Like farmers locking in a wheat price to hedge against market fluctuations, banks may soon be able to offset risk in their credit card portfolios by purchasing futures on the Chicago Mercantile Exchange.
The Chicago Merc filed last week for regulatory approval to permit trading of futures and options tied to the national bankruptcy rate. An issuer could lock in a particular bankruptcy rate, assured that if the rate rose higher it would be compensated for losses.
Though personal bankruptcies have declined for four consecutive months, they hit a record level of 1.3 million in 1997, according to Visa U.S.A. The historically high plateau has been a major concern of credit card issuers and other consumer lenders.
If approval comes from the Commodity Futures Trading Commission-which may decide as early as today-the Chicago Merc would begin marketing the concept to banks and potential speculators.
The monoline credit card lender Capital One Financial Corp. is eager for the product.
"This is the first time a credit derivative addresses retail credit risk," said Peter Sprudzs, director of asset-liability management at the Falls Church, Va., company.
Capital One has played an integral role in designing the product, which is based on an index that tracks new bankruptcy filings. The numbers will be supplied daily by Hogan Information Services, a subsidiary of First Data Corp.
Scott Gordon, chairman of the Chicago Merc, said the market for the derivatives is particularly ripe among card lenders.
"Credit card issuers have seen their rate of nonperforming loans grow from 4% to 7% in the past three years, making the need for risk management ever more urgent," Mr. Gordon said.
Under the plan, the Chicago Merc would act as a clearing house, setting up margin accounts between buyers and sellers who would bet on the number of bankruptcies at the end of a future quarter.
If a card issuer, for example, wanted to hedge against chargeoffs in the first quarter of 1999, it could buy a contract to lock in its risk at a certain level. If bankruptcies fell below that level, the issuer would pay; if bankruptcies climbed higher, the counterparty would pay.
James Shanahan, a partner in the Newark, Del., office of Business Dynamics Consulting Inc., hailed the innovation.
"It is way-out-of-the-box thinking," Mr. Shanahan said. "It could be a significant enhancement to business from a Wall Street perspective. It would make stocks worth more because it would take away some of the risk."
James Chessen, chief economist of the American Bankers Association, said, "Anything that gives a bank an ability to hedge or offset some of the risk is positive." But he also said he wondered who would bet against the banks: "The assumption is, there will be speculators."
