The year 2004 shattered records when it came to credit losses! Given the past few years that have seen credit card chargeoffs grow and stay at high levels, this comment most likely would be interpreted as, "Oh no, here we go again!" But this time it is actually excellent news for the card industry. Losses dropped from 6% of receivables in December 2003 to 5.2% in October 2004, putting 2004 on track to set a record in loss reduction once the final numbers are in.
What's more, this decrease is the result of a decline in contractual chargeoffs and not lower bankruptcies, a significant development. The last time the industry experienced a major decline in credit losses was in 2000, mainly because of lower bankruptcies.
Was 2004's sizable decrease in credit losses expected? No. Sure, most in the industry anticipated positive news on the economic front, but not credit losses declining by over 80 basis points.
What was the key driver for the improvement in credit quality? There are many variables responsible for this. Many industry publications have focused primarily on recent, relatively positive economic data as being the source for the improvement in credit losses. While it is definitely true that the better economy helped, another critical factor is that the card industry's significant investments in new credit-risk management tools over the past few years paid nice dividends in 2004.
These tools include enhanced regression models utilizing key internal and external cardholder information, which allow for a very sophisticated analytical approach to portfolio segmentation. This in turn drives critical underwriting, credit-line management, authorization, and collection queuing strategies.
In January 2004, in both the industry peer groups that my firm is involved with-the Visa IRKI and the CKIP Report-we were surprised to see issuers report a significant decline in one of the key credit-risk benchmarks, the so-called 0-1 roll rate. This performance measure is critical in assessing potential change in a portfolio's credit-risk exposure. It measures the percentage of prior-month current receivables that flow delinquent in the present month.
To provide some perspective, the full-year 2003 month-end inflow rate was 5.3%. Results for 2004's first half showed some of the lowest rates in many years, falling to as low as 4.5%.
This ratio provides important insight about the potential direction credit losses will be moving in six months. Based on what we were observing, it was clearly evident that the card industry would be getting fantastic news starting in July and for the remainder of 2004. Not only were these initial inflow rates low but the subsequent roll rates-the percentage of initial delinquent receivables flowing to 30-plus days overdue-also were coming in lower than expected.
Meanwhile, most issuers' collections departments performed well, having benefited greatly from the enhanced risk models that did a good job in identifying which initial delinquent accounts should be worked as well as the intensity they should be worked.
Not only were delinquencies and credit losses lower than what had been seen in many years, there were other interesting developments in 2004. The monthly payment rate increased sharply, from slightly less than 16% of outstandings to 17%. Reasons for this included revolving cardholders having more disposable income due to mortgage refinancing, higher interest rates on revolving debt, and payments in full on the expiration date by those who accepted a 0% balance-transfer rate for nine to 12 months.
Recovery rates climbed during 2004, the result of card issuers electing not to sell high volumes of fresh chargeoffs from 2000 to 2004, thus allowing inventories of charged-off debt to grow.
The present environment has seen better underwriting criteria resulting in issuers providing the right price with an appropriate credit line to the right customer. The next challenge will be the management of the consumer life cycle. Success here will separate the excellent, average and underperforming card programs.
Utilizing the right internal transaction data and pulling the appropriate external credit-bureau data at appropriate intervals is essential. This will allow for effective credit-line management, which in turn ensures an account remains priced correctly, correct authorization strategies are used in the event the account becomes delinquent, and that those accounts which should be offered promotions such as convenience checks or low-rate balance transfers are identified.
Present industry data indicate the positive credit-risk results observed in 2004 will definitely continue during the first half of 2005. True, high consumer debt loads and increasing interest rates will be challenges. It will be imperative for card issuers to intelligently manage the consumer life cycle with their new tools and lessons learned from the recent period of high bad-debt levels that finally came down in 2004.
Stan A. Myers is managing director of San Mateo, Calif.-based Card Analytics Consulting Inc. He works extensively with Visa and major card issuers on operations, collections and credit-quality issues. He can be reached at smyers
Authoritative analysis and perspective for every segment of the payments industry
Authoritative analysis and perspective for every segment of the industry
Have an account? Sign In