Small banks have been fighting for a bigger piece of the credit-card market in search of higher returns. Now, they’re contending with rising losses.
Missed payments on credit cards at small banks have risen sharply over the past year, a sign that their cardholders are taking on more debt than they can handle. Their charge-off rate, or the share of outstanding card balances written off as a loss after consumers failed to pay, hit 7.2% in the fourth quarter, up from 4.5% a year ago, according to Federal Reserve data.
Concerns have been mounting in the broader credit-card industry about the recent trend of rising delinquencies. While overall card losses are still relatively low—below the historical average of the last 30 years, for instance—they’ve been slowly climbing in the last two years.
But they’ve especially surged at smaller banks, those outside the 100 largest by assets that have less than around $10.4 billion in assets. There, the average charge-off rate is near an eight-year high, while the 3.5% loss rate at large banks remains well below the 10.6% seen in 2010.
Both large and small banks pushed into the credit-card market in the wake of the recession in search of higher yields and an affluent customer base. As competition intensified, big banks splurged on customers with cash rewards and points that could be redeemed for vacations.
Some smaller banks battled back by loosening credit-score requirements, but that strategy now seems to be backfiring, even though the economy is improving and the unemployment rate is near record lows. Wages are rising only slowly and some consumers have simply taken on more debt than they can handle.
Deja Reid, a 20-year-old college junior, said she received a credit card offer shortly after her 18th birthday from Credit One Bank N.A., which specializes in issuing credit cards to consumers with low credit scores.
During the application process, Ms. Reid said she informed the bank that her annual salary was around $2,000. The bank, which didn’t respond to a request for comment, approved her for a card with a $500 spending limit.
She soon fell behind on payments and began to incur late fees and interest payments that pushed her balance to $1,000. She turned to her parents for help and is in the process of paying off the balance. “It’s been hard,” she said. “I don’t think I’ll be using a credit card anymore.”
‘I don’t think I’ll be using a credit card anymore’
—College student Deja Reid
While the hundreds of smaller U.S. banks that offer credit cards account for just around 2% of outstanding credit-card debt, according to a measure by S&P Global Market Intelligence, some investors view that debt as a window into the financial health of the middle-and-lower-income consumer.
Comenity Capital Bank, with about $8.5 billion in assets, issues store credit cards, often for shoppers at mall-based retailers. The lender, a unit of Plano, Texas-based Alliance Data Systems Corp . , had a credit card charge-off rate of 5.96% in the fourth quarter, up from 5% a year prior.
Alliance Data Chief Executive Ed Heffernan isn’t worried, saying many riskier consumers got shut out of credit during the recession and now have returned. The company is capturing a “higher share of households which have a higher tendency to write off” after a period of unusually low losses, he said.
But the deterioration at small banks has raised some concerns about how much worse losses could get if the economic recovery falters.
The small banks’ experience is “simply a leading indicator of a downturn to come,” said Robert Hammer, founder and chief executive of credit-card industry consultant R.K. Hammer. In the run-up to the last recession, he noted, losses accelerated for small banks before they did for big ones.
Some small banks have viewed credit cards as a way to cross sell their customers and to bring in new creditworthy customers. That became a challenge as big banks pursued the same set of borrowers by charging low interest rates for promotional periods. Personal loans offered by a growing number of lenders provided even more competition.
That left many small banks with card applicants who had lower credit scores.
“There’s almost been a panic in getting their product out there to subprime borrowers,” said John Heath, directing attorney at Lexington Law, a consumer law firm based in Salt Lake City specializing in credit repair. Some clients struggling to pay back credit-card bills to small banks were earlier rejected by large ones, he added.
Large banks’ outlook for card borrowers has soured a bit, too. Half of large banks surveyed in the Federal Reserve’s senior loan officer survey for January said they expect delinquencies and charge-offs on their credit card loans to worsen this year. That is up from 37% a year earlier and 10% in January 2015.
Some smaller banks are backing away from the card business. Nationwide Bank, a subsidiary of Nationwide Mutual Insurance Co., stopped marketing credit cards in 2016 when it concluded that it couldn’t compete against the big banks. As charge-off rates in its portfolio continued to rise, it stopped issuing new credit cards last year.
“This for me is a pause—a period of time to figure out if and how cards will make sense going forward,” said Andrew Walker, Nationwide Bank’s president.