Commentary

What’s in Capital One’s Wallet?

“What’s in your wallet?”, the fierce looking Viking asks at the end of the Capital One commercial. Now, Wall Street investors are asking the same question of the creator of this amusing advertising spot.

As the headlines scream about the collapse of the subprime mortgage market and the relentless meltdown of real estate prices, far too little attention is being paid to the other shoe that is about to hit the floor – which sports the consumer debt fashion label in bold type on its side.

Credit card delinquencies (the percentage of accounts that are unpaid after the due date) are increasing for serial issuers such as Capital One. But, these outfits are actually stepping up their lending activity. They are following in the footsteps of their inbred cousins in the mortgage lending arena, which means that they are sowing the seeds of their own demise.

Just like mortgage issuers, Capital One and other large publicly traded peddlers of credit card debt have depended on the securitization of loans (packaging them as asset-backed securities that are sold to investors) in order to keep them off their own balance sheets, allowing for the continuing issuance of consumer credit.

This charade is what allowed mountains of debt to be created, from housing to credit cards to auto loans. The problem is that given rising credit card delinquency rates, investors are becoming much less enthusiastic about purchasing securities that are backed by such questionable assets. This will eventually force credit card issuers such as Capital One to curb their lending
to consumers.

This will rain heavily on their earnings parade, reducing the revenue streams derived from charging criminally high interest rates and siphoning sleazy fees from their docile customer base.

Rising delinquency rates are forcing credit card issuers to increase loan loss reserves to cover the giant stain of red ink from customers who are no longer paying their bills. This has already reduced profits for Capital One in the second quarter of this year, and will only get worse if the economy weakens.

The combination of a growing pot of delinquent consumers and an increasingly hostile asset-backed market will continue to squeeze Capital One and other big issuers of credit card debt. And, as their profits dive, so to will their lending activity, which will dampen overall consumer spending.

The picture perfect conditions that brought eager borrowers and gullible investors together is unraveling into a nightmare that will feature the Capital One Viking turning on its creator.

© 2008 Splendid Marbles.