Advanta shows spreading U.S. credit woes
The decision of the 11th biggest U.S. credit card issuer Advanta to pull all of its credit lines from one million customers bodes poorly both for the economy and the banks.
You can’t really blame Adventa, which specialises in credit cards for small businesses, for closing its credit window: uncollectable debt reached 20 percent at the end of March.
Just compare that to the loss rates, two year cumulative loss rates mind you, that the U.S. used in the banking stress tests: 12-17 percent in the baseline scenario and 18-20 percent in the more adverse one.
Advanta is offering $1.4 billion to buy back loans it securitised, but for 65 to 75 cents on the dollar, an indication that things in its portfolio will get worse from here.
Now, there are differences between Advanta and the rest of the U.S. credit card and banking industry. It has a lot of exposure to the hard-hit Florida and California economies and its business grew strongly in 2006 and 2007, in retrospect not the best years ever for credit.
And the relationship between small business and real estate, a symbiotic one in the boom years, has turned vicious. Many small business owners used equity from their houses, equity now vanished, to fund their start ups. Many also had businesses predicated on real estate.
So perhaps, just perhaps, Advanta is a case of the weak being picked off, a flushing out of past excesses rather than a trend. It might, on the other hand, reasonably be seen as a bellwether.
“Advanta’s a nationally visible brand. It’s going to be seen as a leading indicator. The first one to fall,” Jim Shanahan, chief executive of prepaid-card company Maverick Network Solutions told the Philadelphia Inquirer.
“The industry is looking at charge-offs (bad loans) above 20 percent…But if 20 percent is true, this is uncharted.”
The trouble with small businesses may be an extension of the trend that started in 2007, when subprime borrowers, in a reversal of historic behaviour, kept their credit cards, which they need to buy food and gasoline, current while allowing their mortgages to go bad.
Business owners similarly may, having drawn down on cards in a desperate attempt to keep their enterprises afloat, now be defaulting on the business card while keeping their personal ones current. But as those businesses fail, personal card delinquencies should track higher too.
The implication now is that that consumer loan losses will follow where mortgage and business loans lead.
WHO ARE YOU CALLING STRESSED?
Advanta is not the only reason to doubt the severity of the stress test assumptions about credit card losses. Moody’s has said their projection is for industry wide charge-offs to top out at 12 percent in mid-2010, which they say translates to about a 22 percent two year cumulative loss. And again, this is their central prediction, rather than a worst case one.
And even with the Federal Reserve taking heroic measures to prop up the credit markets, the Advanta news is one more indication that the credit crunch and economic downturn may be self sustaining. Banking analyst Meredith Whitney estimates that credit card lines in the U.S. will be cut by $2.7 trillion, or 50 percent, by the end of 2010, as banks try and deleverage and preserve capital. This will constrain consumer spending, hit company profits and spawn yet new defaults.
She describes the credit card companies as playing a game of “hot potato,” with no one wanting to be last with exposure to a given business or consumer. Advanta has just pulled some very hot potatoes out of the oven and tossed them at its peers.
New regulatory proposals to limit credit card companies’ ability to hike interest rates and impose fees, while perhaps needed in the long term, will have the perverse short run impact of accelerating this deleveraging process — and consequently reducing access to credit.
Some businesses doubtless which lose credit lines will be pushed over the edge and many more will slow expansion or cut back on investment or staff.
This is particularly troubling in the U.S., where by some estimates small businesses are responsible for two thirds of all private sector new jobs created. It may not be entirely chance that the growth and dynamism of the small business sector has been coincident with the growth and availability of credit to individuals.
There is a long and storied history of Americans losing their jobs in recessions but cashing in their retirement accounts, borrowing against the house and maxing out the credit cards in order to start a new business. Many fail but many jobs are created in the process.
All three of those funding sources are less available this time round, and there is good reason to think that the recovery will be less strong and more vulnerable to a relapse as a result. So, Advanta may well be an outlier, and the big banks and the rest of us may be on the road to recovery.
But they called Countrywide an outlier too.
— At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. —