What happens to credit card debt if a bank fails?
You still owe it, but you'll pay someone else, perhaps on different terms
By Jay MacDonald | Updated: September 27, 2008
What would become of your credit card account should the bank that issued it fail?
There's only one foolproof way to find out.
"The watchword for cardholders should be this: Watch your mail," advises Robert Hammer, a Thousand Oaks, Calif., investment banker who specializes in the buying and selling of credit card portfolios. "That's where you'll be notified of any changes."
High-profile bank belly flops such as the recent
Washington Mutual, Wachovia Bank and IndyMac Bank collapses, naturally sends customers scrambling to claim their cash. WaMu, with assets of more than $300 billion, is the largest bank failure in U.S. history. IndyMac, with an estimated $32 billion in assets ranks, was the third largest. And the Sept. 15 failure of Lehman Brothers, whose $613 billion in debt made it the largest bankruptcy in American history, is liable to make consumers nervous about their own financial institutions.
But there's good news for IndyMac Visa cardholders: because IndyMac was not a card issuer (issuing bank) but merely an agent bank (marketing agent of the issuer), in this case of Elan Financial Services, its cardholders may never feel any effect from the closure.
"It's typically a nonevent," says Hammer. "The cards continue to be usable and, especially if the bank was an agent of somebody else, there will be zero change in card terms."
One exception: Lines of credit
The one asterisk in IndyMac's case could be credit card access to home equity lending, according to spokesman David Barr of the Federal Deposit Insurance Corporation (FDIC).
"IndyMac really didn't have credit cards; they had home equity lines of credit (HELOC) and one of the ways that customers could access HELOC was via a credit card. But they really didn't have a (credit card) portfolio," he says.
Banking experts expect IndyMac to be the first in a flurry of bank failures. The FDIC has 90 banks on its "watch list" of problem banks, up from 76 at the end of 2007. The FDIC's best-known role in the event of a bank failure is to insure deposits. But it also has a mission to preserve as much of its insurance fund as possible by getting top dollar for the failed bank's assets -- its branches, core deposits, and receivables such as mortgage loans and credit card portfolios.
When, in the judgment of federal regulators, a bank cannot meet its depositors' demands, the FDIC steps in, pulls its charter and assumes full control over the bank's assets and day-to-day operations until a suitable buyer can be found, ideally within 90 days.
Credit cards portfolios and bank failures
Former FDIC Chairman L. William Seidman, who oversaw the failures of more than 1,000 banks and 700 savings and loans during the S&L scandal of the late 1980s and early 1990s, says credit card portfolios, though rare in failed banks, are both valuable and problematic for the federal liquidators.
"Generally, I think it's a good asset that the acquiring bank would want. It depends on the standards of credit card issuing they've been using as to whether the balances are any good or not. As far as being easily collectible, they are probably problematic. The question is, is the acquiring bank in the card business themselves? Is this a business they want to be in?"
Hammer says the buyer pool often determines the fate of the card portfolio. "The FDIC wants to sell in whole, but credit card portfolios sometimes get carved out," he says.
"For example, the credit card portfolio might trade for 20 percent premium above book value, so a $100 million credit card portfolio in a larger bank can generate $20 million in profit to help offset some of the discounted sales they're going to have at a fire sale to get somebody to buy all the branches and things. The pieces, if sold for a profit, could help offset the loss that they take selling other pieces of the business."
Will your terms change?
As part of its due diligence, the acquiring bank compares the terms and conditions of the failed bank's credit card portfolio with its own. Do acquirers typically honor the contracts made by the failed bank?
"Most do," says Hammer. "There is a process called data mapping that compares the old terms of the seller to the terms of the buyer: What's their annual fee, what's ours? What's their over-limit fee, what's ours? What's their late fee, what's ours? Unless there is something egregiously out of kilter, it is in the interest of everyone not to have a whole lot of change -- except to maybe offer better services or new services. Sometimes it works out to be even better for the cardholders."
Unfortunately, sometimes it doesn't. Consider the case of Internet-based NextBank, the financial institution founded by the now-defunct NextCard, which failed in February 2002. The FDIC auctioned off NextBank's 590,000 card account accounts to Utah-based Merrick Bank.
Based on its experience in subprime lending, Merrick repriced NextBank's card portfolio based on its own risk models. Soon, 100,000 NextCard holders received notice that their interest rates were being raised, from as low as 9.9 to as high as 29.7 percent. Some also were hit with annual fees of up to $120 and an additional $500 to their account balance to offset the risk to Merrick.
Sometimes it works out to be even better for the cardholders.
|-- R.K. Hammer
CEO, R.K. Hammer Investment Bankers
Hammer attributes the NextBank uproar and ensuing legal action to a risky Internet-based portfolio ending up with a bank better schooled in subprime risk aversion.
"That was a rough marriage, no question," Hammer says. "That was an acquisition that was going to be tough going anyway you looked at it."
Fortunately, he says such rocky transitions are rare.
"Usually that doesn't happen. The major banks have done this for decades and they know exactly what to do to have a seamless transaction and assuage the fears of the cardholders. If you chase off all the cardholders, you've just lost your shirt on the transaction."
Hey, you're an asset!
That's right: As upside-down as it may seem, your credit card debt is viewed as a positive to your issuing bank. They like you to be a so-called "revolver" who doesn't pay your card off each month, but instead contributes interest, late fees and over-limit morsels to their bottom line. (The industry's term for people who pay off their balances monthly is "deadbeats.")
Is there a chance your interest rate could suddenly jump as fallout from a bank failure? Yes. Credit card terms are tightening today along with all other forms of consumer credit.
But is it likely? No. After all, the successful bidder acquired the deck that your card is in specifically because they want to keep you as a happy card user. Mass account closures would be their worst-case scenario.
Your best move to protect yourself as a cardholder should your bank fail? Actually read your mail from your credit card issuer -- at least until the dust settles. If you have questions, call the customer service number listed on the back of your card, not the local branch of your now-defunct bank.
"Consumers can still use their credit and debit cards; they continue to work until they receive something from the acquiring institution," says FDIC spokesman Lujuan Williams-Dickerson.
Oh, and don't assume just because your bank is off the hook that you are. Continue to make those credit card payments.
"You shoot yourself in the foot if you do that, you'll trash your own credit," says Hammer. "Loans are still due and payable, just as issuance of credit is due as well. They have to continue to honor your use of the credit card. Which they would."
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