Subprime Credit Cards Are Still Profitable, So They Aren't Going Away

With the country in a deep recession, and a new law that has many banks concerned about the profitability of their credit card products, you might be thinking that subprime credit cards are on their way out. To the contrary: it seems that subprime cards are performing relatively well for certain banks, thank you very much.

Consumers who have a limited credit history or no credit profile at all, and those who have bad credit, may be glad to know that subprime cards are still profitable for banks, so they aren't going to die out any time soon.

Here's a clip from a recent Wall Street Journal article:

"...British bank HSBC Holdings PLC, which has a large portfolio of U.S. credit-card customers, now generates better results with its subprime credit-card businesses than the portfolio that includes more-creditworthy customers, North America Chief Executive Brendan McDonagh said in a conference call Monday.

HSBC's subprime credit-card customers generally have lower credit limits than prime customers, averaging less than $500, and are defaulting at a lower-than-expected rate. The reason: For many of those borrowers, a credit card is their only form of noncash payment.

About a quarter of HSBC's $41 billion credit-card portfolio is considered subprime, and the delinquency rate on that is 10%, a 21% increase over last year. But because of higher interest rates charged to these borrowers, HSBC says that business is profitable.

One reason prime delinquencies are up is rising unemployment. When these borrowers lose their jobs they typically focus on making their mortgage payments and, because they tend to have multiple credit cards, they are more likely to let some of them default..."

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The Credit Card Accountability Responsibility and Disclosure Act of 2009

Perhaps you've noticed that you are not receiving loads of credit card offers in the mail anymore. Remember how many you used to get during the credit boom years? Tons. Back then, you may have asked yourself, "how are banks able to make money with credit cards by offering credit to just about anybody? Aren't the bad apples who pay late or default going to cost the banks millions, if not billions?" Good question.

American banks were able to make massive profits from all types of consumers -- including the subprime borrowers -- because they were free to reprice cards whenever they wanted. Even so called fixed-rate cards could be repriced, with little warning. That new credit card customer who turned out to be irresponsible with his finance, as evidenced by late or missing payments, did not phase the banks. As soon as Joe Spendthrift started paying late, or not at all, the banks were free to simply jack up his interest rates to usurious levels, and charge him late fees, over-the-limit fees, telephone payments fees, etc. It was a good time for the banks. They made billions.

Enter the newly enacted Credit Card Accountability Responsibility and Disclosure Act of 2009 (also known as the Credit CARD Act of 2009.)

Because banks can no longer reprice credit cards the way they used to, they've had to ditch those tried and profitable models that worked just fine during the boom years, and figure out how to make money within the limits of the new law. Fees and fee traps have been reigned in. Disclosures and terms will have to be easy to access and understand. No more retroactive rate increases.

The credit card banks are also working within the context of the worst recession since the Great Depression. Moreover, since the market for credit card receivables dried up during the early part of the credit crisis, banks won't be able to sell credit-card debt to investors as easily as they used to; not even close.

What can you expect? Most items in the Card Act will go into effect in February 2010. Here's what consumers can expect between now and February, and beyond:

• Lower credit limits.
• Tighter lending standards (i.e. harder to get an application approved)
• More expensive pricing (i.e. higher APRs)
• Less generous rewards programs, with some programs charging a fee for participation
• More manual reviewing of credit card applications, and fewer instant-approval cards
• Documentation requirements: you may have to provide copies of recent paystubs to prove that you are really earning what you declare on your credit card application.

Are we returning to the days when everyone paid a 19.99% annual percentage rate with an annual fee to boot? I doubt it. But terms and conditions won't be favorable until the economy returns to prosperity and banks have had time to figure out how to make strong profits while conforming to the new credit card regulations.

For more on the Credit CARD Act of 2009, visit this page and this page.

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