Prime Issuers Tiptoe Into Riskier Waters

  Intense competition is forcing even the most conservative credit card issuers to venture into riskier territory in search of more revenue.
  When the self-described "ultraconservative" Fifth Third Bancorp announced earlier this year that it is lowering the minimum FICO credit scores required for its credit card applicants, industry analysts say it is part of a much bigger trend. The higher rates and fees associated with riskier credit sectors have become an irresistible lure for many prime issuers hungry to boost profits in the oversaturated credit card marketplace.
  "Many prime credit card lenders are moving into riskier segments this year in order to meet their business goals," says Ezra Becker, senior business consultant with the Chicago-based credit information company TransUnion. "A host of competitive pressures is forcing issuers to accept lower FICO scores than they did in the past."
  To offset the risks of taking on customers with weaker credit scores, issuers are turning to technology to help them monitor accounts more closely. They also are becoming more aggressive about squeezing new business out of existing customer files. But the risks of pursuing credit card customers with lower FICO scores are becoming steeper than ever before, say analysts.
  "Even if you don't target consumers with lower FICO scores, the environment for marketing consumer credit cards has simply become riskier than it was last year," Becker says. "Debt loads for consumers are increasing. And as interest rates rise, those with adjustable loans will get hit with higher payments. In some cases, consumers will see their mortgage payments double."
  Most prime credit card issuers refuse to discuss subprime lending or the specifics of their shifting risk policies. Anecdotally, however, industry observers say a growing number of issuers routinely are dipping into prospect pools filled with customers whose FICO scores are close to the subprime border of 660 and below. The full range of classic FICO scores is 300 to 800, and issuers consider the risk of giving cards to individuals with scores of 740 and higher to be relatively low.
  "A lot of issuers are loath to say they're going into subprime because it has a negative connotation and might attract the interest of regulators. Just in terms of reputational risk, a lot of issuers don't like to think of themselves as being in that end of the market," says Marianne Berry, managing associate at Auriemma Consulting, a credit card consultancy in Westbury, N.Y. "But we know of issuers considered to be prime, mainstream players that are exploring prospects with FICO scores lower than 660, which they are calling 'near-prime,'" Berry says.
  Fifth Third says it has no plans to go near the subprime zone, and for good reason. Regulators have stepped up their scrutiny of lenders' practices in this arena, and the recent spread of losses in the subprime mortgage market has added to its negative stigma.
  JPMorgan Chase & Co. also says it is not pursuing customers in the subprime zone. "The great majority of Chase customers fall into the "super-prime" and "prime" categories," says Paul Hartwick, a Chase Card Services spokesperson.
  In Fifth Third's case, the Cincinnati-based issuer says its move to accept lower FICO scores will align it more closely with its competitors' policies. According to Fifth Third, the average FICO score of customers in its current card portfolio is in the 740 range, which is higher than the industry's average of around 700.
  "Where we see the opportunity is in penetrating customers in the 680 to 720 range," says Stephanie Honan, a Fifth Third spokesperson.
  To boost its portfolio, Fifth Third also plans to base many of its new card offers on the behavior of its bank branch customers, to whom it believes it can cross-market its products more effectively across its various channels. With these strategies, the bank hopes to nearly triple the size of its portfolio to $2.9 billion in receivables by 2009, says Kevin Kabat, Fifth Third's president and incoming CEO. Fifth Third had $1.1 billion in receivables at the end of last year.
  But even a slight change of FICO scores can have a significant impact on an issuer's bottom-line risk, say experts.
  "You can't book customers with lower FICO scores without seeing your risk of delinquencies and losses increase," says Robert Sanders, global solutions leader of MasterCard Advisors' Global Credit Risk Practice. To succeed with a strategy based on weaker credit ratings, issuers must make some operational changes, including retooling internal software systems and deploying some new tools to offset risks, Sanders says.
  CAREFUL MONITORING
  The best way to do that is to step up internal controls and monitoring of customer behavior, he says.
  "What you can do is understand your organization's appetite for risk and, through technology, leverage the best practices and strategies to minimize it," Sanders says. "What issuers need to do is to keep a close watch on how their customers are behaving and react appropriately."
  For issuers seeking new approaches to managing their credit card portfolios in an increasingly risky economic environment, MasterCard provides consultation for a software-based statistical modeling practice called decomposition analytics. In development over the past five years, MasterCard has helped to refine it so issuers more easily can isolate the various factors affecting cardholders' delinquency rates, Sanders says.
  "Decomposition analytics can help issuers more quickly and accurately identify the source of a cardholder's delinquency by taking into account a broader range of factors than what was previously considered, including blips in the file caused by the issuer's operational events or strategic changes," Sanders says. "Previously, most issuers filtered out this data. But now operational events are not only included but modeled to estimate the potential impact of performance, which becomes part of the risk analysis."
  Using decomposition analytics, issuers combine data about market dynamics related to the economy and to competitors, as well as internal events, which eliminates many variables, Sanders says. "For example, one issuer implemented decomposition analytics to increase forecasting precision by accounting for economic effects in addition to changes in the composition of borrower quality and realized a 37% reduction budget variance," he says.
  Frequency and disciplined documentation also are key strategies for issuers striving to manage higher risks in a changing economy, Sanders says. He recommends running deep analyses on customer files at least each month, including refreshing credit-bureau data on each customer, and keeping accurate logs of various analyses performed.
  Technology vendors say they have software systems that could help with such ventures and overcome risks associated with delving into lower FICO scores in search of profitable cardholders.
  Chordiant Software, a Cupertino, Calif.-based supplier of mainframe computer-based software programs designed to help issuers identify new prospects through predictive modeling, recently customized its Decision Management system for use by credit card issuers, says Bill Brown, Chordiant's director of card product marketing.
  Brown says one of the nation's five largest credit card issuers is using Chordiant's Disputes Manager and Fraud Manager products to streamline the labor involved in servicing new accounts with higher risk factors. "Chordiant products fully automate the entire fraud- and disputes-management processes, so the customer was able to significantly cut the number of employees they need to manage these processes for existing accounts, which means they could also reduce projections of the incremental staff required as they grow," Brown says.
  Another way to offset the risk of taking on customers with lower FICO scores is to work with well-known prospects: those within an institution's own walls.
  LOOKING WITHIN
  Banks with multiple product lines often have customers with checking, savings, mortgage or auto-financing relationships, but no credit card accounts. These customers represent safer targets because their histories and behaviors already are on file. But many banks lack the tools to find them even within their own systems, say industry experts.
  Bozeman, Mont.-based Zoot Enterprises Inc. aims to tackle this problem with its Enterprise Cross-Sell Management System to help banks cut through intra-department barriers.
  "Most larger banks are organized around silos, and customer information is stored in such a way that one part of the organization cannot easily capture data from another area," says Tom Johnson, Zoot vice president of product development. "Our software takes a cross-sell approach that lets a bank see many access points for each customer and devise a strategy to market products more effectively to them."
  Using Zoot's cross-sell management system, all of the contacts between a bank and an individual customer can be tracked at a glance, including through inbound and outbound telephone contacts, Internet connectivity, direct-mail offers and personal visits.
  "Our system allows bank personnel to see all of these connection points, plus other credit-history and scoring data, in one glance on a single computer screen," Johnson says. "This means that when a credit card prospect comes into the bank or calls, bank personnel can immediately spot an opportunity to make an offer for a credit card."
  Unlike some mainframe systems that require deep re-engineering to link the data from different organizational units, Johnson says Zoot's system is far simpler. Its biggest advantage is the speed with which it can analyze a prospect's file, he says.
  "One issuer, in risk of losing over 15 million customers and billions of dollars following the Bank of America purchase of MBNA, needed help launching its own consumer card business platform," says Johnson. "They turned to Zoot and in five months the platform was ready for processing using the Zoot Credit Card Solution."
  Zoot was able to develop a decision engine that not only met the company's needs but was highly configurable and easily filled changing requirements, he says.
  WebRules, another software module Zoot sells, provides a quick path for banks to build test scenarios for various card offers to see which ones get the best results. "A nonprogrammer can create the algorithms for a new credit offer at his computer, which can be tested immediately," Johnson says. "This is a big improvement over the process of having a marketing person come up with an offer, which is then sent to a programmer who writes the code to make the offer. That can take months, but with our system you can test such offers the very same day."
  Fifth Third would not reveal which tools it will use to offset risk. "While no final plans have been made at this time relative to new technology, we plan to optimize our existing portfolio through modest investments in marketing, analytics, human capital, sales technologies and by better leveraging our retail distribution network," says Fifth Third's Homan.
  TransUnion's Becker says the marketplace's competitive dynamics leave prime credit card issuers with no choice but to forge cautiously ahead into riskier sectors.
  And emerging technology could help secure the information that reduces the chances for failure.
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