Chargeoffs a Key Driver in Declining Credit Card Balances

Credit card balances outstanding in the United States have fallen nearly $70 billion in the past 10 months, according to the Federal Reserve. It’s the longest and steepest period of decline since the Fed started keeping records. 

Much of the popular press has credited the decrease to a more frugal consumer. While consumers certainly are paying more attention to their credit card spending, that is only one factor driving the plummeting numbers.

“Consumers have certainly gotten religion as far as credit is concerned,” said Chris Cornell, an economist at Moody’s Economy.com.

At the end of September 2008, total consumer credit card balances in the U.S. stood at $975.1 billion, an all-time high. Every subsequent month has seen a decline. In the Fed’s most recent report on consumer credit, total credit card debt outstanding – called revolving debt by the government – was $905.5 billion (“Consumer Credit Contracts at Record Pace in July,” Sept. 9).

Dana Wiklund, research director for Financial Insights’ Risk Management Advisory Service, noted that overall consumer use of credit has definitely dropped off since the onset of the recession. And while some credit products may show signs of improvement, credit card debt is still sour. 

“Delinquencies on mortgages started to level off in the second quarter. I think that we’ve hit the bottom there, the same with home equity loans. But credit cards will continue to be in distress,” Wiklund said. “Consumers aren’t using credit as much anymore.” 

However, Wiklund noted that consumers will still use credit cards when they need additional liquidity. “It’s the consumer capital of last resort.”

But a newly found consumer frugality is only one of a number of factors he sees in the rapid reduction in total consumer credit card balances as reported by the Fed. 

The second largest factor, according to Wiklund, is that lenders are charging off credit card balances at a record rate. Once charged off the loans no longer show up in the Federal Reserve’s consumer credit figures, a Fed economist told insideARM.

In the second quarter of 2009, the Fed reported an average seasonally adjusted credit card chargeoff rate of 9.55 percent for all banks, the highest rate ever by far. It represented a massive increase from the 7.64 percent rate reported in the first quarter, which itself was surpassed only by a 7.85 percent rate reported in the first quarter of 2002. 

Some of the banks should be charging off the loans more quickly, according to Cornell, who points to the number of bank failures, which hit 94 for the year last. “The credit quality problems are going to continue for a while,” he said.

Increasing credit card chargeoff rates have a direct impact on the accounts receivable management industry, especially debt collection agencies that work card accounts. 

“In the short term, higher charge off rates will bring more volume to ARM companies,” said Paul Legrady, director at ARM advisory firm Kaulkin Ginsberg. “But a declining credit card usage environment will not always be the case. The pendulum will eventually swing back in the opposite direction.”

“Once you start putting loans into collections, if you recoup the losses at all, you’ll recoup only 30 to 40 cents on the dollar,” noted Adiel Moussa, analyst for Aite Group, Boston, Mass. 

Due to those losses, lenders have lowered the amount of the credit they are granting, another factor in the drop in consumer credit, Wiklund pointed out.

Because they are granting less credit, lenders are currently demanding much more from consumers in terms of proof of income, ability to repay (percentage of income that will be loaned) and other proof of creditworthiness than before the recession. This greatly limits the number of consumers that can obtain credit.

Wiklund added that any recovery process will likely be very slow in coming, and will be dependant on consumer spending.

“Consumer spending is 70 percent of the economy,” Wiklund explained. “Businesses will not produce if there’s no demand. And with just in time [business models], companies can wait to produce until the demand returns. So government has become the backstop to the economy. It’s going to be a long walk out of the woods.”