Some months ago, someone posted here about a fear they had that "the credit cards would stop working". At the time, I was a trifle arrogant and dismissive, suggesting that this wasn't realistic.

I can't remember who I directed that post at, whoever you are, I'm sorry. While this is a tiny, tiny card issuer, the "Early Amortization" (read the article) is just incredible from a financial perspective.


From Bloomberg

May 12 (Bloomberg) -- Advanta Corp., the issuer of credit cards for small businesses, will shut down accounts for its 1 million customers next month and seek to pay off securitized debtholders early as the recession pushes defaults higher.

Lending will cease June 10 as part of a plan to preserve capital after uncollectible debt reached 20 percent on some cards as of March 31, the Spring House, Pennsylvania-based firm said yesterday in a statement. Advanta will use as much as $1.4 billion to pay investors as little as 65 cents on the dollar to buy back securitized credit-card loans. That would be the first so-called early amortization of a trust since 2003, according to JPMorgan Chase & Co. analyst Christopher Flanagan.

“Early-amortization has been viewed as a catastrophic event for issuers,” Scott Valentin, an analyst at Friedman Billings Ramsey & Co., said today in a research note. “Given that all credit-card accounts in the trust will be shut down to future use, we expect losses to increase as the cards have substantially less utility to cardholders.”

Advanta has reported three consecutive quarterly losses and has seen its shares plunge from about $30 in June 2007 to $1.13 at the close of New York trading yesterday. The U.S. jobless rate reached 8.9 percent in April, a 25-year high, squeezing sales for small business owners. The economic slowdown affected Advanta’s customers across the country, Chief Financial Officer Philip Browne has said.

“We’ll be shutting down accounts for future transaction activities, but many of the customers will maintain balances and pay us off over time,” Browne said yesterday in a telephone interview. “We’ll have to service and collect on that, and that will be the first order of business for the company.”

Martin,

Could you please explain what this might mean to the average Joe?

Thanks.
-Blast

The current financial crisis was brought about by the collapse of the mortgage backed securities bubble bursting leading to the bankruptcy of many of the Trillion Dollar Asset sheet banks around the world requiring the bailout from central governments across the world. You know the odd trillion dollars here, trillion dollars there.

This wasn't the only bubble out there in the financial world, there was the Credit Card Bubble and then there is the Derivatives bubble which equates to around $190,000 per person on the face of the planet, which you can imagine dwarfs both the Credit Card bubble and the Mortgage backed securities bubble. The Derivatives bubble is essentially just future bets placed on future bets based on the premise that Mortgage backed securities and Credit Card bubbles will grow ever bigger and better.

Looks like the start of the beginning for the end of the Credit Card bubble. Round 2 ding ding.

I don't think that a single company with a million customers closing down is gonna bring the economic system down with it.

Isn't this what some folks have said needed to be done anyway? Let the companies fail that are going to fail?

I've never had an Advanta card but I do seem to recall that they were or are a place that specialised in higher risk, higher rate credit cards? They took a chance, made what I'm sure was plenty of profits for a while and now they get to pay their own creditors 65 cents on the dollar for their debts. Sweet deal. Given the loan shark type behaviour on the part of some credit card issuers it sounds like they're getting a much better deal than they probably ever offered their own customers.

Well, or it could simply serve like a canary in a coal mine or be the tip of an iceburg. It may not bring down other companies with it, but other companies may be in similarly dire condition and just haven't had to go this far yet.

Actually, as we saw last Fall, psychological factors can be just as important as financial factors. I think most high finance folks thought it was impossible for overnight credit markets to freeze up overnight, but that's basically what happened when fear and suspicion, and not hard financial news, caused everyone to hold onto their purse strings really, really tightly all of a sudden.

You could probably put commercial real estate into that race, too.

Should have added this to my last post, while it may be obvious Advanta will still be earning finance charges on all that money they've lent out. It's not like all of their customers have reneged on the deals that they made when they used the Advanta credit cards. A million accounts, minus the thousands that have or will default is still a decent number of accounts with payments coming in every month and they won't be lending any more money out on top of it.

There's a very good reason why you don't see many credit card issuing banks actually going out of business. They are for the most part extremely profitable companies.

One thing we have to realize.

All credit-card debt is non-secured debt. Meaning there is no collateral backing up the debt, unlike a car loan where they can come repo the car, the credit card companies are pretty much hosed when it comes to collecting their debts. In a bankruptcy it is not uncommon for credit card companies to never be paid off.

While in many, if not most, of the country it is either illegal or highly frowned upon to run up a credit card knowing that you are about to declare bankruptcy, it happens every day. And the rest of the credit card holders have to pay for the losses. Corporations will pass along their costs to the consumers however they can.

I know that many people have seen a reduction in their card limits, new fees tacked onto the cards they use, and some have had their rates increased for being even one day late with a payment. MOre reason than ever to wean yourself off the plastic.

I guess in the shortest possible explanation, this is all about a second wave of massive devaluation of debt-backed assets - not as big as the housing crash, but still another potential trillion dollars or so in imaginary money owed to real people, pension funds and 401(k) plans that's exceedingly close to vanishing.

If you have a 401(k) with a mix of stocks and bonds, remember that the value of some of those bonds are made assuming that someone, somewhere, keeps paying their credit card bills, keeps paying their mortgage, keeps buying cars on credit.

The average American Household owes $8,400 in credit card and other revolving debt, but through the magic of Bretton-Woods finance, that debt can represent well over $32,000 is "asset values" by the time it's recorded on various company balance sheets. It's all about the idea that the amortization of debt causes positive cash-flows for someone else.

There are several things that are at work here.

First of all, there's the basic fact that 1 million credit cards are about to be turned off all at once because the issuing company is in trouble. This is very different than the tactics being used by other issuers - credit line decreases, balance chasing, interest rate boosts, and of course fees. In those cases, they WANT customers who are on shaky ground to balance transfer out or simply pay more in interest to cover the losses of other defaults.

Your bigger, safer card issuers are happy to drop the bottom 15% of their customers, and even a 10% default rate is survivable if many of the other customers are paying more interest to cover the losses.

The main reason this card shutting down might matter to you is if you have a card with a small issuer like this and you're relying on it to manage your cashflow, even if you pay on time every time, even if you don't carry a balance, your credit facility just vanished - and getting credit might not be possible at all. If you can't gain access to the most rudimentary levels of credit - for things like buying supplies or paying for shipping - you might not be able to stay in business.

If this was just for a company that issued personal cards, that would be one thing, but this company serviced smaller businesses and they hit a default rate of 20%. That's massive and reflects a deeper level of financial trauma.

In addition, this shutdown not only affects the good and bad cardholders, it affects (in a tiny way, but still) the bond market, as they are basically telling the bondholders, "whoops you bought total junk" and they are poised to pay back only $0.65 on every dollar invested. yes, there are "junk" rated bonds all the time, but this is the first of what will be a new and fairly miserable effect of the "tightening credit market"

As an aside - Visa recently reported that the majority of all Visa card transactions were debit card transactions - NOT credit cards. Payment processing systems will do fine. It's the issuance of credit that's changing.

If you need credit to operate your business or your home, this would be a good time to look at your actual ability to simply pay your bills and see if you could actually do it without the credit float.

Anyway, I'd suggest that my previous statement that "credit cards are accepted everywhere" while still true does not matter to a million cardholders who now have some useless plastic in their wallet.

I brainstormed a quick solution for the commercial real estate market. If someone could raise the capital, then buy up vacant warehouses, office buildings, even hotels and turn them into minimum security contract detainment facilities. Hire non-union labor at $12 an hour, no benefits, and no quals needed (other than rudimentary psycho screening maybe). Charge the local governments a monthly head fee and then run the place like a boot camp, and put all the inmates to work doing cheap assembly type stuff.

If someone were properly connected, I just bet those facilities would all be filled by Christmas time.