Friday, November 28, 2008

Credit Cards Profit Margins Getting Larger


The Credit Card Crisis is getting closer and closer. Homeowners who mortgage payments got too high, have been using their credit cards to pay the bills. Additionally, it is the Christmas shopping season, when many shoppers use credit cards hoping to pay later for what they buy today. The Credit Card industry - BANKS - are raising their interest rates, at a time when they can borrow money from the Treasury for almost nothing, or possibly get part of the $700 billion TARP (bailout) handout.

Now, for a bit of background. To a Bank, a deposit account of any kind is a liability - it is actually borrowing money from depositors. At the same time, a loan it makes to a Borrower, with depositors money, is an asset. Traditionally, banks have based their profit margins on a 3%-5% spread or margin between deposits and loans. In fact, going back a number of years, a Savings Banker was known as a 3-6-3 Banker. Take it in at 3% (deposits) Lend it out at 6% (loans) and go home at 3 (pm). Strange, but we had gotten back to that formula, at least for mortgages made by Banks.

Banks got larger and felt that they could exploit the revolving credit market - Credit Cards. Here, the Bank (card issuer) give a credit limit that a card holder (borrower) can use and pay, use and pay etc. Because the amounts started out to be small and the debts were unsecured (no collateral), in comparison to a car loan or home mortgage, Banks charged a higher interest rate for Credit Card interest. But the spread began to increase so that Banks had gross margins (before losses and costs) of 8%-10%.

As the traffic would bear, the rates increased so that before the current crisis, it was not unusual to have a Credit Card Issuer (Bank) paying 2%-4% for deposits and charging 14%+/- for interest to average card holders. Sure, there were the promotions for 0% interest, but the majority of those "come-ons" ended with the Cardholder paying one day late, or the Credit Card issuer (Bank) holding a payment for a few extra days, so the Cardholder was charged a late fee of $39 AND HAD THE INTEREST RATE JUMP TO 19.99%-30.99%.

Now, Banks are trying to make up for bad loans in mortgages, in commercial loans, in investments for the Banks portfolio (Mortgage-Backed Securities come to mind), and financial uncertainty. So now even "good" customers are getting charged higher interest rates for keeping a balance on the Credit Card. CitiBank has just sent notices to the bulk of its Cardholders notifying them of a change in the rate. Regardless of the prior rate, the new rate is now the Prime Interest Rate (rates that the best borrowers pay to Banks) plus 8.99% WITH A MINIMUM OF 14.99%. Cardholders can opt-out of the change so long as they pay-off the card balance by the time the card renewal dates comes around. If one opts-out, at the renewal date, Citi will close the account and either demand payment in full or force the Borrower to pay the ten current rate on any balance.

Citi is not alone. If you pay regularly, but have a balance for more than 2 years, JP Morgan Chase will charge a monthly fee, and increase the minimum monthly payment from 2% of the balance to as much as 5% of that balance. The list of card issuers (Banks) goes on but the basic theme is the same: Borrow money from the Treasury or Federal Reserve Bank, paying .5%(1/2% ), or from depositors paying about the same rate, maybe .5% higher, AND LEND IT OUT TO CREDIT CARDHOLDERS FOR 15%-25%, while making the minimum payments twice what they have been. The Consumer portion of the Credit Market is going to pay for the commercial losses and bad investments - Main Street is paying for Wall Street. And do not forget about the Universal Default Rate - be late on one card, and the rest of the Cards can move your interest rate to its default rate.

This explanation is a bit over-simplified, but not much. Margins in the Credit Card business are at all-time highs. What will happen in February when all of the Christmas gift generated Credit Card bills come in? Who will be able to afford them? And, if the credit lines get closed by the Banks, how will the homeowner/credit card holders pay to live in the house?

This formula spells disaster for Cardholders (consumer and small business borrowers) and as a result will probably lead to a new round of mortgage defaults and foreclosures, and certainly a spike in Bankruptcy filings as more and more Cardholders find that a 5% minimum payment is so far out of reach that it makes no sense to even try. A good portion of my practice is in the fields of Bankruptcy and Debtor workouts, but I shudder when I think of the disruptions to families, losses of homes, the payment defaults will bring.

Congress could act to stop the gouging by Credit Card issuers (Banks), regulate the issuers which are not Banks, and provide the needed Mortgage Relief that would eliminate some of the need to use the Cards.

I encourage every Credit Cardholder to read carefully all of the information she/he receives to be certain the change, if there will be one, can be at least anticipated and plans made to deal with the "financial dislocations" (unpaid bills and blown budgets) which result.

Please feel free to e-mail through the website link at the bottom of this post if you need a calculation or advice. The service is free and the margin is less than 0% (My contribution to the cause)

Author's Copyright by Richard I. Isacoff, Esq - November 2008

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