Credit line reductions, account repricing, and other steps that card issuers are taking to control risk could soon start causing their customers to do something many homeowners did this year: walk away from their obligations.
In the past month current and former industry executives and observers have raised concerns that prevalent risk management tactics may spur such behavior — even among customers who still have the capacity to pay.
For example, some observers said aggressive repricing could lead to a spike in "bust-outs" — when cardholders decide to run up as large a balance as possible before abandoning the account. In the past, bust-outs have typically been perpetrated by fraudsters who always planned to default, but they may soon become more common among regular consumers who obtained their cards in earnest, these observers said.
One way to prevent this from happening is by reducing credit limits, but that also can have unintended consequences.
"The question always happens, and it happened in the crisis of '92, '93 … if you're having to reduce people's credit lines, does that give them more incentive to pay, or less?" said James L. Bailey, a former Citigroup Inc. executive who ran its North American consumer banking and credit card business in the 1980s and '90s. Cardholders whose credit limits are cut down to their existing balances may decide that their card bill is no longer a priority for payment, "because that card has no utility for me anymore," said Mr. Bailey, who is retired.
When compared to home or car loans, or to other household expenses, a card with no purchasing power ranks especially low in a consumer's "payment hierarchy," he said.
Cards have long stood at or near the bottom of that hierarchy, but in recent years they have gained more importance — as long as they could be used.
In an October survey of 1,000 households that the Internet bill-payment company Online Resources Corp. released this month, about a third of the delinquent consumers polled said they continued to use their cards even after falling behind on payments. If they did not have enough money to cover all of their household expenses, about 26% of consumers said they would most likely skip their credit card bill, a drop of 8 percentage points from a year earlier. About 2%, roughly the same as last year, said they would skip the mortgage first.
Credit line reductions and interest rate increases can negatively affect the behavior of customers who may be current on at least one card, said Rick Wittwer, who oversaw collections and recoveries as an executive vice president for Washington Mutual Inc.'s cards unit and as an executive for Providian Financial Corp., which Wamu bought in 2005.
"You'll reduce the credit line to the balance that they have, so it becomes a useless card at that point," said Mr. Wittwer, now a managing partner in Virtual Point Capital Corp., a distressed-asset fund specializing in consumer loans. As a result, the cardholder decides, " 'If I can't use it, then I'm not going to pay it.' What it does is, it pushes them into delinquency when they weren't there before."
Issuers like American Express Co. and Citi have said they are raising interest rates by 2 to 3 percentage points.
This month regulators adopted rules that will restrict issuers from raising interest rates on existing accounts unless a customer is 30 days or more delinquent. The rules will not go into effect until July 1, 2010, and some industry representatives and analysts have said the prospect of tighter regulation helped prompt issuers' recent rate hikes.
And most major issuers, including Amex, Citi, JPMorgan Chase & Co. (which bought Wamu's banking operations this year), Bank of America Corp., and Discover Financial Services, have been lowering some consumers' credit limits.
Most issuers have said their line reductions targeted certain higher-risk customers. But Mr. Bailey said such reductions can occasionally push more cardholders into that group.
"What happens to that person if you take away the utility of the future use of the card? We always believed that we would slide them down, and make them into worse customers," he said.
Some executives say such concerns have discouraged them from lowering lines.
"We have empirically tested credit line decreases in the past and find that they actually have strikingly little leverage," Richard Fairbank, the chairman, president, and chief executive officer of Capital One Financial Corp., told investors at a conference in New York this month.
Cutting lines may alienate reliable cardholders, who usually can take their business elsewhere, leaving an issuer with the dregs. "In some ways it creates adverse selection," Mr. Fairbank said. "The bad guys already have your money."
Capital One, which has traditionally set a relatively low cap on its lines, has been decreasing lines more than it normally does, Mr. Fairbank said. But most of the reductions have been for inactive accounts, "which I think will have no impact on consumers, because by definition they are not even using these cards." A spokeswoman for Capital One said this month that the McLean, Va., company was also offering line increases on "a case-by-case basis."
A spokesman for Discover wrote in an e-mail, "Experience shows that risk-based interest rate changes motivate consumers to improve their payment behavior and most keep their accounts." Other issuers did not respond to requests for comment.
Mr. Wittwer said that when he ran collections for Wamu and Providian, his team tried to tread gingerly with consumers who had just fallen behind. "You typically just do a reminder call" for customers who are no more than 30 days late with their payments, he said. "If you push too hard when they're already teetering, you run the risk of no longer becoming the card of choice, and you create more delinquencies."
Brian Shniderman, a director of the banking team at Deloitte Consulting LLP who advises issuers and other card industry players, said he anticipates a rise of "individual bust-outs" — as opposed to premeditated bust-outs by professional fraud rings. "It's a concern," he said. "A lot of issuers are not thinking about the long-term ramifications of their actions."
Though Mr. Shniderman agreed with other observers that a job loss or sudden expenses are the most common triggers for a consumer to splurge and then default, he said high interest rates can be a contributing factor. "It's a fairly desperate measure," but "let's say I've got a $10,000 line on my credit card, and I'm paying some ridiculous double-digit interest rate. … I've lost my job, and my credit is shot, so spending out the remaining amount and walking away from it" becomes a temptation.
John R. Ulzheimer, the president of educational services at the lead generator Credit.com Inc., said consumer frustration with issuer pullbacks has risen noticeably since the summer.
"We are hearing from more people who are getting treated poorly by their credit card issuers in the past three to six months than I have in the first 16 and a half years I've spent in this industry," he said. He is not counseling any of them to withhold payment on their credit cards, but "you absolutely have people who will choose to make a stand" and stop paying, he said.
Mr. Shniderman said such responses have not yet been seen "in material numbers," but "we haven't seen an environment like this" before.
Observers said that issuers can stem individual bust-outs by making additional efforts to communicate with their cardholders as they change their pricing or account terms.
"While huge numbers of clients often dictates that a cardholder is notified by letter of a raise in rate or decline in limit, I think it's imperative for any financial institution … that there's additional contact, whether at the branch, or by phone, or online," said Craig Focardi, a research area director for consumer lending and retail banking at TowerGroup Inc., an independent research unit of MasterCard Inc. "Instead of just pushing out the negative news, initiate requests for consumers to call in. … At least some of those potential lost clients will be maintained."