By Auriemma Consulting Group
The consumer lending industry has never before seen a year like the past one, when the entire global business was shaken to its core. We've seen bad years for banks, but never on this scale. The mortgage and auto finance businesses were on the front lines of the crisis. Then, as the crisis spread, the credit card industry, already reeling under an avalanche of bad debt, became the focus of public outrage. This, in part, prompted legislative mandates in the United States, Canada and the U.K. that has fundamentally altered pricing strategies, risk management practices and revenue streams for years to come.
Credit Losses
The single biggest story for consumer finance in 2009 was of course bad debt: both its magnitude, and the rapidity with which losses mounted. Our secured lending clients have some different concerns than credit card issuers. The specifics vary across the markets we cover, from the U.S. to the U.K. and other European and Asian markets. Nevertheless, there are some striking convergences in the challenges facing collections and recovery operations in general.
First and foremost is the tremendous increase in volume. Lenders have had to double or triple their collections staff in short order, with predictable problems in hiring, training and managing. Many lenders have transferred staff from their customer service units where lower transaction volume and fewer new customers have created some excess capacity. A growing number of lenders have taken it further, experimenting with blended call centers staffed with agents who can handle multiple functions. With or without these blended units, we have observed a growing trend toward sharing customer information across organizational lines, and consolidating collections and recovery operations across lines of business into a single unit reporting to one executive. We believe that this momentum toward a holistic approach will continue, although it will take some time for systems and organizational silos to be fully integrated. Many banks have professed for years to be striving toward the goal of customer relationship management, but the present crisis has created a sense of urgency that is accelerating the transformation. Most of the enormous increase in bad debt is attributed to changes in the macroeconomic environment rather than in the way people think and act. Risk scores that predicted willingness and ability to pay were not predicated on the dramatic loss of asset value and sharp increases in unemployment and underemployment that we're experiencing now. Nevertheless, the consequences are confronting lenders with qualitative as well as quantitative challenges.
Risk managers didn't expect to see high credit scores among their delinquent ranks, and prime customers were equally shocked to find themselves in that state. A great deal of collections, recovery and loss mitigation strategies have been based on time-tested approaches to the delinquent customer, who was likely to have had previous experience with paying bills late and could be counted on to act in predictable ways. The "new" delinquents, in contrast, behave differently. They're likely to have kept their payments current right up to the end, and kept their increasingly precarious status a secret. They're difficult to reach, with a wider range of tools to help them avoid unwanted contacts. Once found, they often have a highly combative attitude about their unpaid debts and the causes of their predicaments.
Consumer Behavior
We see it in industry statistics, and we hear it from respondents to our U.S. and U.K. Cardbeat® surveys: consumers are spending less on their credit cards. Behind those lower sales volumes, though, are a number of complex interactions. In absolute terms, consumers are indeed spending less, as retail sales volume will attest. If this were a "normal'' recession, we'd expect to see it bounce back as the overall economy improves.
Increasingly, consumers say that they put a purchase on their credit card only if they specifically intend to revolve. If that behavior persists, it would point to the return of credit cards as a vehicle specifically for borrowing. The U.S. landscape may look more like the U.K. and Canada a decade ago, where debit cards were well-established and revolve rates on credit cards were exceptionally high. Although such portfolios carry additional risk, revolvers have traditionally been the engines of profitability when appropriately priced and managed. We expect to see more card products that are specifically designed for revolvers, with competitive APRs but no reward programs and, perhaps, no grace period. In fact, "no grace" cards have already been introduced in the U.K.
Co-branding and Private Label
When a bank sneezes, its partners catch a cold. Issuers trying to claw their way back to profitability are taking a hard look at their co-brand and private label programs, as well as the financial models behind them. In some cases issuers are deciding that they can no longer afford the deals they signed. A number of programs are being offered for sale, and ACG is aware of many difficult contract renegotiations that are currently taking place.
Partners have grown used to getting revenue in return for providing access to their customer base and contributions to usage based rewards. With spending down, profits erased by high loan losses, and little appetite to acquire new accounts, the value contributed by the partner is less evident and the cost of the revenue-sharing more painful. All partnerships are not created equal, and some sectors are under more strain than others. Retailers are hard-hit for the same reasons as issuers, and banks' reactions of decreasing lines, raising APRs, and dramatically lowering approval rates impact store purchase volume negatively at a time when they can least afford it. Retailers are left with few alternatives, as most sold off their private label businesses over the last few years, raising much-needed cash but also losing the people and skills that would allow them to support the business with a captive finance facility.
Overall, ACG expects that the number of co-branded and private label programs will shrink, mostly at the expense of small partners, and the economic construction of deals will shift. We expect to see less up-front money for partners, fewer guarantees, and more emphasis on profit-sharing. At the same time, with "big banks" in particular suffering from a dismal public image, the appeal of a strong partner brand will be enhanced, and partners who are willing to acknowledge and accommodate the changed landscape can reap significant rewards.
Portfolio Sales and Customer Acquisition
"If you find yourself in a hole, stop digging." In the past year, banks took this adage to heart. Acquisition marketing slowed to a trickle, and portfolio purchases ground to a halt. A number of large portfolios that came onto the market as far back as 2008 have not found buyers, and the unsold inventory has been swelled by increased capital requirements. Some banks that had been aggressive purchasers are now trying to sell assets to shrink their balance sheet as part of their overall plan to rebuild their capital base. In many cases, these for-sale portfolios include an option for the buyer to extend an existing alliance, co-brand, or agent bank relationship. These third parties add complexity to the deal, but also present the opportunity to acquire an ongoing source of new account origination.
The market will also benefit as issuers regain some confidence in their ability to forecast. Before the financial crisis, lenders were accustomed to looking at the previous 12 months performance, adding some tweaks and management factors, and producing a reasonably good prediction of the following year's results. Indeed, one of the strengths of the card business has been the stability engendered by the sheer numbers of customers and transactions. The velocity of change over the last year reduced issuers to focusing on the previous quarter for guidance. The unknowns of pending regulation further exacerbated this lack of predictive power, depressing portfolio sales, new deal creation and acquisition marketing. As issuers digest the implications of the Credit CARD Act in the U.S. and other government intervention across international markets, and revise their P&Ls to reflect changes in cardholder behavior, they are regaining confidence in their projections.
The hiatus in customer acquisition, coupled with high attrition and reduced spending volume is shrinking the denominator of receivables, and loan losses as a percentage will remain high throughout 2010, even if the absolute volume of bad debt gets whittled down. However, we are hearing more about new acquisition marketing plans beginning to take shape and ramping up throughout this year, and competition for the individual cardholder will make the wholesale acquisition of consumer portfolios all the more attractive.
Back to the Future?
When ACG started up in 1984, most credit cards had annual fees, APRs were around 20 percent with relatively little price competition, and there were no balance transfers or teaser rates. Travel and entertainment was considered to be the province of charge cards, while retailers of all kinds issued their own private label cards. American Airlines, flush with the success of its innovative frequent flyer program, was mulling over ways to extend its reach, and American Express got tongues wagging with the introduction of the Platinum Card.
We're not predicting a return of all those things, but there are certain elements of the card business that may start to look a bit retro. Charge cards and installment loans are coming back into style, while teaser rates and penalty fees are fading. We expect to see more products designed to fit a specific need, and more explicit tradeoffs: low rates or rewards, but not both. More people will carry cards from their main bank, and they may have fewer in their wallet. Credit will be tighter and more expensive, at least for the short run, and retailers will be more aggressive in offering low rates for major purchases. There will be fewer co-branded programs, but strong brand name partners will continue to be in demand, although they may need to share some of the risks as well as the rewards.
About the Author
Auriemma Consulting Group offers comprehensive management consulting to the financial services industry with a particular focus on payments, lending and retail banking. This article was adapted from the firm's annual market outlook letter. To receive a copy of the full letter, please call +1.516.333.4800 or email info@acg.net