ANALYSIS-Credit card weakness a vicious cycle for lenders

By Jonathan Stempel

NEW YORK, Nov 19 (Reuters) - Efforts by large U.S. credit card issuers to gird for historically high customer defaults may actually make the global credit crisis worse.

A seizure of global credit markets has left issuers unable to sell to investors the loans they make. This means issuers must be extra sure that when they extend credit, they do so carefully.

But even better credit control might not stave off the damage, with economies worldwide under pressure and unemployment heading higher, as banks tighten lending.

This deterioration comes on the heels of more than half a trillion dollars of writeoffs of subprime mortgages and other debt industrywide since the credit crunch began last year.

"We, as an industry, may end up with possibly the highest credit card losses the industry has ever experienced," Bank of America Corp Chief Executive Kenneth Lewis said in Detroit this week.

The desire to thaw credit markets and boost lending is the reason the U.S. Treasury Department threw hundreds of billions of taxpayer dollars at Bank of America, JPMorgan Chase & Co , Citigroup Inc , Capital One Financial Corp and other lenders to strengthen their balance sheets.

Even American Express Co , with just $11.9 billion of customer deposits, decided to become a bank holding company so it could get some of this new capital.

While banks are growing more comfortable lending to each other, they are demonstrating no such confidence in consumers.

Experts said credit card lending standards were never so bad that the industry were susceptible to the type of meltdown that occurred in the U.S. subprime mortgage market.

And yet, banks are reducing credit further for the many borrowers who can no longer keep up with their mortgage payments or tap their homes for cash

Moreover, they are also making credit less available for lower-risk cardholders, including wealthier ones.

It's a dangerous strategy. Tighter credit can reduce spending, weighing on broader economies. It could also hurt earnings later if issuers lose their most desirable customers.

"If you want your card to be the top card in the wallet, the day you send that letter tightening the credit line is the day you make that customer unprofitable," said Ronald Mann, a Columbia University School of Law professor and card expert.

SECURITIZATIONS STOP

One reason card issuers are cutting back is the seizure of the market for securitizations, which involves the packaging of consumer loans into securities that investors can buy.

"Investors are making the same judgments as banks: that new credit card loans are likely to be taken out by people with difficulty covering their expenses, and are much less likely to be paid than two or three years ago," said Arthur Wilmarth, a professor at George Washington University Law School.

Since the end of September, the $2.8 trillion asset-backed securitization market has seen only a single, $500 million new consumer issue, according to Barclays Capital.

"Right now, we have enormous supply pressures from managers who are liquidating assets, and no big buyers," said Katie Reeves, an ABS research analyst at Deutsche Bank Securities Inc. "It is part of the global deleveraging we're seeing."

Credit card debt comprises much of the $971 billion of revolving credit outstanding in September, Federal Reserve data show. Lenders kept $511 billion, and securitized $460 billion.

"Most credit card securities are still money-good, and can withstand significant deterioration in loss rates," Reeves said. "But such conversations are on the back-burner, given the liquidity issues in the market."

Though the Treasury Department recently decided to use some of its bank rescue package to back consumer lending, lenders may conclude a surge in delinquencies is not worth the cost.

"We are not going to say, 'This is over,' and extend credit like we did without fear," JPMorgan Chief Executive Jamie Dimon said last month.

NOT YOUR FAULT

Valentin said issuers typically set aside reserves to cover a year of card losses. But he said that hasn't prevented a 14 percent drop in new card solicitations, 2 to 3 percentage point interest rate increases, and lower credit lines generally.

This comes on the heels of a third quarter when Bank of America and Citigroup card units had their first losses since the credit crunch began, and card profit tumbled at JPMorgan, American Express and Capital One, regulatory filings show.

October has been no better. American Express' delinquency rate rose to the highest on record, Valentin said, while Capital One's also increased.

GE Money, a unit of General Electric Co , is reducing credit lines of many cardholders at upscale clothing retailer Brooks Brothers. It is telling them the change "is not a reflection of your personal credit rating or our confidence in you," according to the notice announcing the change.

"The economic and fiscal conditions we're facing are really unprecedented," GE Money spokeswoman Dori Abel said. "They have led us to tighten risk by reducing exposure, including by bringing down overall credit limits."

GE Money and other lenders also use internal risk models to gauge who deserves credit, and who does not.

"Suppose you shop at Brooks Brothers, and then you start shopping at Wal-Mart . It's a flag," said Scott Valentin, an analyst at Friedman, Billings, Ramsey & Co. "They're hypersensitive to changes in consumer behavior."

Target Corp , Wal-Mart's chief rival, said more of its customers are struggling to keep up, especially in troubled housing markets in Arizona, California, Florida and Nevada.

"Tightening of credit across all U.S. credit card issuers has already had a very important adverse effect on our sales, Chief Financial Officer Doug Scovanner said this week. "I'm sure it will continue."

RISING UNEMPLOYMENT HURTS

Many experts said the health of the card industry is closely tied to the nation's unemployment rate.

That rate is at a 14-1/2 year high of 6.5 percent. Many economists say it could soon top 8 percent, disproportionately affecting borrowers who use cards to fund day-to-day expenses.

Analysts estimate the industry charge-off rate, or loans that issuers don't expect to be repaid, is now in the 6 percent to 7 percent area. That's twice as high as it was in the first quarter of 2006. And it is heading higher.

"You could have companies see loss rates of 8 to 10 percent, as in the early 1990s," Valentin said. "The question is whether they go to levels like in the early 1980s, when unemployment peaked near 11 percent."

Consumer credit has increased sevenfold since then.

Still, all may not be lost for card issuers. Mann, the Columbia professor, said the collapse of securitizations may reflect a "herd instinct" among some investors who wrongly liken the risks of card debt to that of mortgage debt.

"Companies like Citigroup and Capital One are having a bad year in cards," he said, "but a bad year means profits have fallen, not that losses are threatening their viability." (Additional reporting by Soyoung Kim in Detroit, and Martinne Geller and Nancy Leinfuss in New York)