Sweeping new regulations for credit card issuers are likely to curtail lending and crimp profits. But whose lending — and whose profits?
A widely held view is that the rule changes will create the most pain in the subprime sector — an enormous business that makes up close to a third of the portfolios of four of the top six issuers. Those four — Bank of America Corp., Capital One Financial Corp., Citigroup, and Discover Financial Services — would therefore stand to lose the most volume. American Express Co. and JPMorgan Chase & Co., on the other hand, have relatively limited exposure to borrowers with poor credit histories, and should fare better than their brethren in this analysis.
Another, more counterintuitive view says there's more risk to the prime market. The days of offering low rates to entice high-credit-quality borrowers to switch to a new lender are numbered, some experts contend, because lenders will be well aware they won't be able to raise rates should those borrowers become riskier.
"The superprime segment, with the high lines … is vulnerable," said Leigh Allen, the principal of Global Consumer Finance Advisory, a New York consulting firm. "They used to be able to give people good rates because they could always adjust it if the guy went bad — and now they can't."
Whatever part of the credit spectrum issuers retreat from, the broader outcome of a smaller industry will be an intensified, margin-grinding fight for what remains, analysts said.
Paul Grill, a partner with First Annapolis Consulting, said competition has been heating up as is. The market is "almost saturated already," and it is shrinking as consumers try to reduce their debts and underwriting standards tighten.
Issuers have "been competing aggressively for that incremental customer," Grill said. "Certainly that will be more challenging today, just given that the low end of the market is not viewed as the same growth opportunity it was before."
According to an American Banker review of prospectus filings for sales of credit card-backed bonds, Bank of America's portfolio has the biggest proportion of loans to cardholders with FICO scores of 660 or less among the country's six largest issuers, at 31%. Citi is in second with 29%, followed by Capital One and Discover with 28% each.
Significantly smaller pieces of the portfolios at JPMorgan Chase and Amex are in the same strata — 20% and 17%, respectively.
Andrew Wessel, an equity analyst with JPMorgan Chase's securities unit, said the new regulations are "going to put a wall up for at least the lower-quality game of giving low balance transfers on low-limit cards."
In that play, new cardholders quickly max out their cards and produce so much revenue for the issuer "so that even on a low dollar amount you're generating enough fee income to offset any of the potential losses."
President Obama signed the Credit Card Accountability Responsibility and Disclosure Act in May. An array of restrictions on price increases and other practices are due to go into effect in February.
The law "in effect says you've got to make sure your customers can pay you back," said Duncan MacDonald, a former general counsel of Citi's Europe and North America card businesses. Hence, "in an environment where there's growing unemployment, and layoffs and overindebtedness and bankruptcies," issuers with subprime customers "are going to have to let them go … and a number of them are going to just shut the door in terms of letting them in."
The issuers "that have the biggest positions with these types of customers … are going to get hurt," MacDonald said.
In a note sent to clients last month, Wessel predicted that credit card debt would contract by about a third, or $280 billion, nationally as a result of the new regulations, which will "all but eliminate" access to credit card borrowing for subprime customers.
"It's going to be very, very difficult to make a risk-adjusted return on subprime lending that's adequate to make those loans," Wessel told American Banker.
Issuers are "going to have to move up the credit curve along with everybody else and leave the lower-quality borrower behind."
Discover, however, said that it does not expect a significant impact on its portfolio of loans to such borrowers, and that its position in the lower-credit-score tiers reflects deterioration in customer risk profiles after accounts were opened.
A massive reduction in lending in the segment is "unlikely assuming their accounts are in good standing," a spokeswoman for Discover said.
One business where Discover does plan to slash volume is balance transfers — which are predominantly a tactic used with borrowers with higher credit scores. In a conference call last month on the $42 billion-asset Riverwoods, Ill., company's fiscal second quarter, which ended May 31, its chief financial officer, Roy Guthrie, projected that it would trim such activity by 75% in the second half of this year as compared with the same period last year.
Allen, the consultant, said that the impact of the legislation on borrowers with low credit scores depends largely on the way the standards are put into practice. Much has been left up to the Federal Reserve Board to determine, for example.
For "the bottom-tier segment, it's really subject to interpretation at this stage," he said.
But higher initial prices for customers with good payment histories are assured, he said, because of severe restrictions on the ability of lenders to change rates.
"People with good credit are going to have to be priced initially to the fact that they might become bad credits, because I can't reprice them until they're really delinquent," Allen said. "As a result of that, there won't be as many balances with those people."
"There's going to be a much more pronounced effect in the upper tier segment," he said.
Allen and others suggested that in the future the industry's best customers may be the fair to middling credits.
Balances among such borrowers might contract the least, Allen said. They already pay higher rates than the choicest cardholders. So when issuers raise initial rates to compensate for restrictions on subsequent prices increases, "maybe the differential … is going to be less" for the mediocre borrowers than for the sterling ones.
Wessel projected in his note to clients that 25% of outstanding lending to consumers with "midtier" FICO scores (or from 660 to 719) would be eliminated. That may sound like a steep reduction, but it pales in comparison to his forecast that 85% of loans from the country's six biggest issuers to cardholders with credit scores below 660 — or $158 billion — would vanish.
Improving credit performance and ongoing moves by lenders to raise rates are poised to make the middle tier "the new most profitable segment," Wessel wrote.
Srini Venkateswaran, a partner at the management consulting firm A.T. Kearney, said dynamics are working against the card business both at the low end of the credit spectrum — as loans are withdrawn from risky borrowers — and at the high end, where borrowers tend to demonstrate greater "discipline to pay on time," and therefore don't generate as much interest income.
There is a pull toward the midtier, he said, because of a "combination of availability of credit, and need for credit."
But carving up a business by credit tier is too "simplistic," he said, because spending and borrowing patterns can cut across boundaries, and because revenues are dependent on several variables — spread income, interchange and customer fees.
Amex declined to address the impact of the new rules specifically on borrowers with lower credit scores, but a spokeswoman said the company believes some of the rules "will eliminate some access to credit and consumer choice."
BofA, Citi, and JPMorgan Chase declined to comment for this story. Capital One declined to make executives available ahead of its second-quarter earnings report next week.
Capital One offers one snapshot of the intersection of potential challenges from the new rules.
Like most of its major competitors, it has a large position in subprime. And some analysts worry that its reliance on fees will be a weak point in a system where over-limit charges and other key sources of profit could be choked off. (Noninterest income accounted for 37% of revenues before set-asides for credit losses in the first quarter.)
But the McLean, Va., company emphasizes that it has eschewed the balance-transfer game, and it has said that the new rules will restore a playing field in which it found its footing in the 1990s.
Sanjay Sakhrani, an analyst at KBW's Keefe, Bruyette & Woods, wrote in a report published last month that Capital One "will adjust" and may be able to pick up share in the prime credit-quality market as the new law suppresses the teaser-rate warfare that the company has traditionally avoided.
Among other factors leaning against teaser rates, the new rules would require lenders to steer payments toward balances with higher interest rates first.
At a conference in May, Richard Fairbank, the chief executive officer of the $177 billion-asset Capital One, said that though there were elements in the new regulatory regime he did not like, "if faced between the choice of having none of this regulation and legislative change or all of it, I would much rather have all of it than none of it."