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Credit Card Delinquency

Written By Brian Hicks

Posted January 11, 2008

Should we be surprised that Capital One (COF:NYSE) warned yesterday? No.

When Capital One announced that its 2007 earnings would fall short of previous expectations, thanks in part to loan delinquencies, how could you be shocked?

The only shock is that there are those who believe this is the bottom for the company.

It’s not. And I’d use any up-move to short even more.

This isn’t the first time I’ve encountered a Capital One short opportunity. Along with the homebuilders, lenders, sub-prime, Alt-A, and prime names I shorted, I also saw a profit opportunity from credit card companies, especially those with sub-prime exposure.

Wooing Higher Risk

When homeowners become delinquent in housing payments, the lender can foreclose on the property. But when a credit card borrower becomes delinquent in monthly payments, one of the things the bank can do is give that borrower more credit. That would explain why companies like Capital One have tanked from $80 to under $40 in recent months.

A 2007 Boston Globe article reported that “Credit card companies woo struggling mortgage-holders,” and that “as sub-prime borrowers began to default on their mortgages in rapidly growing numbers this year, credit card issuers increased their efforts to sign up such customers with tarnished financial histories, according to a market research firm.”

That means that credit card issuers boosted their marketing efforts to a group of people who are having a hard time paying other bills. Thinking that these same people would be able to pay off credit card debt, the companies offered more credit. These are the people that can no longer refinance or tap into home equity, and are turning to credit cards as a last alternative.

Unfortunately, the move proved to be a bad one.

Delinquencies on the Rise

In the first five months of 2007, credit card delinquencies were 3.7% higher than in 2006. Late payments were up by 30% over the same time.

Even more interesting, and worrisome for those long credit companies, is that throughout the housing boom, home equity was used to pay off credit card debt. But nowadays, with home equity woes, people can’t do that any more.

As of November 2007, credit card debt “soared at an 11.3 percent annual rate in November following an 8.5 percent rate of increase in October.” There’s more than $850 billion of credit card debt out there. Worse, according to this Business Week article, delinquencies are still on the rise, spelling further bad news for credit card issuers . . . especially credit cards issued to sub-prime folks.

Other negatives for Capital One: The company may have shut the door on GreenPoint Mortgage, but it’s another sub-prime credit card and auto lender witnessing delinquency problems.

What’s shocking is that no one saw this coming. I did, in February 2007, as my team and I shorted homebuilders, lenders, Alt-A, sub-prime, and big banking names.

And if you don’t believe me, here’s a video I was asked to do in June 2007.

Be sure to stay tuned for my new options service coming soon.