Issuers Take Steps to Sidestep Subprime Mortgage Meltdown

  Near-term damage from the subprime mortgage market's collapse will be minimal for most credit card issuers, say experts. But ripple effects over the next 12 months could be more severe.
  So far, the damage seems to be contained within the subprime mortgage arena. But because the sector's economic impact is so broad, mainstream credit card issuers are taking precautionary measures by tightening credit-underwriting practices and reining in balance-transfer solicitations to new customers (see story page 34), say experts.
  Lenders' third-quarter results will reveal just how far the impact of the subprime mess will go, when they reset millions of consumers' adjustable-rate mortgages, observers say. President Bush recently proposed a program to restructure payments and provide tax relief to some overstretched mortgage borrowers, but higher interest rates are likely to put the squeeze on many consumers. As more people struggle to make ends meet, credit card issuers could face greater exposure to losses next year, analysts say.
  "If the subprime mortgage mess turns into a tsunami spreading across all income sectors, the credit card industry will be in deep trouble," says Robert Hammer, president of the credit card advisory firm R.K. Hammer Investment Bankers in Thousand Oaks, Calif. "However, I don't think that will happen."
  Hammer speculates that with smart portfolio management, most credit card issuers with healthy portfolios will get through the next year with minimal impact. The worst of the subprime mortgage problems are expected to work their way through the economy and begin to abate within a year, he says.
  But indirect negative repercussions are a concern to many credit card issuers, says Dennis Jacobe, chief economist for the Gallup Organization, which conducts a regular survey to create the Experian-Gallup Personal Credit Index. The survey's results through the second quarter of this year showed consumer credit confidence has fallen, and the subprime mortgage market's troubles plus the decline of real-estate values seem to be putting a chill on consumers' plans to borrow.
  "We asked people whether they have applied for credit in the last three months, and one in five said yes," says Jacobe. "But only about one in 10 said they plan to apply for more credit in the next three months, which seems to indicate some psychological impact from the subprime mortgage situation," Jacobe says.
  The Experian-Gallup Personal Credit Index, which was benchmarked at 100 at its inception in February 2005, fell to a new low of 82 in August from a 95 score in July. It was the lowest level for the Personal Credit Index since May 2006, when it was at 74. The index reached its highest point ever in February of this year at 105 (see chart page 31).
  "Consumers appear to be doing the same kind of re-evaluation that lenders and investors are doing," Jacobe says. "A lot of consumers are thinking about their use of credit and the availability of credit."
  Despite concerns about these repercussions, the subprime mortgage market's difficulties could be a boon to credit card issuers, say some observers. The decline in real-estate values means fewer banks will be extending home-equity loans to consumers, which could create fresh consumer credit demand among prime borrowers.
  "If credit card offers are targeted to the right borrowers and priced correctly, there may be some increased opportunities for certain issuers who can tap into the demand created by the drying up of home equity credit lines," says Catherine M. Williams, vice president of financial literacy at the Chicago-based nonprofit credit-counseling firm Money Management International.
  Jacobe agrees that through artful portfolio management, some card issuers could benefit from the fallout of the subprime mortgage market's problems.
  "There is an opportunity here for credit card issuers to take advantage of consumers shifting borrowing from home-equity loans to credit cards," Jacobe says. "Issuers can cherry-pick the customers that present the best risks for this kind of opportunity."
  For most issuers, however, the next 12 months will be a challenge.
  "Most credit card issuers with healthy portfolios have about 5% to 6% of subprime customers in there along with the prime and super-prime customers," Hammer says. "The key to avoiding spillover from the subprime mortgage market situation will be to maintain a healthy mix of creditworthy customers and extend just enough credit capacity to customers to drive charge volume without risking more charge-offs."
  Issuers would be wise to try to entice creditworthy customers to activate dormant accounts during the fourth quarter, Hammer suggests. "Getting consumers to use inactive accounts is found money in an environment like this, as long as you don't go too far and end up with a bunch of new charge-offs," he says. "It will require careful discipline in managing the decisioning and credit limits."
  Hammer's theory is supported by the fact that at mid-year, when subprime mortgage concerns were becoming a serious concern, issuers such as JPMorgan Chase & Co. were telling investors they were reining in their teaser offers for balance transfers and concentrating instead on pushing transactions.
  Chase and several other major issuers declined to comment on the impact of the subprime mortgage sector on their operations or marketing.
  "In the next several months I would expect to see credit card issuers spending more on portfolio-management technology and tools, and less on marketing," Hammer says.
  LESSONS LEARNED
  The credit card industry learned its own lessons in past years about the dangers of extending credit to high-risk markets.
  "A lot of the troubles facing the mortgage industry are based on the fact that they didn't learn the lessons the card industry learned in the 1980s and afterward, when there were heavy losses due to poor underwriting standards," says Scott Strumello, an associate with Westbury, N.Y.-based Auriemma Consulting Group. "Credit card issuers learned the hard way to avoid what the mortgage industry did, and in recent years issuers have been a lot more judicious in terms of extending credit to people."
  Card issuers also learned to price products accordingly when extending credit to riskier segments, he says.
  Those lessons now are paying off. For the first time in recent history, consumers in the subprime sector this year began to default on mortgages at a higher rate than on their credit cards, as poorly structured mortgages unraveled amidst declining home values.
  "Historically, it was credit cards that went delinquent first, then mortgages," Strumello says. "People will do anything to hold onto their houses. But that trend reversed recently, which tells you that credit card issuers have come a long way in educating consumers about the importance of keeping their credit accounts intact."
  Credit-scoring firm Experian confirmed this trend recently with a study analyzing consumer payment behavior in the subprime lending market. Data from January 2003 through the end of 2006 show that subprime consumers are a month or more delinquent on mortgage debt than on credit card debt. Late payments to mortgages began to outpace bankcard late payments in the second quarter of 2005. Housing values nationwide peaked in 2005, when a record number of mortgages were extended to subprime consumers, including those without substantial income documentation.
  The impact of bankruptcy reform in October 2005 also may be playing a role in this dynamic, as it has become more difficult for consumers to escape from debt by declaring insolvency.
  As long as card issuers maintain smart underwriting discipline, they are unlikely to fall into the abyss currently plaguing the subprime mortgage market, Strumello says.
  Low-income and minority consumers will have a tougher time qualifying for credit cards if issuers tighten underwriting standards in response to mortgage-industry fallout, says Christian Weller, a senior fellow at the Washington, D.C.-based Center for American Progress. The organization released a study in August analyzing the access to credit for low-income and minority consumers, revealing that even in a robust economy these groups face greater credit constraints and higher borrowing costs.
  ACCESS DENIED
  In a tighter credit environment, credit access will be denied to more low-income consumers, Weller says.
  "More denial of credit will be a triple-whammy for Latinos," he says. "They are disproportionately employed in the construction industry, which has slowed down along with new-housing sales."
  Moreover, many Latinos also happen to be in the subprime market with adjustable-rate mortgages, and they tend to have less savings to fall back on than the general market does, Weller says. "A slowing economy and tighter credit-issuing practices will hit them hard," he says.
  Weller says he also expects to see some issuers limit their relatively new marketing initiatives to Latino credit card prospects, as a result of the subprime meltdown.
  "I won't be surprised to see Bank of America pull back from their outreach to Hispanic credit card customers and banks in general pulling back on all types of lending to people in emerging markets," Weller says.
  By exercising various controls and disciplines, card issuers may emerge unscathed by the current subprime mortgage mess, but there still are some long-term uncertainties, says Eva Weber, research analyst for Boston-based Aite Group.
  "The third quarter will be critical in determining how widely the subprime mortgage market's problems will spread," she says. "One of the big unknowns is how all of this will affect the economy in general."
  When Wall Street loses confidence in certain types of credit, it could spill over into other areas of credit, including consumer credit cards. It may take a year to gauge whether that actually happens.
  (c) 2007 Cards&Payments and SourceMedia, Inc. All Rights Reserved.
  http://www.cardforum.com http://www.sourcemedia.com