Nervous card industry executives have yet more unpalatable news
to digest with the publication of PricewaterhouseCoopers’s Precious
Plastic report, in which a convergence of economic bad news means
bad times for the industry. Victoria Conroy reports.

It will come as no surprise to card industry executives that
consumer credit lending in Western Europe is stalling amid a glut
of economic bad news stretching from the US to the rest of the
world. This has been evidenced by global business consultancy
PricewaterhouseCoopers (PwC), which in its report Precious Plastic
2008 examines the consumer credit lending markets in the UK and
other major European countries.

The report makes for gloomy reading, with PwC pointing to
increasing consumer indebtedness, contagion from the US subprime
mortgage fallout and the ensuing credit crunch, and tighter lending
practices putting further strain on credit card profitability.

A warning flag comes in the form of rising consumer indebtedness
in the UK, which reached over £1.3 trillion ($2.57 trillion) by
June 2007. Although secured lending, such as mortgages, continues
to be the driver of increasing borrowing, growth in unsecured
lending continues to slow, falling from 2.4 percent in the year
ended June 2006 to just 1.1 percent for the year ended June 2007.
“Although total borrowing in the UK market continued to grow by
nearly 10 percent per annum, consumer credit lending has clearly
stalled, having reached a natural ceiling. PwC does not expect to
see any significant growth over the short to medium term,” the
report notes.

In examining the UK market, PwC says that outstanding credit
card receivables fell from £66.3 billion in June 2006 to £64.7
billion in June 2007, along with a declining number of credit cards
in issue, although the drop in the number of cards has had the
effect of increasing the average outstanding balance per card at a
CAGR of 5.4 percent over the four years to June 2007. According to
PwC, this implies that risk embedded in portfolios has increased as
default risk is now spread over fewer cards. However, PwC points
out that there is firmer evidence to suggest that there has been a
significant reduction in credit card acceptance rates over the last
12 to 18 months.

“Slowing rates of growth in credit card balances in recent years
partly reflect the mature state of the UK industry, along with the
well-documented high overall indebtedness of the average consumer,”
the report states, noting that the ratio of household debt to
annual income has risen by around one-half since the start of the
decade to 160 percent in the first quarter of 2007. Along with
increases in the base interest rate, greater overall debt servicing
is subduing demand for consumer credit. The report also notes that
consumers appear to be repaying credit card debt to a greater
extent – over the course of 2006, monthly repayments of credit card
advances represented 97 percent of borrowing, the highest repayment
rate since data was first collected in 1997.

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Income reduces as risk improves

PwC says that although the average credit risk of issuers’ books is
improving, the knock-on effect for issuers will be a reduction in
both interest and fee income. Issuers would typically expect to
achieve a lower interest margin on higher-quality accounts
reflecting reduced credit risk, but combined with the lower
propensity of such customers to revolve their balances, issuers are
likely to experience increasing pressure on interest income. Income
arising from late and over-limit fees would also be expected to
fall as impairment performance improves.

The report also highlights the continuing trend of falling net
interest yields after charge-offs for credit cards. Although the
rate of decline over the past six months has been less severe than
the 12 months to December 2006, this profitability measure
continues to fall. PwC estimates that net yields after charge-offs
now stands at 2.2 percent, a fall of around 9 percentage points
over the last seven years – equating to ‘lost profits’ of around £4
billion for the market. PwC says that future delinquency trends
will play an important role in determining whether card
profitability will recover.

Customer retention will take on increasing importance, the
report states, due to the declining number of cards in issue and
the need to identify and retain profitable customers. PwC suggests
that issuers will subsequently place greater importance on reward
and loyalty schemes, with evidence beginning to suggest that
co-branded or affinity cards are becoming an increasingly important
segment of the market.

An increasing reliance on innovation and development of products
which are more engaging for consumers will become evident,
according to PwC. “Future growth in consumer credit will have to
come from innovation to displace existing propositions or through
entry into less mature markets in Europe where growth potential
still exists. PwC predicts that contactless cards will prove
successful, with around one in ten people regularly using a card in
the UK by the end of 2008. PwC also sees the ‘greening’ of
financial services as a significant opportunity if the proposition
is credible and engaging with the consumer,” the report notes.

As to where issuers can expect future growth to come from, PwC
says that overseas expansion will be the main focus. “Credit card
issuance is a scale business and those issuers currently
experiencing, or facing the prospect of, net attrition in
outstanding balances in the UK will be keen to maintain and grow
balances through other channels. We believe that international
issuers will continue to seek to expand their overseas customer
base through direct acquisition, organic growth and partnership
deals,” the report states.