Looking Over Issuers' Shoulders

  Lax credit card lending policies that drew the ire of federal regulators in recent years-culminating with the January release of guidelines urging issuers to stop the fire sale on credit-are being tightened, early signs show.
  Criticizing practices ranging from open-ended workout agreements to extending credit to people already knee-deep in debt or lending to those with weak credit histories, the guidelines are designed to encourage credit card issuers to get tough.
  The directives are the collective work of the Office of the Comptroller of the Currency, the Federal Reserve, the Federal Deposit Insurance Corp., and the Office of Thrift Supervision-the agencies that make up the Federal Financial Institutions Examination Council.
  Six months later, the OCC reports considerable progress in two key areas of concern: "inappropriately low" minimum-payment standards and repayment programs. The guidelines were aimed at subprime issuers, but regulators were quick to point out that prime issuers should take heed, too.
  "We were looking for banks to establish reasonable repayment periods for over-the-limit accounts," says Barbara Grunkemeyer, deputy comptroller for credit risk with the OCC. "If accounts are in over-the-limit status for more than three to six months, then banks should step up the repayment program. We're seeing progress."
  Although the federal agencies initially became aware of the questionable lending practices through their work with subprime issuers, Grunkemeyer says, "We quickly discovered some had migrated to the prime shops."
  Minimum Standards
  David Sanger, a credit card analyst for Moody's Investors Service, says the guidelines are aimed more at subprime shops-particularly those dealing with a practice known as "negative amortization," which occurs when a minimum payment doesn't cover tacked-on interest charges and fees. It's a common practice that has many cash-strapped consumers engaged in an ugly dance with issuers. Minimum monthly payments in the past decade dropped from 4% of the balance for most issuers to 2%-and even lower at some banks.
  The guidelines direct issuers to raise minimum-payment requirements high enough to cover all finance charges and fees-thus keeping consumer card balances from inordinately growing.
  Reducing overlimit income will hit subprime issuers the most, experts say. "For prime issuers it's not as big a source of income because they have much higher lines of credit," says Reilly Tierney, an analyst with Fox-Pitt Kelton in New York. "A $29 fee on a $500 balance for a subprime account has a much greater impact than a $29 fee on a $5,000 balance."
  Subprime loans account for nearly 40% of card debt, according to credit-reporting agency Equifax Inc. Competition is likely behind the lowering of standards. Clamoring for a larger share of the market, card issuers loosened standards to lure more business.
  But several recent market events-dating back to the failures of Pacific Systems Loans, BestBank, Superior S&L, Keystone Bank, and NextCard Inc.-prompted federal regulators to act. "In each of these cases, there was the common theme of subprime lending on securitizations," Sanger says. "In each case the FDIC suffered substantial losses, so in response regulators stepped up to examine subprime lenders who were active securitizers."
  High-profile problems and questionable practices at such subprime houses as Metris Companies Inc. and Providian Financial Corp., as well as at Capital One Financial Corp. also helped spur the FFIEC to action, says Michael Zamorski, director of the FDIC's division of supervision.
  More Teeth Needed?
  Bad debts ballooned at Providian and Metris during the recession and, last year, the FDIC was forced to pay off NextCard depositors after the online card issuer was shut down. The FDIC estimates the liquidation ultimately will cost taxpayers up to $400 million.
  Linda Sherry, editorial director for Consumer Action, a national consumer advocacy group, applauds the guidelines but wishes they had more teeth.
  "They shine light on the problem and banks may start looking at their policies more closely. They're just not as good as regulation," she says. "But if many of the subprime lenders follow these measures to the letter, I don't think they'd be able to do business."
  Lending to people with weak credit, after all, is what subprime banks do. "The kind of customer that comes to these banks is the kind that wants more credit. It's been common practice to issue new credit to people with overextended credit," Sherry says. "Can they and will they really shut this market out?"
  Metris officials say the company has several initiatives under way to make sure it's acting within the spirit of the guidelines. "A lot of this we've already had in place because of working with the OCC last year," a spokesperson says. "But we are going to take some time and make sure that there won't be any additional issues."
  Capital One reports that, based on the language in the guidelines, the company didn't need to make any major changes concerning its overlimit fees. It's already complying.
  A year ago, as talk of guidelines grew, most of the major players took action to comply ahead of time. "The principle area (where) they made changes was in their reserves for finance charges," Sanger says. "MBNA and Citibank both established separate reserves for finance charges."
  Meanwhile, there are additional signs card issuers are taking the guidelines to heart-including conducting more thorough credit reviews and considering the repayment ability of borrowers before raising credit lines or approving new cards.
  Issuers mailed 896 million offers to consumers in the first quarter of 2003, down about 7% from the 962 million mailed in 2002's first quarter, reports Mintel's Comperemedia, which provides research for direct-mail and advertising. They're also offering lower interest rates. In the first quarter, 15.3% of the offers carried an interest rate between 5% and 7.99%, compared with 3.2% in the first quarter of 2002. Offers for cards with interest rates of 22% or higher have almost disappeared. They accounted for 0.7% of all first-quarter 2003 mailings, compared with 8.4% a year earlier.
  Banks Lobby
  In the end, hard lobbying from banks helped tone down the guidelines. An early draft sought to require borrowers exceeding their limits to be brought back under limit in the current billing cycle, which was changed to within a "reasonable period." The guidelines also could have declared overlimit fees to be illegal, says Tierney, with Fox-Pitt Kelton.
  While such prime issuers as MBNA and Citibank made early changes to meet the guidelines and subprime issuers now appear to be doing so too, it will be some time before the larger impact of the guidelines is clear.
  The OCC's Grunkemeyer says the FFIEC has no plans to issue another round of guidelines. "These aren't laws, but the expectation is that banks will pay attention and do what they need to do to comply," she says. "That seems to be happening. We're seeing progress."