Magazine article Economic Trends

The Availability and Profitability of Credit Cards

Magazine article Economic Trends

The Availability and Profitability of Credit Cards

Article excerpt

10.05.09

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Credit cards serve a dual purpose in our economy. First, they are a means of payment in lieu of cash or checks. Used in this way, credit cards simplify people's day-to-day transactions and cash management needs. At the same time, credit cards are often used by individuals and small businesses for short- or medium-term unsecured borrowing. Individuals may use the revolving balance of a credit card to finance large purchases ahead of their income. Small businesses may rely on credit cards for their working capital needs.

Because they are not secured by marketable assets and have uncertain repayment periods, credit cards often carry substantially higher interest rates than secured debt like mortgages and auto loans. The rates can also serve as a barometer for the broader risk profile of consumers as well as the availability of credit to them. Interest rates for credit card holders have increased over the past two years.

Rates must compensate credit card issuers for the charge-offs they take on uncollectable balances, which is why they are a gauge of credit risk. Charge-offs can be particularly problematic during recessionary times, and the current recession is no exception. Charge-off rates have crept steadily upward since the recession began in late 2007. More recently, charge-offs dropped a bit and rates rose, which led to a slight rebound in credit card issuers' excess spread (a measure of profitability) of 2 percentage points in July.

Liquidity in the market for credit card debt--and in the overall bank credit market more generally--also factors into the availability and cost of unsecured credit. Last fall, both the market for short-term bank funds, gauged by the LIBOR tate, and the market for securitized credit card receivables seized up, meaning banks could only fund new credit card debt at high interest rates. In many cases, financial institutions chose to severely restrict the amount of new credit extended in order to conserve capital. For the five months between September 2008 and March 2009, no asset-backed securities (ABS) secured by credit card receivables were issued, and spreads on existing securities spiked from around 1 percent to nearly 8 percent.

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In order to restore the flow of new credit, the Federal Reserve included credit cards in the securities that were eligible for its Term Asset-Backed Securities Loan Facility (TALF). So far this year, $23.8 billion--or 60 percent--of the $40 billion in credit card ABS debt issued has been submitted to the TALF for financing. …

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