Recession Inevitable, Card Charge Offs to Rise: Analyst

The U.S. credit card industry will be hit by a widespread consumer credit recession due to the dead-on-its-feet housing market, credit tightening, rising unemployment, an overwhelming debt burden, and a return to a normal bankruptcy environment, an influential Morgan Stanley analyst writes this week.

Kenneth A. Posner uses his latest write up on the prospects for Discover Financial Services (NYSE: DFS) to predict a dire 2008 and 2009 for credit card issuers and consumers, noting that Morgan Stanley’s U.S. economists have forecast unemployment rates rising to at least 5.4 percent and possibly 6 percent. The U.S. Department of Labor reported an unemployment rate of 4.7 percent in September.

Posner forecasts credit card issuers will see charge offs peaking at 6.5 percent in 2009, due to the disaster taking place in housing, U.S. consumers’ all-time-high debt service burden of 14.5 percent of disposable income, the 5 percent to 7 percent growth in revolving credit in the last 18 months (compared with the typical 2 percent to 4 percent), and bankruptcy filings that have increased 43 percent year-to-date.

Posner applies forecasts from Morgan Stanley’s U.S. economists and its large-cap bank research team to project the impact of a recession on Discover. In a summary of these experts’ projections, Posner writes, “While we cannot be sure what lies around the corner, a number of risk factors suggest that financial institutions will experience widespread deterioration in consumer credit quality.”

Following his predictions of gloom-and-doom for the economy, Posner rates Discover as Underweight-V, giving it a price target of $15 a share, down from its recent close of $20.14. Morgan Stanley uses the V to stand for More Volatile, with the stock indicating it has a more than 25 percent chance of a 25 percent price move up or down in a month.

Discover has its strengths, writes Posner, and could face the recession better than its card-issuing rivals. It is “more careful with credit,” so its charge offs will rise “to 5.5 percent by year-end 2008 and peak at 6.0 percent in 2009,” according to Posner. In contrast, Discover’s charge off rate was 3.7 percent in its fiscal third quarter, compared with a U.S. average of 4.4 percent as reported in the S&P Credit Card Quality Index.

It also appears to have fewer problem cardholders, with about 20 percent carrying subprime level credit scores, “compared to 30 percent at many other issuers.” In addition, it grew card managed receivables at a 6.3 percent rate in its fiscal second quarter, compared to an industry-wide growth rate of 6.9 percent, according to the Federal Reserve.

In addition to Discover, Posner follows American Express, Capital One, MasterCard, Nelnet, SLM Corp., and others.