Credit Cards Lending Not Badly Squeezed — Yet.

28 Aug Credit Cards Lending Not Badly Squeezed — Yet.

Despite the current credit crunch, Paul Davis of American Banker reported the sale of credit card-based bonds are still being sold while subprime mortgage bonds are going wanting. In the odd world of consumer securitization, loans like credit cards are apparently seen as safer than home loans.

Credit card debt is packaged and resold by lenders as a type of bond, just like the mortgages that have caused so much disruption in the credit markets this year. While one is covered by a lien on property which presumably has a concrete value, buying credit card debt is a bet on a person’s willingness and ability to repay. Davis’ article indicates that the price investors are willing to pay for such investments have gone down and the banks are setting aside greater reserves for losses in these portfolios (which will provide more confidence to investors in those securities). Yet banks are finding buyers.

Why would bond investors buy a bond based on a credit card before buying one secured by someone’s home? A simple reason could be greed. The credit card-based bond will usually have a higher yield and the investors may be willing to take greater risks of default in return for the higher potential payoff.

And they might believe the bankers did a better job identifying credit card risks than they did with mortgages. Much of mortgage lending in the last few years has been based on the value of the real estate, not on the realistic ability of a borrower to pay. In simple terms, they didn’t care if you could pay it back so long as the house was worth enough. But with a credit card, they don’t have that luxury, so they have to identify a borrower who is more likely to repay the debt out of future income — not rely on property values.

They may also think bankruptcy reform in 2005 will actually protect them. According to Davis’ article, between 30-50% of credit card charge-offs relate to bankruptcy filings. Due to lower rates of bankruptcy filings since October, 2005 when BAPCPA went into effect, banks have been able to project lower default rates.

Will this mean that these investors will really do better? Prior to BAPCPA, bankruptcy filing rates typically increased between 10 and 20% each year, roughly matching the increase in consumer debt during the same periods. In the most recent quarter, bankruptcy filings increased over 40%. To imagine the current credit squeeze — which make it hard for consumers to refinance their way out of payments they can’t manage — would do anything but trigger an increase in consumer filings, would be astonishing. So if institutional bond investors are betting on credit card-based bonds to really hold up, they may discover the banks bet here was as optimistic as the property appraisals underlying subprime mortgages.

The one thing we can all count on: The higher risks and costs of selling some of these bonds — or the simple need to meet profit targets — will likely mean rising rates on credit cards for consumers. Wouldn’t that mean more defaults and bankruptcies?

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I have been a bankruptcy attorney since 1989. Our firm represents consumers filing bankruptcy almost exclusively, although I have represented bankruptcy trustees as well as creditors. For 2017-2018 I am also serving on the American Bankruptcy Institute's Commission on Consumer Bankruptcy. If you live in Eastern Missouri, visit our website, send an e-mail or give us a call (314) 781-3400. Our website: STLBankruptcy.com
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