What's the best way to make money in the credit-card business? To most card issuers, the answer is easy: Go after the best risks. But as the battle to sign up the cream of the creditworthy has intensified, a few enterprising bank issuers are targeting a different group: the worst risks, a group that has been growing rapidly since the recession began battering consumer balance sheets. Banks are finding they can make high profits from high-risk customers with a relatively new kind of credit card: the "secured" card.
The secured card works this way: The cardholder must put up collateral in the form of a security deposit at the bank, which is usually equal to the credit limit on the card. While issuers of standard credit cards, due to heavy competition, are having to reduce rates and fees to attract creditworthy customers, marketers of secured cards are under no such pressure. They're finding that people with poor credit histories are so anxious to get credit that they're willing to pay interest rates as high as 22%, nonwaivable annual fees ranging from $20 to $75, and in some cases, application fees as high as $65. Customers are also willing to put up with relatively low interest rates--and sometimes even no interest rate--on their deposits. While only 450,000 secured cards are in use now, estimates of the eventual market run as high as 30 million.
SCAMSTERS. Despite some risks, secured cards can be considerably more profitable--higher revenues and lower losses--than conventional credit cards. "Basically, you're lending someone back their own money and charging them a lot of money for it," says John M. Stein, an associate in the financial-services practice of Chicago-based consultants MAC Group/Gemini. He figures that on an outstanding balance of $1,000, a bank offering a card with an 18% rate and paying 5% interest on a cardholder's deposit can make as much as a 5% to 7% aftertax return on assets. That's compared with an industrywide ROA on unsecured cards of from 2% to 3%, down from around 4% in the 1980s, according to RAM Research. Most banks won't disclose the return on their programs, but Key Federal Savings Bank in Maryland cites a 3.67% pretax return.
Interest in secured cards is growing rapidly. In the past year and a half, the number of banks in the MasterCard system with active secured-card programs has jumped from 13 to 29. Eight of the banks have over $1 billion in assets. Just 18 months ago, none of the banks offering secured cards had more than $200 million in assets. The field has also attracted a rash of telemarketing scamsters, who cheat customers out of exorbitant application fees.
Not surprisingly, the biggest bank testing the secured-card market is Citibank. "Citi has traditionally had a higher risk appetite than any of the other card purveyors, and it has always said, don't look at the credit losses, look at the return," says Donald E. McNees, head of the financial institutions consulting practice at Towers Perrin's New York office.
Citibank launched a secured-card pilot program in June, 1991, by direct mail and is expanding the test. The secured card, which looks identical to Citi's standard card, carries a 19.8% annual percentage rate compared with the 15.9% that will be charged to Citi's best standard-card customers starting this June. Unlike many other secured-card issuers, Citi will not give cards to people who have declared bankruptcy. To get a card, customers must deposit between $300 and $5,000 with the bank in an 18-month certificate of deposit paying 5% in interest. After a year and a half, cardholders who maintain a good credit history can "graduate" to the unsecured program.
`TURNDOWNS.' The bank will say only that it mailed applications to "tens of thousands" of people, but it adds that it has received an "amazing" number of calls for applications from people who hadn't been in the mailing but had heard about the program. Citi recruits many customers from its "turndowns," applicants for regular cards who can't meet the credit requirements.
The key to the secured-card business is controlling losses. MAC Group/Gemini's Stein estimates losses on secured cards to be about 1% to 2%, vs. around 4% to 5% for typical unsecured programs. "What drives losses is how organized and operationally capable the bank is," says Nigel W. Morris, who heads the secured-card business for Richmond (Va.)-based Signet Bank.
To hold down losses, banks need to monitor accounts much more carefully than with standard credit cards. Poor management has sunk unsophisticated banks. Recently, an experiment with only partially secured cards at Larchmont (N.Y.)-based American National Bank of New York resulted in losses of $3.83 million on loans of $15.96 million for a quarterly loan-loss ratio of more than 20%. The bank became insolvent and was eventually liquidated. Yet even banks that require deposits equal to the credit limit have a much higher risk of loss than issuers of regular cards if cardholders exceed credit limits.
Catering to a customer base that has a history of money problems is never easy. But for banks able to manage the process, battered consumer balance sheets may turn out to be a gold mine.