While credit card investors have access to issuer financial statements, regulatory filings, conference calls, and annual reports, there are many red flags not apparent, masking potential risk.
Robert Hammer, Founder and CEO at R.K. Hammer & Card Knowledge Factor, ticks off the seven early warning signs to look for in any credit card portfolio.
1. Watch Cash Advance Use as a percentage of the total booked loans.
These non-purchase draws against the card credit line are higher risk. That is why so many issuers charge a higher APR for those loans; instead of the normal 14% APR for purchases, many charge 50% higher, or 21%. Some even go as high as 29.9%. If that isn’t demonstrating high risk I don’t know what is. What is too much cash advance from a card portfolio risk profile perspective?
Green flag: less than 15% of the portfolio loans are from cash advances; risk threat, Low
Amber flag: 15 – 25%; risk threat, Moderate
“Red Flag” alert: 25%+; risk threat, High
If management never discusses these, ask them yourself. As with any metric, it is the trend line not the point in time that matters most. Of course we want to balance risk and reward; it is simply that at some point that ratio may turn against you. Examiner beware.
2. Certain Changes in Card Policies
Are all card policy changes bad, in a word, no.
The ones we are concerned about are those which could be used to conceal or mask true risk, or that delay the loan loss recognition protocol. Examples: any change which loosens controls, regardless of management’s rationale; reage policy, where a shorter number of cycles are used to define when a delinquent account has paid as agreed to classify it now as ”current” (taking 3 cycles down to 2, for example, or 2 cycles down to 1); delaying charge offs from bankruptcy notification; practices which do not match policies; reducing the new applicant cutoff score. Also any policy change just prior to sale may be suspect. “Trust but verify.”
There are bank card issuers who no longer exist today who have done much of the above. If you don’t see any of this discussed in any report or conference call, ask them for yourself. You won’t see these on any CD121 FDR/FDC system report.
3. Frequent card member address changes, Returned NSF payments, and First Payment Default.
Bells and whistles ought to be going off. Take the loss early, and it will be less than allowing it to roll through the delinquency queues. Find out what the figures are, especially FPD, by asking management. I have never seen this in any report or discussed in any conference call. Ask, especially about First Payment Defaults (FPD). Most of them are destined for charge off. Take your losses early. Close the account.
4. High Gross Card Member Attrition Rates.
A gross amount of 10 – 12% of the file may attrite each year; say, 4% for charge offs, and another 6-8% voluntarily leaving/closing their account. You’ve got to book at least another 10-12% of high quality new accounts just to stay even Y/Y. What are some of the red flags? If the gross attrition rate climbs to higher than 12%, danger ahead. You may need to re-examine your value proposition. Customers paying down much greater than the typical 19-20% repayment rate, calls to customer service inquiring about the full payoff amount, and active card member suddenly becoming inactive. Management needs anti-attrition strategies for each of these events. Ask yourself what those strategies are and the results of their execution.
5. High Line Utilization Rates.
It not uncommon for an average card portfolio to have a 40-45% utilization rate. Higher than that, and our antennae go up. Line usage by FICO bandwidth can reflect very wide rates. Higher risk accounts (and higher risk portfolios) tend to have far higher line usage. The portfolio yield looks very nice before the high risk accounts start rolling through to charge off at 120 – 150 DPD; by then it’s way too late. Watch the rate of climb in any attrition metric.
6. Watch the “30-day delinquency bucket” for changes, that’s the “leading indicator.”
The trends of cure rates and subsequent roll rates in the delinquency queues can be very revealing. Watch for changes to the trends early in the cycles. Make sure management exposes that to the light of day, including you. Total delinquency by accounts and balances doesn’t give you the early warning risk profile you need to full judge portfolio quality. Watch that first bucket trend.
7. Other Things to Verify:
Repeated requests for line increases, frequent and wide loan balance swings, high unemployment regions, multiple card applications or inquiries being reported, frequent open-to-buy requests. Investors and others may not have the granularity in existing reports to find all of the above, but one should ensure that management does have each of those addressed and monitored. How they do the monitoring is what I would want to ask about and see for myself. I don’t think you won’t find these on any CMO51 system report.
There are many Red Flags that do not appear on any system report be it TSYS or FDR, perhaps not even on monthly Board reports. Much of it is rarely discussed outside the Risk Committee, Policy Committee or Managing Committee; as an outside interested party or investor you’ve got to ask for the metrics and see for yourself.
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