The recent spate of unattractive earnings announcements from credit card issuers spells bad news for bank shareholders. The fallout is also causing pain for certain classes of cardholders, while offering new opportunities for others.
Financial institutions with extensive credit card portfolios have begun to shift their card offers away from those on the low end of the credit spectrum, according to a CreditCards.com analysis of 2007 year-end reports from card issuers and interviews with industry experts. Cardholders with credit troubles could see their accounts turned over more quickly to collections agencies, with issuers also moving faster to reduce credit lines on problem accounts, says Robert Lime, a partner with consulting and advisory firm First Annapolis in Linthicum, Md.
“It’s a bit of a flight to quality on the new-account prospecting front. And on the existing cardholders, it’s more of a proactive approach to addressing early credit issues in the form of collections and risk mitigation strategies,” Lime says. That means even if you have good credit now, it’s a terrible time to slip up. One mistake will be severely punished.
If you have bad credit, look out. Issuers report they have set aside more money for credit card losses, which means less-favorable interest rates and terms for those with poor credit histories. “People who have deterioration in their credit scores can be re-priced, and will be re-priced,” says Dennis Moroney, senior bank card analyst with TowerGroup.
On the other side of the credit fence, cardholders with pristine credit may benefit by shopping around, since they may see their credit card terms improve as card issuers try to trim their overall risks by peeling away bad credit customers and luring those with good payment histories. However, the negative impacts are likely to be felt sooner than the positive.
Delinquency first spikes in November
Banks experienced a sharp spike in delinquencies and charge-offs during November, says Kevin Mixon, an analyst with RiskMetrics working in Rockville, Md. Prior to November, credit card issuers had seen a slow rise in credit card delinquencies, but downplayed it, labeling it as a return to normal following bankruptcy reform in 2005. That reform made it harder for borrowers to refile quickly for bankruptcy, encouraging lenders to offer credit to consumers with troubled credit histories. The more-recent deterioration in credit quality knocked the pins out from under that theory.
“After that reasoning was called into question, then banks started reporting” their annual results, Mixon says. Major issuers, including American Express, Capital One and Bank of America, posted weaker earnings in the fourth quarter of 2007 as delinquencies and charge-offs rose.
Looking at this set of bank announcements, “Earnings are down primarily because loan loss provisions are up,” says Samuel C. Li, principal consultant at PA Consulting Group in New York. With more trouble expected, credit card issuers “had to increase loan loss provisions because they are looking at some losses in the future,” Li said. “They are anticipating a rise in delinquency rates, brought on by the housing crisis.”
For example, credit card issuer Capital One saw its fourth-quarter earnings decline following approximately $1.9 billion in loan loss provisions. That provision was comprised of about $1.3 billion in charge-offs and an allowance build (money added to the company’s reserves) of around $650 million.
“Banks rely on their credit card business to generate a lot of revenue,” says TowerGroup’s Moroney. That means that when credit card losses are mounting, banks need to protect themselves and make that money up elsewhere. Since issuers essentially price their card products for risk, uncertain times should mean tougher pricing.
That stricter pricing appears to have already begun: In mid-January, Bank of America sent letters to some responsible cardholders indicating that their interest rates would climb to as high as 28 percent, but did not include an explanation for the APR hike. While consumers didn’t get an explanation, shareholders did. BofA President and CEO Ken Lewis put it clearly to shareholders in a Jan. 22 conference call. “We’re focused on getting paid for the risk we take.”
Experts note that one of the easiest ways for banks to control credit risk is to slow their lending — offering credit to a more select group of borrowers. Many banks have already adpoted this strategy, according to the January 2008 Senior Loan Officer Opinion Survey from the Federal Reserve. That report showed the number of respondents who tightened their credit card lending standards over the prior three months doubled to about 10 percent from about 5 percent in the October survey.
Additionally, “About 30 percent of respondents noted that they had reduced the extent to which such loans were granted to customers who did not meet credit-scoring thresholds; smaller net fractions also indicated an increase in minimum required credit scores and a reduction of credit limits on credit card loans,” the Fed said. That could hurt cardholders with shaky credit histories. In the wake of those poor earnings announcements, “credit cards are being less generous already,” Li says, noting that he expects APRs to not be as low and generosity of credit to not be as high.
The decision to offer credit
Banks have always varied in how they decide to offer credit, based on corporate vision, desire for expansion and other factors. Now, some issuers are hurting financially more than others, so credit card issuers’ view of the same consumer may differ more dramatically.
According to Li, banks could lower cardholders’ existing credit limits, while fees for ATM withdrawals, account overdrafts and late payments could rise, depending on the borrower’s past behavior. Against a backdrop of rising delinquencies, banks may rely on such fees more than in the past. Since banks have come to depend on those fees, consumer need to be extra careful to avoid getting hit with penalties, advises TowerGroup’s Moroney.
Rewards, balance transfers, minimum payments less forgiving
Meanwhile, reward credit cards may get less generous. Just as airlines have cut costs by making frequent flier miles harder to redeem, “the same will be true around rewards cards,” Moroney says. He suggests that banks may prevent cardholders from redeeming their rewards if the cardholder is not current with payments on his account.
In this environment, it may also become more difficult for consumers to transfer balances to a low-interest-rate credit card. Consumers who generally transfer their balances may instead need to pay off their balance (assuming they have the extra cash handy) or get stuck with a higher APR.
As getting new credit becomes tougher, consumers who have put away old credit cards may realize they need this plastic again. But re-check those terms, Moroney advises, since minimum payments may have increased significantly, along with other possible changes to card terms.
Prime borrowers more desired
However, as credit card delinquencies increase, consumers with strong credit scores become even more valuable to issuers. “For those with prime credit ratings, these individuals will likely become a highly desired target market,” says Li. “They tend to pay off most, if not all, of their credit card balances monthly. Thus, to entice them to carry balances, credit card companies may offer them attractive rates and terms.” Whether individual prime borrowers see such preferential treatment will depend on the issuer.
Responsible existing customers may be especially valuable to card issuers. When given the choice of a banking relationship with a new customer with an uncertain banking history, an existing customer with bad credit or an existing customer with good credit, banks would “rather grab share of wallet from somebody they know and like,” Li says. He adds that for existing customers it really likes, “the bank may give you some offers you can’t refuse.” Li says while banks haven’t reached this point yet, they may start to model programs targeting these high-value existing customers.
Still, even consumer with solid credit histories need to watch their spending. “The closer you are to being maxed out, the less likely you are to see some great deals,” Li says.
Rates come down, credit card rates do not
Although the Federal Reserve has been cutting rates, that doesn’t mean that cardholders will see rate relief as long as delinquencies and charge-offs continue. “Consumers should not bank on the fact that the Fed funds rate is falling,” Li says. Since the prime rate, which variable rate credit card APRs are often tied to, doesn’t have to follow Fed decisions, the current environment may leave banks unwilling to change their rates. “If most of the banks don’t want to drop the prime rate, it won’t move anymore,” Li says. In some extreme cases, the prime rate could in fact move in the opposite direction to the Fed’s lending rate.
Election year issues
The fact that 2008 is an election year could spell added trouble for bank earnings. As Moroney explains, during elections politicians fight even harder for results that their constituents will appreciate, such as in the realm of consumer protection. Consumer protection initiatives that include scrutiny of fee income could cause banks to become skittish and adopt pre-emptive policies, which may in turn boost the credit card issuer’s expenses and hurt the bottom line.
Against this backdrop, cardholders have some leverage. Moroney says that Capital One, in particular, has come under fire from analysts over the quality of its revenue since Cap One derives a large portion of its top line from punitive fees, such as late and over-the-limit fees. Capital One has a large number of subprime borrowers who may be hit with such fees, he explains, but cardholders who discover these types of fees on their credit card statements may be given some relief from paying them in all or in part by their issuer. “My sense is because of all the attention that Cap One has received in the press on punitive fees (like BofA) they should be responsive to giving consumers a break on these,” Moroney says.
More delinquencies ahead?
Experts predict that tough times for both cardholders and credit card issuers will continue. “Delinquencies will rise; we’ll see a lot of losses starting to pop up in the summer time,” says Moroney. He hopes to see some moderation by the fall.
Moroney explains that in an effort to attract customers, mail volume for credit card offers increased in the third and fourth quarters of last year. Banks mailed about 30 percent of their offers into the risk segment on the knowledge that consumers had fewer options in terms of funding their debt. The question now is whether cardholders will be able to pay the issuers back.
“That’s the thing we all get to find out before too long,” Moroney says.
Credit card delinquencies, charge-offs rise
After spiking late in 2005 due to a change in bankruptcy law, credit card charge-offs have risen. Delinquencies have also come up to a rate not seen since the 2001 recession.
Source: Federal Reserve Feb. 28, 2008, report on commercial bank charge-offs and delinquencies, all banks, seasonally adjusted.
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