It isn’t surprising to see spreads on credit card debt on the increase. In fact, it might seem odd that it has taken this long.
However, one perverse effect of the 2005 bankruptcy bill is that it is easier for consumers who are not eligible for a Chapter 7 bankruptcy to walk from their mortgages, which are de facto non recourse, than from their credit card debt (yes, refis as opposed to purchase money mortgages are recourse, generally speaking, but servicers seldom pursue borrowers for any shortfall, since the cost of the exercise will almost certainly exceed the rewards). The repayment plans, if you do not qualify for Chapter 7, are, in the words of a bankruptcy lawyer, draconian.
We noted earlier that banks feel newly emboldened by the bill to try to extract more from credit card borrowers than they would have in the past. In March, we quoted a Business Week article:
Until recently issuers often agreed to ratchet down interest rates permanently, to as low as 0%, for those working with credit counselors. That has been a critical concession, says the industry, since it makes monthly payments more affordable and helps ensure the principal is getting paid down. But now some credit-card companies are balking. Discover Financial Services, (DFS) counselors contend, won’t cut rates below 17.9% for clients, while Capital One Financial (COF) is holding firm at 15.9%. At least 5 of the 13 largest issuers are offering smaller breaks on rates than they did five years ago, according to a study by the Consumer Federation of America
However, as Elizabeth Warren of Credit Slips pointed out, you can’t get blood from a turnip, and if overstressed consumers have to give priority to one debt, it merely means that a different one will not get paid:
…. family debts are tied to each other. If fewer consumers can get any relief, more counseling plans will fail. That means more bankruptcies, and, while they are at it, more consumers discharging other debts such as medical bills. More consumers will also take a second look at whether it makes sense to give back the car for which the loan far exceeds the value. This is also the time to look at the home mortgage and think about whether trying to make the payment after a reset is worthwhile. Don’t get me wrong: this won’t affect millions, but, at the margins, a credit card squeeze on interest rates will push more people to give up altogether–and that will affect returns for other lenders as well.
Yields relative to benchmark rates on securities backed by credit card debt rose to records amid concern that falling household income will curtail spending and make it harder for consumers to pay their bills.
Spreads on credit card asset-backed securities of different ratings and maturities rose by 10 basis points to 50 basis points during the week ended Aug. 28, according to JPMorgan Chase & Co. Credit card bonds rated AAA and maturing in five years rose 15 basis points from the week earlier to 150 basis points more than the benchmark swap rate, analysts led by Christopher Flanagan in New York wrote in an Aug. 29 report….
“The focus is on the weakened consumer,” Christopher Sullivan, chief investment officer at United Nations Federal Credit Union in New York, said today in a telephone interview. “The consumer is severely pinched, and we are likely to see this trend in consumer ABS products continue.”….
American Express Co. paid 130 basis points more than the one-month London interbank offered rate in its last sale of AAA asset-backed debt on Aug. 8, according to data compiled by Bloomberg. The company paid 4 basis points over Libor on similar debt sold in July 2007…..
New York-based American Express had a credit-card delinquency rate of 3.42 percent as of July, Bloomberg data show. Uncollectible debt rose to 5.3 percent of loans from 2.9 percent a year earlier and will climb as the year progresses, American Express Chief Executive Officer Kenneth Chenault said on July 21.
Consumer purchases slowed to an increase of 0.2 percent in July, one-third the pace in June, the Commerce Department said Aug. 29. Incomes dropped 0.7 percent, the first decrease since August 2005.
U.S. consumers borrowed more than twice as much as economists forecast in June. Consumer credit rose by $14.3 billion, the most since November, to $2.59 trillion, according to the Federal Reserve..
Interesting, yet possibly related old thoughts here (very long post worth a read if you missed it):
El-Erian Says Raising Bank Capital Is Harder
We heard yesterday, Mohamed, from Nassim Taleb and Peter Fisher of BlackRock, and certainly they both spoke of this idea of correlations of co-movements, as we've heard from David Goldman of Asteri Capital, this linkages within the noise. Do you see an increased set of linkages, or co- movements, within the noise now? Or, is it abating a bit?
EL-ERIAN: I think the dynamics are increasing, and that's because we are now having three balance sheets delevered at the same time. So the noise, if you like, has started to contaminate the technicals, and the technicals are impacting more balance sheets.
So, we understand the financial balance sheet, which is deleveraging. Housing is clearly another big balance sheet that is deleveraging and now the consumer's balance sheet is in play.
So, I think it's too early to expect the noise, if you like, to be reduced. But it is morphing, and one has to be open to the fact that the signals are starting to come from many different places.
KEENE: Yes. And you've got a wonderful quote here from Keynes, page 96, folks, of “When Markets Collide,'' Keynes saying, “Markets can remain irrational longer than you can remain solvent.''
Is that what the banking system of the United States faces right now is a solvency issue within this irrationality?
EL-ERIAN: I think solvency is strong for the banking system as a whole. I think there may be a few institutions that have it. The banking system as a whole faces an adjustment process, one that has to recognize that the system is being forced to derisk and delever, first by the market and soon by the regulators.
So, we are in the process of a major adjustment of the banking system, which is made harder by the fact that you don't have the capital to lubricate it. But, I think the system as a whole is solvent. There are certain institutions that may face problems, but the system as a whole is solvent.
KEENE: Can you get business done at Pimco? Is there such a liquidity issue that even the giant of Pimco is struggling? Can you get transactional business done?
EL-ERIAN: We can. In fact, this is a situation that plays to our strength, because we can be the provider of liquidity in size, but also capture the liquidity premium.
EENE: We heard from Professor Feldstein of Harvard, Martin Feldstein, and Allan Meltzer Carnegie Mellon, both agreeing the dollar must go down, in the words of Feldstein.
Does Pimco have a changed view on the U.S. dollar? Or could you restate that for us right now?
EL-ERIAN: Sure. We think that we are in the midst of a cyclical retracement of the dollar, which has made us stronger. However, the outlook for the dollar is to resume its depreciation. And in our mind, the big difference is not going to be whether the dollar depreciates again but who appreciates against the dollar.
EL-ERIAN: And that's where we're likely to see the change is which currencies are going to carry the burden of appreciation.
Yves, this post has general “bankruptcy content” so this seemed like a good place to concisely express my views on that subject.
I think some of our coming difficulties will need to be worked out on a local basis as our national institutions are clearly in decline and help delivered locally can be very effective.
To that end, absent some compelling arguments to the contrary, I’m in favor of legislation allowing individual bankruptcy judges to renegotiate mortgage terms in bankruptcy court.
One key point is never mentioned in discussion of this legislation. People who fear that debtors in possession will take undue advantage of this legislation never discuss the following objective fact:
Most bankruptcy judges started off as bankruptcy lawyers and the best way for a bankruptcy lawyer to make the big bucks sufficient to make the political donations that can open minds to possible appointments to the bankruptcy bench is through representing CREDITORS.
The only real money to be made in bankruptcy law is by representing creditors.
So most bankruptcy judges have a decisive tilt toward creditor rights and have a well-developed sense of smell for debtor fraud.
So I’m personally in favor of providing BK judges the right to renegotiate mortgage terms.
I think this would have a non-trivial impact on the accelerant to the conflagration engulfing the USA, namely the gasoline on the fire of PREVENTABLE foreclosures.
Solve the problem of preventable foreclosures and you begin to contain the fire.
Fail to do so and we are all doomed.
My hunch is that AMEX, despite this horrific rise, still has a lower cost of funds than the median of credit card issuers.
But this is just a hunch and the countervailing arguments are also pretty obvious.
Anyone have any data on the relative COF for AMEX?
I’m much less familiar with US credit card ABS than the UK market, but here are a couple of points based on my understanding:
1) The US is definitely in a worse position than the UK as far as credit cards go. For a start, in the UK the credit card bubble was burst back in 2004 when the bankruptcy laws were eased, forcing lenders to tighten their criteria. Second, the US consumer is more stressed than in the UK (at the moment, anyway).
2) That said, US credit card ABS should be better positioned than mortgage debt, although by how much I can’t say. While charge-offs have been increasing, so have portfolio yields, so there is still a fair amount of excess spread in the securitisations. Credit card companies themselves are likely to suffer as they find themselves less able to refinance maturing debt and early amortisation triggers are threatened, however.
“However, one perverse effect of the 2005 bankruptcy bill is that it is easier for consumers who are not eligible for a Chapter 7 bankruptcy to walk from their mortgages, which are de facto non recourse”
This is incorrect. In the majority of US states mortgages are recourse loans.