Recommendations for Credit Card Issuers to Mitigate Credit Risk

Existing models and metrics did not prepare issuers for the credit crisis that followed in the wake of the subprime mortgage collapse. To remain successful, TowerGroup believes, card issuers must look deeply into each segment of their portfolios and react more quickly to the fast-changing environment.

he most important message for card issuers in 2008 is that each segment of their customer base will behave differently. Tools that worked well before (such as linear regression models that follow the month-to-month aging of payment delinquency) have never been tested under the current extreme risk conditions. In order to prevent systemic failure issuers must look at all functional processes to ensure that each business segment is tuned to the new environment.

In the research, TowerGroup outlines five core challenges to the credit cycle.

• Changing Purchasing Habits -- Diminished savings, lost home equity, increased debt, and higher unemployment means that U.S. card issuers must be ready for changes in card members' purchasing habits across every portfolio segment.
• Changing Payment Patterns -- Once industry darlings for their contributions to interest revenue, customers who carry a balance month to month must be scored more aggressively to assess risk.
• New Tests for Risk Models -- Revenue and risk models, along with the capacity plans that assess staffing requirements, are typically regression based and volume sensitive. Current business models have never been tested at higher delinquency rates.
• Redefinition of a "Good" Customer -- The definition of a profitable customer (traditionally, a card member who uses most of a credit line and revolves the balance, but with modest delinquency) can quickly change when that customer faces stressed household budget.
• "Wild Card" Vulnerabilities -- Traditional support mechanisms like domestic collection agencies and offshore call centers that work to collect overdue receivables will be subjected to stress as delinquency volumes rise. Issuers must try to anticipate where unexpected vulnerabilities might crop up.