Profiting from Credit Card Defaults
Last week I disavowed negativity about the world of personal finance until 2009. I don’t intend to break that vow today. However, writing about how we might profit from negative financial projections is actually positive, so I’m going for it. You can file this as a last minute, end of year stock tip. Maybe you could still benefit from taking a capital gains loss in 2008. (Don’t forget that up to $3,000 of that loss is deductible from ordinary income.)
Mr. ToughMoneyLove takes no pleasure in believing that many more American consumers will be unable to make their credit card payments next year. I will, however, toss in a little “you should have known better” attitude right here – then move on to the positive attitude.
So how do those of us who don’t have to worry about paying down credit card balances make money from news of an avalanche of credit card defaults? Obviously, a high default rate is bad for banks that issue the cards and hold the balances. It could get very bad for some, given that the historically high default rate is 7.5%. We are almost certain to break that record.
So, the first thing we need to do to make money from this prediction is not lose money. That means dumping stocks in financial institutions who are poorly positioned to absorb substantial losses arising from credit card defaults. I’ve already dumped the bank stocks that we owned when they cut their dividends.
According to Barron’s, the banks and card issuers with the highest current credit card default rates are:
American Express (Remember when having an American Express Card was a status symbol? Now those cardholders are one of the biggest deadbeats of all, with a 7.0% charge-off rate.)
Bank of America (7.86% charge-off rate)
Citigroup (6.94% charge-off rate)
TARP funds are no doubt flowing to these institutions but I’m betting that charge-offs are growing faster than Paulson can print money. If you own these or any other institution with a significant credit card business, consider moving your money elsewhere. If you are a risk taker, shorting these stocks could be a big profit play for you in 2009 or 2010.
This brings us to the question of whether there are any card issuers who are expected to perform comparatively better than others during this difficult period. The key factor here is likely to be having substantial bank deposits on hand to prop up the balance sheet. In that regard, Capital One has been very aggressive in acquiring smaller banks to get access to their deposits. In addition, Capitol One Online bank has a sweet deal with Costco, getting access to Costco customers in exchange for offering a .50% premium on depositis. If you watch any television at all, you will know that Capitol One is still promoting the heck out of its credit card business so it must be feeling pretty good about its future in that department.
In summary, consider whether you want to (a) sell, hold or short stocks in financials with big exposure to credit card defaults; or (b) look for a relative winner in the financial services sector, e.g., Capitol One.
I chose (a) and took my losses on Citi and Bank of America. Good luck with your decision.