Debtors' Diligence Pinches Card Issuers

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Debtors' Diligence Pinches Card Issuers

elymiles

29th May 2006

The credit card industry has a problem: Although Americans are deeper in debt than ever, they are paying off bigger portions of their monthly credit card bills.

For card issuers, which profit by collecting interest on unpaid balances, that's bad news. In the past, when interest rates crept up, as they are doing now, fewer cardholders could afford to pay down balances.

"Normally at this point in the economic cycle, you start to see payment rates decline. But that's not happening," said Richard Srednicki, who runs the credit-card business at J.P. Morgan Chase & Co., the nation's second-largest card issuer.

"It is a tougher business if payment rates continue to stay up and consumers continue to pay off more. It's something we've got to understand and work at."

Although consumers are using plastic for more of their daily purchases, they are giving card issuers fits by juggling their debts more shrewdly.

When cardholders are hit with high interest rates on one card, they routinely transfer balances to new cards at lower rates. And in recent years, as real estate values soared and mortgage rates fell sharply, more consumers wiped out credit card debts altogether by borrowing against their homes.
To make matters worse for card issuers, federal bank regulators issued new guidelines in 2003 meant to ensure that cardholders pay off more each month than just the fees and interest charges that have accumulated.

To comply with the rules, many banks have raised minimum-payment requirements, bumping up the payment rate further.

In March, U.S. cardholders paid down 20.6 percent of total credit card debt, up from 17.9 percent a year earlier, according to an analysis by Barclays Capital of one portion of the market - $400 billion of credit card debt sold to investors as securities.
That was the highest payoff rate in the five years tracked by Barclays.

Follow up:

According to the Federal Reserve, during the fourth quarter of 2005, consumer debt, which includes credit card debt and auto leases, represented 5.71 percent of total homeowner debt, down from 6.4 percent in the fourth quarter of 2000. That was the lowest level in a decade.

American consumers have not curbed their appetites for borrowing. During the fourth quarter, 13.86 percent of disposable personal income of Americans was consumed by debt payments of all kinds, up from 12.77 percent five years earlier. But an increasing portion of that total went to mortgages and home-equity loans, which ballooned in recent years as rates fell.

Now, rebounding mortgage rates could provide relief to credit card issuers because they will make it less advantageous for cardholders to consolidate debts with home-equity loans. But the new credit card minimum-payment guidelines could negate some of that benefit to card issuers.

Last year, banks notched pretax profits of $30.6 billion on credit card operations, down 3 percent from the year-earlier period, the first such decline since 1998, according to CardWeb.com, a closely held firm that tracks the industry.
The after-tax return on average assets - one measure of industry profitability - was 1.21 percent at the end of the year, down from 1.48 percent a year earlier, CardWeb reports.

Card issuers are trying to replace lost interest revenue by increasing late-payment fees and raising interest rates for customers who are unable to pay their bills in full.In an effort to build customer loyalty and increase spending, issuers have launched a slew of new cards and have introduced new checkout-counter technologies to encourage more card use. They have spent billions of dollars to grow through acquisitions, buying rival card issuers and specialized credit-card portfolios from retailers.

At Citigroup Inc., the world's largest financial services firm based on market value, credit cards accounted for about 17 percent of the bank's $24.59 billion of net income last year.

Sallie Krawcheck, Citigroup's chief financial officer, told investors and analysts last month that first-quarter revenue fell 6 percent in its U.S. card business. More consumers are using cards that emphasize rewards programs, which she said are more likely to be paid off each month.

"The part that makes it a little bit tougher in terms of the revenue perspective is the payment rate, as a result, remains high," she explained. "It remains high for the industry. It remains high for us."

Citigroup cardholders paid off 20.3 percent of their loan balances during the first quarter, on average, up from 18.3 percent in the year-earlier period, she said.
Krawcheck said Citigroup was responding by introducing new card products, including some aimed at businesses.

She said the bank's credit card executives are

"working to get the growth in receivables and the growth in revenues so that we can have this business be in a healthier and growing state on the top line."

Consumers such as Nadine Bode, a factory worker from New Ulm, Minn., are contributing to the industry's woes.
Bode, 51, had been shelling out more than $300 a month in payments to Citigroup, Capital One Financial Corp. and the finance arm of General Motors Corp. for cards carrying interest rates as high as 25 percent, she said.

When she inquired recently at a Wells Fargo & Co. branch about a car loan for her 18-year-old daughter, she discovered that she could wipe out all of her credit card debt with an $18,000 home-equity loan, at a fixed rate of 12 percent, she said.
She signed on the dotted line. For the next three years, she said, she will owe Wells Fargo just $210 a month.

"I can breathe now," Bode said.

Credit card companies make most of their money by charging interest to customers who don't pay off their balances each month. Such customers are known as "revolvers."

Card issuers, who have raised interest rates in tandem with Federal Reserve increases, now charge an average interest rate of 17.9 percent on unpaid balances, according to the Nilson Report, which tracks the card industry.

Retailers began offering payment cards to their best customers in the 1920s. The modern general-purpose card took hold in the 1950s, and by the 1980s, the industry was awash in cards and rewards programs.
Some banks spun off credit card operations, giving birth to credit card powerhouses such as MBNA Corp. and First USA Corp. During the 1990s, strong consumer spending fueled double-digit profit growth.

During the past several years, the market has become saturated with cards, and consumers are finding it increasingly difficult to see any advantage to using one over another.

Nearly 700 million general-purpose credit cards are now in circulation in the United States, according to the Nilson Report.

The average American now has more than five credit cards, according to Celent Inc., a Boston-based research and consulting firm.
Consumers also carry charge cards that require full payment each month, debit cards, and pre-paid cards loaded with everything from paychecks to Starbucks coffee money.

"I do think the industry is much more saturated than it has ever been, and that the heyday of double-digit loan growth is long gone,"

said Srednicki, J.P. Morgan's credit-card chief.

Jim Raley, a 34-year-old choreographer from Atlanta, said he puts nearly all of his monthly expenses on a Delta SkyMiles credit card, issued by American Express Co.

Each month, he pays off his entire bill, which runs between $3,000 and $4,000. He pays no interest, he said, and earns substantial frequent-flier rewards, which are funded by American Express.
Raley, who used to work as a Delta flight attendant, said that after falling $14,000 into debt to three credit card companies a decade ago, he vowed never again to carry a balance.

"I am one of their nightmare customers because I don't let the balance revolve at all,"

he said.

An American Express spokesman says customers such as Raley still generate revenue for the company in several ways.
He pays an annual fee for his card, for example, and merchants pay American Express a fee on each transaction.

"If you have someone who uses their card, is a high spender and pays their bills on time, they are an attractive customer for us,"

American Express spokesman Michael O'Neill said.

Low-interest home-equity loans have taken a chunk out of total credit card debt. Debt consolidation is the top reason that people take out home-equity loans, followed by home repair and remodeling, according to market researcher J.D. Power & Associates. Interest paid on home-equity loans is tax-deductible, unlike credit-card interest.

"There's always been a group of people who are taking out home-equity loans to pay off other kinds of credit," said J.P. Morgan's Srednicki.

"Between that and the minimum-payment increase, we are concerned about the overall levels of payment rates in the business, and we just have to stay tuned to it and adjust our spending and programs accordingly."

One way banks are maintaining growth in credit card loan portfolios is by buying independent card companies.
Last year, Bank of America bought MBNA, Washington Mutual Inc. purchased Providian Financial Corp., HSBC Holdings PLC bought Metris Cos. and Barclays PLC acquired Juniper Financial Corp. Citigroup bought a $6.6 billion card portfolio from Federated Department Stores Inc.

Banks are also trying to increase portfolio sizes by stealing customers from competitors. They have flooded the mails with offers of zero-percent balance transfers and new cards carrying no interest for one year.