Before the last U.S. economic crisis, banks were well positioned to anticipate an imminent spike in consumer loan defaults. The mortgage market’s implosion materialized gradually in 2007 and 2008, giving lenders time to prepare for the fallout by tightening lending standards and closing accounts.
By contrast, the coronavirus crisis arrived suddenly and without warning. “No one prepared for the pandemic,” said Scott Barton, the founder and managing partner of 2nd Order Solutions, a credit advisory firm. “That’s why banks have had to hustle.”
Since March, credit card issuers have been scrambling to manage the risk that their customers, a large percentage of whom are now unemployed, will fail to repay their debts. Their actions have included both small changes, such as doing more legwork to verify that prospective borrowers still have jobs, and the rollout of major programs that aim to minimize the lenders' long-term losses.
It is far too early to tell how successful the lenders’ efforts will be, since the extent of the economic damage will hinge on how long the pandemic lasts. But card issuers, blindsided by the economic shutdowns that started in mid-March, have gone to great lengths to mitigate their downside risks.
One step they have taken is to curtail credit to new customers, including borrowers who want to transfer balances from another card lender. Bank of America has disclosed that card originations were down 55% during the first two weeks of April compared with average February levels.
Credit card accounts typically have the highest losses during their first two years, which helps explain why banks are tightening their lending criteria at a time of great economic uncertainty.
Another reason is the idea — known as adverse selection — that people who apply for credit during an economic downturn are more likely to be desperate for cash than those who apply in sunnier times.
There is likely a high amount of adverse selection in the market today, Capital One Chairman and CEO Richard Fairbank said during the company’s first-quarter earnings call. “So our strategy, in the face of the current challenges and uncertainties, is to aggressively manage credit,” he said.
One action that Discover Financial Services has been taking is to step up its efforts to verify applicants’ employment status. More than 40 million Americans have filed jobless claims since mid-March.
Lenders should be seeking to identify customers in vulnerable employment situations, industry advisers at Boston Consulting Group and 2nd Order Solutions wrote in a recent white paper. “For example, a customer working in the hospitality industry might have supplied pay stubs that are both recent and impressive, yet that job may no longer exist and the loan should now be categorized as high risk.”
Card issuers have also been managing their exposure to existing customers more aggressively by closing accounts that cardholders haven’t used recently. Inactive accounts are thought to present bigger risks because consumers may be more likely to start using such cards when they are strapped for cash.
In April, credit issuers closed 16.5 million revolving accounts, according to data from Equifax, up from around 13 million in each of the first three months of the year. This kind of pruning may continue. There are more than 100 million open and inactive revolving accounts, representing at least $500 billion in unused credit lines, according to Fair Isaac Corp.
Card companies have also become more careful about increasing credit lines to their existing customers, and some have grown more aggressive in suspending the ability of delinquent customers to keep spending. But so far, they appear hesitant to reduce the credit lines of customers who continue to pay on time.
Card issuers may be stopping short of decreasing credit lines to avoid angering customers. Mike Taiano, an analyst at Fitch Ratings, said consumers’ credit scores “could potentially get dinged” if credit lines are lowered.
“This feeling of resentment can also make the customer place this card lower in the list of bills to be paid,” noted the advisers at Boston Consulting Group and 2nd Order Solutions, “which can become a significant consequence to the lender when many customers are struggling to meet obligations.”
In recent public remarks, top executives at credit card companies have argued that their firms are better prepared for the current crisis than they were 12 years ago. Riverwoods, Ill.-based Discover says that its customers have 2.7 times more credit available to spend than its card loans outstanding, down from a 5.7-to-1 ratio at the end of 2007.
And Citigroup says that more than 60% of its branded cards portfolio is with consumers who have FICO scores above 720, compared with less than 40% before the last crisis. Lenders also have better technology for assessing credit risk than they did 12 years ago, according to industry observers.
But some card issuers have acknowledged that there is more they could have done to prepare. While the industry was anticipating an economic downturn, it was not expecting one to arrive with the speed and intensity of the coronavirus crisis.
One area where some card issuers are scrambling to catch up is in the digital collection of overdue debt. Such online operations may be cheaper than phone calls, and they may often yield better results, since some borrowers prefer the anonymity of dealing with a website.
Synchrony Financial CEO Margaret Keane said this week that the Stamford, Conn.-based card issuer, which specializes in partnerships with retailers, needs to become much more digitally savvy in how it collects delinquent balances.
“We have to rethink how we connect with customers,” Keane said at an industry conference Thursday. “I wouldn’t say we’re state-of-the-art there.”
Perhaps the most important step that card issuers have been taking recently to manage their credit risk is to offer loan forbearance on a widespread basis. While these offers are often described as assistance to borrowers, they are also in the interests of the card companies, since they tend to result in better long-term payment rates.
During the current crisis, cardholders who affirm that they are experiencing hardship as a result of the pandemic can qualify for a payment deferral, often in the range of one to three months.
One big challenge that card issuers now face is over what to do at the end of the forbearance periods. “There is no playbook on how to handle these people,” said Barton, a former senior vice president of risk operations at Capital One.
Card issuers do not want to extend a forbearance period unless the borrower truly needs the help, Barton noted. But they lack sufficient data to separate those customers who cannot make a payment from those who can, he added.
Barton expects card issuers to tilt their communications with borrowers who are currently in forbearance in favor of encouraging them to make their next payment, which would put the burden on those borrowers to proactively ask for an extension.
