Web posted and Copyright © July 13, 1998, American Bankruptcy Institute.

Recent Trends in Bank Credit Card Marketing and Indebtedness

Stephen Brobeck
Executive Director
Consumer Federation of America

July 1998

Introduction

Last year in February and December, the Consumer Federation of America (CFA) issued reports on credit card debt and its
financial impact on consumers. The reports revealed that 55 to 60 million households (55-60% of all households) carry credit
card balances and that these balances average more than $7,000, costing these households more than $1,000 per year in interest and fees.

The reports also concluded that this mounting credit card debt was the most important reason for the rise in personal
bankruptcies (1.3 million in 1997). In recent years, the industry significantly increased its card marketing to low and
moderate income households. Not surprisingly, then, typical Chapter 7 bankrupts had relatively low incomes and high credit
card debts -- in 1996, after-tax income of $19,800 and credit card debts of $17,544 according to research by the industry-
funded Credit Research Center.

Experiencing rising losses from these insolvencies, the credit card industry organized a campaign to persuade Congress to
restrict access to Chapter 7 bankruptcy. The campaign succeeded in persuading the House of Representatives to pass legislation quite similar to the proposal developed by the industry. This month, the Senate will consider only slightly less restrictive legislation.

This report examines the recent behavior of those credit card banks that have extended the large majority of all revolving
credit. Most importantly, it demonstrates that recently these banks have expanded their marketing and extension of credit at
the same time they have increased their political spending on a bankruptcy "reform" campaign intended to reduce their mounting
debt losses. This report also suggests a far more effective and fairer strategy to reduce consumer financial insolvency and
personal bankruptcies.


Banks Expand Card Marketing and Related Credit Extension

Banks now extend the large majority of all credit card debt. As the table below shows, the ratio of bank credit card debt to all
revolving credit was 79.1% in the first quarter of 1998 and is even higher for credit card debt since an estimated 5% of
revolving credit is not card debt, according to the Fed. This percentage has grown significantly in recent years.

TABLE 1:
Relation of Bank Card Debt to All Revolving Credit

Despite rising chargeoffs (bad debt losses), banks have recently expanded their card marketing and credit extension. This marketing and credit extension has risen much more rapidly than bank card debt, as the table below shows.



TABLE 2:
Bank Card Mailings, Credit Lines and Debt (in billions)

*Data on mailings for January through March and projected annually; data on credit lines and debt for end of March.
Sources: Data on mailings from BAI Global Inc.; data on credit lines and debt from Veribanc, Inc.

The above table suggests two striking trends. First, total credit extended on bank cards (unused credit lines plus actual
debt) rose to more than $2 trillion by the end of March 1998. Second, in the past six years, bank mail solicitations and unused
credit lines grew nearly twice as rapidly as bank card debt. Banks have been far less restrained in their marketing and credit
extension than consumers have in their accumulation of credit card debt. That has been especially true recently. In the 15-
month period from the beginning of 1997 to the end of March 1998, all revolving credit increased 7.6% and bank card debt rose 23.5%, but unused bank credit card lines increased 50.3%.

This latter trend raises the question, why have banks expanded solicitations and credit lines while forced to write off
increasing bad debt losses -- according to Veribanc, from 3.0% of outstanding debt in 1994, to 3.4% in 1995, to 4.4% in 1996, to 5.4% in 1997, to an annual rate of 5.6% in the first three months of 1998? Despite the rising losses, for most banks credit cards are still profitable. During the past decade, credit cards have been the most profitable bank product. While profit margins have declined in recent years, for those banks marketing cards aggressively, they are still large enough to sustain huge debt losses and marketing expenses. As CFA's 1997 reports indicate, last year, consumers paid more than $60 billion in interest and about $10 billion in fees on credit cards. Banks collected the large majority of this revenue.


Who Pays Credit Card Losses

Credit card companies have run ads claiming that all bankruptcy-related losses are paid by consumers -- an average of $400 per household per year. That would only be the case if creditors raised prices to cover bad debt losses.

There is little evidence that creditors have raised prices to cover increasing losses. A significant percentage of these
losses represent credit card chargeoffs. But, as the table below shows, there is no relationship between bank card interest rates
and chargeoff rates.


TABLE 3:
Bank Card Interest Rates and Chargeoff Rates

Sources: Interest rates from Federal Reserve Board; chargeoff rates from Veribanc, Inc.


The fact is that, for many years, bank decisions about credit card prices have been independent of credit card losses. For two
decades, the average credit card interest rate has hovered around 18% (1.5% on the unpaid balance monthly). (The rates reported by the Fed are somewhat lower than that of other data sources such as Bank Rate Monitor.) These rates are the highest which banks believe they can charge.

It is true that, recently, banks have raised prices for some of their riskiest customers. They have hiked typical late payment and over-the-credit limit fees to $25 and have raised the interest rate charged to many of these late payer and over-the-limit customers to well over 20%. But these fees are paid mainly by a minority of customers. CFA's 1997 reports estimated that about one-third of households with a card pay off all balances in full, and most other cardholders make payments on time and do not exceed credit limits.

Who, then, pays for the credit card losses? In the past several years, a portion has been paid by the minority of cardholders who were assessed most fees. But most of these losses have been "paid" by bank investors to the extent bank stocks have been depressed by declining credit card profitability. Most of the roughly $20 billion in bank card losses last year was borne by
investors who earned a lower return on their investments. At most, only several billion dollars of this amount can be
attributed to rising credit card fees.


Which Banks Extend the Most Credit and Do So Most Prudently

Just as the portion of credit card debt held by banks has increased recently, so too has the portion held by a few big
banks. As the table below shows, at the end of last year, a few banks held more than half of all bank card debt. In fact, if announced mergers had been consummated, five institutions -- Citicorp; MBNA; Banc One/First Chicago; Chase Manhattan; and BankAmerica/Nationsbank/Barnett -- would have held 53% of all this debt. (These institutions also accounted for most recent mail solicitations; in fact, in 1997 Banc One accounted for more than one-quarter of all mailings.)


TABLE 4:
Big Bank Credit Card Debt and Net Chargeoffs

*Debt includes that held by institution and that which was securitized.
**Chargeoff rate computed only on debt held by institution.

Source: Veribanc, Inc.


The chargeoff rate is the best indicator of the prudence and responsibility of institutions extending credit. It is not a perfect index; for example, it can be inflated by selloffs of debt (securitization) and deflated by rapid increases in outstanding debt. Nevertheless, it is accurate enough to be used as an important statistic by investors.

Banks with chargeoff rates below 3%, even if they market aggressively, do so fairly prudently and responsibly. On the other hand, banks with chargeoff rates above 6% are highly likely to extend too much credit to high-risk consumers. Even if their bank card operations are profitable, they are lucrative at the expense of many consumers who are loaded up with debt that they will not be able to repay. It is hypocritical of these creditors to complain that they need bankruptcy relief.


Creditor Strategies to Restrict Consumer Access to Bankruptcy

Last year, credit card companies and banks organized a campaign to restrict consumer access to Chapter 7 bankruptcy. (In Chapter 7, all or nearly all unsecured debts are discharged; in Chapter 13, most debts are repaid over time.) This campaign has been extensively reported on by the press. (For example, see Jacob M. Schlesinger's lead article in the June 17, 1998 issue of The Wall Street Journal.) Campaign strategies include:

• research disseminated, among other means, in advertisements;
  
• campaign contributions totaling millions of dollars;
  
• lobbying the National Bankruptcy Review Commission;
  
• lobbying of Congress that cost Visa and MasterCard alone more than $2 million in 1997;
  
• grassroots lobbying by creditors in congressional districts and states; and
  
• attempts to intimidate the bankruptcy bar.

CFA asked the Center for Responsive Politics to compute the campaign contributions of big banks in the 1997-98 cycle. They found that the 25 largest credit card banks made $3.6 million in PAC, soft money, and individual contributions. Interestingly, the big five banks (noted in the previous section) contributed more than $2.5 million of this amount.

Why were these contributions made? Certainly the banks wished to influence legislators on financial services issues other than bankruptcy reform, especially modernization. But it should be noted that, since legislation passed by the House is predicted by the industry to reduce bankruptcy losses by about $4 billion annually, if this bill becomes law, big banks could well recover an additional $2 billion or more a year from their political "investment" of several million dollars.


How Consumer Insolvencies, Including Bankruptcies, Can Be Reduced

It is unclear whether contemplated bankruptcy reforms will reduce personal bankruptcies, let alone consumer financial insolvencies.  On the one hand, restricting access to Chapter 7 bankruptcy, together with other proposed measures, would prevent consumers from discharging as much debt and would probably discourage them from declaring bankruptcy as frequently. On the other hand, by allowing creditors to collect more debt, bankruptcy reforms would encourage credit card banks to market and extend credit more aggressively. Thus, it is quite possible that these reforms would aggravate the problem of consumer financial insolvency.

At the very least, bankruptcy legislation should include creditor responsibility measures that reward responsible credit granting and punish irresponsible credit extension. Here, irresponsibility is defined as granting credit to consumers who are highly likely to default on their debt obligations. One specific measure Congress should seriously consider is to make it difficult for lenders who extend credit to consumers with high consumer debt to income ratios to collect this debt in any bankruptcy proceeding, even one involving Chapter 13. Since most experts believe that consumer debt to income ratios (excluding mortgage debt) should not exceed about 20%, 40% is a ratio that should be considered as a threshhold.

While in most instances it is not politically practical to require aggressive and irresponsible credit grantors to "cease and desist," these lenders could be identified, criticized publicly by opinion leaders, and jawboned privately by regulators. Most of those big credit card banks with chargeoff rates over 6%, for example, should be on this list.

Regardless of the success of any of these efforts, many consumers must use credit cards more intelligently. Frankly, for most consumers it is foolish to carry any balance on credit cards. The large majority of the more than $70 billion cardholders are paying each year in interest and fees is wasted; it could be allocated much more sensibly and satisfactorily on other goods and services or on savings.

Even more foolish than carrying large credit card balances for a long time is using home equity to refinance credit card debt without curbing credit card use. Fed research suggests that over 40% of home equity borrowing is used to refinance consumer debt. Even more recent research, by Brittain Associates Inc., indicates that about two-thirds of households that use home equity loans to refinance credit card debt run up new credit card debts. In the future, particularly in any recession, many of these households risk losing their homes.