Has Consolidation Brought More
Rational Competition?

In the Product Trends section of this month's issue we noted that both credit card profits and solicitations were up sharply in the third quarter. Analysts at Morgan Stanley Dean Witter (MSDW) believe this trend will continue over the next 12 months. In part, their conclusion derives from familiar arguments: strong household finances and declining loss rates. However, they offer an interesting new twist that reinforces their conclusion of continued profitability. In an Industry Report titled "Consumer Credit Cycle: Sweet Spot to Persist," (MSDW, Equity Research, September 8, 2000) they argue that consolidation in the consumer finance industry is making competition both more intense and more rational, with greater profitability as the end result.

Consider this observation: in the past the willingness of the banking sector to make consumer loans has moved inversely with delinquencies. When delinquencies rose, banks pulled back: when delinquencies fell (as they have since 1998) banks loosened their standards and extended more credit. However, this boom and bust cycle, which tended to feed itself, has been largely broken in recent years. The Federal Reserve Board senior loan officer surveys reported that more banks tightened lending standards on consumer loans than loosened from mid-1997 through the second quarter, 2000. Dramatic consolidation has characterized the credit card and subprime home equity sectors and is beginning to affect the prime mortgage industry as well. In 1999, the top five credit card issuers accounted for 55% of industry receivables; the top 10 accounted for 75% of receivables. The shakeout in subprime home equity financing has been even more dramatic: the top ten lenders accounted for almost 60% of total industry originations in the first quarter of 2000, up from 25% of originations in 1996.

Many smaller issuers and lenders (and even some very large ones) have given up and sold their portfolios, or sharply scaled back their marketing efforts. MSDW analysts note that the remaining industry leaders, e.g., the top five credit card issuers "are highly disciplined competitors, unlike many of the local and regional banks that have occasionally moved in thundering herds from one asset class to another." Consequently, the undisciplined lending in pursuit of market share that once characterized the card business has been much reduced. Offers and pricing are better targeted to match risk and return than was the case just a few years ago. One encouraging sign for the future has been the slowing growth in unutilized credit lines on bankcards. The chart below displays the very rapid build-up between 1993 and 1998 in unused lines of credit, relative to balances outstanding on existing accounts. However, that growth has slowed markedly in the past 18 months.

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