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This story appears in the November 2008 issue of Cards&Payments.
As the credit crunch deepens and card delinquencies and charge-offs rise toward record levels, U.S. card issuers are executing a variety of complex strategies to blunt their losses.
Many issuers are moving to sell off troubled accounts earlier in the loan-life cycle. They simultaneously are stepping up efforts to counsel and negotiate with cash-strapped borrowers to work out payment plans before writing off the accounts.
Nearly every issuer also is performing the difficult dance of reining in cardholders' credit lines just enough to offset deeper losses, balancing regulatory requirements and maintaining customer loyalty during uncertain times.
Analysts say the benefit to issuers of cutting cardholders' credit lines is reducing their loan-loss reserve requirements. By shrinking shaky borrowers' credit lines and lowering the ceiling on solid borrowers' large, unused credit lines, issuers hope to minimize the need to set aside additional large loan-loss reserves in case risky borrowers tap those lines.
But though they face gloomy economic conditions expected to continue at least through next year, card issuers are not going into panic mode, says Rajiv Shah, a partner in the financial consulting practice of U.S.-based A.T. Kearney Inc.
"Credit card issuers are not dramatically changing their underwriting strategies, but instead they are making adjustments," he says. Instead of slashing credit lines across the board, issuers are using "a razor focus" in trimming credit lines from the riskiest accounts. "Card issuers must take a long-term view based on preserving customer relationships."
Consumers with healthy credit scores commonly qualify for credit lines of up to $50,000, and small-business credit card lines often extend beyond $100,000 per account, observers say. Card issuers will not reveal their average credit lines, but anecdotal evidence reveals that some individual cardholders' credit lines are being cut from as much as $30,000 to well less than $5,000.
But trimming cardholders' credit lines can be risky because it could drive away potentially valuable customers.
"As soon as you kill a customer's credit line, the customer loses interest and begins to look elsewhere for another card that will extend credit to them," says Brian Riley, research director at TowerGroup, an independent research firm owned by MasterCard Worldwide.
Discover Financial Services and American Express Co. are under particular pressure to reduce larger credit lines. Unlike many large bankcard issuers, they cannot rely on bank deposits to help fund their credit, says Sanjay Sakhrani, an analyst with U.S.-based Keefe, Bruyette & Woods.
"AmEx and Discover must fund their own loans through the card-securitization market, and as demand for those loans has softened, their funding costs are rising," he says. "Both issuers are pulling in borrowers' credit lines wherever they can." AmEx and Discover would not disclose details on how much they are cutting credit lines.
But analysts say they are doing so delicately. "An issuer that cuts off credit to all customers above a certain level is acting like a bull in a china shop and probably will lose valuable customers," Riley says.
Issuers should use payment histories to determine whether cardholders are at risk of default, Riley advises. If a cardholder begins using a credit card primarily to pay for groceries and household bills, it could be a sign of pending default that should trigger close monitoring of credit limits, he says.
Issuers typically notify customers in their monthly statements of changes in their credit limits. However, many cardholders with healthy credit scores whose accounts are in good standing will receive no such notices.
'Right Balance'
"The art is finding the right balance between constraining cardholders' credit limits at safe levels but keeping them interested in using their cards," Riley says.
AmEx is curtailing credit lines based on "payment history, credit-bureau scores and whether consumers are holding subprime mortgages or are located in areas with higher home-value declines," says Kimberly A. Forde, an AmEx spokesperson.
"On the small-business side, we look at reducing credit lines on customers in industries hit hardest by the downturn, such as home builders, contractors, mortgage brokers and real-estate agents," Forde adds. "There are many contributing factors. No single item dictates a decision."
As leading economic indicators began to change last year, JPMorgan Chase & Co. began increasing credit-score cutoffs for direct-mail marketing and increased the number of new-account applications it reviews, according to a Chase spokesperson. The company says it may lower credit lines for customers "who show signs of increased risk," but it did not disclose its criteria. And even during the present credit crunch, Chase may raise credit lines for more creditworthy customers, the spokesperson says.
Discover has selectively cut cardholders' credit lines and reduced its marketing in U.S. areas hit hardest by the economic slowdown, including zones with the sharpest declines in home values.
"We are suppressing automated (credit) line increases in riskier states and closing potentially high-risk inactive accounts," a Discover spokesperson says. "A prospect living in an economically stressed area who otherwise meets the company's new-account criteria would probably receive a lower credit line today than they would have received a year ago."
Besides minimizing credit lines, issuers are paying closer attention to card accounts flirting with delinquency. Although delinquencies often result in charge-offs, the correlation is not a direct one, analysts say.
"Delinquencies occur for a variety of reasons. And as the economy has become more volatile, issuers are paying close attention to early-stage delinquency to better manage their risks," says Edmund Tribue, global practice leader of MasterCard Advisors' Global Credit Risk Practice.
As more customers carry debt in an increasingly fragile economy, issuers should prepare to take swift action when a customer misses a payment, signaling trouble ahead, Tribue says. "Issuers must decide whether a delinquency is a one-time event or due to a short-term condition. If the situation is salvageable, the issuer can move into a workout mode with a borrower," he says.
Options include offering borrowers new payment terms on existing card loans or extending them a new type of loan to get them through temporary financial gaps. By studying delinquency trends, issuers can determine how important the consumer credit card is to the household versus the mortgage, the car payment and other loans, Tribue says.
"Knowing where the credit card stands compared to other financial obligations is critical in making the decision about whether it's worth it to try to work with the borrower or write off the account," he says.
If an issuer learns a card account is delinquent because of a job loss, a divorce or another catastrophic event, the issuer should act quickly to minimize losses, Tribue advises. "A year ago, some issuers waited until an account was 15 or 20 days past due before they took action, but now some issuers are taking action when an account is only one day past due," he says.
The key question is whether the account is worth collecting, observers say. With the cost of collections rising because of higher training and compensation costs, issuers "must weigh the option of spending money to collect on the loan versus selling off the debt on 30 to 50 cents on the dollar," Tribue says. "The equation for deciding whether to try to collect a delinquent loan or just sell it varies with every issuer and the quality of their portfolio."
And tougher times are putting the heat on large issuers' collection operations.
"During good economic conditions, effective performance is easily masked," Brad Neigel, a senior analyst with U.S.-based Aite Group, wrote in a report last August. In more-difficult times, collection efforts must focus on identifying the source of delinquencies and resolving them instead of "putting a Band-Aid on the situation until the following month," he wrote.
If delinquencies continue to rise and hit new heights, some card issuers may be forced to outsource all or part of their collection operations, according to Neigel.
"Part-time staffing, temporary staffing and even overtime are viable options for minor fluctuations in delinquency trends during seasonal highs and lows throughout the year. But when these figures are up 300% to 500% in less than 12 months' time, external assistance will be required," he wrote.
Issuers can aim to offset losses by trimming credit lines where appropriate and by taking quick action on accounts in early-stage delinquency. Improved collection practices and better risk-forecasting tools also may help stem further losses. CP
