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Why We're Bearish on Credit Cards

Written By Brian Hicks

Posted November 25, 2008

Credit card debt is just beginning to resemble the mortgage debt problems at the core of our financial meltdown. And the last thing the financial sector needs to feel is further squeeze, as Americans have accumulated some $970 billion in revolving consumer debt since the end of September 2008, up 3.4% from the close of 2007.

Sure, the credit card industry is typically resilient during our economic slowdown, thanks to pricing flexibility. And the thinking was, that as the economy sours, and consumers become late on payments, credit companies can boost earnings through late fees and higher interest rates.

But that’s no longer the case.

That’s because consumers are tapped dry. Defaults are growing. Charge-offs have been pushed well beyond expectations. And losses are far outpacing what companies were hoping to account for with extra card fees and higher interest rates.

And, according to Moody’s, there’s plenty of evidence pointing to further downside.

"Issuance of asset-backed securities linked to consumer credit cards ground to a halt in September after holding up fairly well in the first nine months of 2008. Moody’s doesn’t expect the ABS market to rebound in 2009 and said credit card issuers will continue to rely on access to U.S. government liquidity measures," says a report.

"We continue to have a negative outlook on the credit card sector and believe collateral performance will deteriorate throughout 2009. There is a greater likelihood of credit card-backed debt downgrades in the coming year, especially among subordinate notes."

The best way to play this is to buy put options on American Express, Discover, and Capital One, and calls on the likes of Visa and Mastercard.