Tough Love for Debtors


By Mara Der Hovanesian Like a lot of Americans, Robert and Jill Proctor of Kansas City, Kan., are getting hammered by credit-card debt. When Robert lost his job two years ago, the thirtysomething couple ran up $35,000 on 10 different cards just to pay everyday expenses like groceries and gas. Even after Robert found work last year as a country club manager, their combined income just covers monthly outlays for two cars, a mortgage, and credit-card bills on top of household expenses. Says Robert, who makes minimum payments on the cards with the biggest balances as he struggles to pay off the smaller ones first: "If they tack on more charges, we'll be stuck."

That's just what's about to happen. Because of a crackdown by the Office of the Comptroller of the Currency (OCC), most banks and credit-card issuers will ratchet up required minimum monthly payments over the next 12 months or so. In the future, the payments must cover all fees and interest and pay down at least some of the outstanding borrowing.

MINIMUM PAYMENTS. The goal is to help people pay bills faster and slash the interest due. Monthly payments on many cards will double, to about 4% of balances, say card experts. Barbara J. Grunkemeyer, deputy controller for credit risk for the OCC in Washington, explains: "We were concerned that people were making smaller and smaller payments, but not making any headway" in paying off loans.

The new rules will hit consumers hard, especially on top of higher energy prices, rising interest rates, and record levels of overall household debt, now $10 trillion, or 87% of gross domestic product. American households, on average, possess nearly 8 major bank cards -- or 17, including store and gas cards. Either by choice or necessity, some 19 million households -- about 1 in 6 -- now make minimum payments on their cards, according to card tracking service CardWeb.com.

"The main concern is that there could be an increase in defaults and personal bankruptcies," says Michelle Grabow, credit-card research manager at Informa Research Services. That in turn would hit banks' bottom lines as they have to charge off more loan losses. Worse, the shrinking of families' disposable incomes as they step up repayments could put a crimp in consumer spending. The massive indebtedness of Americans is a "huge macro risk factor for the U.S. economy," warns Stephen S. Roach, Morgan Stanley's chief economist. "The debt bomb is ticking."

ON THE EDGE. Banks were so worried about the potential impact on their businesses that they persuaded the OCC to give them a long transition period before applying the rules, originally published back in January, 2003. Their fears seem justified. Bank of America (BAC), one of the first issuers to raise minimums, in the second quarter of 2004, saw net charge-offs for bad loans soar 63%, to $691 million, though by the end of that year only $40 million was related to the increased minimums.

Bank of America also increased loan-loss reserves by 21.1%, to $170 million. That surprised some analysts because the Charlotte (N.C.) bank had told them that hikes in payments amounted to a modest $10 to $20 per month for most cardholders. Says David A. Hendler, a bank analyst with researcher CreditSights: "It seems that even a small monthly increase in minimum payments can cause some borrowers to tip into default."

Minimal impact? So far, BofA, Citigroup (C), Discover Card (MWD), and MBNA (KRB) -- which together issue some 275 million of the 658 million general purpose cards in circulation -- are among those with timetables for raising their minimums. JPMorgan Chase (JPM), with roughly 96 million cards, will "experiment" with higher minimums later this year on a "small portion" of its customers, according to Ray Fischer, chief financial officer of JPMorgan Chase Card Services.

STEPPED-UP PRESSURE. Fischer says 90% of the bank's customers make more than the minimum payments. The New York bank is not sure just what the financial impact will be. Still, it reported in a recent filing that it, too, is bracing for more delinquencies and charge-offs.

Some issuers continue to insist that the impact will be small. At Wilmington (Del.)-based MBNA, new cardholders will have to pay higher minimums starting in July. Existing customers will receive notices in September and see changes soon after. They'll have to pay interest and late fees, if they have them, plus 1% of the remaining balance. Currently, MBNA customers have to pay interest and fees plus $15, or 2.25% of new balances, whichever is less. MBNA spokesman James Donahue says the change "won't have a practical impact" since most cardholders make the minimums.

That doesn't mean MBNA and others won't be stung by the extra vigilance of the OCC. It has also warned banks that they must consider substantially reducing interest rates -- which quickly jump from introductory offers of 0% to an average of 16%, according to CardWeb.com -- or eliminating fees so that more of cardholders' monthly payments go to cutting their balances. Banks haven't been "overly keen about the prospect, but we needed to keep the pressure on," says the OCC's Grunkemeyer.

TOOTHLESS IN CALIFORNIA. No wonder. Last year, credit-card issuers reported record profits of $30 billion -- much of it earned on liberal lending policies and punishing fees that often exacerbate the financial woes of cardholders who have gotten in over their heads. Borrowers who make a late payment -- whether it's for the phone bill, a credit card, or a house payment -- often are charged punitive rates averaging 29% on all their cards. These on-the-edge borrowers are the most profitable part of any bank's card operations, as long as they don't default.

To make matters worse for banks, consumer groups and legislators are pressing them hard to disclose more on monthly card statements about minimums and fees. Senator Chris Dodd (D-Conn.) reintroduced the Credit Card Accountability Responsibility & Disclosure Act in March, after a stalemate in 2004. The bill seeks, in part, to force credit-card companies to say how long it would take to pay off outstanding balances if customers just pay minimums, and how much interest they would pay over the life of the loan.

California enacted a similar law three years ago, but "it's not being enforced," laments Tom Dresslar, spokesman for State Attorney General Bill Lockyer, because the banks argue that federal rules preempt the state law.

180-DAY WINDOW. If customers saw exactly how much credit was costing, they might be more inclined to pay higher monthly amounts voluntarily. Consider a customer who has a $10,000 balance with a 16% interest rate, and who makes a 2% minimum monthly payment. It will take more than 40 years to pay off the balance and cost $19,329 in interest. With a 4% minimum, the loan is paid in about 14 years, and interest costs are $4,931.

The full impact of the OCC rules depends on whether customers can pay the new minimums. What is certain is that once banks implement the changes, they have 180 days to charge off any bad loans that result. "The hope is that there'll be only a temporary increase as you push those customers over the edge and they default," says David L. Fanger, a banking and finance analyst with Moody's Investors Service. If so, that would be a big relief for banks, strapped American consumers, and the U.S. economy. Der Hovanesian is Finance & Banking editor for BusinessWeek in New York


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