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Amex Outlines Bleak Credit Future


Bad loans, strapped consumers take toll.

More than any other credit issuer's earning results, last night's news out of American Express (AXP) brought out into the open the problems facing its industry: higher credit losses coupled with lower discretionary spending.

And while these problems may seem obvious to Minyanville readers, and generally characterize every recession, I would offer that no credit card issuer is adequately prepared for the potential secular deleveraging that is ahead.

Over the past 25 years, credit card issuers and credit card processing firms benefitted immensely from the secular consumer migration from cash and check purchases to plastic. And thanks to affinity marketing and rewards programs (and computer generated credit scoring), huge low loss "convenience" balances were built and interchange fees (the fees paid everytime you use the card) skyrocketed as cardholders went to extremes to find new ways to earn airline miles or rewards points.

But with these enormous "risk free" loan balances, issuers saw the opportunity to take increasing credit risk through higher and higher interest rate and fee (particularly delinquency fee) products offered to increasingly marginal credit quality borrowers. (And to see this visually check out the "vintage" curves from AXP's earnings presentation which show a clear deterioration in "vintage" loss rates over the past five years.)

But the net result of the industry's strategy was largely hidden from the public barbell, where low-loss "transacters" masked high-loss revolving borrowers.

What Amex courageously announced last night was that it sees significant problems ahead in both credit quality and spending. With flat to declining transaction activity, balances will fall and with higher and higher unemployment, losses will rise. The net result will be far higher percentage loss rates.

How high?

My belief is much higher than people think. I can easily foresee double digit credit card losses across the industry as US consumer purchase activity is downsized to "needs" not "wants". I also continue to believe that current unemployment forecasts grossly underestimate what's ahead.

At the same time, with Citigroup (C) reporting last week higher consumer losses in Mexico, Brazil and India, I would also offer that the emerging market middle class consumer boom, which many are relying on for global growth ahead, may be far more at risk than people think. As any student of Iranian or South African history can attest, natural resource booms are not nearly the boost to the middle class as one might suspect.
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