Banks looking to grow credit card receivables face the problem of wooing the right borrowers into their programs. Since the credit crisis, they have restricted new accounts to consumers with pristine credit, but these customers continue to pay down outstanding their outstanding balances while newer cardholders use the plastic like a debit card, paying it off each month.
Reaching a little further down the credit spectrum is one of the few ways to grow this business.
In doing so, banks are extending credit to consumers who have been shut out of the market since the credit crisis. Subprime borrowers, those with FICO scores below 660, back in the mid-2000s, represented roughly a third of issuance.
A February analysis by investment bank Jefferies of publicly available data on credit card master trust filings spanning seven years concluded that since 2009, approximately $122 billion in credit availability to Americans with scores of below 660 has been removed from the market.
At Bank of America, for example, the portion of the company’s securitized card portfolio that involved loans to people with credit scores below 660 fell to 15% in 2012 from 28% in 2007, according to Jefferies’ analysis.
Lenders however appear to be thawing standards beyond only the top-tier borrowers. In October, Moody Investor Service published data from Equifax showing that bank card lenders had increased originations to borrowers with FICO scores below 620, the lowest category reported by Equifax, as of August. These borrowers now account for 19% of total lending; still down from approximately 30% before the financial crisis, but creeping back up from 14% at the height of the crisis.
Rosemary Kelley, senior director in Kroll Bond Rating Agency’s consumer ABS group, said this trend reflects a turn in the credit cycle. “It’s not as surprising (that) pre-recession standards were looser and the banks tightened standards and now they are loosening up standards again — that is fully expected.”
Weaker Borrowers Getting Credit, but Not Running Up Balances
At the same time the amount of “available credit” — the difference between cardholders approved credit lines and their current balances — has widened for weaker credit quality cardholders from pre-crisis levels.
“In bank cards we are seeing plenty of issuance but we are not seeing any run up in balances; that is, consumers take out these cards and don’t use them,” said Equifax Chief Economist Amy Crews Cutts.
Eventually, as the economy improves, the logic is that these weaker credit quality consumers could leverage up and the accounts would make their way into the credit card securitization trusts. Moody’s is concerned that lending to borrowers with riskier credit profiles, even if they aren’t subprime, may lay the groundwork for a deterioration of performance in credit card securitizations if the U.S. economy falls into a recession again.
That is because “of the unused portion of credit lines on which lower-credit-quality cardholders can draw down if they come under financial stress,” said Luisa DeGaetano, vice president and senior credit officer at Moody’s. According to the rating agency’s report, credit card utilization for cardholders with the lowest FICO scores has dropped to approximately 52% currently compared with over 70% pre-crisis.
FICOs for these new originations are lower than for the accounts that were originated just after the crisis, but that is not to say that they are lower than the FICOs of accounts that are in the trusts today. In fact they are about the same, according to DeGaetano. “If lending standards are relaxed further, however, the credit quality and performance of the new accounts would worsen relative to the highly seasoned accounts that are in the trusts today,” she said.
Almost 100% of accounts in securitization trusts today were originated four years ago. So banks don’t have to immediately include these new accounts with lower FICOs in the securitization trust.
This wasn’t the case before the crisis, explains De Gaetano. “The banks would add new accounts to their securitization trusts all of the time,” she explained. “You would always see some portion of accounts originated in the past year, some portion in the past two years, and so forth.
“The amount of receivables in the securitization trust today is much larger than the amount of outstanding ABS in the trust, so the banks have a lot of room to issue more ABS before they need to contribute new accounts.”
Benefits Limited to 620-700 FICO Borrowers
Crews Cutts said that the uptick in lending to this lower quality borrower coincides with lenders gaining more clarity on capital requirement rules. The finalization of the Basel III capital adequacy rules have clarified the conditions in which banks would have to hold excess capital reserves on unused line of credit (credit cards fall under this definition). So “banks may be more comfortable now in marketing cards to lower-rated borrowers,” she said.
There’s a limit to how much further down the credit spectrum banks are comfortable treading, however. “The benefit of clarity on Basel III rules is only for these 620 to 700 FICO borrowers and not for anyone below 620,” said Crews Cutts.
At the same time, another regulator, the Consumer Financial Protection Bureau, is discouraging banks from tapping subprime borrowers.
The Card Act of 2009 prohibits credit card issuers from extending credit without assessing a consumer’s ability to pay. It restricts the amount of “upfront” fees that an issuer can charge during the first year an account is open, and limits the instances in which issuers can charge “back-end” penalty fees when a consumer makes a late payment or exceeds his or her credit limit. The act also restricts the circumstances under which issuers can increase interest rates on credit cards and establishes procedures for doing so.
According to Michael Dean, head of the U.S. consumer ABS group at Fitch Ratings, this regulation acts as a “significant disincentive for banks to target subprime borrowers with credit cards, so these borrowers just aren’t getting offers anymore.”
Retail Card Issuers Also Moving Down Market
Retail credit card issuers are also moving down market, and this is one of the reasons this segment of the market has entered a new growth stage.
According to Equifax, utilization rates have remained elevated on retail cards, both due to limited credit availability and the fact that most new accounts are opened to make a purchase and so start with a balance. Bank card balances have decreased by $150 billion, or 21%, from their recession peak $675 billion, and now stand at $525 billion.
In comparison, retail card balances are up $5 billion, or 10%, from pre-recession levels of $55 billion and now stand at an all-time high of $60 billion.
Consumers are attracted to the ability to compartmentalize purchases that private label, retail credit cards offer. Crews Cutts said that consumers don’t want to over-lever on the one “general purpose card” (the bank card) and that retail cards allow them the option to better manage interest payments on these charges.
The economist said that figures also show lenders in this space, unlike bank card issuers, are targeting subprime borrowers. “The cards may be serviced by larger banks, but the retailer puts up the money for the loans,” she said. “Retailers are just much more willing to lend to people with subprime quality credit.”
GE Capital Retail Bank, Alliance, JPMorgan Chase, Capital One, Data Systems, Wells Fargo and TD Bank are amid the leading financial institutions offering private label card programs in the U.S.
Subprime Outstandings Still Not Showing Up in Trusts
Even if banks (and retailers) are starting to make credit cards available to borrowers with slightly weaker credit profiles, these receivables have yet to show up in securitization trusts
In fact, the exposure of trusts to accounts with lower FICO scores has been falling since 2011 as these accounts have paid off. According to the Jefferies’ report, credit card securitization trusts shed $35 billion in subprime accounts in 2011 and another $12 billion in 2012.
“We estimate that since 2009, approximately $122 billion in sub-prime (<660 FICO) credit availability has been removed,” said Daniel Furtado, an equity analyst at Jefferies and author of the February report.
The credit card securitization data shows that, over the past 12 months, the Big Six issuers have continued to reduce outstanding balances to subprime borrowers while increasing loans to those borrowers with FICO scores above 660.
However “it wouldn’t be surprising, as consumers take on debt and as the economy improves, that banks may begin to show an inflection towards taking on lower scored accounts,” Furtado said.
“When the economic environment justifies lending and the regulatory environment is clear enough to do it, I think you will see some players get back in,” he said.
Still the biggest challenge to accessing this segment of borrowers is the new regulatory environment under the Card Act, which Furtado said makes repricing and risked based pricing much more difficult than it was in the past.
“You have to be much more certain about the borrower that you are lending to,” the analyst. “In the past you took a chance and if something went wrong you could change the credit card limit or increase the rate or penalty pricing – that ability to reprice has been severely impaired by the Card Act.”
That means that issuers must now have a better forecast of the future. It explains why most of the players have moved up FICO, into the rewards space, where borrowers are less likely to default as opposed to the subprime borrower, which just wants the credit availability.
Anecdotally, however, Furtado said he hears stories that subprime issuers are reemerging. “If it’s not right now, the market is getting pretty close to the time where you do want to be lending to the subprime borrower,” he said. “That is because you have an arguably improving economic backdrop with decrease the unemployment rate.”
Furtado also believes that Capital One will make a material move back into subprime because the bank “grew up on subprime” and will be “the most comfortable under the new Card Act paradigm to lend to that segment.”
Securitization Steady, but Outstandings Declining
At a projected $30 billion or so by the end of the year, total issuance for 2013 looks good compared with the low of $7 billion reached in 2010. But issuance this year, or for that matter what is predicted to come in 2014, is nowhere close to the high of $110 billion issued in 2007.
And while volume has hovered above the $25 billion mark since 2011, this has done little to reverse the slide in outstanding credit card ABS. Outstandings currently stand at $124 billion, according to figures reported by the Securities Industry and Financial Markets Association. That’s down from about $197 billion at the beginning of 2011 and a peak of $325 billion in 2007.
Recent data from the Federal Reserve’s report on consumer credit paint show that receivables are on the decline as well. In August credit card balances declined for the third consecutive month. Revolving credit fell by a seasonally adjusted $883.4 million in the month, or at a 1.25% annual rate. Over the past three months, revolving balances have declined by more than $6 billion.
Still, the level of outstandings could at least level off. Credit card ABS maturities slowed this year, to $50 billion from upwards of $60 billion seen from 2010 to 2012, according to Fitch.
Dean expects there will be close to $40 billion in maturities next year, which should support roughly the same level of issuance in 2014 as seen in 2013, which he said could come in somewhere in the $30 to $50 billion range.
“For the most (part), new issuance volume has remained broadly consistent with the amount needed to replace maturing ABS in the absence of real receivables growth,” John McElravey, senior analyst at Wells Fargo, said in the bank’s 2014 forecast report.
Analysts at Deutsche Bank are more optimistic. The bank forecasts only $25 billion of bank card maturities next year, and it expects that a “modest rise in new issue activity” could boost outstandings into positive territory in 2014, according to a Sept. 25 report.
That new activity could come from improved consumer health, as recent macroeconomic data show that initial jobless claims are only about half their 2009 highs. “Although wages have not moved much, borrowers are becoming somewhat more comfortable with taking on more card debt,” analysts said in the report.
For now, consumers continue to deleverage. Figures published by the Federal Reserve Bank of New York show that few credit card securitization trusts have experienced more than minimal growth in their receivables base and the number of credit inquires within six months (a gauge of future demand) remained essentially flat.
The same report showed that total consumer debt was down in the second quarter by 0.69%, to $11.15 billion, from $11.23 billion in the first quarter, while credit card balances increased a slight 1.21% to $668 billion from $660 billion.
“Even though consumer spending is up — we see that at the bank portfolio level and at the credit card securitization trust level that spending on the card is rising at a pretty fast clip — borrowing on the card is not rising at the same level, which means they are spending, but consumers are cautious about leveraging with credit card debt,” said Moody’s De Gaetano.
Consumer deleveraging isn’t the only reason banks are only issuing enough credit card ABS to offset the amount maturing. There’s also the fact that securitization may not be as an efficient a means of funding credit card accounts as it once was. Historically low interest rates make deposit funding attractive, as are other forms of funding, including issuance of corporate debt.
“Banks have deposits, so to the extent that they have this source of funding they wouldn’t need to issue debt but then they can also issue corporate debt,” Kelley said. “Bringing a deal to market depends on what the market looks like relative to the cost of securitizations.”
The regulatory environment has also changed. Banks can no longer transfer securitizations off their balance sheet which makes this type of financing less appealing to them.
This change in regulations has impacted the credit card ABS issuance strategy of large banks. Bank of America, for example hasn’t returned to market since the credit crisis – “they obviously believe that there are more effective ways to fund their book,” said one industry source. Bank of America declined to comment for this article.
Citibank, Chase, Discover and American Express are the top issuers for this year through September, according to data from Thomson Reuters and Bloomberg that Deutsche Bank published in its report. That’s a big change from 2012, when GE Capital was one of the top four contributors of annual volume and Citi was not.
So far, Citi has contributed $7.7 billion, or 33% of the market, compared with $500 million, or about 1% for the full year 2012. GE, on the other hand, contributed $5 billion, or 13%, to the 2012 market, and $969 million, or 4%, to the 2013 market.
Still, deposit funding may become less attractive, relative to securitization, as interest rates rise. There are capacity constraints on both deposits and corporate funding and to the extent that issuers believe that the market is getting saturated, obviously ABS is a good outlet for the banks.
Performance Still Strong
In both its 2012 and 2013 forecasts, Fitch predicted that losses and delinquencies in credit card trusts would begin to trend back up to historical norms. This has yet to happen, because banks haven’t been adding new accounts, leaving seasoned, high quality accounts in these pools. “The deals have been performing better than what we expected,” said Dean.
For example, J.P. Morgan reported a third-quarter charge-off rate of 2.9%, down from 3.6% a year earlier and 3.0% in the first quarter of 2006.
During the recession, charge-offs rates in the industry ran as high as high as 10% or 11%, but cardholders have been deleveraging since 2007, paying off more of their card balances every month.
Structural changes to deals have also helped. At the beginning of the financial crisis, some issuers put additional credit supports to offset the expected impact of a deterioration in collateral.
However, a study Fitch conducted a couple of years ago showed that, even without this enhancement, only one of the deals it rates (a Bank of America deal) would have been downgraded at the triple-A level. And there would have been no defaults by bonds originally rated double-A, which Dean said “shows that credit card ABS are a very resilient asset class.”
Moody’s DeGaetano reasons that, “if you opened an account four or five years ago and you’ve been paying, (then) it’s unlikely that in this environment which is getting out of recession that you are going to run into trouble, unless a new recession hits.”
Even banks that continued originated credit cards to lower FICO borrowers are finding that those lower FICOs are also performing really well and they are paying off their balances, according to Moody’s.
However Fitch’s Dean warns that “a lot of this wonderful performance that you are seeing today is just because you have a lot of convenience users in those master trusts.” He said that dynamic could go away once consumers stop de-levering.
If credit card securitization issuance continues to pick up, it will likely find a ready investor base. The dearth of issuance in the broader consumer space has created a supply/demand imbalance that has driven deals to print at tight levels.
William Liebler, vice president at Conning Asset Management, said that any significant uptick in issuance would have to be accompanied by a slight widening in pricing. “I don’t think they would have any difficulty at all at the right levels but issuers probably don’t want to do this because it’s not in their best interest economically,” he said.
Deutsche Bank says that there has already been some spread widening in the triple-A tranches of new deals as a result of the elevated issuance in the third quarter. But the bank noted that bank card spreads have been less volatile in recent months than spreads on bonds backed by federally guaranteed student loans, another unsecured form of consumer debt. “We attribute this stability in part to the very limited headline risk of the card sector and the still-solid, steady performance of this asset class,” the report stated.