The subprime credit card market, long down for the count, may finally be poised for a comeback.
A team assembled by ex-regulator Raj Date is preparing to launch a plastic card for Americans who don't qualify for mainstream credit. Over the last five years, that segment of the market has been hollowed out by shifting economic forces and an overhaul of regulations.
The fledgling credit card venture is owned by Fenway Summer LLC, a Washington-based advisory firm that Date founded after he left the Consumer Financial Protection Bureau a year ago. Date's team is partnering with a bank — the identity of which has yet to be revealed — that will issue the cards. Its goal is to start offering the product to consumers within six months or less.
In an exclusive interview with American Banker, Date said that for many cash-strapped consumers, subprime credit cards are a better option than payday loans. For financial institutions, he argued, subprime cards can offer an attractive risk-adjusted return, despite regulatory changes that have reined in certain fees.
"The size of the subprime card market has probably come down by a factor of three or four since before the recession until now. Which is a real shame," Date said. "It's better for consumers, it's better for providers. We should be doing more of it, not less."
The newly assembled team at Fenway Summer has considerable experience both at Capital One Financial (COF), which has been one of the leading players in subprime credit cards, and at the government agency responsible for protecting consumers from the card industry's abuses.
Date was an executive at Capital One from 2001 to 2007 before becoming the No. 2 official at the CFPB.
Last month he hired Marla Blow to serve as chief executive of the new subprime credit card venture. Blow spent seven years in finance and risk roles at Capital One before joining the CFPB, where she served as assistant director of card and payments markets.
Another Capital One veteran, Toby Shum, is the new venture's chief financial officer.
Serving as an adviser to the credit card initiative is Miles Reidy, an ex-chief financial officer for Capital One's credit card operations. Also on the board of directors is Jane Thompson, the former president of Walmart Financial Services.
Many details regarding the pricing, branding and structure of the new subprime card are still being determined. But the card is likely to carry a fee and offer no rewards, and to be targeted at consumers with credit scores around 620, according to Fenway Summer executives.
The subprime card is being designed for consumers who have been relying on payday loans, or other high-priced sources of credit, and are showing signs of an increased ability to manage credit responsibly.
"In any given pool of new payday customers, six out of 10, or seven out of 10, ultimately are going to default," Date said. "Well, three or four out of those 10 are not. And those people have shown the ability to be financially resilient even in times when they have kind of an idiosyncratic need for funding."
Since the start of the recession, it has become harder for consumers with low credit scores, low incomes, or both, to qualify for a credit card. The volume of direct mail marketing for cards with a fee and no rewards fell by 85% between the fourth quarter of 2007 and the fourth quarter of last year, according to data from Mintel Comperemedia.
Factors that drove the industry's contraction include the 2009 passage of the Card Act, which limited card issuers' ability to charge late fees and over-limit fees, and changes in accounting rules that made the subprime card business more capital-intensive.
What's more, at a time of high unemployment, consumers have been more reluctant to take on debt, while card issuers have also become more risk-averse.
Today, the subprime market still includes Capital One, which bought HSBC's subprime card business in 2011, but the combined firm's footprint is smaller than it used to be. Specialized lenders like First Premier Bank in Sioux Falls, S.D., and Merrick Bank in South Jordan, Utah, also compete for subprime borrowers.
The debut of Fenway Summer's new subprime card venture would come at a time when banks are trying to determine whether they can profitably lend to customers who currently rely on payday lenders, auto title lenders and other high-priced forms of credit.
Late last year, federal banking regulators issued new rules requiring banks to ensure that borrowers have the ability to repay short-term consumer loans without rolling them over into a new loan. In response, all six U.S. banks that offered deposit advances, a product with strong similarities to a payday loan, announced last month their plans to quit the business.
Subprime credit cards could allow banks to fulfill some of the consumer demand that remains in the wake of the deposit advance's demise.
Blow, who previously served in various risk and finance roles at Capital One, says it's hard to predict whether other lenders will jump back into subprime card business.
"Based on historical cycles, I do expect that we'll see risk expansion in the credit card space," she said in an interview. "I personally doubt it will happen at significant scale in the near future, but I would not be surprised to see some existing players going deeper into the credit spectrum over time, especially if the risk environment remains low."
In an interview, Sanjay Sakhrani, a credit card industry analyst at Keefe, Bruyette & Woods, raised questions about the potential size of the subprime card market. But even if it's relatively small, the business can be lucrative, he said.
"I do believe that there's an investment case to be made," Sakhrani said.
Fenway Summer's foray into subprime credit cards follows a previously announced venture into making home loans that do not meet the qualified mortgage regulatory standard. That move drew complaints from congressional Republicans, who suggested that various Fenway Summer executives left the CFPB in order to profit from rules they helped create.