Order Code RL34393
The Credit Card Market: Recent Trends, Funding
Cost Issues, and Repricing Practices
February 27, 2008
Darryl E. Getter
Specialist in Financial Economics
Government and Finance Division

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The Credit Card Market: Recent Trends, Funding Cost
Issues, and Repricing Practices
Summary
Rising consumer indebtedness and increased reliance on credit cards over the
last two decades have generated concerns in Congress and among the general public
that cardholders may be paying excessive credit card rates and fees. Specifically,
some borrowers have reportedly been unaware of assessed penalty fees and interest
rate increases that follow after a delinquency episode. Consequently, proposed
legislation such as H.R. 1461, the Credit Card Accountability Responsibility and
Disclosure Act of 2007 (introduced by Representative Mark Udall with 39 co-
sponsors), and S. 1395, Stop Unfair Practices in Credit Cards Act of 2007
(introduced by Senator Carl Levin with nine co-sponsors) has been introduced in the
110th Congress.
This report examines developments in the revolving credit market, including
recent trends in usage, funding, and repricing practices. Descriptive data that
document recent U.S. household experience with credit card usage and delinquency
information is presented. Next, the funding of credit cards, with a particular focus on
the securitization process, is discussed. Credit originators are increasingly using
securitization to fund revolving credit because this method minimizes the costs to
fund these loans. There are payoff and default risks, however, that tend to increase
funding costs for future credit card loans. A brief overview of credit card repricing
practices is presented followed by a summary of possible policy responses.

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Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Recent Trends in the Revolving Credit Market . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Revolving Credit and Funding Cost Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
The Impact of Securitization on Funding Costs . . . . . . . . . . . . . . . . . . . . . . . 5
Risks to Yield and Impact on Funding Costs . . . . . . . . . . . . . . . . . . . . . . . . . 7
Convenience Users and Early Amortization Risk . . . . . . . . . . . . . . . . . 7
Default Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Summary of Current Risks to Yield . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Repricing Practices and Possible Policy Responses . . . . . . . . . . . . . . . . . . . . . . 10

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The Credit Card Market:
Recent Trends, Funding Cost Issues,
and Repricing Practices
Introduction
Financial innovations have increased credit availability for U.S. households over
the last two decades. For households with collateral assets, financial innovations,
specifically those in the mortgage market, have allowed households to leverage their
balance sheets and finance large expenditures they might otherwise have had to
forgo. Such developments can be advantageous because they make some households
less sensitive to temporary disruptions in income or cash flow. On the other hand,
financial innovations also make consumers more vulnerable to unexpected changes
in asset prices. A sudden increase in the value of underlying collateral assets used
to secure consumer borrowing, such as house prices, may entice some households to
increase their borrowing; a sudden decrease may translate into financial distress.1
Financial innovations similarly facilitated greater borrower access to revolving
credit or credit card loans. Although all types of lending may reduce sensitivity to
cash flow disruptions, unsecured lending can be particularly helpful to borrowers
who hold few, if any, collateral assets to draw upon to avoid a financial crisis.
Furthermore, credit card borrowers may be less affected than those with secured
loans when asset values fall. On the other hand, credit card borrowers pay higher
rates relative to secured credit borrowers. The relatively higher borrowing costs, fees,
and repricing practices, therefore, may still undermine or offset the financial benefit
of being detached from a decline in collateral asset values, which adds to borrower
financial distress.

This report discusses developments in the revolving credit market, including
recent trends regarding usage, funding, and repricing practices. The first section
provides a brief summary of descriptive data that documents the recent U.S.
household experience with credit card usage and delinquency rates. The next section
analyzes the funding of credit cards, and specifically the securitization process in
detail, since this method minimizes those costs. Conversely, payoff and default risks,
which are also explained, tend to increase funding costs for credit card loans.
1 For more discussion about why households may increase their indebtedness, see Karen E.
Dynan and Donald L. Kohn, “The Rise in Household Indebtedness: Causes and
Consequences,” Finance and Economics Discussion Series 2007-37, Board of Governors
of the Federal Reserve System (August 2007), available at [http://www.federalreserve.gov/
Pubs/Feds/2007/200737/200737pap.pdf].

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CRS-2
Finally, a brief summary of credit card repricing practices and possible policy
responses are presented.
Recent Trends in the Revolving Credit Market
The Survey of Consumer Finances (SCF) is a useful source for understanding
consumer indebtedness. The SCF, which is conducted tri-annually by the Federal
Reserve Board, asks approximately 4,000 households to provide information about
their income, assets, and debts. The discussion below follows observations reported
by economists from the Federal Reserve from 1989 to 2001 and 2001 to 2004, paying
special attention to credit card usage.
SCF evidence indicates that the number of households having at least one credit
card rose from 70% in 1989 to 76% of households by 2001; this increase was
attributed to several factors. First, households with riskier financial characteristics
were granted increased access to revolving credit.2 A greater proportion of low-
income households and households with lower liquid asset levels became new
cardholders. Risk-based pricing, the practice of charging riskier borrowers higher
rates to reflect the credit or default risk, allowed for increased participation in
consumer credit markets and fewer credit denials.3 Second, households over the
1989-2001 period increased their use of credit cards as a convenient way to make
payments. Third, the SCF also indicates a greater use of variable rate credit cards,
which fluctuate with market rates. Given more frequent usage of credit cards for
making convenience transactions, it is arguable that households grew more
responsive to the interest rate movements and preferred cards that would allow them
to benefit from market rate declines. On the other hand, it is at least equally likely
that lenders may have offered more variable rate cards to borrowers to benefit from
market rate increases. Hence, these developments suggest increases in both the
supply and demand for revolving credit, resulting in growth of the revolving credit
market.
The most recent 2004 survey evidence suggests the following changes from
2001.4 Approximately 74.9% of the U.S. families surveyed in 2004 had credit cards,
and 58% of those families carried a balance. In 2001, 76.2% of families had credit
cards, and 55% of those families carried a balance. These findings over a three-year
period do not indicate a substantial change in credit card holding or borrowing rates.
SCF data, however, do indicate that borrowing levels increased simultaneously as
households enjoyed greater access to revolving credit at lower rates. In 2004, the
median credit limit was $13,500, which represents a 26.2% increase from 2001. The
2 See Kathleen W. Johnson, “Recent Developments in the Credit Card Market and the
Financial Obligations Ratio,” Federal Reserve Bulletin, vol. 91, Autumn 2005.
3 See Darryl E. Getter, “Consumer Credit Risk and Pricing,” Journal of Consumer Affairs,
vol. 4, no. 1, summer 2006.
4 See Brian K. Bucks, Arthur B. Kennickell, and Kevin B. Moore, “Recent Changes in U.S.
Family Finances: Evidence from the 2001 and 2004 Survey of Consumer Finances,” Federal
Reserve Bulletin, vol. 92, February 2006.

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CRS-3
median interest rate on the household credit card with the largest balance was 11.5%,
down by 3.5% from 2001. The median outstanding debt level for households
carrying a balance was $2,200, a rise in real (inflation-adjusted) terms of 10% from
2001.
Despite higher credit limits and lower interest rates by 2004, the median
outstanding debt level relative to the median credit card limit declined. The use of
credit cards at levels below card limits suggests that borrowers have access to ample
amounts of revolving credit to sufficiently cover their borrowing needs. The
proportion of the median household balance relative to the median level of credit
available was 16.3% in 2004, which is 2.4% lower than 2001. Given that overall
consumer indebtedness rose during this period, one possible interpretation of this
result is that households relied more on other types of loans, such as mortgage or
home equity loans, where the interest costs are tax deductible. In fact, the share of
mortgage debt relative to other U.S. household liabilities rose by 8.6% while the
share of other types of consumer lending declined by 17.1% between 1990 and 2006.5
Despite a relatively smaller increase in revolving debt relative to mortgage debt,
credit card delinquency rates have risen. A Federal Reserve statistical release shows
that, as of November 2007, the percentage of delinquent credit card loans has been
greater than the percentages of any other types of bank loans since the fourth quarter
of 1995.6 The delinquency rate averaged about 4.4% over this period, compared to
2.0% for residential mortgage (including multi-family and home equity) loans and
1.8% for commercial real estate loans. Although credit card delinquency rates began
to decline after the first quarter in 2002, they have been rising since the first quarter
of 2006.
Credit card delinquency rates for commercial banks, however, are not
representative of the delinquency experience for the entire revolving credit industry,
since only approximately 40% of credit card loan originations remain on bank
balance sheets. It is difficult to identify a single numerical measure to evaluate the
health of this sector given the dramatic increase in credit card receivables that are
now funded or financed via securitization in modern financial markets.7 Despite
measurement issues, higher delinquency rates ultimately translate into higher
borrowing costs in this sector. The next section provides the institutional background
to illustrate why this relationship may exist.
5 See CRS Report RL30965, Rising Household Debt: Background and Analysis, by Brian
W. Cashell.
6 The Federal Reserve Board uses data from the Consolidated Reports of Conditions and
Income, compiled by the Federal Financial Institutions Examination Council (FFIEC), to
calculate a statistical release entitled “Charge-off and Delinquency Rates on Loans and
Leases at Commercial Banks”. Loans and leases are considered delinquent after 30 days,
and charge-offs are the value of these loans and leases (net of recoveries) removed from
b a n k b a l a n c e s h e e t s a n d char ged agai nst l oss r e s e r ve s . S e e
[http://www.federalreserve.gov/releases/chargeoff].
7 See Mark Furletti, “Measuring Credit Card Industry Chargeoffs: A Review of Sources and
Methods,” Payment Cards Center Discussion Paper, Federal Reserve Bank of Philadelphia
September 2003.

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CRS-4
Revolving Credit and Funding Cost Issues
Credit cards were initially issued by department stores in the 1950s as a more
efficient way to increase customer convenience and manage their accounts.8 Stores
selling big ticket items such as major appliances eventually allowed customers to
decide whether to pay in full or in installments subject to a finance charge. Once
commercial banks recognized the profit potential from providing open-ended,
unsecured financing to consumers, the general-purpose credit card became more
popular towards the late 1960s.9 Of course, since this occurred prior to the rise of
securitization, which will be discussed in more detail below, local banks set the rates
on the credit cards they issued.

During the late 1970s and early 1980s, the rise in inflation made unsecured
lending unprofitable, especially since state regulations limited the interest rates banks
could charge. Credit card lenders responded by charging annual fees and restricting
the number of credit cards issued to supplement the income loss. Banks also began
moving their credit card operations to states with high or no interest rate ceilings.
Inflation diminished towards the end of the 1980s; this development along with less
restrictive interest rate caps, reduced the need to charge annual fees. In addition to
falling inflation rates, the growth of banking on a national scale resulted in increased
competition, which contributed to a drop in revolving credit interest rates below the
18% to 19% levels maintained through most of the 1980s and early 1990s.10
The funding of revolving credit through securitization, which first began in
1987, also helped reduce the cost of credit.11 Securitization occurs when financial
institutions that originate credit card loans choose not to retain the loans on their
balance sheets.12 Loans originated in the primary market, where the credit card
purchaser and the loan originator conduct business, are often sold in the secondary
market, where the loan originator and an investor conduct business.13 The
securitization of assets helps originators manage liquidity and credit risk, which then
translates into lower interest rates for cardholders. Given that approximately 60% of
8 For more information on the historical development of the credit card market, see Glenn
B. Canner, “Developments in the Pricing of Credit Card Services,” Federal Reserve
Bulletin, vol.78, no.9, September 1992.
9 A charge card must be paid in full every month, unlike a credit card.
10 See Glenn B. Canner and Charles A. Luckett, “The Profitability of Credit Card Operations
of Depository Institutions,” Federal Reserve Bulletin, vol. 84, June 1999.
11 See the Risk Management Credit Card Securitization Manual, which is available from the
Federal Deposit Insurance Corporation at [http://www.fdic.gov/regulations/examinations/
credit_card_securitization/pdf_version/index.html].
12 The term “bank” may be used interchangeably to mean any type of financial institution
that originates a credit card with a specified loan amount.
13 For a more detailed explanation of the securitization process, see Mark Furletti,
“Overview of Credit Card Asset-Backed Securities,” Payment Cards Center Discussion
Paper, Federal Reserve Bank of Philadelphia, December 2002.

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CRS-5
credit card loans are securitized, a more detailed discussion of the process is
provided.
The Impact of Securitization on Funding Costs
Although loans may be funded using deposits or surplus capital, securitization
may be a lower cost funding alternative for lenders.14 When depository institutions
fund loans with deposits, the terms of the assets (loans), specifically the timing of the
receivables, may not match perfectly the terms of the liabilities (deposits) that must
be repaid. Depository institutions, therefore, are required to hold certain amounts of
capital against such timing mis-matches and in the event the assets do not perform
as expected. An opportunity cost, however, is incurred when capital held for
regulatory reasons is not used for other, more profitable, lending activities or
investments. Moreover, non-bank or non-depository institutions may enjoy a
competitive funding cost advantage, since they are not subject to the same regulatory
capital requirements as depository institutions. Even if greater capital requirements
were not an issue, as in the case of non-bank institutions, originators would still incur
servicing and monitoring costs if loans are funded from balance sheet activities.
Hence, securitization allows for the off-balance-sheet funding of loans, which may
lead to a reduction of funding costs and an elimination of risks associated with on-
balance-sheet funding. These cost savings may be passed on to cardholders in the
form of lower credit card rates.
The modern securitization process begins with a credit card issuer or loan
originator who, after approving and making loans with unsecured lines of credit for
a specified amount to numerous applicants, decides to securitize these assets.15 Next,
the assets, which in this case are the loan receivables or repayment streams from the
credit card loans, are sold to a trust that will be referred to as a special purpose entity
(SPE).16 SPEs are created as trusts, typically by financial institutions with a large
amounts of credit card originations, for two reasons. First, originators may sell assets
to trusts without paying taxes on the sale of those assets. Second, the investors’
rights to cash flows generated from the underlying assets are protected if the
originator were to become insolvent or file bankruptcy. Hence, the SPE may be
defined as “bankruptcy remote.” Given the associated tax and legal advantages,
SPEs may not carry out any other activities unrelated to the specific purpose for
which they were created. The SPE’s specific purpose is typically to transform
individual receivables into new financial securities with specific risk and return
14 See Charles T. Carlstrom and Katherine A. Samolyk, “Securitization: More than Just a
Regulatory Artifact,” Economic Commentary, Federal Reserve Bank of Cleveland, May
1992.
15 For a more detailed overview of the underwriting and loan approval process, see the
Credit Card Activities Manual, which is available at the Federal Deposit Insurance
Corporation at [http://www.fdic.gov/regulations/examinations/credit_card/].
16 See Gary Gorton and Nicholas S. Souleles, “Special Purpose Vehicles and Securitization,”
Working Paper No. 05-21, published by the Research Department of the Federal Reserve
Bank of Philadelphia.

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CRS-6
characteristics, the next step of the securitization process.17 Securities backed by
credit card loans can be created for any desired maturity, since new receivables are
continually added to the pool as older receivables are paid off by borrowers.
When transforming the individual credit card loans into new issues of asset-
backed securities (ABSs), SPEs may subdivide them into various tranches, or groups
of securities with specific risk and return characteristics. The ultimate lenders are
typically large investors, such as hedge funds, pension funds, or other financial
institutions, who purchase securities from the different tranches. A common tranche
arrangement, for example, is a senior-junior tranching structure. The senior tranche
may be designated as the one that pays its investors first, but the yield may be lower
than the junior tranche, which is designated to pay its investors last. When the
securitizer decides to sell the tranches in the secondary market, the senior tranche
will appeal to investors that prefer lower risk, quick paying investments, while the
junior tranche will appeal to investors that prefer to take higher risks for the
possibility of earning a higher yield. The senior-junior tranching structure is only one
of the numerous disbursement structures securitizers use to entice investors. This
particular tranching structure, however, is used throughout this report for the sake of
illustration.18
The tranching structure is used to satisfy the specific risk, return, and investment
grade needs of investors in the secondary market. When the SPE can effectively
identify and create ABS tranches satisfying specific needs, they can appeal to more
investors and attract more credit to fund credit card loan originations in the primary
market. For example, suppose the SPE is currently using the senior-junior tranching
structure described above. The junior tranche would consist of the cash flow
remaining after both the principle and yield to senior tranche holders and any losses
associated with default were paid. The holder of the junior tranche, therefore, keeps
whatever cash remains. This repayment structure reduces the credit risk for senior
tranche holders, since junior tranche holders incur most of the credit risk. The senior
tranche receives payment first, followed by the junior tranche; conversely, the junior
tranche initially suffers the losses first, followed by the senior tranche. Of course, the
junior tranche holder receives a higher yield or rate of return in exchange for
assuming higher risk. The investors in the senior tranche would be adversely affected
only if default costs exceed the value of payments that would have accrued to the
junior tranche investors.19 Hence, a tranching structure may also serve as a credit
17 In many cases, two SPEs may be involved in the securitization process. The first SPE
receiving the assets from the originator subsequently transfers these receivables to a second
SPE that does the actual repackaging and creates the new credit-card backed securities,
which are then sold to investors. Each SPE would be created in response to an accounting
and/or legal issue that would make it difficult for cash in-flows and out-flows to occur
without financial and/or legal consequences impacting the ability to issue, sell, and re-invest
the securities.
18 Note that only the loan receivables are collected and securitized. Hence, the sum of all
cash payments received is dispersed according to SPE tranching guidelines, but individual
loans do not have to be assigned to any particular tranches.
19 The liquidity crisis of August 2007 was triggered by senior tranche holders reassessing
(continued...)

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CRS-7
enhancement, or a method of reducing the credit risk of senior securities, which may
attract more investors, in particular those restricted to purchasing high quality
investment grade securities.
Rather than sell all of the ABS tranches to third party investors, the loan
originator may also want to act as an investor in its own asset-backed securities.
Whenever the originator chooses to keep one or more tranches in its own portfolio,
the retained tranche is referred to as excess spread. Suppose an originator retains a
junior tranche, which now is subsequently referred to as the excess spread, then the
originator is also providing credit enhancement to senior tranches issued by the SPE.
Again, the junior tranche, now referred to as the excess spread, consists of the cash
flow remaining after the principle and yield to senior tranche holders, and any losses
associated with default, are paid. The holder of the excess spread, therefore, has a
strong financial incentive to effectively minimize defaults, which translates into
lower funding costs or more investors as explained below.
Risks to Yield and Impact on Funding Costs
Lending activity must be considered a viable investment regardless of whether
loans are funded on or off the balance sheet of originators. If funded on-balance
sheet, loans may be backed by capital, or the asset values may be hedged using swaps
or other derivatives. If lending activities are funded off-balance sheet, the pools of
receivables are rated by credit-rating agencies, and maintaining a positive excess
spread becomes important for attracting funding for future ABS issues. The excess
spread should yield what investors would consider a viable return, in particular if the
excess spread tranche is being used as a credit enhancement for senior ABS tranches.
This section discusses risks that may lead to a reduction in the profitability of credit
card lending.
Convenience Users and Early Amortization Risk. The yield or profit
from credit card receivables is dependent upon whether borrowers make minimum
payments or pay off their balances every month. Consumers have the option during
each billing cycle to pay the minimum balance, pay off the entire loan, or pay
something in between. When credit cards are used for convenience transactions
rather than for borrowing, this does not generate any investor yield. In addition, early
amortization, which occurs when the outstanding balance of a credit card account is
suddenly paid off, also reduces yield. (Early amortization also occurs when a credit
card is paid off and the balance is transferred to another card issued by a competing
card issuer.) A reduction in yield ultimately makes investing in credit card
receivables less appealing to investors, a development which itself increases the
funding costs to provide these loans in the future.
19 (...continued)
the riskiness of their exposure to financial problems that exceeded expectations. See CRS
Report RL34182, Financial Crisis? The Liquidity Crunch of August 2007, by Darryl E.
Getter, Mark Jickling, Marc Labonte, and Edward Vincent Murphy. Rather than rely solely
upon a tranching structure, investors may also choose to purchase bond insurance, which
may serve as additional credit enhancement.

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CRS-8
Default Risk. A revolving credit loan is higher in credit or default risk relative
to other forms of lending. For credit cards receivables that have not been
securitized, these types of loans involve much higher operating costs and greater risks
of default per dollar of receivables than do other types of lending.20 For securitized
credit card receivables, the default risk of these loans generates uncertainty
surrounding the cash flowing into the excess spread. In both cases, defaults increase
future funding costs.
Revolving credit lending is risky for the following reasons. First, the loan is
unsecured, which means the card holder has put forth no collateral assets that can be
used to repay the loan in the event of default. Second, the card holder has the option
to use the card when unemployed or lacking sufficient cash flow to cover routine
expenses and payment obligations. The borrower may suddenly become highly
leveraged (up to the credit card limit) without any prior notice. Without knowing
whether or not the cardholder intends to pay off the balance at the end of the billing
cycle, every transaction made with a credit card is potentially a new loan, and the
outstanding principle balance can change at any time. Next, a credit card is also far
more susceptible to fraud than any other type of loan. Should unauthorized charges
be made on a lost or stolen card, the Fair Credit Billing Act limits the liability for
cardholders to $50.21 Hence, unrecoverable fraudulent charges may translate into
sizeable losses for originators or investors.
Delinquencies may eventually turn into defaults, which are defined as 180 days
delinquent. When borrowers initially fail to make timely credit card payments, the
servicer attempts to contact the borrower within several days of delinquency to
arrange payment. The servicer, and not necessarily the loan originator, is the
designated collector of credit card payments (and forwards them to the SPE if the
payment streams are being securitized). After 30 days, which is considered one
complete billing cycle, the servicer must decide whether to cut off credit to the
borrower and send the account to collections. Different financial institutions may
have different policies for handling delinquencies. If, however, accounts are sent to
collections, then the Fair Debt Collection Practices Act (FDCPA) prohibits abusive,
deceptive, and improper collection practices of third party debt collectors.22 Hence,
the collections process is regulated by federal guidelines.23
If the credit card issuer still owns the loans, contractual charge-offs (which are
account receivables deemed uncollectible due to missed payments) must be written
20 For a more detailed discussion about the costs of credit card operations, see Glenn B.
Canner, “Developments in the Pricing of Credit Card Services,” Federal Reserve Bulletin,
vol.78 no.9, September 1992.
21 P. L. 93-495, as codified at 15 U.S.C. 1666j. See [http://fdic.gov/regulations/laws/rules/
6500-500.html].
22 P.L. 90-321, as codified at 15 U.S.C. 1692 et. seq., and as amended by P.L. 109-351, §§
801-02, 120 Stat. 1966 (2006). See [http://www.ftc.gov/bcp/edu/pubs/consumer/credit/
cre27.pdf].
23 For a summary of these guidelines, see [http://www.ftc.gov/bcp/conline/pubs/credit/
fdc.shtm].

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CRS-9
off the issuer’s books after 6 billing cycles or 180 days of nonpayment, according to
guidances issued by the Federal Financial Institutions Examination Council
(FFIEC).24 When a borrower files for bankruptcy, accounts must be charged off 60
days after receipt of notification of the filing from the bankruptcy court. It is
estimated that 60% of charge-offs result from 180 days, or six billing cycles, of
missed payments, and 40% of charge-offs are the result of bankruptcy.25 If the loans
are securitized, delinquency and default costs generated from the account may be
subtracted from the proceeds paid to the SPE, which eventually has adverse effects
on the excess spread tranche.
When revolving credit is securitized, issuers may find it difficult to attract
investors and fund revolving credit loans without “implicit recourse.” Implicit
recourse refers to a perception among investors that credit card originators will
repurchase non-performing loans from ABS-pools and absorb default losses, which
may seem to negate the benefits of securitization.26 A Removal of Account Provision
(ROAP), which is a provision that exists in some credit card securitization
agreements that allows issuers to remove delinquent accounts, or accounts with
fraudulent charges, from an ABS pool, may be exercised. Exercising this option too
often, however, may still imply that the tranche(s) should receive lower credit ratings,
which could make it more difficult to attract some ABS investors.
Summary of Current Risks to Yield. Fewer convenience users, early
amortizations, and defaults reduce the yield on credit card ABSs. The impact on
yield may be even more significant should all of these risks materialize
simultaneously. Slightly more consumers, however, are carrying a balance and the
median balance has increased, as discussed earlier in this report. Consequently, the
payoff risk associated with an increase in convenience users has seen some decline.
On the other hand, defaults are rising. Should defaults continue to accelerate, the
increase in funding costs may encourage lenders to re-evaluate the profitability of
providing revolving credit. One option may be to curtail revolving lending activities
and pursue more profitable business strategies. Another option may be to employ
various repricing practices.
24 See the February 10, 1999 FFIEC press release entitled “Federal Financial Institution
Regulators Issue Revised Policy For Classifying Retail Credits,” which can be found at
[http://www.ffiec.gov/press/pr021099.htm].
25 See Furletti, “Measuring Credit Card Industry Chargeoffs: A Review of Sources and
Methods.”
26 According to FASB 140 accounting rules, a “true sale” means the seller is no longer
responsible for the subsequent performance of the financial assets sold. If poor performance
is transferred back to the originator, then a true accounting sale of assets did not occur, and
the originator should be required to hold capital against the value of the collateral. The only
permissible exception to this recourse provision is when the originator wants to remove a
delinquent account from a pool to offer a workout solution to the borrower. The exception
was not designed to simply allow issuers to absorb losses, for example, by removing early
amortization accounts to enhance the performance of securitized tranches. For more details
on this point, see Charles W. Calomiris and Joseph R. Mason, “Credit Card Securitization
and Regulatory Arbitrage,” Working Paper No. 03-7, Federal Reserve Bank of
Philadelphia, April 2003.

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CRS-10
Repricing Practices and Possible
Policy Responses
When borrowers are delinquent, exceed credit limits, or bounce payment checks,
they may face penalties, fees, and increased loan rates. The borrower is now viewed
as a greater credit risk and is, therefore, re-priced for the credit. Repricing is an
extension of risk-based pricing in that higher risk borrowers shoulder more of the
costs associated with having access to borrowing services. Furthermore, if
cardholders are sensitive to increasing charges, then repricing could be an effective
method to encourage delinquent borrowers to repay their obligations faster and
discourage them from further borrowing. Repricing ultimately increases the cost of
unsecured borrowing for delinquent cardholders.
“Hair-trigger” repricing, “universal default”, and “double-cycle billing” are
common repricing practices. Hair-trigger repricing refers to raising cardholder rates
almost immediately after a payment is late, which means the elimination of any grace
period. Universal default occurs when a borrower defaults on a loan serviced by a
lender, and other revolving creditors respond by increasing the lending rates on the
loans they are servicing for that particular borrower, even if the borrower has not
defaulted on those loans. Double-cycle billing is the practice of calculating interest
over a two-month billing cycle period, as opposed to a one-month billing cycle, that
can result in higher finance charges. The average balance over a longer period is
likely to be higher than over a smaller period of time. Whereas hair-trigger repricing
and universal default typically occur after a delinquency, double-cycle billing
practices may be initiated when card balances suddenly approach the card limit,
which may be an indicator of an increase in the probability of delinquency.27
Repricing practices are unpopular with borrowers because they are perceived to
be changes in the credit terms that were not part of the original agreement when the
card was issued. It is also possible that borrowers unknowingly agreed to these terms
simply because the terms were very difficult to understand.28 Loan originators,
however, are concerned primarily with the cash flow necessary to maintain lower
funding costs, in particular at a time while defaults are rising. Moreover, maintaining
cash flows sufficient to cover losses accruing to the lower tranche is also important
if the subordinate tranche is being used as a credit enhancement for more senior
tranches.
One response might be to eliminate unpopular repricing practices. The
unintended consequences of this response, however, may lead to a reduction in cash
27 This billing practice, however, does not necessarily have to be associated with an increase
in borrower risk. Some credit card issuers may simply be able to get the borrower to agree
to these charges, especially if the borrower is unable to find other financial institutions
willing to provide credit cards at lower costs or accept a balance transfer.
28 The Government Accountability Office reported that disclosures of complex risk-based
pricing practices in the credit card industry have become extremely difficult for consumers
to understand. See “Credit Cards: Increased Complexity in Rates and Fees Heightens Need
for More Effective Disclosures to Consumers,” GAO-06-929 Government Accountability
Office (September 2006) located at [http://www.gao.gov/new.items/d06929.pdf].

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flow resulting in an increase in bank charge-offs or excess spread tranches with
insufficient returns to make this type of lending attractive to future investors. Credit
card issuers could also respond in a variety of ways. They may increase loan rates
across the board on all borrowers, making it more expensive for both good and
delinquent borrowers to use revolving credit. Issuers may also increase minimum
monthly payments, reduce credit limits, or reduce the number of credit cards issued
to people with impaired credit. Given that credit cards also serve a convenience
transactions purpose, a reduction in card accessibility may make it more difficult for
affected households to make such transactions as booking airline tickets or hotels.
On the other hand, some financial institutions have stated that they will no longer use
pricing practices such as double-cycle billing and universal default.29 Hence, it may
be possible for other institutions to manage their cash flows and delinquencies
without relying upon these more controversial pricing practices. If such is the case,
then legislation geared toward ending these practices may not adversely affect
borrower access to unsecured credit.
Another response might be to enhance disclosures to borrowers so they are not
taken by surprise when repricing occurs on delinquent accounts. The Federal
Reserve is currently engaged in studies that could lead to revision of Regulation Z,
concerning the disclosure of consumer credit.30 These consist of using consumer
focus groups and individuals to determine what types of disclosures are effective
with helping them understand the possible charges they could face. Upon completion
of the interviews, the Federal Reserve expects to propose a format that may be
considered more transparent for consumers to evaluate the credit terms and facilitate
their usage of credit cards.
29 For example, see “Chase ends double-cycle billing” at [http://www.bankrate.com/brm/
story_content.asp?story_uid=20919&prodtype=today]; and “Citi Announces Industry
Leading Changes to its Credit Card Practices: To End ‘Universal Default’ & ‘Any Time for
Any Reason’ Changes” at [http://www.citigroup.com/citigroup/press/2007/070301b.htm].
There is no mention in these announcements, however, if subsequent increases in minimum
payments or subsequent reductions in credit card issues will occur.
30 See [http://www.federalreserve.gov/newsevents/press/bcreg/20070523a.htm].

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