Money Matters - Simplified

Curious Numbers for Credit Cards

The Federal Reserve released its monthly minutes yesterday, and for the first time in recent memory, some parts of the outlook were fairly chipper. "Financial market conditions," it states, have "generally strengthened, and surveys and anecdotal reports pointed to a pickup in household and business confidence."

One piece of data that caught my attention was the Fed's
unemployment expectations. In an upward revision from its last meeting,
the Fed now expects the jobless rate to be between 9.2% and 9.6% by
late this year.

These are interesting numbers when compared with the Treasury's
recently completed stress test. That test -- which was used to
determine whether banks were adequately capitalized under a worst-case
scenario -- assumed that 2009 unemployment would fall between 8.4% in a
baseline scenario and 8.9% in the worst-case scenario.

In other words, the Fed's baseline outlook is grimmer than the
Treasury's worst-case outlook. These funny inconsistencies remind us
why economics is an art, not a science.

Why fret over a handful of basis points, you say? Simple: According
to some Fitch Ratings analysis, there's a historical one-to-one
correlation between unemployment and prime credit card charge-offs.
That is, if the unemployment rate doubles, so does the credit card
charge-off rate. It's even worse for lower-quality cards.

And since so many banks have massive credit card portfolios, even a
slight increase can mean big losses. Here's how much a few major banks
hold in their credit card portfolio:


Total Credit Card Loans

JPMorgan Chase (NYSE: JPM)

$176.1 billion

Bank of America (NYSE: BAC)

$173.3 billion

Citigroup (NYSE: C)

$117.9 billion

American Express (NYSE: AXP)

$56.5 billion

Capital One (NYSE: COF)

$58.7 billion

Discover Financial (NYSE: DFS)

$26.2 billion

When you're talking about numbers this big, an increase in the
charge-off rate of a few dozen basis points is nothing to sneeze at.
And since the stress test's goal was to adequately capitalize banks,
the thought that more money may need to be raised in the future doesn't
seem far-fetched.

Will it be the end of the world for banks? For most, no. But when
the Federal Reserve's own projections challenge the Treasury's stress
test by what could equal billions of dollars of losses for several
banks, there's yet more reason to wonder whether the test was more of a
confidence campaign
than an objective and realistic analysis.

For related Foolishness:

  • How to Destroy the Credit Card Industry
  • Dream On, Credit Card Companies!
  • Get Ready for Credit Card Hell 

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