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January 2010 Navigator _FINAL_pub.pdf


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									                                                                                                                                JANUARY 2010

Credit CARD Act and Senior                                                           Small Business Credit Cards –
Loan Officer Survey Findings                                                         Has a Point of Inflection
By Frank Martien                                                                     Been Reached?
Every quarter, the Federal Reserve releases a Senior Loan Officer                    Over the past few years, small business credit card issuers have
Opinion Survey on Bank Lending Practices. In the most recent                         been experiencing steadily rising net charge-off rates. Increasing
October 2009 survey, loan officers were asked how the Credit CARD                    credit risk for these types of loans appeared to hit a crescendo in
Act (referred to herein as "the Act") might impact credit card lending at            2009 as charge-off rates for several leading small business card
their respective banks. In this article we summarize some of the                     issuers hit the mid-teens, marketing budgets were curtailed, credit
relevant results, which aggregate responses from approximately 35                    lines were cut, and millions of accounts were closed.
leading credit card issuing banks.
                                                                                     To study the trends more closely, First Annapolis evaluated FDIC
Based on dialogue we have had with various card issuers over the                     Call Report commercial and industrial (C&I) loan data via SNL for
past year, none of the findings come as a huge surprise. Nonetheless,                Discover, Capital One, and American Express and combined this
the survey results help to further substantiate the position of major                data with two business credit card issuers who publicly report net
card issuing banks as they work through the changes imposed on the                   charge-offs: Bank of America and Advanta. As shown in Figure 1
business as a result of the actions taken by the regulatory agencies.                (Page 4), net charge-off rates continued to climb through 2Q 2009
                                                                                     for all five issuers; however, 3Q 2009 results were mixed and finally
As of year end, roughly 75% of the respondent banks were still
                                                                                     broke the rising loss rate trend.
working through the necessary changes to be in compliance with
regulations as dictated by the Act (Figure 1); however, all planned to               Rising levels of credit risk have been exacerbated by shrinking small
be in compliance by February. Anecdotally, the effort required to reach              business credit card portfolios. For example, data in Figure 2 track
compliance ranges from issuer to issuer, but most agree that it was a
very large and expensive undertaking. And, of course, more work will                                                                 (Continued on Page 4)
need to be done as the final set of regulations on fees are expected
soon and will need to be implemented later this year.

                        Figure 1:                                                         Retail Banking and Payments
          Credit CARD Act Implementation Timing
                                                                                               Expert, Melissa Fox,
                                                                                          Joins Deposit Access Practice
                                                                                      Melissa Fox has joined our Deposit Access practice as a
                                                                                      Manager. With extensive retail banking and payments
                                                     By Year-End '09
                                                                                      experience, Melissa will enhance our market coverage from a
                                                                                      product and delivery channel perspective. Melissa was most
                                                     By Feb '10
                                                                                      recently a Senior Manager in the Financial Services Practice
                                                                                      at Hitachi Consulting (via its Dove Consulting acquisition)
                 Source: The Federal Reserve and First Annapolis analysis.
                                                                                      where she advised leading financial institutions, payment
                                                                                      networks, and processors on a wide range of strategic and
In some cases, prioritization of Act-related changes has temporarily or               tactical matters across the payments value chain. She also
indefinitely deferred program, platform, or product innovation
initiatives – many of which have been pushed out to late 2010 or early
                                                                                      co-authored a number of research studies, including the 2008
2011. Although scarcity of IT resources is a driving factor behind these              Study of Consumer Payment Preferences, the 2007 Debit
delays, banks are also waiting until Act-related changes are complete                 Issuer Study, and the 2006 ATM Deployer Study. Melissa
and the financial performance implications of these changes are fully                 graduated cum laude from Dartmouth College with her
understood before solidifying long-term program and product changes.                  Bachelor of Arts degree.
                                                         (Continued on Page 2)

  Navigator                                                                                                                              JANUARY 2010
(Credit CARD Act Continued from Page 1)                                           Along the same lines, more than half of bank respondents have or
Many industry publications have referenced the Act's negative impact              plan to increase APRs in response to the Act; and, in the "Non- Prime"
on the availability of credit, both in terms of more conservative                 segment, nearly three-quarters have increased APRs with more than
underwriting and aggressive reductions in credit lines. This is                   half describing the change as "considerable." These increases are
substantiated by the survey, which shows roughly half of responding               largely in response to certain requirements of the Act that limit the
banks reacting by raising their minimum credit score cut-offs for new             ability to change APRs on existing balances or during the first year the
account applications and a similar number indicating a tightening of              account is open. This requirement is also driving more prevalent use
credit lines as a way to manage risk. By both measures, the impact                of variable APRs to manage the spread over the banks' cost of funds.
was more pronounced for "Non-Prime" borrowers, for whom roughly                   The response to grace periods is largely driven by new regulations on
one-quarter of banks have "considerably" tightened. Of course, we                 due dates and statement mailing time frames, and as such, a
should point out that it is difficult to fully separate the Act's impact on       significant portion of banks actually needed to lengthen the available
credit availability from the general economic conditions that existed in          grace period.
2008 and 2009.
                                                                                   As we said earlier, none of these findings are all that startling, but they
By its design, the Act exerts pressure on card profitability, and most             do help confirm the widespread impact the Act is having on the
banks are busy evaluating their mitigation options. According to the               industry. At this point, most major issuers have done the best they can
survey, one-third to one-half (depending upon sector) of the                       to prepare for February 22nd and mitigate the immediate impact on
responding banks have                                                              the business. As we write this article, several issuers have released
considered annual fees as                                                                                                         their earnings for the
one such alternative.                                       Prime Borrowers                        "Non-Prime" Borrowers          fourth quarter with some
However, in today's                 Credit Terms   Tightened Unchanged            Eased      Tightened Unchanged         Eased    signs of improvement.
market, relatively few card Credit Score Cutoff       47%         53%                0%         53%          47%            0%
                                                                                                                                  However, the downstream
products outside of the Credit Limits                                                                                             impacts are largely
                                                      51%         49%                0%         58%          42%            0%
core T&E sector (airline,                                                                                                         unclear at the moment.
hotel, etc.) can command APRs                         54%         43%                3%         74%          26%            0%
                                                                                                                                  The ultimate size of the
annual fees from                 Grace Periods        11%         63%              26%          16%          68%           16%    revenue impact will drive
cardholders, and most            Annual Fees          38%         62%                0%         44%          56%            0%    future decisions such as
industry participants are Penalty Fees                14%         63%              23%          16%          53%           32%    modifications to reward
taking a cautious approach                                                                                                        programs, migration to
                                                                                               Source: The Federal Reserve Board. alternative products such
to avoid mass attrition of
their best customers. Retailers, in particular, are watching carefully             as charge cards, introduction of new product features and
and resisting as their customers have grown accustomed to no-fee                   customization such as those available with Chase Blueprint and the
private label and co-brand card programs. On a related note, we are                like. It is true that not all banks will be impacted uniformly, but all
beginning to see signs of alternative fee approaches as an offset,                 issuers will be playing under a new set of rules for the foreseeable
including the introduction of paper statement fees, and we expect                  future.
more activity in this area throughout the year.                                           For more information, please contact Frank.Martien@firstannapolis.com

  Dynamics of Manual vs.                                                          per day per FTE) or throughput via end-to-end automation. Card
                                                                                  issuers should seek opportunities, where cost effective, to automate
  Automated Dispute Processing                                                    one or more areas of the operational value chain as well as review
  Many factors influence the performance of dispute processing                    business rules and policies to eliminate unnecessary or low probability
  operations, including front-end goodwill policies (i.e., eliminating            of success chargebacks and related costs.
  low probability of successful chargebacks or disputes that fall                        For more information, please contact Scott.Reaser@firstannapolis.com
                                                                                                       or Jonathan.Goldman@firstannapolis.com
  below an issuer’s cost to process the dispute), labor costs, staff
  tenure and experience, and the level of integration and                                                       Cost per Dispute Handled ($ per Unit)
  coordination among customer service, data collection, and                                               $40.0
  chargeback functional areas. We have observed great variability                                                                             Primarily Manual
  in performance among issuers of comparable size, primarily                                                                                  Fully Automated
  driven by their respective policies, business rules, and operations.
  One area that has received a lot of attention recently is process
  automation. Our experience shows that end-to-end automated                                                                     $12.5
  dispute processing operations tend to perform more efficiently
  than manual operations. Average cost per dispute and average
  dispute handle time, among other metrics, tend to be more
  favorable for fully automated operations than primarily manual                                         Issuer A    Issuer B   Issuer C   Issuer D    Issuer E
  operations. It is not uncommon for a card issuer to achieve 30% or                   Avg. Dispute
                                                                                                           59           27         27         24          13
  more in increased efficiency (as measured by number of cases                       Handle Time (Min)
                                                                                                                                  Source: First Annapolis analysis.

     Navigator                                                                                                                                              JANUARY 2010

Q4 2009 U.S. Credit Card Issuer                                                                       3. Sales Volume Growth: It has been quite some time since we
Performance Snapshot                                                                                     have had the opportunity to use the word "growth" without
                                                                                                         utilizing the phrase "credit losses," but most issuers did
As 2009 fades into the rear-view mirror, it will certainly go down as one of                             experience a sequential lift in purchase volumes from Q3 to Q4
the toughest years in the history of the industry. Make no mistake, 2010 is                              2009. While still down relative to Q4 2008 purchase volumes, a
going to continue to be challenging as well, but the fourth quarter of 2009                              return to normal cyclical spending patterns is likely a positive sign
did offer a few glimpses that better days may lie ahead. Below are our                                   for 2010.
thoughts on Q4 as well as considerations for 2010:
                                                                                                      4. Stabilizing Loss Rates: As 2009 concluded, the U.S.
1. CARD Act: During the last half of 2009, issuers were squarely
                                                                                                         unemployment rate hovered at 10.0%, a level it maintained for
   focused on preparing for the CARD Act. Waves of re-pricing were
                                                                                                         the entire quarter. Despite strong head winds, most issuers
   implemented and significant resources were directed at operational
                                                                                                         managed to reduce their loss rates during the quarter, albeit
   readiness. While the industry awaits the Federal Reserve Board's
                                                                                                         modestly. Managing through the credit cycle will remain the
   ("FRB") ruling on late fee restrictions, the FRB issued a new ruling
                                                                                                         significant story line for issuers, but initial indications suggest that
   on January 12, 2010 that has issuers implementing (and
                                                                                                         the second half of 2010 may be a turning point.
   interpreting) a range of requirements surrounding "ability to pay"
   and a myriad of new disclosure protocols.                                                          5. Marketing Investments: In general, card marketing was dialed
2. Receivables Decline: The final quarter in 2009 followed the                                           back in 2009. However, Chase was very active and introduced a
   same pattern it had all year long with most issuers posting both                                      new suite of products (e.g., Slate, Sapphire, Ink) and features
   year-over-year and quarter-over-quarter declines in receivables.                                      (i.e., Blueprint) supported by significant national advertising.
   Receivables declined by an average of 11.0% with total                                                American Express also ramped up its "Take Charge" campaign
   liquidations of over $80 billion. However, asset growth was not a                                     hoping to engage customers on its charge products. We expect a
   priority for most issuers given the recession and the looming                                         fresh wave of new products and pricing constructs after issuers
   uncertainty of CARD. Notably, there was a slow-down in                                                fully integrate CARD into their business models.
   receivables liquidation and modest signs that the industry may
                                                                                                              For more information, please contact Jason.McNutt@firstannapolis.com
   begin to stabilize once issuers get through the Q1 holiday
   pay-down season.

                                           Change      Change       Volume      Change       Change        Net Loss Rate    Change        Change      After-Tax ROA     Change       Change
             Issuer      A/R ($B) 4Q09   (vs. 4Q08)   (vs. 3Q09)   4Q09 ($B)   (vs. 4Q08)   (vs. 3Q09)         4Q09        (vs. 4Q08)    (vs. 3Q09)        4Q09       (vs. 4Q08)   (vs. 3Q09)

    Chase1                  $163.4                                   $86.9                                    9.33%                                      -0.74%
                                           -14.1%       -1.1%                    -9.5%          5.2%                        377 bps        -97 bps                      5 bps        90 bps

                            $143.8                                    NR          NR             NR           8.64%                                        NR            NR           NR
    (ex-WaMu)1                             -11.3%       -0.2%                                                               335 bps        -77 bps

    Bank of America 2       $160.8                                   $54.9                                    11.88%                                     -2.01%
                                           -11.7%       -2.3%                    -3.0%          3.5%                        472 bps       -102 bps                     -199 bps      -7 bps

    Citigroup               $140.4                                   $68.7                                    11.08%                                     -0.49%
                                           -6.5%        -0.7%                    -9.0%          0.9%                        302 bps        -40 bps                      -23 bps      -55 bps

    Capital One              $60.3                                   $24.6                                    9.59%                                      3.05%
                                           -15.0%       -2.6%                    -2.5%          3.5%                        251 bps        -5 bps                      405 bps      116 bps

    American Express 5       $52.6                                   $92.1                                    7.50%                                      2.80%
                                           -15.7%       1.3%                     0.1%           8.1%                         80 bps       -140 bps                     239 bps      198 bps

    Discover                 $47.5                                   $21.9                                    8.81%                                      2.75%
                                           -4.5%        -1.4%                    -0.6%          -3.8%                       322 bps        18 bps                       -66 bps     -156 bps

    Wells Fargo              $24.0                                    NR          NR             NR           10.61%                                       NR            NR           NR
                                           1.9%         1.7%                                                                192 bps        -35 bps

    Sum / Wtd. Avg.7        $649.0                                  $349.1                                    10.25%                                     -0.11%
                                           -11.0%       -1.2%                    -5.0%          4.1%                        344 bps        -68 bps                      -2 bps       23 bps

                                                                                                                               Source: Issuer quarterly reports and First Annapolis analysis.
1 Includes income from acquiring business and private label receivables and volume. Purchase volume includes cash and BT volumes. Net loss rate results reflect the impact of
  purchase accounting adjustments related to the Washington Mutual transaction and the consolidation of the Washington Mutual Master Trust. Ex-WaMu A/R and net loss excludes
  impact of WaMu.
2 Receivables, purchase volume, and net loss rates are for U.S. consumer and international consumer cards. After-tax ROA includes U.S. consumer and business, international, and

  merchant acquiring.
3 Restated splitting between Citi-branded North American and CitiHoldings Retail Partners from Q1 2008. Purchase volume includes cash advances. All figures for combined portfolios

  with the exception of ROA, after-tax ROA only includes Citibranded NA cards.
4 U.S. card business, small business, installment loans only. Purchase volume excludes cash advances. 2007 figures re-stated by issuer.
5 Receivables and charge-offs are for U.S. Cardmember Lending business only. Purchase volume is for U.S. Card Services segment, consumer and small business. Includes restated

  NCL rate.
6 Includes U.S. domestic receivables and purchase volumes only. ROA includes merchant services and implied U.S. Cards tax rate of ~40% as well as a Q4 2009 $472MM pre-tax gain

  ($285MM after-tax) related to the antitrust settlement (Q3 2009 $472MM / $287MM; Q4 2008 $864MM / $535MM).
7 After Tax ROA and purchase volume totals exclude Wells Fargo.

Navigator                                                                                                                                                                     JANUARY 2010

(Small Business Credit Cards Continued from Page 1)                                                  as the portfolio of closed accounts has contracted; and American
business card balances for Bank of America (owned basis) and                                         Express achieved a substantial reduction in charge-off dollars as well.
Advanta (managed basis) and C&I loans for the other four issuers
(owned basis). Green bars denote when the portfolios were growing                                    Now may not be the time to jump back into the small business credit
and blue is the peak. All six portfolios have been declining in size                                 card market with both feet; however, we believe small business
per the red bars. (Net charge-off rates from Figure 1 are as a                                       customer relationship-based strategies will succeed long term.
percent of the loans in Figure 2.)                                                                   Although the small business credit landscape has weathered a severe
                                                                                                     blow, the basic fundamentals, such as 59% of small businesses using
In fact, closer analysis of the net charge-off data reveals that the                                 credit cards to meet financing needs (NSBA, April / May 2009 survey)
total amount of net charge-off dollars fell significantly in 3Q 2009 as                              because they are easier to get than traditional bank loans and do not
shown in Figure 3, which is also sourced from First Annapolis                                        require justification for how they are used (Kauffman Foundation
analysis of: (i) FDIC data via SNL queries for Discover, Capital One,                                study, August 2009), will persist.
and American Express; and (ii) Bank of America and Advanta public                                             For more information, please contact Frank.Martien@firstannapolis.com
filings. In particular, dollars charged off by Advanta in 3Q 2009 fell

                    Figure 1: Proxy for Business Card                                                                           Figure 3: Proxy for Business Card
                   Net Charge-Offs (% of Ending Loans)                                                                          Net Charge-Off Dollars ($ Million)
                                                                                      45%                             Advanta
              Advanta                                                                 40%                             Bank of America
              Bank of America                                                                                         Cap One Bank (USA), N.A.
                                                                                      35%                             Discover Bank
              Cap One Bank (USA), N.A.                                                                                Amex Bank, FSB                                                            $187
              Discover Bank
              Amex Bank, FSB
                                                                                      20%                                                                                                       $796
                                                                                      10%                                                                                                        $18
                                                                                      5%                                                                                                        $373
                                                                                                                '06      '07      1Q       2Q 3Q                 4Q       1Q       2Q 3Q
     '06   '07               1Q      2Q       3Q      4Q      1Q      2Q      3Q
                                                                                                                                            2008                                  2009
                                                                                              Figure 2
             Bank of America ($ Billions)                                                             Barclays Bank DE ($ Millions)
                                                                                                                                                                $218     $221     $213
                                      $20.1   $19.9                                                                                                    $200
                             $19.6                    $19.4
              Not Reported

                                                                      $18.8                                                                 $143
                                                                              $18.0   $17.9                                       $106
                                                                                                        $0       $39

             Capital One Finc'l Corp. ($ Billions)                                                           Discover Bank ($ Millions)
                                                                                                                                                  $454    $462         $448     $451
                             $16.4                                                                                                       $416                                            $418
                                      $15.5           $15.5   $15.6   $15.8
                                                                              $13.6   $13.3                                     $342


             Amex Bank FSB ($ Billions)                                                                      Advanta Bancorp ($ Billions, Managed)
                                                                      $14.8   $14.2   $13.8
                                              $11.0   $11.0                                                            $6.3     $6.2     $6.0
                             $10.7    $10.8                                                                  $5.2                                  $5.5
              $9.1                                                                                                                                            $4.9     $4.6
                                                                                                                                                                                $3.4     $2.9

               '06            '07      1Q      2Q      3Q      4Q      1Q      2Q      3Q                      '06      '07      1Q       2Q       3Q         4Q        1Q       2Q       3Q
                                                    2008                       2009                                                             2008                            2009

                                                                                              Source: First Annapolis queries of FDIC data via SNL and publicly traded company reports.


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