A combination of pressures on the UK consumer credit market
means that issuers will have to employ an array of defensive
measures in order to safeguard the quality and profitability of
their lending portfolios. Victoria Conroy reports.
UK issuers and consumer credit lenders are bracing themselves
for stormy economic conditions in the UK over the next year.
Already feeling the effects of the credit crunch and weakening
consumer confidence, issuers are preparing to batten down the
hatches as a combination of pressures on consumer spending,
regulatory scrutiny and intense competition all take their toll on
the bottom line.
The UK is the most indebted rich nation in the world, racking up
a record £1.4 trillion ($2.8 trillion) in debt, more than the UK’s
gross domestic product. By comparison, personal debt in the US is
$13.8 trillion, including mortgage debt, slightly less than the
country’s $14 trillion GDP.
CI looks at the main factors that will impact the UK consumer
credit market over the next year.
UK credit card market at saturation point
With over 1,200 credit cards in the market, UK consumers are spoilt
for choice. Since its inception just over 40 years ago, the UK
credit card industry has been transformed by the influx of US
issuers to the UK, such as Capital One and MBNA, who introduced
aggressive marketing tactics. According to UK payment industry body
APACS, at the end of 2007, there were over 71.8 million credit
cards in circulation, compared to 51.7 million at the end of 2001.
The average UK adult has 2.8 credit or debit cards, more than any
other country in Europe. However, in terms of average purchases
values on credit cards, these figures have remained relatively
static, at least for the period between 2000 and 2004.
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The UK credit card market can also be characterised by the use
of teaser offers on the part of issuers, which have always been an
important element of recruiting and retaining card-savvy UK
consumers. Up until a couple of years ago, there was a
proliferation of balance transfer deals offered at 0 percent and
with no fee to transfer balances. The popularity of these deals
proved to be an initial success for the issuers, helping them to
increase market share, but it soon became evident that consumers
were engaging in the practice of ‘rate-tarting’, continually
jumping from one free balance transfer offer to another. Figures
from December 2006 showed that 1 in 4 UK credit cardholders had
switched providers over the previous year, transferring an average
debt of £760. In total, UK credit cardholders transferred credit
card balances of £6.5 billion, with 1.4 million consumers switching
more than £5,000.
According to professional services firm PricewaterhouseCoopers’
(PwC) Precious Plastic 2006 publication, it was estimated by PwC
that such 0 percent balance transfer offers were costing the
industry £1 billion per year. It is now typical for these balance
transfer deals to come with a fee of between 2 and 3 percent of the
total transferred balance, which has dampened the enthusiasm for
consumers to continually swap cards, and has also impacted the
volume of transferred balances. PwC estimated in 2006 that the lost
revenue to the industry of balance transfers was in the region of
£600 million per annum.
The impact of the credit crunch has coincided with a trend of
rising insolvencies and bankruptcies in the UK, which is set to
continue throughout the rest of 2008 and into 2009, particularly if
economic conditions remain turbulent. Over the past two years,
lenders have tightened up their lending criteria by significant
degrees and some, such as Egg, have disposed of swathes of
Lenders are rejecting greater numbers of credit card applicants
and slashing the credit limits of existing cardholders in an effort
to minimise the impact on portfolio profitability. It is to be
expected that UK cardholders will find it much more difficult to
open new card accounts and to take advantage of 0 percent balance
transfer offers, leading to the possibility of issuers receiving a
greater degree of interest income and fees from cardholders who
have been forced to stick with their current offering due to the
paucity of attractively cheap cards elsewhere.
Net yields/falling profitability
According to PwC, net interest yields after charge-offs now stand
at around 2.2 percent, a fall of around 9 percentage points over
the last 7 years, equating to lost profits of around £4 billion.
The proliferation of interest-fee offers has damaged profitability
significantly, and there are emerging threats to interchange, as
evidenced by the recent EC ruling on cross-border interchange fees.
The UK card industry has been aware of the above factors affecting
profitability for some time new, but recent market and consumer
developments also threaten to hurt the bottom line.
Consumer spending growth is slowing concurrent with a decline in
consumer confidence, which has hastened in recent weeks. UK
consumers are in the process of tightening their belts amid
uncertainty over rising energy, fuel and food prices. Statistics
from the GfK/NOP Consumer Confidence Index published in February
2008 reveal that confidence among UK consumers has fallen to a
13-year low as fears grow about recession. The Index score for
February is at its lowest since December 1994, with a drop of four
points to -17.
Rachael Joy, consumer confidence researcher with GfK/NOP, said:
“This month’s drop in consumer confidence comes in spite of the cut
in interest rates earlier this month. Consumers are feeling a
little less confident about their own personal finances and much
less confident about the general economy as a whole. This may have
been fuelled by the wide reporting on a housing market slowdown,
high fuel and energy prices and rising food prices. These factors
all squeeze budgets, causing consumers to be much less confident
about making major purchases.”
The official rate of consumer price inflation as defined by the
UK government stood at 2.5 percent in February 2007, up from 2.2
percent in January. The largest upward pressure came from housing
and household services due to gas and electricity bills rising by
more than a year ago. But council tax bills, public transport costs
and fuel bills are currently rising at rates above official
inflation. Consumers are being forced to cut back on discretionary
spending in order to meet the costs of essential bills like fuel
and council tax.
Hard-hit low income earners
Consumers everywhere are starting to feel the pinch, but a recent
government measure may hit lower income consumers harder. In April
2007, it was announced by the government that the 10 percent income
tax band would be abolished in 2008. This essentially means that
lower income consumers who fell within the tax band will be paying
more in tax on their income, leaving them with less available for
other spending. This will include UK consumers who earn the average
UK salary of £23,400 or less.
It remains to be seen just how much this measure will impact
upon the borrowing and spending habits of lower income consumers
but it is possible that a greater number of lower income consumers
will find themselves over-indebted and at greater risk of
defaulting on credit card and other consumer credit commitments –
meaning higher losses for issuers.
The importance of the UK housing market should not be
underestimated. Within western Europe, the UK has the highest rate
of home ownership, far outweighing countries like Germany and
France. A feature of home ownership in the United Kingdom is the
relatively large number of homes purchased with a mortgage.
Approximately three-quarters of house purchases are financed with a
mortgage loan facility. At present the Bank of England base rate
stands at 5.25 percent as of March 2008, following a series of
reductions from the high of 5.75 percent in July last year.
However, interest rates have been steadily creeping up since the
low of 3.5 percent in July 2003.
The Bank of England’s interest rate increases last year are now
impacting on mortgages at a time when banks are becoming more
reluctant to lend.T
The impact of the credit crunch has led to mortgage rates rising
substantially over the past six months, not just for those
homeowners tied to the Bank of England rate but even more so for
those whose mortgages are tied to the Libor rate, which is far more
volatile. Many homeowners are approaching the end of fixed mortgage
periods. In the current climate, many will find it much harder to
remortgage on comfortable terms, at a time when housing prices are
on the verge of falling. Standard variable mortgages will be much
more expensive to maintain, leading to even more pressure on
consumer confidence and spending. More than 1.4 million homeowners
have mortgages that are expected to reset in the next 12 months to
significantly higher rates. For UK householders used to withdrawing
equity in their homes to pay other debts and fund discretionary
spending, this represents a major credit tightening.
Added to that are the facts that in 2006 22,700 properties in
the UK were taken into possession, representing 0.19 per cent of
all mortgages held. This figure had jumped to just over 27,000 at
the end of 2007. Households whose disposable income was less than
£1,000 per month were paying 39 percent of their income in
mortgage, according to the Office of National Statistics.
More UK homeowners (1 million as of October 2007) are using
their credit cards to pay their mortgages, a classic sign of
financial distress. A survey by the UK housing and homelessness
charity Shelter revealed that rising housing costs are forcing more
householders to turn to credit cards to pay mortgages or rent.
A growing number of young people are turning to more expensive
sources of credit to hang onto a home. The survey polled 2,000
households last month after the run on UK bank Northern Rock in
September 2007, and found that 6 percent of householders paying a
mortgage or rent reported using a credit card to make payments,
rising to 7.5 percent among younger people aged 18-24, who were
trying to keep a foothold on the first rung of the housing ladder.
The charity says that the 6 percent who have used credit cards in
this way reflects the experience in over 1 million homes. While
this will undoubtedly lead to higher profits for issuers, the risk
of defaulting will also shoot up substantially.
Banks turn to the courts
It appears that some lenders in the UK are taking pre-emptive
action. The use of charging orders by UK banks has surged in the
past year. This is a legal action whereby banks can go to court to
request that unsecured unpaid debts, such as credit card bills, are
secured against the cardholder’s assets, which usually means their
property. Effectively, banks are able to turn unsecured debt into
secured debt. Figures from HM Courts Service show that there has
been a sevenfold increase in the number of court orders to secure
personal debt against property in the past six years. These have
included applications from mainstream lenders such as Egg,
Nationwide and NatWest. HM Courts Service received a total of
92,933 applications in 2006, compared with only 16,014 in 2000. In
2006 the courts approved 72 per cent of applications from lenders
to secure customers’ debts against their homes, up from 60 per cent
This practice is set to grow as lenders seek to reduce the
amount of unsecured personal debt on their books and reduce risk
profiles. An added bonus is that lenders who are successful in
securing charging orders will get the higher interest rates of an
unsecured credit loan on a secured lending basis. However, securing
debt against a customer’s property is usually the last resort for
In a climate of weakening spending and consumer confidence,
measures such as these illustrate how issuers are taking action to
reduce credit exposure, although this will likely change the shape
of income statements, as PwC notes in Precious Plastic 2008. Also,
selective retention of the most profitable customers will be a
decisive factor. The need to identify and keep profitable customers
will become a key objective for issuers over the course of 2008.
PwC states that issuers will be placing a greater emphasis on
reward and loyalty schemes, although the increasing use of customer
data in terms of tracking spending and repayment history will
likely prove to be more valuable than ever.