A recession. Rising unemployment. Declining personal incomes. Tighter lending
standards. Declining interest rates. These are just a few of the headwinds
facing credit card issuers, prompting Innovest to predict that bad debt
charge-offs will almost quadruple by the end of 2009.
On Monday, Fitch Ratings weighed in. And they concur. We’re in store for
record losses. I, of course, agree. I just think it’s going to be worse than
even the gloomiest predictions. Here’s why…
- Consumers are predictable. If consumers aren’t paying their mortgages,
which means they will eventually lose their houses, they’re definitely not
concerned about their unsecured credit cards. If they don’t pay them, they don’t
lose anything – except their credit score. And that’s not tangible, or as vital
to survival as shelter.
- Old habits are hard to break. After maxing out home equity lines, or having
them frozen before getting a chance to max them out, consumers will resort to
credit cards to pay for a greater percentage of living expenses. We shouldn’t
expect them to act any more responsibly. Once they use up all this borrowed
money, they’ll default on it, too. Especially since the option to transfer the
balances to new cards with low (or zero) introductory interest rates no longer
exists.
- The responsible will remain responsible… and harder to sign-up. Super-prime
customers will respond to the current economic weakness by using less credit.
And a notable slowdown in direct mail advertising – the slowest in three years
based on the latest numbers – ensures credit card issuers will not be able to
offset the heavy losses with new, higher quality customers.
- The government won’t hold the “victims” accountable. Our elected
representatives don’t believe in any personal responsibility. In their eyes,
borrowers couldn’t possibly have lied about income on mortgage applications. Or
known about their inability to pay when interest rates reset. And that’s why the
next phase of the bailout includes eliminating or drastically reducing over
limit fees and late payment penalties. A source of income vital to earnings
growth for credit card issuers.
Of all the credit card issuers, here’s why we’re going with Capital One
Financial (NYSE: COF)…
With $68 billion in credit card debt exposure, it ranks as one of the biggest
pure-plays in the space. More than 60% of revenues come from credit cards. And a
good chunk of the remaining 40% comes from another doomed business – auto loans.
To be sure, the recent results are less than inspiring. Earnings dropped 53%.
Delinquencies increased 22%. And charge-offs rose to 5.85%.
But as the recession plays out, I fully expect the fundamentals to
deteriorate further. And bring shares prices along for the ride. This is the
kind of investment environment for a very smart strategy.
