Credit card issuers are jacking up rates and fees — while they still can — but keeping up with fast-rising credit losses is not going to be easy.
Raising prices now, to the extent that card companies can do so, makes sense. Unemployment, which hit 8.1% last month, has led to near-record loss rates. In fact, the traditional one-for-one relationship between joblessness and chargeoffs is fraying. In some hard-hit markets, chargeoffs are accelerating even faster. And federal rules scheduled to take effect in July of next year will severely limit price increases.
But raising prices involves a thorny competitive calculus — first movers could push customers to other issuers — and risks toppling marginal borrowers into default, something that politicians and the regulators who developed the federal rules will surely notice.
"It's a downward spiral," said Michael Dean, managing director for asset-backed securities at Fitch Inc. "You're pricing your cards higher because you have higher defaults, which at the same time is chasing your best borrowers away, which will leave you with adverse selection and even higher defaults down the road. It's a tricky situation."
Gordon Smith, the head of JPMorgan Chase & Co.'s card unit, said during a presentation for investors last month that he expected the industry to adjust to the new rules by raising rates and adding fees, among other steps.
"Think back to 1989," the year before AT&T Inc. shook up the industry by introducing a credit card without an annual fee, he said. "Typically most cards in the United States had fees."
JPMorgan Chase is working on "a number of different product constructs, nothing that we're ready to bring to the market yet," Smith said. A slide accompanying his presentation identified two strategies: offsetting "low contract APRs" with annual fees and enabling "customers to restructure borrowing into fixed payment terms."
The new rules will largely prohibit price increases on existing balances unless the borrower has missed a payment to the issuer. The rules also will require lenders to apply payments to balances carrying the highest interest rates first. Proposed legislation would accelerate the implementation.
"Credit card issuers are probably looking at this as having one or two bites at the apple to try to get their portfolio priced" before the rules take hold, said Leigh Allen, a consultant at Global Consumer Finance Advisory LLC. "You only have a couple more shots. You've got to get it right."
According to Allen, issuers are asking themselves, "Exactly what types of repricing moves should I be making on people who I didn't necessarily regard as that risky before? Now, if I'm not going to be able to reprice them anymore, I'm going to have to."
However, "there's a penalty for moving first here," and customer defections are a possible consequence of overshooting, he said. Issuers "have to watch each other very carefully."
Smith said that at JPMorgan Chase, "we don't want to increase those rates too far and cause those customers to defect and go somewhere else."
In addition, "this is a stressful time for customers," he said. "You increase the rate too much, you push people into collection."
Duncan MacDonald, a former general counsel of Citigroup Inc.'s Europe and North America card businesses, cited political complications — particularly for Citi, which, among issuers, has received the most financial support from the government.
"Who do you notify if you're going to do it first?" MacDonald asked. "Do you tell the OCC? Do you tell Barney Frank? … And do you take the risk that they savage you in advance? Or is the better risk to take the beating after you send the notice out?"
Still, he said, the pull toward higher pricing is universal among issuers. "The first few out of the gate" with drastic increases "will drag everybody else with them."
In a January letter to Sen. Robert Menendez, D-N.J., who had urged issuers to adopt the new federal rules quickly, Ryan Schneider, the president of Capital One Financial Corp.'s card business, wrote that, in view of the deterioration in the economy and credit quality, "it is imperative that credit card issuers maintain a reasonable degree of flexibility to reprice accounts to reflect the risk environment."
It is only responsible for issuers to consider "changes to accounts whose terms do not appropriately reflect these increased risks or are simply misaligned with the new regulatory structure," Schneider wrote.
At a meeting with investors in January, Roy Guthrie, the chief financial officer of Discover Financial Services, said it "pushed hard throughout 2008 to maintain stable finance charge income" as the prime rate, the benchmark for credit card rates, fell to 4%.
In the quarter that ended Nov. 30, the interest yield on Discover's managed U.S. credit card receivables fell only 13 basis points from a year earlier, to 12.72%. Guthrie cited steps like a reduction in promotional balance transfer offers and "targeted, account-level repricing."
The Riverwoods, Ill., company said its price increases averaged 425 basis points and affected "a relatively small segment" of customers. A Discover spokeswoman said it is already in compliance with some of the new rules, but "we are evaluating the possibility that we may need to adjust our portfolio to accommodate for the lack of future ability to risk-reprice accounts."
American Express Co.'s chief financial officer, Daniel Henry, said last month that it had "repriced" about 55% of its portfolio, generally raising rates 200 to 300 basis points.
Capital One, Citi and JPMorgan Chase & Co. would not say what proportions of their portfolios had been subject to price increases. B of A said that at the end of last year 91% of its customers had the same rate or a lower one compared with a year earlier, though that tally reflects the fall in the prime rate.
Citi told American Banker that it was changing terms for a group of customers whose base rates had not been changed "in at least two and in many cases three years."
Amex, B of A, Citi, Capital One, Discover and JPMorgan Chase all said they let customers opt out of price increases. (The consequences of opting out vary. JPMorgan Chase requires cardholders to close their accounts when they opt out; Citi lets them keep the old terms until the cards expire.)
Smith reaffirmed JPMorgan Chase's forecast that its first-quarter managed chargeoff rate would jump 171 basis points from the fourth quarter, to 7% (excluding the portfolio acquired with Washington Mutual Inc.'s banking operations). But he also said the rate, which historically has lagged the unemployment rate by a bit, would deteriorate more quickly as unemployment rises.
JPMorgan Chase projected that its chargeoff rate would rise to about 8% by the fourth quarter if unemployment reached 8%. But the company said that if unemployment rose to 10%, its chargeoffs would climb to between 10% and 10.5%.
"Think of all of the factors that have come into bear here, with unemployment rising quickly, with the home price depreciations across the nation, with the huge drop in equities and commensurate impact on a customer's 401(k)s," Smith said. "The American consumer just feels much poorer than just in a typical recession."
JPMorgan Chase has already witnessed the phenomenon in markets with the worst unemployment, like California and Florida, he said. "Where the unemployment rate is accelerating most rapidly, that's where the relationship is breaking."
MacDonald said the threat of out-of-control chargeoffs is a reason to act sooner rather than later.
The "savvier" issuers will say, "'Let's approach this on a two-part basis. Let's test the waters right now, with maybe somewhat of a hefty fee and see if we don't lose too many customers and see what revenues we get out of it, because if we fail, we may have to be even more hefty later, or maybe we can shave it back because of competition because we overshot.'"