Big Reform May Mean More of the Same

  It is good that somebody knows what is going to happen. President George Bush proclaimed a new bill designed to reduce bankruptcy filings would lower the cost of credit. "When bankruptcy is less common, credit can be extended to more people at better rates," he said during the signing ceremony in April.
  But it is not clear how credit card issuers will react to the new law that will take effect Oct. 17.
  Issuers were reluctant to discuss their strategic plans following the law's passage. Card industry consultants and research houses say they either have not been contacted to work on studies or are just beginning to investigate the topic. And the experts are not sure if losses will be reduced, revenues will increase or things will stay about the same.
  That may be because passage of the bill seemed to come out of the blue. A bankruptcy-reform proposal had been floating around Capitol Hill since 1998. President Bill Clinton vetoed one version, and clever maneuvering by opponents led to the downfall of another write-up in 2002.
  This time, however, passage was assured with Bush's re-election in November and Republicans gaining control of both the U.S. Senate and House of Representatives.
  One would tend to believe if an industry has been fighting for something for eight years that the payoff would be a big one. But the experts do not see it that way.
  Todd J. Zywicki, a visiting professor of law at Georgetown University, testified to the Senate Judiciary Committee that the legislation indicates that creditors could recover about 3 billion of the 40 billion of debt discharged annually through bankruptcy filings. He projected that about 10% of the consumers filing for Chapter 7 today would be shifted by the new law to Chapter 13, thereby requiring them to pay back at least a portion of their debt. That translates into about 120,000 of the 1.2 million consumers that have filed for Chapter 7 in each of the last three years and essentially were able to write off their debts.
  Other experts are less optimistic. "There may be 100,000 at most" that shift to Chapter 13, says Alan C. Hochheiser, lead bankruptcy attorney at Cleveland-based creditors' attorneys Weltman, Weinberg & Reis Co. LLP. And creditors, he adds, should not expect to recoup vast sums, as only about 30% of Chapter 13 bankruptcy filings are successfully completed.
  The legislation implements a complicated means test that reviews the prospective filer's average household income for the previous six months, then subtracts payments for secured debts such as a mortgage along with other necessities to identify disposable income at the end of the month. If there is more than 100, the consumer likely will be placed in a five-year repayment plan in Chapter 13, says Jeffrey Morris, resident scholar at the American Bankruptcy Institute.
  Morris is skeptical that a stream of Chapter 7 filers soon will be flowing to the Chapter 13 pool. Research shows that the average Chapter 7 filer earned less than 30,000 annually while median household incomes range by state from 40,000 to 60,000, says Morris. "That suggests many filers may not be subject to the means test," he says.
  Moody's Investors Service reported in April that the law would not "lead to any significant changes in the profitability of U.S. consumer lenders." Moody's estimates that the U.S. bank credit card industry wrote off about 13 billion in card receivables in 2004 because of cardholders filing under Chapter 7.
  If 10% of these Chapter 7 filers are shifted to Chapter 13, card issuers may garner another 1.3 billion from debtors, according to Moody's estimates. Taking it a step further and considering that only 30% of Chapter 13 filers complete their plan, then issuers may see as little as 325 million, Moody's reports. That is spare change when considering that the industry's average outstandings were nearly 660 billion in 2004.
  Enhanced Recoveries
  "The credit card companies will see enhanced recoveries. But I'm not sure how much," says Richard B. Levin, a LexisNexis analyst and attorney with Skadden, Arps, Slate, Meagher & Flom in Los Angeles. In the mid-1970s Levin was a counsel to the House Judiciary Committee and one of the principal authors of the bankruptcy code that the new bill reforms.
  "If you chase these people, you may only make the lawyers rich," says Levin. "It's not clear how much you actually collect from people filing for bankruptcy."
  The card industry should benefit from a bill provision that restricts debtors' ability to write off the purchase of luxury goods or services and cash advances made shortly before filing. In the new law, debtors can discharge up to 500 of debt for luxury goods from a single creditor within 90 days of filing, compared with 1,225 of debt taken on within 60 days of filing under the old rules. And the new law states that a filer can discharge a cash advance up to 750 that was made within 70 days of filing, compared with a maximum discharge of 1,225 within 60 days of filing under current law.
  Putting a restriction on filing may expand the number of consumers toward whom issuers can market their products, some marketing strategists say. After all, if the law reduces the potential loss from bankruptcy, then issuers can market more aggressively to the unbanked, the newly banked and other, riskier consumers.
  But marketing pros discount that theory. "I don't think it's plausible that the big-10 issuers will put the pedal to the metal because they think they're going to recover more debt," says Theodore Iacobuzio, vice president of research at TowerGroup, the independent research arm of MasterCard International.
  The issuers' approach today is to encourage existing, solid cardholders to use their cards in place of cash and checks, says Iacobuzio. "The smart guys are saying, 'how can I get my cardholder to use the card more? How can I get a transactor to become a revolver?'" he says.
  Or issuers are seeking to diversify their loan mix beyond cards, says Gwenn B?zard, a payments analyst with Boston-based Aite Group. Witness Capital One Financial Corp. paying 5.3 billion in March for New Orleans-based retail bank Hibernia Corp. and its 315 branch locations. Auto loans made up over 16% of its receivables at the end of the first quarter for Cap One, once the epitome of the super-sophisticated marketing monoline card issuer.
  The industry has changed since it began pushing the bill nearly a decade ago, says B?zard, as the focus today is on building long-term relationships with consumers. Instead of issuing a credit card to an unproven consumer, some credit grantors are experimenting with prepaid debit as a method of getting a new person in the tent, he says.
  Another example is Providian Financial Corp., the San Francisco-based issuer that made its bones in the high-risk consumer market. It sold a 447 million subprime portfolio of about 350,000 cardholders in the first quarter and reported a delinquency rate of 3.15%, down 210 basis points from the same period a year ago. A basis point is one-hundredth of a percent.
  Issuers Mum
  Large issuers declined to discuss their marketing plans or claimed it was too early to theorize about changes wrought by the law. Insisting on anonymity, a spokesperson for a major issuer says the firm will not be pumping up the bucks to garner risky consumers.
  "I don't see the bill changing our marketing in any way," the spokesperson says. "That's a pretty cynical approach."
  Still, issuers keep adding fuel to the fire with their never-ending direct-mail efforts. Synovate's Mail Monitor reported that issuers in 2004 sent a record 5.3 billion acquisition letters. This year in January and February alone, issuers mailed 924 million letters and are on a pace to beat last year's total, Synovate found.
  "I assume they are marketing to people with lower credit quality. I don't know, but that makes sense," says bankruptcy expert Morris. "If you are more likely to recover from risky people, maybe you take more risk."
  The general consensus is that a rush of consumers will file before the mid-October cut off. Fitch Ratings reported there was an all-time monthly record of 165,459 bankruptcy filings in March, as press reports covered Congress passing the bill. Fitch projects, however, consumer filings in 2005 will end up about the same as 2004's 1.6 million total because of "continued economic improvement, particularly on the employment front."
  Still, the six-month pop means higher near-term losses for credit card issuers, says Chris Brendler, an analyst that covers credit grantors for Baltimore-based investment house Legg Mason Inc. "You will probably see a meaningful increase in loss rates, particularly for large issuers," says Brendler. Long term, however, major issuers will feel little impact from the new law, he says.
  Issuers have shown a mixed reaction in preparing for the predicted losses. American Express Co. increased its provision for loan losses to 545 million in the first quarter from 514 million at the same time a year ago, a change an executive called "a rounding error." MBNA Corp. decreased its provision for possible credit losses to 1.3 billion from 1.5 billion.
  Issuers have been toughening their minimum monthly payment requirements. In the third quarter MBNA will require new cardholders to pay any interest, plus any fees and 1% of the balance. The same rule will apply to veteran cardholders in the fourth quarter, says a spokesperson. Currently, MBNA requires its cardholders to pay any finance charge plus any fee and 15, or to pay 2.25% of their balance.
  Bank of America Corp. last year adopted a rule that requires revolving cardholders to pay 10 each month, plus any fees and finance charges. Previously, BofA required such cardholders to pay either the lesser of 2.2% of the balance with a 10 minimum payment, or 10 plus fees and finance charges.
  Cardholders across the board are picking up the pace in paying off their bills. Standard & Poor's reported that the payment rate on its Credit Card Quality Index reached a record 19.1% in March, up from 17.1% in February. The S&P Index tracks pools of credit card debt from major issuers to determine general quality of the card market.
  The loss rate on the index fell from 7% in March 2004 to 6.1% in 2005, and the 30-day delinquency rate fell from 4.8% to 4.2% during the same period.
  Issuers also may catch a break from the added paperwork and expenses required to file under the new law.
  First, a consumer will have to bring information on income and expenses necessary to meet the means test, says Robert J. Ralis, a consumer bankruptcy attorney in Chicago. The law also makes the consumer's attorney liable for any incorrect information in a filing, forcing the lawyer to conduct much more due diligence, he says.
  Inevitably attorney's fees will rise, says Ralis, who estimates he may have to double the 500 fee he now charges for the most basic Chapter 7 filing. "That means it will be harder for the lower class and middle class to pay an attorney," he says.
  Credit grantors will experience more paperwork as well, says Hochheiser. Lenders must provide more information to debtors on their monthly statements, offer a central address for payments and gather more information on the debtors. That suggests that issuers may hire new staff or implement new technology to proactively work with consumers on the cusp of bankruptcy.
  J.P. Morgan Chase & Co. and BofA have been turning to online collections, a cheaper alternative to traditional phone and mail-based methods. Web-based collections typically allow the debtor greater authority in reaching a settlement and lessen the sometimes contentious dealings with a phone representative.
  The online collections system of Irvine, Calif.-based Apollo Enterprise Solutions uses credit scores and credit histories to find the most appropriate offer to display to a debtor. Apollo now is marketing its program as a means to reach cardholders before they are late on a card payment. The program sends an e-mail or letter that offers the cardholders a break for a month or a reduced payment until they get back on their feet, says Chris Imrey, Apollo's president.
  "You may look for the consumer that hasn't paid their gas bill for several months," he says. "That is typically the first [bill] that isn't paid."
  It might appear that quick passage of the bankruptcy-reform law took issuers and their advisors off guard. But the industry has been addressing losses with tougher requirements for cardholders, improved risk management and new technology. For now, it looks as though issuers may face a summer storm with October delivering blessed relief.
  (c) 2005 Cards & Payments and SourceMedia, Inc. All Rights Reserved.
  http://www.cardforum.com http://www.sourcemedia.com