While other industry analysts may be claiming that economic
recovery is in sight, US payment consultancy TowerGroup is firmly
of the belief that hefty losses are set to continue, and could even
result in negative balance growth by the end of the year.
Charles Davis reports on its gloomy outlook.


The drumbeat of sour economic reviews of the US cards industry
continues unabated, with a new report warning that the industry
could find itself in the red this year as economic conditions
further constrict issuers’ profit margins.

According to a new report by US payment consultancy TowerGroup, the
combination of economic pressures and the new credit card rules
going into effect next year will force issuers to further slash
cardholders’ credit limits.

As Dennis Moroney and Brian Riley, both research directors of bank
cards at TowerGroup, explained in the report, two factors drive
credit risk management at US credit card-issuing banks: outstanding
balances, the debt the banks’ customers have already contracted;
and contingent liability, the banks’ potential obligation for the
amount on card credit lines still available to the cardholders
though as yet unused. Both present challenges for US credit card
issuers struggling to hit upon a strategy to get past the

Falling spending hitting balances

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The first problem is that reduced consumer spending has resulted in
a decline in revolving credit card balances. The Federal Reserve
reported a modest 2 percent increase in consumer revolving balances
from 2007 to 2008, but as of April 2009 revolving consumer credit
balances, which consist primarily of credit card balances,
decreased at an annualised rate of 11 percent, with calamitous
results in profit margins.

US credit card issuers’ performance as measured by return on assets
(ROA) also was poor. The Federal Deposit Insurance Corporation
(FDIC) reported that US credit card lenders’ ROA annualised for
first quarter 2009 was a negative 1.30 percent – the first negative
ROA for the cards industry since the 1977-1981 time period.
Highlighting the woes plaguing the industry, Moroney and Riley note
that credit card issuers and commercial lenders were the only two
segments of the five reported by the FDIC in March 2009 with
negative performance as measured by ROA (the other segments
reported are international banks, agriculture, and mortgage

Based on that gloomy picture, TowerGroup expects that a combination
of factors will result in negative balance growth for US credit
cards in 2009. TowerGroup further forecasts a continued decline in
revolving balances through 2010 and modest balance growth beginning
in 2011.

As for the other side of the equation – contingent liability –
TowerGroup’s message clearly is that issuers must get a much
tighter grip on unused balances, and the sooner the better.

Credit limit evolution

As the authors note, the majority of credit cards issued as far
back as the early 1980s offered credit lines that were low, less
than $1,500. Although the cardholders could revolve the balance on
their accounts, credit card issuers expected the majority of
customers to pay any outstanding balance upon receipt of the
monthly statement. That all changed in the mid-1980s when ‘gold’
Visa and MasterCard credit card products were launched with minimum
credit lines of $5,000. Credit lines in excess of $50,000 are now
fairly commonplace.

As the gold cards squared off with the travel and entertainment
cards offered by American Express, Diners Club, and Carte Blanche,
issuers found that gold card customers revolved their balances at a
much higher rate than issuers had expected. Credit card issuers
quickly realised the financial opportunity inherent in issuing
large credit lines, and the credit line race was on.

The predictable result was an explosion of unused credit lines,
which now threaten the financial health of the industry. The FDIC
reports that for the first quarter of 2009, unused credit card
lines managed by US credit card issuers amounted to over $3.6
trillion. TowerGroup estimates that unused credit lines grew by
more than 80 percent from 2000 to 2008, from $2.5 trillion to a
stunning $4.7 trillion.

Beginning in the third quarter of 2007, however, credit card
issuers began to tighten their credit policies. The tightening
intensified in 2009 as delinquencies and charge-offs increased. In
about one year, US credit card issuers have cut their contingent
liability by over 25 percent. A decline in credit card lines from
2008 to 2009 reflects a significant change in credit card risk
management. The credit card issuers have tightened credit and
reduced the number of new account credit offers as well, the report

The return of annual fees

“Not only have card issuers curtailed new offers of credit, but
they have also changed the nature of the offers,” the authors note.
“They are increasing their use of annual fees to offset the
anticipated impact of the Credit Card Accountability,
Responsibility, and Disclosure (CARD) Act of 2009, which limits the
use of risk-based pricing.”

In the first quarter of 2009, for example, 27 percent of offers
carried an annual fee compared with 18 percent in 2008. TowerGroup
expects that tightening of credit will result in the growing use of
annual fees and higher annual interest rates approaching 19

TowerGroup believes that the modest extent and slow pace of the US
recovery will entail, indeed will demand, that issuers limit access
to credit for both consumers and small businesses. The CARD
legislation, which takes effect in 2010, includes major changes
affecting credit card terms and limiting risk-based

Credit card issuers will be unable and unwilling to liberalise
their credit policies until at least six months to a year after the
CARD Act comes into force, which suggests that growth will be
minimal until mid-2011. The risk to credit card issuers is that
consumers having reduced access to credit will adjust their
purchasing behaviour and become comfortable with pay-now (debit)
and pay-ahead (prepaid) products and no longer rely as much on
credit card lending.

TowerGroup expects that unless delinquency rates and retail sales
improve, the bank card industry could report its first full year
loss in 2009. The forecast assumes a positive 1 percent ROA based
on improvement in delinquency and charge-offs in the later part of
2010. The forecast also assumes that baby boomers will moderate
their usage of credit cards but not discard them and that small
businesses will get access to additional credit.

That means that while things are likely to get worse before they
get better, the good news is dependent upon several balky
variables, any one of which could fall short of