it's also something you live in. There's an emotional attachment. Some people will try to hang on no matter what."
Shares in American Express (NYSE:AXP) have fallen 8.5% from their July peak. MasterCard's have plunged about 20%.
In May, American Express announced a program to let cardholders pay monthly mortgage payments with credit cards and earn reward points in the process.
It was believed to be the credit-card industry's first such program. AmEx's first partner -- American Home Mortgage, the nation's 13th biggest lender -- filed for Chapter 11 protection in early August.
While mortgage companies have tightened lending practices, it's business as usual in the credit card industry, observers say.
"The latest senior loan officer survey from the Fed shows very few banks tightening lending standards on credit cards," said Ashworth. "More generally, there hasn't been any major change in lending practices for credit cards."
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