The novel coronavirus, or COVID-19, pandemic will affect payment transaction volume, as Visa indicated in its March 31, 2020 Form 8-K filing with the Securities and Exchange Commission, which showed an anticipated 7% decrease in U.S. credit card transactions during the third month of 2020. However, there are different numbers for credit card issuers to watch. New account bookings, which are the lifeblood of credit cards, are tightening, and delinquencies are rising although they have not yet begun to cause a problem. The looming 180-day charge-off standard, which requires that credit card issuers remove a charged-off account as an asset and incur a loss, will begin to hit issuers in the U.S., and similar standards based on local rules will hit issuers abroad.
Credit Card Issuance
As the Wall Street Journal reported, top U.S. lenders, including Bank of America, Capital One, and Chase, are “reviewing and revising” their credit card lending strategies. Expect to see lower spending limits, tighter scrutiny of scoring, and more in-depth investigations for income verification. The WSJ article mentions that American Express, Bank of America, and Chase froze their credit card mailing a week ago.
With more than 10 million workers in low-wage food service in the U.S. laid off, another 7 million in retail laid off, and millions in a variety of other sectors, now is the time for credit card companies to shore up their lending strategies. Financial inclusion is no longer the order of the day. Defensive, sound lending is needed to protect the balance sheet.
The Downstream Danger Is Credit Risk
While new bookings represent 15% of credit card issuers’ accounts, the base business revolves $1 trillion in debt each month, and consumers have access to another $3.7 trillion in open credit lines. Credit card issuers must look at these volumes with an eagle eye to ensure that the cards do not bring new risks to their own business. We saw in the Great Recession that credit card issuers implemented risk-averse strategies and collapsed many credit lines in the spirit of risk mitigation. (For more detail on credit exposure and contingent liability, see the Mercator Advisory Group research report titled 2020 Credit Card Data Book.)
The core concern is credit card aging, which will undoubtedly reflect the impact of credit card deferments that so many card issuers are offering as a temporary solution to the stress on household budgets resulting from the COVID-19 lockdown and layoffs. For cardholders who have not arranged a deferment, there will be an additional risk.
The credit card cycle is simple. When the month closes, if you are cardholder you receive an account statement. You have the option of paying at least the minimum due (roughly 1/36th of the balance) or any amount higher. Should you not pay, your account “ages” to 30 days, which is to say, one month past due. The scenario follows the schematic below.
In the current environment, payment deferrals can not stop account aging. Instead of receiving calls from collectors with pressure increasing as aging occurs, deferrals will receive a pass on the collection call. Still, cardholders will not receive forgiveness on the charge-off event at 180 days delinquent. The consumer credit bureau file will be marred with a writeoff, and the credit card issuer will feel the impact on its Profit and Loss statement. (For more information on managing a credit card charge-off, see Credit Card Charge-off Collection Takes Brains not Brawn.)
The challenge will depend on how the year unfolds. In our best case scenario, we see erosion from a 3.8% charge-off rate to between 5.5% and 7.8%. If you recall, in the Great Recession, top issuers who posted loss rates of 10% experienced billion-dollar revenue losses.
Circle the Wagons
Credit card issuers must be sensitive to the account aging process. We at Mercator Advisory Group believe that the best solution would be for the Office of the Comptroller of the Currency and National Bank Examiners to consider extending the 180-day charge-off standard to 240 or 270 days. This would protect bank card revenue models. An alternative would be for banks to consider programs to rewrite the revolving debt into installment loans. Either way would help cardholders balance their budgets. Issuers must consider the credit cycle or they will face balance sheet and revenue risk later in 2020 and into 2021.