October 4, 2022

Dear Congress – Thanks For Doubling My Credit Card Interest Rate

Congress Takes Bow For Credit Card Act of 2009

The Credit Card Act of 2009 was intended to curb certain practices of the credit card industry that were deemed abusive to consumers.  With a great deal of public fanfare, Congress passed legislation that provided the following benefits to credit card holders:

  • Credit card bills would be mailed at least 21 days before the payment due date
  • Customers would be given a 45 day advance notice of contract changes
  • An increase of the interest rate could be rejected by consumers who would then be required to cancel their card and pay off any existing balance within 5 years, possibly with a much higher minimum monthly payment
  • Payments would have to be applied to that portion of debt with the highest interest rate
  • Interest rates could not be raised on existing balances unless the borrower was more than 60 days delinquent
  • Prohibited “universal default” provisions and double cycle billing
  • Better disclosure of fees, card rules and interest costs

Senator Dodd of Connecticut, Chairman of the Senate Banking Committee, stated that “The new rules of the road established by the Credit Card Act will shield credit cardholders from widespread abusive practices”.   Whether or not the Senator (who faced an ethics probe relating to the special low rate mortgage he received from Countrywide) actually succeeded in providing any real benefits  to credit card holders remains questionable.

Credit Card Industry Response To Credit Card “Protection” Act

The credit card industry is not based on philanthropy – they seek profits and  have been exceptionally proficient in doing so historically.   Faced with huge losses from defaulting customers and the prospect of legislated profit limitations, the credit card industry reacted to these threats with the following changes:

  • Reduced or eliminated fixed rate credit cards; when interest rates increase, card rates will increase commensurately
  • Instituted annual fees, higher balance transfer fees, international transaction fees, higher cash advance fees, reduced award programs, slashed credit limits, canceled over $500 billion dollars in credit lines, summarily closed accounts deemed risky, raised monthly minimum payments and imposed strict standards for new credit cards
  • Increased interest rates by as much as 10 percentage points or more across the board, regardless of credit or payment history.  Unable to adequately assess risk or price accordingly, every credit card holder was assumed to be a potential default and charged accordingly – See Capital One Can’t Identify Their Low Risk Customers.

I have heard countless cases of people telling me that their card rates have been raised to 20% to 28% for purchases and cash advances.  Personally speaking, virtually every credit card I have has had the interest  rate increased substantially, with Capital One taking first prize by going from 8% to 17.9% on purchase balances.

Ironically, my General Motors credit card has actually dropped the interest rate from 14.15% in 2006 to a “low” 9.9% currently.  I assume that the low rate from General Motors has something to do with the fact that GM has an unlimited credit line with the US Treasury and does not have to worry about silly things like making a profit.

Why The Credit Card Companies Are The Biggest Winners Under The Credit Card Act Of 2009

What was supposed to be a major consumer protection act has turned into a future profit bonanza for the credit card companies.  Many credit card customers may go under financially but the credit card companies will do just fine, judging by the price performance of their shares and their actions taken cited above.  The credit card industry has adjusted their business model to the new reality and will prosper.

While the S&P 500 has increased by 52% since March of this year, the stocks of credit card companies have performed dramatically better.   Since March 2009 the stocks of companies such as American Express and Capital One have tripled in value even as write-offs of credit card debt hover in the 10% range and new restrictions on credit card companies become law.

“I Am From The Government And I Am Here To Help”

After bailing out the banking industry, our government (perhaps inadvertently) managed to provide even more help to the credit card industry.   Thanks for trying to help Congress – I feel much better now that I am paying 18% instead of 8%.

COF

COF

AXP

AXP

Disclosures: None

Pay Back Time For Credit Card Companies

Card Company Practices Draw Heat                                                                                   Credit Cards

The credit card industry has drawn considerable attention in Washington.  It’s the kind of attention that the card industry did not want but probably deserves.   In an effort to reduce mounting credit losses, the credit card industry has increased interest rates and fees and reduced credit lines.   The backlash by consumers has resulted in the  House of Representatives passing the “Credit Card Holders’ Bill of Rights”, which will prohibit some of the more dubious  practices employed by credit card companies.

The new legislation will prohibit retroactive rate increases and the infamous double cycle billing, require 45 days advance notice of rate increases and require that a borrower be at least 18 years of age.

Prior to passage of the new legislation, lobbyists for the card industry were warning of the adverse impact that new legislation would have.

Congressional action may make credit-card debt less attractive to investors, said the American Bankers Association, the American Securitization Forum, the Financial Services Roundtable, the U.S. Chamber of Commerce and others, in a March 30 letter.

House legislation will “have a negative effect on lenders’ ability to offer reasonably priced credit,” said Kenneth Clayton, senior vice president for card policy at the Washington-based ABA, in a statement.

Card lending is unsecured, meaning the bank doesn’t have any collateral to claim when loans go bad. “The industry is taking massive losses on consumer credit across the board,” Kenneth Lewis, CEO of Bank of America, said on April 8. “Banks in the industry are just trying to protect those assets.”

Weak arguments such as these obviously did little to prevent the new legislation.  My advice to the card companies is – make your debt attractive to investors by restricting lending to people who have the ability to pay back their debts.  Sub prime lending of unsecured money to deadbeat customers regardless of rate will guarantee losses.  Responsible lending will allow you to offer “reasonably priced credit”.

Card Companies Victims of Their Own Tactics

The credit card companies have created their own disaster through reckless lending.  For years I have observed credit card companies extending ridiculously large credit lines to borrowers with minimal ability to service their debts.   It was common to see fixed income retirees or low income wage earners with credit card balances far in excess of their yearly income.   Many borrowers, living on the edge, cannot be blamed for accepting the “no questions asked” easy credit and payment terms pushed by the card companies.   The lenders are the ones responsible for ensuring sound lending.

The logical question is why would anyone lend money to people who in the end cannot pay you back?  The answer is that for decades the scheme worked and resulted in huge profits, as noted in Bloomberg.

Citigroup, Bank of America Corp. and the rest of the top seven U.S. card issuers together raked in more than $27 billion in operating profit from credit cards in 2007, according to Bloomberg data. Now they’re mostly earning customer outrage.

It became routine for borrowers to max out credit card debt and then pay it off through a mortgage refinance (using stated income of course) and then repeat the cycle.   This routine produced large profits for the credit card industry until housing went bust.   No surprise that suddenly maxed out and over leveraged customers started defaulting en mass on their credit cards.  Needless to say, the huge losses were quickly transferred onto the backs of taxpayers  via the magic of the TARP program.  Logically reckless borrowers walk away from their debts and reckless lenders get reimbursed for losses – does anyone see a problem here?

As delinquencies spiraled out of control, the card companies implemented new harsh policies to cut their losses. The problem that the card companies face  is that there is no way for them to accurately forecast who will default and who will pay, since they had previously approved cards without bothering to thoroughly verify the borrower’s financial profile – see Capital One’s Losing Strategy. Not knowing the card holder’s income or asset situation and facing huge losses, the credit card industry had no choice but to raise rates and fees for everyone.

The problem with this new “strategy” is that the borrowers willing to pay 18 to 25% interest rates are probably those most likely to default.  No one who has sufficient income and  spends prudently would be willing to owe card balances at ridiculously high interest rates.   Given these circumstances, the customers owing balances on their cards tend to be the highest risk borrowers, which necessitates  higher rates to offset higher losses.  Maybe the credit card guys should rethink their basic lending strategy?

Disclosure: No positions in companies mentioned

Capital One’s Losing Strategy

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The Trust Dilemma

It is widely known that the credit card industry has serious problems.   Defaults are reaching all time highs as unemployment and high consumer debt levels impede borrowers’ ability to repay their debts.  Defaults based on job losses or over leveraged customers  are nothing new to credit card lenders, who have traditionally lent to less than sterling credits at rates commensurate with risk.

In the past, card issuers extended generous credit to all borrowers, seemingly indifferent to credit or income levels. The lower credit score borrowers’ losses would be covered by higher rates. Card loans to homeowners could always be paid off when the borrower refinanced his home. The higher credit score borrowers got lower rates but would never default in large numbers. This scenario worked well and produced huge profits for the card companies until the housing market crashed and the securitization market for credit card debt disappeared.

Recently, in addition to expected losses,  the credit card industry is now experiencing a troubling new phenomenon not accounted for in their risk models.

Customers with high credit scores and no previous history of default are suddenly defaulting on their card payments.   Since the credit card companies never expected large default rates by their “high credit high income” borrowers, they now seem forced to suspect that every customer is a high risk and should be dealt with accordingly.

Have the dynamics of the credit card industry fundamentally changed or should the credit card companies have done a better job of qualifying their borrowers before extending generous lines of credit?

Capital One Can’t Identify Their Low Risk Customers

Here’s a real life verified example of a borrower approved for a credit card based only on stated income and a credit score.

The applicant’s on line credit card application to Capital One was approved instantly for $30,000 after providing name, address, social security number, name of employer, job title and income.   Income was never verified according to the borrower’s employer.  Credit score was 800 plus when the credit card was approved several years ago.   The borrower has used her card frequently, always paid on time and incurred interest charges at 7.9% when the monthly balance was not paid in full. The borrower has maintained a plus 800 credit score and her credit line has not been reduced. Capital One knows the borrower’s current credit score since they  monitor customer scores on a monthly basis.

This 800 plus FICO score borrower who has never been late with any payments recently received a notice from Capital One that effective April 17, 2009, the interest rate on unpaid purchase balances will be 17.8% and on cash advances the rate will be 24.9%.   Is this just another example of rates being adjusted to reflect lending risks, or an indication of how little Capital One knows about its customers?  Here’s what Capital One does not know about this customer since they never bothered to ask.

Customer has a secure job, little debt and her income comfortably exceeds all living costs.   In addition, customer has verified liquid assets in excess of $1 million plus home equity and other assets that put her net worth in the $2 million range. Net result for Capital One is that this customer will be paying off all monthly balances in full to avoid paying interest at 18%.  Should the need arise to borrow money, the customer has access to a home equity line of credit at 4%.

Establish Lending Parameters Based on Sound Underwriting

In order for Capital One to rebuild their business going forward, they should consider re-qualifying their customer base with a detailed loan application and then verify the information.   For those determined to be low risk customers, charge a lower interest rate.

Capital One now seems to have a strategy of charging high rates to all of its customers which seems counterproductive.   The customers who are  financially strong will not pay 18% rates – they will either pay off their balances monthly or borrow cheaper elsewhere.   Customers willing to pay 18% to 25% interest on a loan are probably stressed financially and the most likely to borrow and default.  This bizarro business strategy of targeting the weakest borrowers in a weak economy seems destined for failure.

Perhaps one day Capital One may come up with the unique concept of restricting lending to borrowers with a verified ability to repay.

Late Update

US consumers in February reduced outstanding revolving debt (which is primarily credit card loans) by $7.8 billion.  Some of the decrease is due to decreased credit card lines and consumer reluctance to take on more debt.  My guess is that a good portion of the decrease in credit card balances is  also due to the sky high rates being charged by the credit card lenders.   The higher quality card customers are accessing lower rate money elsewhere or simply saying no to 25% lending rates.

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