Within Difficulty Lies Opportunity

  For the better part of 2007, there was lively debate on the scope of the mortgage meltdown and whether it would spill over to the credit card industry. New terms such as CDO (collateralized debt obligations) and SIV (structured investment vehicle) become popular acronyms, joining more-familiar jargon such as contagion (as in worldwide epidemic) as the mortgage saga played out.
  Now the debate is largely over as the effect of the credit crunch has spread well beyond the mortgage market and has created a host of challenges for credit card issuers and other stakeholders that rely on consumer credit. Based on fourth-quarter 2007 earnings releases, all but one issuer posted an increase in losses over the previous-year period. Those issuers’ losses were up an average of 75 basis points.
  Guidance for 2008 points to higher loss rates and a cautious overall outlook given the increasing threat of a recession. In general, we expect loss rates in 2008 to be roughly 100 basis points higher than those in the fourth quarter of 2007, and it is reasonable to assume that access to the securitization market will remain challenging and more costly until the uncertainty clears.
  However, it is important to put credit card-loss trends in context. Since 2006, loss rates have been at or near historical lows in the aftermath of the October 2005 bankruptcy-law change, and every issuer expected more “normalized” loss rates heading into 2008 irrespective of the mortgage spillover. By and large, the underlying fundamentals of the credit card industry still are sound, and the credit card is one of the few consumer-loan products with the capacity to both reprice and reduce line exposure in response to worsening trends.
  The key question for 2008 is when, if or how the current trends will stabilize or be reversed, and we are not breaking any new ground by expecting 2008 to be a challenging year for profitability in the card sector. Needless to say, almost every issuer will accelerate expense-rationalization efforts, rebalance marketing investments, and tighten or reprice credit in certain segments.
  There will be the usual flight to quality, which will increase competition for the high-spending affluent cardholder, and, on average, issuers will be more selective in the co-brand partnership sector, where aggressive competition has driven down returns. More broadly, the impact of recent rate cuts by the Federal Reserve on the capital markets remains to be seen, and time will tell if any economic-stimulus package can bolster 2008 consumer spending.
  Historically, merger-and-acquisition activity in the card sector increased during periods of market instability as the stronger players looked to acquire assets at depressed valuations.
  However, to the extent that the current cycle results in a shake-out, we expect any significant changes in market share from receivables transfers to be the result of broader bank mergers and acquisitions. Furthermore, it is not out of the question to expect new players, such as international financial institutions, to enter the credit card business or certain segments where incumbents pull back or exit.
  This year no doubt will be a challenging one from a profit perspective, and most issuers will be very internally focused on credit quality and expense productivity, and on preserving margins. The winners will be those issuers who are in a strong enough position to think long-term, shore up the business to weather the storm and seize external opportunities to gain market share while competitors retrench.
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