Banks Desperate for Profits Seek Out Risky Credit Card Customers

Banks, having trashed their once-sound model for the credit card business, are back trolling to find credit junkies, albeit of a somewhat safer type than the ones that blew up on them in the credit crisis.

Back in the 1980, the credit card industry, despite being more fragmented than now, had what looked a lot like oligopolistic pricing. Card issuers all charged annual fees as well as interest on the order of 19% on card balances. The use of annual fees meant that every type of user was profitable: the sporadic user, the person who paid in full every month, the consumer who ran occasional balances (anything from the occasional late payment to working off Christmas spending). I recall having an argument with an investor in the 1980s who insisted that banks would never shift from this pricing scheme, it was far too attractive to them.

But of course they did. The introduction of no-annual-fee cards meant that the sporadic user and the “pay off my card monthly” types were no longer attractive: the real juice lay in interest charges and fees. So over time, banks became more eager to lend to weak borrowers, which in turn led to perverse outcomes like the passage of the 2005 bankruptcy reform act, in which banks who had decided to lend to weak borrowers claimed these borrowers were so badly abusing credit that it was necessary to change the rules of the game. This is awfully reminiscent of someone who has shot their parents asking for sympathy because they are an orphan.

The 2005 legislation, among other things enabled banks to extract more from credit card borrowers when they hit the wall (a bankruptcy lawyer told me that MBNA, which was one of the moving forces behind the bill, estimated it would make $100 per month more on every customer that went bankrupt, which would increase its profits by $85 million a year). But that was not enough to save them from sizeable losses when the crisis hit (an irony here, most credit card receivables are securitized, but banks found it necessary to support entities with large losses, out of fear of tainting the market).

So per an article in the New York Times, the banks are back trying to build up their credit card businesses, which had become a major source of bank profits. Unfortunately, have trained a whole generation of customers to expect no-fee cards, they’ve made it well nigh impossible for themselves to go back to a more prudent pricing model.

But never fear. The card issuers claim to be wiser and thus better able to make more discerning choices among risky borrowers, such as “strategic defaulters” versus “first time defaulters” versus “sloppy payers”. But how reliable can these credit score and payment history analyses be? We’ve only had two years or so of the “new normal”. The subprime crisis illustrates the perils of extrapolating from unduly short time frames.

Now admittedly, the banks are building in more protection for themselves in the form of annual fees and high interest rates. But the flip side is, independent of the terms the banks put in place is that uptake on its new card offers are very likely to be subject to adverse selection. Yes, some users will be sound, like small businesses owners who use credit seasonally (many entrepreneurs are too small to qualify for regular business loans, and credit cards have long been a major source of credit for them), or people who lost a job or suffered a cutback in hours and are back to working at a decent income again. But in this environment, most consumers are hunkering down and keen to reduce debt levels. Many who take up these offers are likely to be unduly optimistic and/or less disciplined than their credit-stay-away peers.

From the New York Times:

Credit card offers are surging again after a three-year slowdown, as banks seek to revive a business that brought them huge profits before the financial crisis wrecked the credit scores of so many Americans…..But this time, in contrast to the boom years, when banks “preapproved” seemingly everyone, lenders are choosing their prospects more carefully and setting stricter terms to guard against another wave of losses….

Lenders have taken $189 billion in credit card losses since 2007, according to Oliver Wyman Group, a financial consultancy. That was a significant part of the $2 trillion or so that banks are estimated to have lost since the crisis began, and a contributor to the government bailout of the banking system.

To stem losses, lenders halted new card offers to all but their most affluent customers. At the same time, more than eight million consumers stopped using their credit cards, in a sign of the nationwide belt-tightening, according to TransUnion, the credit bureau. Millions more borrowers who still have cards have been compelled to pay down their balances, or are more often choosing to use cash.

That has had a big impact on lenders’ bottom lines. Credit cards once gave the banking industry as much as a quarter of its profits; today those profits have all but vanished and lenders are seeking ways to replace them…..

HSBC mailed more than 16 million card offers to this group in the third quarter of this year, Citigroup 14 million and Discover 10 million, all roughly tenfold increases over the same period last year, according to Synovate Mail Monitor, a market research firm. Capital One’s rate rose fiftyfold, to 22 million..

The response to the card campaigns has been strong, with roughly 4 percent of these riskier borrowers submitting applications. That is about 10 times the typical response rate for the group, though that may be partly explained by the absence of offers over the last two years….

ince the mass marketing of credit cards began decades ago, lenders have waited for years to extend credit to borrowers…..who have fallen on hard times — a process sometimes called “rehabilitating the customer.” But these days, rehab is happening faster because the lenders cannot afford to wait.

This sort of impatience (“we need the profits now, damn the need to have better data”) is tantamount to undue risk-taking. It might work out OK for the banks in the end, but if so, it will be due to dumb luck rather than sound decision-making.

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  1. Francois T

    Dear God!

    So, the banks have not learned anything. They expect another bailout if the economy slows down again and millions of CC holders can’t pay again.


  2. Francois T

    “Banks Desperate for Profits”

    If the banks are desperate for profits while able to borrow at ~0% interest, apply leverage and make 3%, courtesy of the Fed, their situation must be much more dire than I thought.

  3. readerOfTeaLeaves

    So the banks continue to propose usury as the American economic engine? Again?

    So all the political and policy time and resources the banks and usury will continue to suck up will all be time and resources that can not spent on: (1) rethinking economic paradigms,
    (2) focusing talent, energy, and political resources on fundamentally restructuring the economy.

    Will future Americans be saying:
    I pledge allegiance to the Corporate Logo, and to the usury for which it stands…


  4. Daniel Nicolas

    I can attest to this. I’m pretty much a risky bet – i have zero credit history (no credit AND no debt) and yet i’ve received 3 card offers in the mail so far this month, where as normally it’s only a quarterly attempt from AmEx

  5. Expat

    It’s win-win for the banks. You say they might work out for banks based on dumb luck, but in reality it doesn’t matter. If they get lucky, they make money. If they screw up, they get bailed out.
    America is so very, very screwed.

  6. Chris LaHaie

    It makes me think of United Bank States of America, as the banks continue to pillage the country. They have dicatated policy and trampled every law or rule set up to help consumers. Will there ever be serious challenge to excessive power of the financial institutions.

  7. Brick

    The banks will not fool the final investors again though, which means higher costs when the debt is securitised. Most likely those costs will be passed on to the credit card user. Banks endless search for profit will most likely cause the credit card industry to devour itself.Its only a matter of time before we have Fannie and Freddie credit cards and the taxpayer takes all the risk.
    The question should be what is driving banks. You could argue that it is the bonus culture, new capital regulations, the need to write off bad loans or even the low interest environment. All these would play a part but I suspect it has more to do with opportunities to invest in the economy. Past mal investment, deleveraging, structural deficiencies and incorrect policy are reducing the amout of worthwhile new endeavours coming through. The money that should have been used to correct this had been frittered away elsewhere and now the piper must be paid.

  8. Capital Done

    Inside the mail boxes that the banks are plastering with foreclosure proceedings, they slip in a few credit card offers. Two things are unprecedented but we aren’t hearing from Corporate Media: people are continuing to lose their houses in perhaps the greatest swindle in the history of this country, and Banks once again, post reform, push more debt peonage. Bust them UP! Kill Fannie and Freddie! The class war is being fought in courtrooms across the country, we know which side is winning, we know which side most of our politicians are on, most judges are on, most courts are on, most state AGs are on, all Government agencies, most of the press – the war of terror includes destroying homesteads, bankrupting and pushing millions into the struggles of poverty. It’s not only credit card or home purhase contracts that are acts of violence, it is employment agreements that allow tyrannical control of workers, and most Americans simply join the parade, scared shitless of their own chances for financial ruin, they join in the chorus to punish the poor.

  9. Frank

    This is off topic from the original post, but related to Capital Done’s response with respect to corruption and the US government/bankster war now being conducted against the American people:

    According to Wikileaks the US Ambassador to Kazakhstan (one of the most corrupt countries in the world, with an inefficient government but a repressive police state) from Wikileaks we learn that the US ambassador reporting on the attitude of the politicians in Kazakhstan, had this to say: “The Ambassador asked if the corruption and infighting are worse now than before. Idenov (the country’s First Vice President) paused, thought, and then replied, “No, not really. It’s business as usual.”

    Idenov brushed off a question if the current maneuverings are part of a succession struggle. “Of course not. It’s too early for that. As it’s always been, it’s about big money. Capitalism — you call it market economy — means huge money.

    Listen, almost everyone at the top is confused. They’re confused by their Soviet mentality. They’re confused by the corrupt excesses of capitalism. “If Goldman Sachs executives can make $50 million a year and then run America’s economy in Washington, what’s so different about what we do?’ they ask.”

    And so what Wikileaks is showing us is that most corrupt governments in the world consider that what Goldman Sachs gets up to with the agreement of the Federal Reserve is pretty much the same as their own behaviour.

  10. Tom Crowl

    How our ‘bi-partisanship’ works!

    e.g. The easy availability of credit!

    allows the elite “Right” (as opposed to the populist right) to pursue its Cato Institute Randian fantasy of a dog-eat-dog world as the “natural” world and to extol excessive wealth concentration as a healthy product of (a completely discredited) Social Darwinism… and, of course to personally profit.

    and it

    allows the elite “Left” (as opposed to the populist left) to pursue a DLC, Rubin, Greenspan,Summers (their own Randian fantasists) to abandon any real fight for fair wages, fair trade, sane campaign reform, sane healthcare… or anything else… in pursuit of a soon-to-be-discredited Globalization model… and, of course to personally profit.

    There is a non-elite Left and non-elite Right which both have much to add to this conversation since all decisions which a polity must make involve a natural tension between the interests of the Individual and the Group.

    However they’re not really at the table… and can be quite a nuisance.

    Re-Igniting the Enlightenment: On Building Landscapes for Decision

  11. LAS

    After years of mailing me monthly offers (even after I registered to NOT receive such offers), American Express just mailed me a real card (not a phony marketing card) that I did not request or apply for. Are they allowed to do this? Not activating this card. Next they’ll be activating for us, too.

    1. PeonInChief

      Cut the card up and mail it back to them with a letter stating that you did not apply for nor do you want this account. You might also ask them never to send you another card unless you specifically apply for it, but I wouldn’t count on that keeping them away. We received a card for an account we never opened and it took FOREVER to close it down.

        1. Cd

          if you rec’d that card, you need to call the bank ASAP and find out if they ran your credit report to make that decision. Better yet, get your report and see if their is a inquiry from Amex..

          If they ran a report and it puts a hard inquiry on your credit file, you should call a lawyer. It’s illegal! You could make out with a nice settlement.

  12. François

    But I thought credit cards made money from transaction fees — somewhere on the order of 2% of every credit card purchase, depending on the size of the store. So how can credit cards not be profitable, even when there is no annual fee and the person pays off the balance each month.

    I’m one of those people, by the way. I have several credit cards but always pay at the end of the month. I run a lot of my spending through the credit cards for the sake of convenience and points. But I feel like a hypocrite, giving roughly 2% of my spending to the banks via this system. I feel that I should start moving back to cash, and let the merchants keep the difference.

  13. John L

    As soon as my wife and I paid off all our consumer debt last year, we started getting deluged with new CC offers, at least 3-4 a week, nonstop. Every last one of them goes into the shredder; we refuse to get sucked into their “low interest”, “no annual fee” traps again.

  14. F. Beard

    Banks, having trashed their once-sound model for the credit card business,… Yves

    Can a business model based on counterfeiting even if the money (credit) is only temporary ever be sound?

    But also this, many of those who defend fictional reserve lending insist it only be for productive purposes not consumer debt.

  15. leapfrog

    Starve the beast and stop using credit cards. A debit card works just fine for most purchases (unless you are a frequent traveler or very disciplined & pay off the balance every month). When times get tougher, you will thank yourself later for staying out of debt.

  16. Bam_Man

    The business model of the zombie TBTF banks is irretrievably broken. Period.

    This is why we see the Tresury yield curve steepening. People (idiots) are screaming “QE2 has failed!”. Baloney. It is INTENTIONAL. That carry trade is all that is standing between the undead, zombie TBTF banks and federal govt. conservatorship and liquidation.

  17. LAS

    Last week several commenters were getting into discussion about what the Old Testament says about debt … I think some old Jewish laws of that time actually require forgiveness of all debts every 7 years. After landed property is taken away from someone for debt it has to be returned to the family in time. The idea is to prevent a permanent indentured servant class to develop as well as remind all society that everything actually belongs to God. Of course, the Roman empire did not agree with these laws.

  18. Mom

    I read this minutes after my 5-year-old got her first credit card offer (AmEx) in the mail. I can only hope they’d stop short of actually issuing her a card.

  19. Jerry

    We got rid of our credit cards from big banks as a protest about a year ago. This past 6 months we get a credit card letter from Chase everyday!! It really is harassment. Is there anyway to get this JUNK mail stopped?

  20. GregG

    We’re right at the other end of the spectrum; our $5K MasterCard is at $5K and goes over every month from the interest. We can only make the minimum payment right now and it’s been like that for months. Dec 4 we got an automatic approval for an $8K limit — but you had to accept before December 24. The tag line at the end of the “offer” was Get The Most Out of Your Card (which I’m sure was their internal marketing slogan).

  21. Psychoanalystus

    All I have to say is:

    the bananization of America continues…


    PS — the “bananization” term — you heard it from me first. But you have my permission to use it too.

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