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This story appears in the April 2009 issue of Cards&Payments.
Difficult times such as these can drive even the most skeptical listener to lean in closer, hoping to snatch from the growing cacophony of expert opinion bits of wisdom for what the card industry will be like once the economy improves. How will card lending differ post-recession? And what changes to the business will be, if not permanent, part of a long-term cycle?
Payments-industry experts differ slightly in their visions of the future. But they concur that, while the post-recession card-issuing business will be more cautious and less profitable, it also will be more efficient.
"One thing we know is that we will be a smaller (financial-services) industry, and that's not a bad thing," Kenneth D. Lewis, chairman, CEO and president of Bank of America Corp., said during his testimony in February before the U.S. House of Representatives Committee on Financial Services. "Obviously, the rapid growth of our industry in recent years was overdone."
Even without the economic crisis, new federal regulations alone will radically change the way many card issuers operate, sources agree.
Beginning in July 2010, new rules to federal Unfair and Deceptive Acts or Practices regulations (Regulation AA) will prohibit issuers from raising interest rates on existing balances, except in limited situations, such as when cardholders make payments at least 30 days late ("Stiffer Credit Card Policies OK'd," January). They also will change the billing and payment cycle from a minimum of 14 days to 21 days and require issuers to apply cardholders' payments first to their highest-interest balances.
These new rules are an unprecedented reform of the credit card market, and they will fundamentally change the relationship that cardholders have with their banks, according to Peter Garuccio, a spokesperson for the American Bankers Association. "The [Federal Reserve Board] itself has indicated ... that these new rules are likely to result in increased interest rates and decreased credit for some individuals," he says.
Kelly McNamara Corley, chief legal counsel for Discover Financial Services, agrees. "These are the most far-reaching and comprehensive changes in the credit card industry that I've seen," she says.
Limits on interest repricing will influence card-issuing practices most dramatically long-term, McNamara Corley says. "We have, over the last 15 to 20 years, had a real democratization of credit," she says. "Now we will see a back-to-the-future trend for credit."
Issuers today collect and analyze more-sophisticated data on borrowers, but they will be limited in repricing interest rates based on that data. So issuers will tighten lending standards and spread costs for credit risk across their entire portfolios, as they did in the 1980s through early 1990s, McNamara Corley says.
During a presentation for investors last month, Gordon Smith, head of JPMorgan Chase & Co.'s card unit, told investors he expects the industry will compensate for the new restrictions by adding annual fees and raising interest rates. "Think back to 1989," he said. "Typically most cards in the United States had fees."
In 1990, AT&T Inc. introduced a credit card without an annual fee, and other issuers soon followed. Issuers still avoid annual fees on all but high-end rewards cards. But that could change as issuers assess how to survive under new constraints.
Chase Considers Strategies
Chase is considering "a number of different product constructs," Smith said, adding the issuer is not ready to discuss any publicly yet. He identified two broad strategies: offsetting "low contract" annual percentage rates with annual fees and enabling "customers to restructure borrowing into fixed payment terms."
Current economic challenges and legal restrictions make Gary Jewell glad his bank outsourced its credit card portfolio about five years ago to First National Bank of Omaha (Neb.). Jewell is senior vice president of Carrollton Bank, an institution with $410 million in assets owned by Carrollton Bancorp in Baltimore.
Even five years ago, "it was difficult to make money on credit cards" without charging fees and high interest, Jewell says. He worries issuers will tighten their underwriting terms too much and maintain those tough standards even after the recession ends. So a consumer who could have gotten a credit card with a FICO score of 620 or 630, or one who made one payment late in an otherwise blemish-free year, would be unable to obtain new credit cards in the post-recession era.
"The credit card companies are not going to be able to afford to allow him to have a card," Jewell says.
In recent months, more consumers have been cutting back on credit-card spending.
Joakim Mellander, senior executive in the banking practice of New York-based Accenture Ltd., has been watching credit card sales decrease and debit use increase for awhile now. "There has been a 5% to 10% growth in credit cards on the transaction level but double-digit growth for debit cards and [automated clearinghouse transactions]," Mellander says. "Credit card is going to go down even more."
Visa reported 2.4 billion credit card transactions during the quarter, up 4.3% from 2.3 billion a year earlier. Debit transactions during the quarter totaled 5.3 billion on U.S.-issued Visa cards, up 12.8% from 4.7 billion.
MasterCard Worldwide reported 1.6 billion transactions on its U.S.-issued credit and charge cards during the fourth quarter, which ended Dec. 31, down 5.9% from 1.7 billion a year earlier. Debit MasterCard holders in the U.S. initiated 1.9 billion purchases during the fourth quarter, up 11.8% from 1.7 billion.
Just how cautious consumers remain about credit card use and issuers about card issuance after the economy returns to good health, and for how long, depends on the depth and length of the economic downturn, contends Ken Paterson, vice president of research operations and director of the credit advisory service at Mercator Advisory Group Inc.
"The longer it is, the more likely it is to create lasting behavioral changes and changes in the way issuers serve consumers," he says.
Gareth Lodge, who covers European payments as regional research director for TowerGroup, an independent research firm owned by MasterCard Advisors, expects a continued flattening or contraction of credit card issuance and use as card issuers and consumers, even in the debt-prolific United States, come to consider credit as more of a privilege and less of a utility.
"There's going to be a change," Lodge says. "We will start to see credit as not necessarily a bad thing, but we'll be wary."
Greater use of debit cards will fill the void, Lodge adds. "In Europe, [debit] already is the key way of managing your money," he says. "The U.S. will catch up with the rest of the world."
Tighter budgets along with growth of debit card use will drive financial institutions to seek more-efficient ways to manage a variety of banking products, which will be the nudge many issuers need to break down walls between separate business units of their banks and build unified platforms and services, according to Mellander.
Greater Scrutiny
"Right now, credit cards are [managed] by the card units of banks, and debit card is run by the retail units of banks," he says. "Those need to come together."
Also coming together is the consensus that the U.S. needs more-effective oversight of a variety of financial services, from loans to investments.
In testimony before the House Financial Services Committee in February, Jamie Dimon, Chase chairman and CEO, agreed with committee Chairman Barney Frank, D-Mass, that Congress should act quickly to establish a "systemic risk regulator" and reform the financial-services regulatory system.
"The ongoing financial crisis has exposed significant deficiencies in our current regulatory system, which is fragmented and overly complex," Dimon said. "Maintaining separate regulatory agencies across banking, securities and insurance businesses is not only inefficient, but it also denies any one agency access to complete information needed to regulate large, diversified institutions effectively and maintain stability across the financial system."
Quick legislative action is common during crises–the Patriot Act passed days after Sept. 11, 2001, is a prime example. Initiatives legislators had been discussing for years or months tend to get passed during crises as well, Discover's McNamara Corley says.
Such could be the case with additional credit card legislation. The House passed U.S. Rep. Carolyn Maloney's (D-N.Y.) Credit Cardholders' Bill of Rights last September, but the bill died in the Senate. Maloney reintroduced the bill in January, saying that the new federal regulations, which are very similar to the bill, will not go into effect soon enough to help struggling cardholders.
And U.S. Sens. Chris Dodd, D-Conn., and Carl Levin, D-Mich., in February introduced a credit card-reform bill that, in addition to restrictions similar to the new federal rules, also calls on the Government Accountability Office to study the effect of interchange fees on consumers and merchants and for the creation of a card-safety rating system.
Even more-onerous rules that differ slightly from the new federal regulations also could emerge, McNamara Corley says. "There was a proposal inserted into the House Appropriations bill that would give state attorneys general power to enforce Truth in Lending legislation," she says. "Our concern there would be that you could have 50 different ways of carrying out the Truth in Lending Act and 50 different interpretations of how to enforce it."
Whatever legislation gets passed in the coming months will be with the industry for a long time, McNamara Corley notes. "When we're out of crisis mode, we're back to a situation where legislation moves much slower and is harder to undo," she says.
And whatever a new regulatory system might look like after the current crisis is past, all institutions will receive closer scrutiny from shareholders, board members, legislators and public interest groups, McNamara Corley adds, noting issuers that receive federal bailout money will face additional scrutiny until they repay those funds.
Indeed, Citigroup Inc. already is having to explain how it is using federal bailout funds to increase consumer lending. In February, the troubled banking giant released the report "What Citi is Doing to Expand the Flow of Credit, Support Homeowners and Help the U.S. Economy," and Citi executives promised to release subsequent quarterly updates of how it is converting TARP spending into consumer lending.
The report said Citi expected to spend $5.8 billion of the $45 billion it had received so far in federal TARP assistance to support and expand its credit card-lending activities. Citi managed $149.3 billion in average credit card loans during the fourth quarter, down less than 1% from $150.5 billion a year earlier, the report notes.
But the report defended Citi's tighter lending practices. "In this difficult environment, Citi will not–and cannot–take excessive risk with the capital the American public and other investors have entrusted in the company," the report said.
As for new loans, Citi promised to extend a "significant" amount of new card loans to lower-risk U.S. consumers.
Citi's ability to turn itself around has broad industry implications. On March 10, the Dow Industrial Average rose 379 points after Citi reported profits for the first two months of the year. Citi's stock price rose 38%, BofA's rose about 28% and Chase's rose 23% based on Citi's news.
Marketing, Disclosure
If lower risk persists as a requirement for new cardholders long after the economy has improved, many issuers will look deeper into the smaller pool of high-credit-score consumers to find and attract the best cardholders with better-focused marketing campaigns, says Andy Jennings, chief research officer at Minneapolis-based Fair Isaac Corp. (
As marketers try to entice cardholders to seal the deal on new credit cards, they will have to provide cardholders with contract terms in clearer language and in larger type to comply with new federal card rules, McNamara Corley notes.
"If there are penalties and costs that could be incurred, those things are going to be highlighted like a Surgeon General's warning," she says. "Highlighting those risks hopefully will enhance the relationship between the cardholder and the company. We're embracing that change, but that could mean thicker mailings."
Issuers likely will have less of an appetite to expand their markets after the recession into regions of the world still unsaturated by credit cards, according to Lodge. And many banks and consumers in those regions, now avoiding direct effects of the credit crisis simply because fewer of their citizens use credit, will be happy to see new purveyors of consumer credit stay away, he adds.
Even so, issuers should look around the world for reasons to be optimistic about the future, Lodge says.
"Perhaps not so global and not so big, but many other countries have gone through these credit crises before," Lodge notes. Countries such as Finland and Turkey are testaments that countries can emerge from the disruption of financial crises with more-advanced payment systems, he says.
Finland, for example, went through a crisis some 15 years ago in which one-third of its financial institution branches closed. The lack of local branches drove an earlier and more-widespread electronification of banking and payments, Lodge says.
And in Turkey, which nationalized its banks a decade ago to nurse them back to health, now has "perhaps the most innovative card market" in the world today, Lodge says. He points to Turkish institutions such as GarantiBank, which combines loyalty programs, chip cards and mobile payments and can authorize small loans over mobile phones for its online banking users, as an example of innovation arising after a national banking crisis.
Despite big changes industrywide, not all issuers are suffering equally under the economic crisis. And not all will experience major changes to their own operations from restrictive new federal credit card rules.
New card-lending rules are "basically making the people that were doing those [practices] conform closer to our practices," notes William Shaw, group vice president at First Citizens Bancshares, a Raleigh, N.C.-based, $16.5 billion-asset bank holding company that issues 230,000 credit cards. "The industry needed reform."
Shaw does not expect First Citizens will charge annual fees on any but its high-end rewards cards, which already carry annual fees of $39 for personal cardholders and $49 for business cardholders, he says.
First Citizens was conservative in issuing its credit cards only to "prime plus" cardholders even in the recent boom years, according to Shaw. So while other issuers are reporting credit card charge-offs of 8%, First Citizens' card charge-offs remain at about 3%. And the portfolio remains profitable for the bank from interest and transaction revenue, Shaw says.
Most issuers will keep tighter reins on credit for awhile after the recession but gradually will decrease score requirements to broaden their markets, Shaw says. "Anybody that has gotten into issuing in the last 20 years has never seen a downturn," he says. "Those same people, once this [recession] peaks out, are going to get back in the marketing game."
Shaw worries that charge-offs of both mortgages and credit card loans are yet to peak. But, having issued credit cards for 40 years, he still takes the current crisis in stride as another difficult-but-temporary period in an otherwise rewarding business that will return to business as usual eventually.
From 1969 to about 1983, the credit card market "was growing so fast, you didn't recognize the hiccups when they came," Shaw says. "I don't think the downturn in the economy in 1987 and '88 affected the credit card business that much, but the one in 1980 and '81 certainly did," Shaw says. In the early 1980s economic pressure was coupled with a crisis, for issuers, of pricing. Many states capped interest rates on credit cards at around 18% or 19%, but issuers had based their card-loan pricing and profitability on interest rates of around 21%, Shaw recalls.
How long the current crisis will last and how it will affect credit card lending is still a matter of speculation. But industry experts concur that legal restrictions and some long-term memories will keep credit card issuing a tighter, more disciplined business for years to come. CP
Harry Terris of American Banker contributed to this article.
