2017 Outlook: Credit
December 2016
2017 O U T LO O K : C R E D I T
Industry projections and predictions for U.S.
consumer credit cards
Credit cards continue to be the most profitable
segment for retail banking, but margins are
slipping due to changes in non-interest revenue.
Volumes are up but the industry must pay
attention to controllable and operational
expenses to protect profits.
by Brian Riley,
Director, Credit Advisory Service
8 Clock Tower Place, Suite 420 | Maynard, MA 01754
phone: 1(781) 419-1700 | e-mail: [email protected]
www.mercatoradvisorygroup.com
© 2010 Mercator Advisory Group, Inc.
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2017 Outlook: Credit
Industry Performance Projections
Return on Assets Continues to Fall but Is Stronger than ROA of Other Channels
Return on assets (ROA), the metric that measures a card issuer’s profitability after interest and non-interest
revenue and expenses versus outstanding portfolio value, is critical because it indicates return for investors.
Numbers published in the annual Report to Congress on the Profitability of Credit Card Operations of Depository
Institutions, which reports on credit card banks with assets in excess of $200 million, shows a decrease of 74
basis points (bp) between 2013 and 2015. Mercator Advisory Group projects this trend will continue through
2017, when we expect the metric to fall to 3.74%, 146 bp below its post-recession peak of 5.37%, as illustrated
in Figure 1.
Figure 1: Return on Assets for Credit Card Banks, 2006–2017F
10%
8%
7.65%
6%
5.37%
5.1%
4.80%
5.20%
4.94%
4.36%
4%
2.60%
3.98%
3.74%
2.41%
2%
0%
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016(F) 2017(F)
-2%
-4%
-6%
-5.33%
Source: Mercator Advisory Group analysis of Board of Governors of the Federal Reserve Report to Congress
© 2016 Mercator Advisory Group, Inc.
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2017 Outlook: Credit
ROA for 2009, sandwiched between two other recession years, remains a painful reminder of how poorly the U.S.
credit card industry performs in a weak economy. No major U.S. card issuer returned a profit in 2009. In fact, top
issuers such as American Express, Bank of America, Capital One, Citi, Chase, and Discover experienced massive
losses, some in excess of $1 billion. The ROA metric bounced back beyond 5% in 2011, but since 2014 has shown a
steady decrease. The revenue dip stems from non-interest revenue rather than interest revenue. Interest revenue
is generally shielded by U.S. credit card design, card issuers having migrated years ago to a pricing model that
indexes most credit card rates to a spread against the prime rate of interest (the Prime). Based on credit
qualifications, purchase annual percentage rates (APR) typically are equal to the Prime plus a factor typically
between 9% and 25% determined by credit profile. The fixed spread ensures the card issuer’s interest margin
should the Prime increase. Credit card applicants’ credit history, FICO score, and ability to pay drive the
underwriting policy.
The revenue challenge comes from non-interest revenue channels, which rely on interchange, usage fees, and
punitive fees. The Credit Card Accountability Responsibility and Disclosure Act of 2009 (CARD Act) eliminated or
constrained delinquency charges, bad check fees, over-credit-limit assessments, and other fees. Additionally, the
Consumer Financial Protection Bureau (CFPB) aggressively challenged various revenue enhancements offered by
the industry, often citing less than transparent sales strategies.
The decrease in ROA will likely continue, particularly for non-interest revenue sources, making it more important
than ever to manage non-interest expense items such as credit risk, fraud, and operating expenses, but credit card
managers should at least take solace in the fact their ROA consistently outperforms retail bank lending at
commercial banks, as shown in Figure 2.
Figure 2: Return on Assets: All Commercial Banks vs. Credit Card Banks, 2014–2016F
4.94%
4.36%
1.23%
2014
1.30%
3.98%
1.32%
2015
All Commercial Banks
2016(F)
Credit Card Banks
Source: Mercator Advisory Group analysis of Board of Governors of the Federal Reserve 2015, 2016 Report to Congress
© 2016 Mercator Advisory Group, Inc.
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2017 Outlook: Credit
Net interest income is determined by subtracting total income expense from total interest income, which has been
low and stable for both commercial retail banks (commercial banks) and credit card banks. The prime rate of
interest moved only 25 basis points between December 1, 2008 and December 1, 2016 and sits at 3.50%.
Anticipations are that the Prime will increase, which will likely affect both commercial banks and credit card banks.
Most recently published numbers by the Federal Reserve show total interest Income for credit card banks at 9.58%
for 2015, up from 8.67% in 2014, versus all commercial banks, which weigh in at only 2.51% for 2015. Interest
expenses for credit card banks are 0.85%, compared to all commercial banks at only 0.26%, driven by the inherent
risk of unsecured credit card products.
Non-interest revenue varies more significantly with non-interest income as credit card banks hit 4.41% in 2015,
compared to 4.45% in 2014; for all commercial banks the metric was only 1.49%. Mercator Advisory Group expects
the credit card non-interest income metric to continue to decrease, particularly given the regulatory focus of both
the CARD Act and CFPB, which aim at this revenue channel. Our expectation is that return on assets for credit
cards will remain slightly below 4% through the decade.
Portfolio Growth Continues
The general health of credit card lending is best measured by the growth of receivables and collection
performance; both metrics show improving results. Revolving debt, credit card balances that carry from month to
month, steadily grew after the 2009 recessionary fall-off. Delinquencies continue to be held to historically low
levels although, we note, a sudden change in the availability of credit, an increase in inflation, or a shift in
unemployment can force the metrics to go awry. In the post-2016 election environment, Mercator Advisory Group
expects continuing credit availability with less direction on price controls but a continued focus on transparency
and fairness. Inflation shows signs of increasing, which will have a negative effect on credit quality, and it is likely
unemployment will continue to be low in the United States.
Indications are that revolving debt in the U.S. will increase and surpass the 2008 high water mark of $1 trillion as
households gain confidence in discretionary spending and card issuers continue to aggressively build their
receivables. An inflationary spiral might benefit card receivables growth, but protective credit policies would likely
slow borrowing, which would disrupt the trajectory. It is likely that a new record will be set in 2017. Figure 3
illustrates.
© 2016 Mercator Advisory Group, Inc.
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2017 Outlook: Credit
Figure 3: Revolving Debt in the United States, 2014–2017F
Revolving Debt (USD Billions)
$1,002 $1,004
$924
$799
2004
$916
$829
2005
2006
2007
2008
2009
$839
$841
$845
$858
2010
2011
2012
2013
$892
2014
$938
$986 $1,002
2015 2016(F) 2016(F)
Source: Mercator Advisory Group analysis of Federal Reserve Bank G-19 Report
Revolving debt drives credit card interest revenue. Most recent studies by the Federal Reserve show that only half
of consumers carry debt from month to month, others paying balances in full and thus generating only usage fees
and interchange revenue.
The portfolio fall-off that occurred in 2009 was the result of consumers aging to bad debt status as credit card
write-offs exceeded 10% of annualized receivable volume, more than triple the typical rate. Coupled with this was
an aggressive play by credit card lenders to push weak credit card accounts off the books through proactive,
involuntary closure, in addition to customers who intentionally governed their behavior. After bottoming out in
2010 at $839 billion, receivables now project to reach over $1 trillion.
Consumer credit card interest rates are low, particularly those pegged to the prime rate of interest, as shown in
Figure 4.
© 2016 Mercator Advisory Group, Inc.
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2017 Outlook: Credit
Figure 4: Average Credit Card Interest Rates, Q2, 2004–2016
Annual Percentage Rate for Accounts Assessed Interest
15.0%
14.5%
14.0%
13.5%
13.0%
12.5%
12.0%
11.5%
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Mercator Advisory Group analysis of Federal Reserve Bank G-19 Report
The average credit card interest rates are 13.4% based on November 2016 reporting. This average includes
balances that are paid off prior to being assessed interest, typically within the grace period offered by card issuers.
More common market rates are in the range of 16–25% for cards issued by banks and by regulation governed by
the National Credit Union Association (NCUA), no more than 18% for credit unions although it is more common to
find credit unions offering rates in the 10% and 17% range.
It is likely that the Prime will rise in 2017, although Mercator Advisory Group does not anticipate movement of
more than 100 basis points on the current Prime of 3.50%. Consistent with the industry strategy to peg a spread to
the prime rate of interest, most credit card rates will rise, but this event will be of little consequence to U.S.
consumers. On a $4,000 credit card balance at 18.50%, the increase would add about $3.50 to the minimum due at
a 19.50% rate. Minimum due calculations vary by card issuer although the Credit Card Accountability Responsibility
and Disclosure Act (CARD Act) forbids negative amortization; most issuers calculate this into the minimum due and
add at least 1% to foster account pay-down.
It is not the rise in minimum due payments on consumer credit cards that will affect credit card quality, since the
product aligns very closely with household budgets as cardholders in this consumer-driven economy collectively
© 2016 Mercator Advisory Group, Inc.
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2017 Outlook: Credit
place more than $2 trillion on their plastics. Rather, it is the confluence of other factors, such as rising costs for
mortgages, student loans, and inflationary factors such as the increase of gasoline, that set household budgets into
disarray.
For now, the picture of the U.S. credit card business is strong. The country is beyond the angst of the recession,
volumes are on a growth trend, ROA is slipping but not seriously, and financial institution performance for large
banks, regional banks, community banks, and credit unions will likely improve as we enter the next stage of
American politics.
Figure 5 reviews delinquency rates. The improvement since the recession is evident in the downward slope since
2009, and looking forward to 2017, Mercator Advisory Group does not expect significant deterioration or
improvement of more than 50 basis points either way.
Figure 5: Credit Card Delinquency Rates, Q2, 2008–2016
Percentage of Accounts Delinquent
8%
7%
6.8%
6%
5%
5.1%
4.9%
4%
3.7%
3%
2.9%
2%
2.5%
2.3%
2.2%
2.1%
1%
0%
2008
2009
2010
2011
2012
2013
2014
2015
2016
Source: Mercator Advisory of Federal Reserve Bank of New York, Quarterly Report on Household Debt and Credit, July 2016
The next consideration in assessing U.S. credit card performance and operational risk is credit line utilization, the
amount of debt that cardholders place on their open credit lines (Figure 6). This ratio depicts the contingent
liability that card issuers have in the unlikely event that all cardholders were to use the entirety of their open credit
© 2016 Mercator Advisory Group, Inc.
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2017 Outlook: Credit
lines. It is important to note this was not the experience even in the worst of times for the U.S. consumer, when in
2008 credit lines totaled $3.67 trillion and cardholders used $900 billion of their credit lines, leaving $2.8 trillion in
open credit lines. What issuers did as the recession progressed illustrates the effectiveness of scoring systems and
adaptive controls used by most issuers, through either programs supported on their own platforms, such as those
offered by ACI Worldwide, or those with service providers such as First Data, FIS, Fiserv, and TSYS.
Figure 6: Credit Card Line Utilization, Q2, 2006–2016
Credit Card Banks Greater than $200 Million
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
2006
2007
2008
2009
2010
Credit Card Balance
2011
2012
2013
2014
2015
2016
Credit Card Available Credit
Source: Mercator Advisory Group analysis of Federal Reserve Bank of New York, Quarterly Report on Household Debt and Credit,
July 2016
These controls can kick in systemically, either on command or through an automated process that can scour the
receivable to adjust credit lines based on deterioration of a cardholder’s household credit, the specific issuer
credit, or other risk indicators. In the instance of 2009, observe how total credit lines fell by $600 billion to $3.0
trillion, shifting the utilization rate from 23.2% to 27.1%.
The utilization rate also illustrates the importance of engineering the credit card offer properly to ensure robust
card usage. The typical U.S. household has four active credit cards; one is typically held in reserve in the occasion
© 2016 Mercator Advisory Group, Inc.
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2017 Outlook: Credit
of household emergency or financial crisis; two active cards might be used for each spouse and a third may be
reserved for carrying large purchases. Card issuers can easily see these patterns at any one of the three major U.S.
credit bureaus, (Equifax, Experian, or TransUnion) and actively manage credit line increase and decrease programs
as the household budget ebbs and flows. For now, we see the 2016 metric at a 22.6% utilization rate.
Age Demographics
Until passage of the CARD Act, issuers raced to identify potential new card members as they entered college in an
effort to bring in new customers at an early age and then nurture them across a spectrum of retail banking
products, from student loans to retirement accounts. The most sophisticated models often considered school type,
such as Ivy League or state college, as well as degree type, forecasting credit lines that might vary for education
majors versus biotechnology candidates.
The CARD Act added a means test, which required either a qualified parental cosigner or proof that the young
prospective cardholder had the ability to repay the loan. Aside from the lending constraints of the CARD Act, which
now ensures that young adults graduating college will have thin or no meaningful credit history, the rapid buildup
of student loan debt, which now exceeds total revolving debt in the United States, creates a debt burden that
often disqualifies those new entrants from credit.
Student loan doubled between 2008 and 2016, growing from $579 billion to $1.3 trillion according to the Federal
Reserve Bank of New York (FRBNY) Consumer Credit Panel in a study jointly published with Equifax. Classes of 2016
students contend with $37,172 in debt on average, which certainly impacts their ability to qualify for a credit card.
Note the aging cardmember base shown in Figure 7. The range between 70 and 74 years of age owes more than
$2,500 in credit card debt. According to the 2010 U.S. Census, that universe represents 8,857,441 cardholders
carrying $20 billion in credit card debt. Versions of this table published a decade ago showed usage ascending at a
much faster rate among age cohorts aged 23 to 30 than among those on the back end of their credit life cycle.
A wealth of information is available to those with access to Mercator Advisory Group’s primary data research
found in the CustomerMonitor Survey Series illustrating the importance of age demographics and the use of
various devices which illustrate near universal usage of smart devices, scaling down for older age cohorts. A series
of numbers found in Figure 2 of the report from that series titled U.S. Consumers and Credit: Potential Disruption
to Issuers, released in 2015, complements the FRBNY date by showing survey data for credit card ownership
between the ages of 18 and 24, at only 42% for 2015 versus 73% for those over age 65.
© 2016 Mercator Advisory Group, Inc.
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2017 Outlook: Credit
Figure 7: Average Amount of Consumer Debt by Age and Type of Loan Product, 2016
Average Debt (USD)
$14,000
$12,000
$10,000
$8,000
$6,000
$4,000
$2,000
$-
20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 52 54 56 58 60 62 64 66 68 70 72 74
Student loan
Age
Credit card
Auto
Source: Mercator Advisory Group analysis of Federal Reserve Bank of New York, Quarterly Report on Household Debt and Credit,
July 2016
While credit cards offered by insured institutions are governed by the Equal Credit Opportunity Act (ECOA), which
is enforced by the Federal Trade Commission (FTC), the challenge for issuers is certainly not to take advantage of
repelling older customers. It is truly a call to action to continue aggressively developing the digital channels
surrounding payment cards in an effort to correct a long-term issue that otherwise projects a continued downward
revenue model for credit cards.
© 2016 Mercator Advisory Group, Inc.
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2017 Outlook: Credit
Mercator’s Credit Card Industry Predictions
How We Fared with Our 2016 Predictions
Our 2016 predictions proved to be relevant and generally strong, as Table 1 illustrates. Our first projection
anticipated the growth of a retailer-driven merchant solution for payments. While MCX looked promising, the
product never met the market, but various pay models were developed through Chase as a surrogate for low
interchange processing under the name of ChasePay. The model is currently in place and gaining scale at
merchants including Walmart, which also offers Walmart Pay; similar models are in development with large
retailers.
Table 1: 2016 Predictions: A Scorecard
What We Expected
What Happened
How We Did
MCX will field an app, pushing more
merchants into payments.
Market shifted to Chase Pay, Walmart Pay,
et al.
A
EMV volume will surge.
Recarding and terminalization strong;
merchants still lag.
A+
Consumers will try mobile payments
but not embrace them.
Initial take-up strong; persistent usage still
soft.
A
Loyalty programs will evolve.
Some movement but not in the critical
area of wallets.
B
Alternative lending will become more
direct.
Models continue; signs of market
weakness.
B-
Digital acquisitions costs will explode.
Large issuers driving towards this channel;
midrange players still weak in this area.
B
Issuers will push for digital onboarding.
Natural migration; needs more work.
B+
Source: Mercator Advisory Group
Our projection on EMV was a solid A+, with near 100% conformance at credit card issuers in the US, the world’s
largest credit card market. Announcements by American Express, Discover, MasterCard and Visa in October 2016
all professed significant results, and Visa announced there were 771 million Visa chip card transactions, a 453%
increase over October 2015. In the current day, 1.72 million merchants accept the payment form.
Our expectation that loyalty would evolve gets a “B,” and though there has been progress in some program
designs, the industry really needs to grow in the wallet space. Wallets are certainly growing, but as an industry,
they are not near an inflection point. Similarly, we give ourselves a “B-“ for alternative lenders on the revenue side
and an “A-“ regarding penetration, particularly with small businesses and some consumer segments. We anticipate
© 2016 Mercator Advisory Group, Inc.
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2017 Outlook: Credit
that many will continue to flounder as banks build better scoring models that address alternative market
segments, with tools provided by firms and products such as Equifax, Experian, FICO XD, IDAnaltics, LexisNexis Risk
Solutions, and TransUnion.
Our prediction regarding Digital Acquisitions earns a “B” and Onboarding deserves a “B+” although results were
uneven. Chase, the largest branded credit card issuer, reports in its investor documents that 72% of its accounts
were booked through a digital channel and that only 13% of rewards are claimed through call centers; mobile and
tablets service 12%; desktops deliver the remaining 75%.
What We Predict for 2017
We take a different approach to our projections in 2017, categorizing 13 predictions into 6 groups as shown in
Table 2.
Table 2: 2017 Predictions: A Banker’s Dozen
Revenue
Decline in Non-interest Revenue
Reduction in ROA
Risk
Credit Quality Deterioration
Persistent CNP Fraud
Environmental Factors
Interest Rates Will Increase
Inflation
Product Features
EMV Propagation
Mobile Gains Scale
Control
Account Level Expansion
Product Expansion
Regulatory Mandates
Market
Deep Data Integration
Enhance Scoring
Source: Mercator Advisory Group
© 2016 Mercator Advisory Group, Inc.
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2017 Outlook: Credit
For revenue items, we expect to see a fall-off in both non-interest revenue and return on assets, as discussed
earlier in this Outlook for 2017. For non-interest revenue, we expect to see lower performance and the return on
assets metric will likely dip to 3.74%.
In the risk category, depending on how the economy moves, Mercator Advisory Group does not anticipate a
radical shift plus or minus 50 basis points. We still anticipate the industry will face issues with card-not-present
(CNP) fraud, but we look forward to enhancements such as 3-D Secure and other industry developments.
Environmental considerations are essential, and an increase in interest rates is certain after so many years of
regulatory control. We hold our forecast at 100 basis points. or 1%, although this may be more hopeful than
practical. Inflation as reported by the Bureau of Labor Statistics remains at 1% and our expectation is that it may
double but remain under control through 2017.
Product features such as EMV will continue to propagate, with merchants soon completing implementation. The
process will lag in the gasoline industry, where the liability shift has been postponed to 2020. We do project
anticipate mobile to continue its increase but do not expect it to reach a tipping point until the year 2020.
From a control perspective, we expect to see a rise in the use of account-level controls driven by both industry
mandate and issuer initiative. Cardholder account controls such as those offered by Discover or CO-OP Financial
Services’ CardNav are low-cost features that bring similar options to a broad base of payment cards. Mercator also
expects to see more analytic tools to support better account visibility such as FICO Analytic Cloud, IC2 Smarter
Payments, or Saylent’s Relationship360, which are products available directly from vendors or through
relationships with platform service providers such as First Data, FIS, Fiserv, and TSYS. We also believe that
regulators, particularly at CFPB, will continue their mantra of fairness and transparency. Better tools for data usage
will continue to develop and affect better customer management, account sourcing, and risk management.
Finally, in the credit market we expect product development across many channels. The move to digitalization will
continue although cardholders will not yet move in that direction en masse. NFC will likely be an area for more
rapid growth, and the precedent set by Chase with its cooperative merchant alignment is promising for major
players. Enhanced scoring, not necessarily for alternative models that poach existing card members, but rather to
identify underserved markets will continue to gain scale.
Conclusions
2017 will be a good year for the credit card industry. There are some risks, but the industry rebounded well after
the Great Recession and is back on course. Some of the financials will temper, but volumes will continue to grow
and the industry is protected on their net interest margin, which delivers strong investor returns.
© 2016 Mercator Advisory Group, Inc.
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2017 Outlook: Credit
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For more information about this report, please contact:
Brian Riley, Director, Credit Advisory Services
[email protected]
1-781-419-1720
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