The great divide between the top 100 credit card and smaller issuers hit a milestone, based on information published by the Federal Reserve. In Q4 2023, credit card issuers not among the top 100 banks rose to 9.50%, the third-highest level reported in the Federal Reserve’s tracking history. The extraordinary loss rate has been on the rise since Q3 2021.
Larger banks also experienced deterioration, but to a lesser extent. At top 100 banks, the charge-off rate rose to 3.96%. This represents more than double the low metric reported for larger banks in Q1 2022, which was 1.59%.
The challenge consumers face is related to their capacity to repay. In a recent Javelin Strategy Impact Note, Credit Card Lending Needs a Slowdown; Work with Cardholders to Shield Upcoming Risk, we suggest that issuers of all sizes temper their lending until the market settles. The report shows that some lenders already tapped the brakes on lending, and those that do not will pay the price in the form of higher charge-offs.
Actions such as eliminating delinquency fees or putting price controls on credit cards sound like great ideas when regulators pontificate. Still, they force lenders to reduce their lending risk by either exiting certain lending segments or being much more selective in their lending decisions.
Increased charge-offs will continue throughout the next two quarters. The good news is that the January unemployment rate is low, at 3.7%. While it will not be surprising to see smaller banks crossing the 10% threshold in charge-offs in the coming months, remember that larger banks will likely surpass the 4.0% mark over the same period. A rise in unemployment, however, will spike the charge-off rate.
The Art of Lending is in Risk Management
As it affects the banking revenue line, it is important to consider the process dynamics and the impact of well-intentioned regulators. Credit card issuers must reserve funds for the credit lines they deploy. When a cardholder uses the credit, the financial institution will generate revenue through credit card interchange. The interchange model is under attack under the Card Competition Act (CCA). The basis for the CCA is to reduce merchant and consumer costs by lowering interchange costs. Similar to what happened with debit cards, it is unlikely that consumers will benefit; merchants will keep the savings.
Then, after the transaction posts, credit card issuers will bill for the transactions, and in about 40% of the cases, the cardholder will pay in full. This is where charge-off impacts the credit card company’s bottom line. If the account charges off as a bad debt, the financial institution will have to reduce its portfolio value by the charge-off amount, which reduces non-interest revenue. Small financial institutions will lose $9.50 of every $100 in their loan portfolio using the above numbers. Top issuers will lose at the rate of almost $4 per hundred in loan portfolio. And over the long term, consumer credit card lending for many firms will be a losing proposition.
Regulators Must Consider Impacts
And that is where regulators fall short when they try to affect the credit card business model. The top regulatory issue, after fair lending, used to be safety and soundness. There is a lot of grandstanding today, and sooner than later, some lenders will find that the reduced margins in lending are not worth the risk. The ironic spin will be that the moniker to increase competition becomes unachievable because of the price controls.