Montreal, Canada

Credit card securitization is the new dirty phrase in mid-2009 as banks face an avalanche of bad loans tied to consumer loans that were aggressively sold to investors as individual securities prior to the credit crash almost 24 months ago.

Major U.S. banks are now coming to the rescue of their off-balance sheet vehicles tied to credit card securitization or investment products linked to consumer loans. This marks the next chapter of the ongoing financial crisis tied to the explosion of credit that started in August 2007.

Though the worst of the financial crisis appears to be behind us since March, the real economy remains mired in the worst contraction in GDP output since the 1930s. We’re still in the midst of a severe downturn marked by the lack of credit expansion, tepid consumer borrowing, rising unemployment, a housing bear market and a plunge in domestic consumption. Now the credit card world is starting to rip apart at the seams.

According to Moody’s Credit Card Index, losses on U.S. credit cards rose beyond 10% of total loans outstanding in May – a new high in the 20-year history of the benchmark and the sixth consecutive monthly decline. Banks, however, are not obliged to support these structured pools that are sold to investors; but in order to keep the market funded and creditworthy banks continue to pump the necessary capital into what appears to be a wave of growing losses.

Amazingly, like the Fed, which has purchased Treasury bonds and mortgage-backed securities since last November to keep rates down, some banks are buying back their own debt to maintain liquidity and transparency. This form of monetization or buying back bank-issued credit card securitization products can’t persist indefinitely if the market deteriorates further; the Fed can print money – banks can’t.

Since hitting a multi-decade low in early March the bank stocks have more than doubled. But since mid-June the sector is starting to waffle again as it breaches its 200-day and 50-day moving averages (see enclosed chart). Meanwhile, senior bank debt continues to rally over the last three months with credit spreads tightening markedly since May. This price action is not indicative of bank balance sheet stress or fears of renewed losses tied to credit card securitization; it does, however, imply that perhaps the market has already discounted a fresh wave of losses tied to credit card securities since banks have been warning about these impending losses for months.

Still, the market might have incorrectly discounted a modest level of credit card securitization defaults. The trend in this market in getting much worse as losses begin to exceed analysts’ expectations; the bank stocks, in my book, should be viewed like the stock market as one big trading opportunity whereby investors sell the higher end of the ranges and buy the steep declines. Bank balance sheets are still battered.