We have been receiving quite a lot of questions about the impact of the novel coronavirus, COVID-19, and judging by the news, the potential impact would appear to be quite large. However, at Mercator Advisory Group, we focus on payments, and feel that we should rely on economic forecasters to size the risk to economic growth. We are closely monitoring economic forecasts and industry news, and expect to make more statements as new information comes in. For now, our primary thoughts are as follows:
The Payments Industry Has Historically Been Resilient in the Face of Economic Crises
Overall, the payments industry has been remarkably resilient in the face of economic crises. In 2010, the Federal Reserve released its triennial study of non-cash payment volumes, covering the crisis years of 2007-2008, and found that between 2006 and 2009, ACH, debit, and prepaid card volumes went up, while check and credit card volumes went down. We reproduce the table here:
Source: The 2010 Federal Reserve Payments Study: Noncash Payment Trends in the United States: 2006 - 2009, released April 5, 2011. https://www.frbservices.org/assets/news/research/2010-payments-study-summary-report.pdf
With regard to checks, the decline was part of a long-term trend that predated the financial crisis and continued after it was over. As for credit cards, the decline reflects that this fundamentally was a credit crisis; institutions and individuals had over borrowed in expectation of a continued increase in housing prices, and when prices dropped, they had to rapidly deleverage. Card issuers closed millions of accounts, cardholders defaulted on millions more, and the overall effect was that people who might have wanted to use credit cards could not. Since the crisis, credit cards have rebounded smartly, and as our 2020 Credit Card Databook noted, revolving debt increased past $1 trillion dollars back in 2017, and is now well above the point it was prior to the financial crisis.
Credit Card Issuers Are At Greatest Risk
Of course, that all looks quite bad now, and in fact we have been warning for several years that if the good times stopped, there would a reckoning for issuers, particularly those not in the top 100. Specifically, we have noted a vast gap in write off rates between the top 100 issuers and the rest; in 2018, Federal Reserve data indicated that the top 100 issuers experienced a loss rate of 3.55%, while smaller issuers experienced a loss rate of 7.52%. We believe this narrowed in 2019, but smaller issuers are in a very risky situation, and borrowers could be quite overextended. If the shocks to various sectors such as travel and hospitality lead to mass layoffs, we would expect charge offs to increase, and this might be enough to push some issuers over the edge. Continuing the analogy with the financial crisis, this could accelerate the ongoing consolidation in the credit card industry. However, we also point out in the same report, reasons for optimism. The largest card issuers have invested heavily in collections systems, and have recently been raising interest spreads to offset the growing delinquency rates. In the second quarter of 2019, the Federal Reserve found that the average charged interest rate on credit cards was 17.14%, much higher than the prime rate of 5.5%, and in fact the highest since at least 2004 (the earliest year we looked at). Return on assets recovered in 2018 from a long decline to land at 3.79%, and we believe 2019 was even better, at 3.87%. This well exceeds the return on assets for all commercial banks, which was 1.46% in 2018.
In short, the situation is complex: cardholders are quite leveraged, delinquency rates were creeping up before this year, and smaller issuers have been bearing the brunt. On the other hand, issuers have built up quite a cushion, and most importantly, there is no crisis in the home lending market. Unemployment is at modern lows (while that will certainly change), and corporations have been hoarding cash. Post financial crisis reforms mean that today's systemically important institutions are far better capitalized than they were in 2007.
Most Payments Go On Regardless of What is Happening
Broadening the focus beyond credit cards, we see similar complexity elsewhere.
The reduction in spend on travel, entertainment, restaurants and conferences, while large, is still small relative to the total volume of payments. Most payments activity is what we might call "keeping the lights on:"
- Corporate treasuries moving money in and out of various accounts
- Payment processors settling with the Federal Reserve and each other
- Securities transactions
- Bill payments
- Groceries and other staples
We have seen nothing to suggest that people will decrease their grocery purchases (in fact, they have probably gone up this month because of hoarding), stop trading (again, trading activity has been up, not down), stop paying their bills, stop making payroll, etc. To the extent that governments discourage the use of cash, and the number of face-to-face transactions go down, that would increase card and ACH volumes. Subscriptions should go up, as more people stream; digital media purchases should likewise go up. Government bailouts and financial assistance would entail a vast amount of payment transactions. Assuming the current assistance bill in Congress is passed, it would constitute an enormous stimulus. Over the weekend, the Federal Reserve cut the Federal Funds rate to 0.25%, effectively zero, and expanded bond purchases. The Fed and the financial industry learned from the last financial crisis, and the types of measures that were successfully used to address that crisis are being deployed much earlier in this one. With the borrowing cost so low, the ability of the federal government to borrow to compensate for market failures is vast, so we expect more stimulus in the near future.
All this is not to say that the effects of COVID-19 will not be dire; they will be. What we are saying is that the direct effects on the payments industry will be limited, and probably limited to lower growth at that, rather than negative growth. The most recent financial updates from Visa and Mastercard reduced expected growth, but still projected growth. Specialist firms, such as merchant acquirers focused on hospitality and restaurant verticals, may experience a more substantial impact. We will monitor first quarter earnings releases to see if the results are worse than we expect.
You can expect further updates in this space, as well as continuing coverage on our sister site, The PaymentsJournal (https://www.paymentsjournal.com/). As Brian Riley, our Director of Credit, said in his commentary on Friday, March 13, Credit Cards and COVID-19: Caution, but Not a Crisis (Yet) , we are in the process of revisiting our Outlooks and forecasts, and will issue updates as warranted.
As always, Mercator Advisory Group stands ready to assist our clients with all questions, as well as providing individual presentations. Please contact your account manager, or email me directly at email@example.com.