Like the early-'90s floral dresses and flannel shirts that became fashionable again, two retro credit products — secured lines of credit and personal loans — staged a comeback in 2010.
The products, though still a relatively small portion of banks' overall balance sheets, are becoming more prevalent as lenders try to accommodate two very different segments of the population. Financial companies are steering riskier consumers — those who have seen their credit profiles ravaged during the economic downturn or those who have little or no credit history — into secured credit. Meanwhile, personal loans, which remain relatively risky because they are unsecured, have generally been geared to creditworthy people who previously would have taken equity out of their homes but no longer have that option.
"We're going back to almost the kind of credit environment we saw 20 years ago before the world started tapping into equity," said Mary Beth Sullivan, a partner at Capital Performance Group, a financial services consulting firm. "None of these things is new. We're going to see more and more banks segmenting the marketplace, serving consumers who need to rebuild credit, still need to borrow for major purchases, and [banks] are trying to come up with products and services in an age where home equity doesn't exist in a lot of places and — even where it does — the consumer is hesitant to tap into their equity until the housing market recovers."
Analysts expect this trend to continue in 2011 and beyond.
"We're probably looking at a new normal in terms of credit in the U.S. for the foreseeable future," said Ali Raza, an executive vice president at the Atlanta consulting firm Speer & Associates Inc.
There is no question that consumer credit has contracted sharply across the board during the economic downturn. The Federal Reserve has reported that outstanding revolving credit card balances shrank 9.6%, to $865.8 billion in 2009, from 2008, and that nonrevolving credit balances (including both secured and unsecured loans for things such as cars, mobile homes, education, boats or vacations) fell 1.2%, to $1.58 trillion. In October, outstanding revolving balances were down 7.5% from 2009 and nonrevolving balances had inched up 1%.
What is more, a recent study by the Center for Financial Services Innovation, a Chicago nonprofit, said revolving credit was reduced for 33 million cardholders from October 2008 to April 2009 and that consumer credit lines would contract by $1.1 trillion in the coming year.
A report last year from the credit bureau Experian and the Oliver Wyman consulting unit of Marsh & McLennan Cos. showed origination volume and the number of new personal loans jumping by 28% in the second quarter of 2010, from the previous quarter, to $18 billion and 2.8 million, respectively. (Those numbers remained down from their peaks in the third quarter of 2007.)
Recently, though, banks have been bolstering solicitations for unsecured cards, more so than for other credit products. Mintel Comperemedia Inc., a market research provider, said banks sent out 3.5 billion direct mail pitches for unsecured cards this year through October, up from 1.8 billion in 2009 but down from 5.4 billion in 2008.
Pitches for personal loans stood at 162 million through October, versus 165 million in 2009, but solicitations for secured cards totaled just 1.75 million through October, down from 5.1 million in 2009 and 7.3 million in 2008, Mintel said.
The difference boils down to the fact that "unsecured is more profitable," said John Ulzheimer, the president of consumer education at SmartCredit.com, a provider of credit and identity protection services. "The limits are higher, so the balances are going to be higher, so the amount of interest generated is going to be higher."
But for consumers who may be denied unsecured credit, an offer for a secured card or some other alternative can be made, he said. And anecdotal evidence suggests that, even if most banks aren't quite pushing secured cards, they are becoming more popular.
Citigroup Inc. spokeswoman Elizabeth Fogarty said the company has offered its Citi Secured MasterCard since the 1990s and that recently there has been "a moderate increase in demand" for it.
Pam Girardo, a spokeswoman at Capital One Financial Corp., said secured cards "are a popular introductory product for consumers who are new to credit or are rebuilding credit."
The secured card is appealing to lenders because it lets them attract and retain a broader set of customers while offsetting some of the risk.
"So many more customers were in a position where they needed to build credit just because of what was happening in their economy — the credit tightening, less options available — and people just needed a way to make payments and transactions conveniently and build their credit," said Cheryl Wong, a vice president and product manager in the secured card unit at Wells Fargo & Co., which has renewed its focus on both secured cards and personal loans. "Certainly there's a lot of growth."
In the third quarter, the San Francisco banking company wrote 26,580 unsecured personal lines and loans, which included loans for large purchases like boats, planes and motorcycles, as well as loans secured by bank deposits, up from 23,294 in the second quarter and 20,505 in the first quarter. Total accounts stand at 1.5 million, or $6.3 billion in outstanding balances.
Secured credit is an option that many people still do not realize they have.
From November 2009 to December 2010, CFSI, the Chicago nonprofit, did an online survey of more than 2,600 people who either had little credit or bad credit histories or were students. The survey found that less than 5% of those contacted in each category currently used a secured credit card. Fifteen percent of those with bad credit had used one in the past. But 63% of the students and 56% of those new to credit had never heard of such a product.
Yet roughly half of the people surveyed said it is a product they would at least consider.
Secured cards are similar to unsecured credit cards in that holders can draw on their available balance at any time and are expected to make monthly payments. The big difference is that people are required to deposit a lump sum into a separate account as collateral. The line of credit typically reflects the amount of money deposited.
With Wells Fargo's secured card, initial deposits ranged from $300 to $10,000, but customers could add to their balances at any time. The current annual percentage rate is 18.99% on purchases. The annual fee for the card, which operates on Visa Inc.'s network, is $18.
The secured card is similar to a prepaid debit card, a popular product among unbanked and underbanked consumers, in the sense that people contribute an amount up-front.
What differentiates the products is that activity on a secured card is reported to the major credit bureaus. A consumer's use of a prepaid debit card typically has no effect on his or her credit report. (A handful of companies are trying to promote a prepaid debit card with an attached line of credit to help people build up credit histories, but regulatory issues have hampered such a product.)
After six months, Wells rewards customers in good standing with modest increases in their lines of credit. After one year, Wells upgrades customers who are current and have exhibited consistently good credit behavior to an unsecured line of credit — and it returns their deposit. Wong said roughly half the accounts will qualify for an unsecured line by their first anniversary.
This is a good relationship-building tool, she said.
"The secured-card customer — especially those who end up qualifying for graduation — tends to be very loyal," Wong said. "They really appreciate [our willingness] to help them build up their credit. … Having a secured card doesn't only help us to graduate them to the unsecured card portfolio; we're helping them become creditworthy customers for other product lines within the bank."
Though analysts admit that the up-front deposit can be a deterrent to some consumers, many people find that having some credit is better than having none at all.
About two-thirds of Wells Fargo's current secured portfolio participants had no prior credit history, Wong said.
She said she expects the secured card to be a focus for Wells. "This is a product that we definitely want to continue to make available to our customer base and make sure we're really expanding the value proposition of this product," she said.