By Megan Bramlette, Auriemma Consulting Group

The British credit card industry has been deeply affected by the current credit crisis. British consumers are using their credit cards less frequently, and those that do use them are having increasing difficulty repaying their balances. Additionally, industry regulation is placing further constraints on the profitability of the industry.

As a result, card issuers must reconsider their existing commercial models, and develop new lines of revenue. We believe that the most likely ways that issuers will be able to maintain profitability are to introduce fee-based lending to the mass market and apply the credit card business model to non-credit products like prepaid cards. Portfolio growth will not be a priority in the UK credit card industry for the foreseeable future.

Changes To Credit Card Usage

British credit card users are quickly dividing themselves into two groups: those who can afford to pay their bills and are avoiding debt going forward, and those who are already pressured by high levels of indebtedness and are resorting to making minimum payments or simply not paying their bills. As a point of comparison, revolve rates in the United States remained consistent in 2008, while repayment rates fell by 17 percent during the year.

Fewer British consumers are using credit cards as borrowing tools, though those who do borrow are having a more difficult time repaying their debts than in the past. Our consumer research publication, Cardbeat^®, recently reported that the percentage of UK cardholders with revolving debt decreased 21 percent during the course of 2008. Meanwhile, the payment rate in the UK has decreased 13 percent during the same period. These trends illustrate a significant difference in usage behavior from the U.S. market.

Insolvencies (or bankruptcies) are increasing, and collection shops are overwhelmed with volume. Charge-offs are at record levels: At the end of 2008, net losses were exceeding 10 percent of receivables, twice as high as the 2007 loss rate. The unemployment rate in the UK is 7.1 percent — an 11-year high — and is expected to approach 10 percent in 2010. Charge-off levels will likely continue to increase as consumer indebtedness and unemployment rises in the UK. In the United States, the unemployment rate is currently at a 16-year high of 9.4 percent, though net losses are lower at approximately 8 percent, primarily due to the aggressive pre-delinquency strategies employed by U.S. lenders of late. Many UK lenders are beginning to follow the example of the United States and execute similar strategies. As a result, we expect that loss rates in the UK will level off toward the end of 2009.

To further complicate matters, 16 percent of all British households carry promotional-rate mortgages that will expire during the next two years. Additionally, a recent study conducted by the Auriemma Consulting Group indicated that at least one-third of UK consumers are unable to obtain cash in the case of an emergency, especially because British consumers are more likely to look to borrow money from family and friends rather than credit cards in this situation.

Spotlight on Consumer Lending

From a commercial perspective, British credit card portfolio managers are trying to mitigate risk by going through exercises that are familiar to portfolio managers worldwide: reducing credit lines, increasing interest rates, closing dormant accounts and using aggressive pre-delinquency collection strategies. Most lenders have greatly reduced (or even ceased) their acquisition efforts, and portfolio management (as opposed to growth) has become the priority for lenders.

Certainly, consumers will continue to have a need for short-term loans through­out the credit crisis, particularly if their obligations increase because of rising housing expenses. However, even affluent British consumers are finding that it is increasingly difficult to obtain credit at favorable terms. Annual percentage rates for prime cardholders can now easily exceed 20 percent, and it is not uncommon for credit lines to be reduced by as much as 50 percent for existing cardholders. While reducing credit lines is a good way for lenders to reduce their exposure, the reduction of credit available will increase consumers’ debt-to-credit ratio, adversely affecting creditworthiness scores and making credit generally more difficult to obtain.

Some lenders are exploring asset sales opportunities, focusing on streamlining their portfolios to their core business. This shift away from serving the whole market will allow lenders to operate at a lower cost, while focusing resources on developing and managing market-appropriate strategies in the most efficient and cost-effective manner possible. We expect that through 2010, lenders (and servicers) with very specific target markets will become more prominent.

Other priorities in 2009 and 2010 will revolve around expense management and outsourcing efforts. Already, many British credit card issuers have reduced their staff to core personnel only. A com­mon strategy has been to cut headcount associated with portfolio growth, which is no longer a priority in this market. Additionally, many customer service-level agreements have been reduced, so as to cut the number of headcount in call centers. Outsourcing is typically not favored in the British markets, where retailers and lenders tout their UK call centers as part of their value proposition. However, outsourcing has become more prevalent of late, particularly for out­bound servicing strategies. Additionally, mail solicitation volumes have shrunk dramatically, following a pattern well-documented in the United States, with lenders limiting acquisition efforts to branch and Web sales. We expect this trend of aggressive cost management, increased outsourcing and reduced acqui­sition efforts to continue through 2010.

Effect Of American Regulation

The American regulatory authorities and government have been grabbing industry headlines worldwide recently by introducing several aggressive regulations and laws that will drastically change the way that credit card companies issue and manage credit cards. (Also see “A View From Washington, page 65.) The Unfair Acts and Deceptive Practices (UDAP) regulations and the Credit Cardholder’s Bill of Rights have a common effect in that lending practices will become more favorable to consumers, though perhaps at the risk of sacrificing portfolio profitability and lending dynamics.

The British government is becoming increasingly involved in regulating lending practices, introducing debt relief orders (a kind of “bankruptcy-lite”) that allow low-net-worth consumers to relieve themselves from their debts more easily. Authorities are also encouraging credit issuers to be more willing to lend to consumers during these challenging times, though the criteria to obtain a loan or line of credit will be more restrictive than in the past.

To further complicate matters, British regulators are in the process of restricting the sales of payment-protection insurance (the equivalent of credit-protection insurance in the United States), a major revenue stream for lenders in this country. It seems clear that British card issuers will not be able to depend on this revenue going forward, which for many lenders can make up 15 percent of their profits.

However, lending in the UK is already more customer-centric than in the United States. By design, lending disclosures and product terms and conditions are easier for consumers to understand. We expect that as U.S. lenders modify their practices to conform to the new laws and regulations, the UK’s existing practices will act as an example.

The Future of UK Credit Cards

We expect credit cards will be less widely used by British consumers in the wake of the credit crisis, and issuers soon will move to fee-based lending to counter­balance lost revenues and mitigate the risk associated with issuing credit during such a turbulent time. British consumers already have a strong propensity for using debit cards instead of credit cards — a trend we expect to last into the future. As a result, credit card issuers will have to continue to fight a cultural preference for debit and explore product development initiatives that may appeal to debit-preferring consumers.

In particular, prepaid cards appear to have high potential in the UK market. Prepaid cards function similarly to debit cards, and the fee-based nature of them supports the profitability models that credit card issuers require. Additionally, the concept of the prepaid card is one that retailers have already embraced — the commercial benefits of a fee-based, co-branded prepaid card with rewards and in-store benefits would certainly be compelling.

Already, we are seeing successful forays into fee-based lending. In particular, Marks & Spencer, the high street department store, offers its cardholders the option to upgrade their card to a premium product. This premium card has a monthly fee of £10 and offers cardholders higher rewards earning rates, in-store benefits such as free coffee from the store’s cafe and free travel insurance for the whole family. Initial reports indicate that the upgraded card has resonated strongly with the store’s loyal customers and cardholders, and we expect that this model will quickly be copied by other retailers who will mimic the combination of card-and store-based rewards in hopes to convert more standard cardholders into premium cardholders. Further, we think that lenders in the UK (and the United States) will soon begin introducing tiered card products, with richer products having higher fees associated with them.

We also believe that the UK market soon will see credit cards packaged more closely with current (also known as checking) accounts or other financial services. Acquisitions will heavily leverage the Internet and branch channels, and these packaged products will be tiered with a no-fee basic set of products and several fee-based premium sets of products that will offer customers rewards, special benefits and access to preferred customer services.

About the Author

Megan Bramlette is a managing associate at Auriemma Consulting Group, a management consulting firm that specializes in the lending and payments industry. She is based at the firm’s London office and leads the firm’s European research practice. She can be reached at megan.bramlette@acg.net.