My 2 Cents About Credit Card Balances

I’ve kept quiet during the recent news releases from TransUnion and Credit Cards.com who were making a big deal about credit card balances coming down and citing Federal Reserve Statistical Releases as the reference source.

Essentially, their reporting is accurate – credit card balances are indeed coming down. What I can’t buy into is the assertion that consumers are managing their credit card balances better.

Nope – for me the only statistical release I pay attention to is the delinquency and charge off reports from the Federal Reserve. The most recent third quarter report shows credit card delinquency of 6.58% slightly down from the previous month and a charge off percentage at a historical high of 10.24%. The slight drop in delinquency make perfect sense because the charged off balances are no longer on the books.

As an old credit card guy, I played this game many times. And in order to play the game here’s what you use – simple math. Here’s the game:

1. PROBLEM: Delinquency percentages are going up – SOLUTION: Increase portfolio balances. The higher the credit card balances, the lower the delinquency percentage. Offer incentives to borrowers to transfer balances and charge more.

2. PROBLEM: Charge off percentages are going up - SOLUTION: Increase portfolio balances. The higher the credit card balances, the lower the charge off percentages.

3. ANOTHER SOLUTION: Charge off the delinquent balances sooner than the require 180 days past due (that 6 months by the way...) required by most regulators. Sure the charge off percentages will look ugly this month, but the delinquency percentage will show tremendous improvement in the next few months – and hopefully credit card balances will increase significantly, so it will all be masked anyway.

Simple math – the problem is it only works when credit card issuers are aggressively targeting customers to increase their credit card balances. It doesn’t work so great (like now) when card issuers are cutting credit lines and increasing credit score thresholds so they can prove to whomever that they are serious about reducing credit risk. You can’t hide the delinquency and charge offs behind portfolio balances in this scenario.

More simple math – with 10% in charge offs, along with cost of funds around .05%, operational costs around 5%, and now loan loss reserves probably around 7% (if you’re lucky), card issuers would need to increase interest rates to around 24% to be profitable.

Credit card interest rates aren’t going up in anticipation of the Credit Card Accountability Act kicking into gear in February – they’re going up because the math isn’t working.

And you might just see some issuers getting out of the business altogether in 2010...