Credit Card Charge-Offs Could be the Economy?s Next Big Drag

Now that Congress has passed a rescue plan that it hopes will alleviate some of the pain of rotten mortgages, the next concern on the horizon could be credit card charge-offs, according to a recent Webinar conducted by Innovest StrategicValue Advisors.

The rise in credit card charge-offs, which Innovest projects will reach $18.6 billion in the first quarter of 2009 and will mushroom to $96 billion by the end of the year, is not surprising in the wake of the current economic conditions, says Dan North, chief economist at Euler Hermes ACI, a trade credit insurance firm based in Owings Mills, Md.

“We’ve believed since the beginning of the year that we’ve been in a recession,” North tells insideARM. “There are negative wages, increasing bankruptcies and falling housing prices.” Add to that the increasing unemployment rate, which the government reported Friday stood at 6.1 percent after the largest monthly payroll drop in five years, and the evidence of a recession is undeniable, North says.

“We’re into our 10th month of job losses,” North adds. “When people are struggling financially, there are going to be increasing credit card charge-offs.”

During the Webinar — held last Monday — Gregory Larkin, senior banking analyst for Innovest, said he expects credit card charge-offs to soon start catching up with mortgage charge-offs.

Innovest reports charge-offs were $22.6 billion for all of 2007, a figure the firm projects will grow to $41.5 billion by the end of this year.

Others on the Webinar, however, pointed out that a person’s outstanding credit card balance was typically much lower than a mortgage or home equity balance, so each single default would have much less impact.

The growing charge-offs are starting to hit even the more conservative issuers like American Express and Discover, points out Dimitri Michaud, consumer finance analyst for Kaulkin Ginsberg. Indeed, American Express increased its loan loss reserves to $2.6 billion for the second quarter of the year, up from $1.4 billion in the year earlier period.

Capital One, which tends to issue cards to riskier consumers than American Express and Discover, had a higher percentage increase in its provision for loan losses, doubling the figure to nearly $1.1 billion during the same reporting period, compared to $535 million for the same period a year ago.

Card issuers and other financial services companies will be reporting their third quarter financial numbers in the next few weeks.

Those figures are likely to show continuing weakness. Michaud points out that the unemployment situation is probably much worse than reflected in government figures, because the unemployment report doesn’t take into account any effects of part-timers or self-employed (like contractors, carpenters and others in the weak construction industry) who have lost portions of their income in the downturn.

While the Federal Reserve’s latest estimate for average credit card balance is $2,200, that figure is likely to shoot up when the next report comes out, according to Michaud. “People are cash-strapped. The credit card might be something they use to pay for household goods on a daily basis.”

Therefore, cardholders will continue to pay at least the minimum when at all possible just to keep the card open, Michaud says. However, that will mean increasing total balances and a higher likelihood of future charge-offs.