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JUN-26 98 05:12 FROM: IWPR 2028334362 TO: 202 456 6244 PAGE: 02 ONE MUNDRIED PIFTH CONGREGA ML ARCHER. TEXAS CHAIRMAN PHILIP M CRANS ELINOIS CHARLES & RANGEL NEW YORK BILL THOMAS CALIFORNIA FORTHER PATE STARK CALIFORNIA E. Q.S. SMAW. A. FLORIDA ROBERT T. MATEUR CALIFORNIA MARCY L JOHNSON, CONNECTICUT BARBAKA a. KENNELLY. CONNECTICUT - BURNING KENTUCKY WILLIAM 1 COYNE PENNSYLVANIA COMMITTEE ON WAYS AND MEANS Fyi - getting 9 AMO HOUGHTON, NEW YORK BANDER M. LIVIK, MEDICAN WALLY HERICAL CALIFORNIA BELIAMIN L CARDIN, MARYLAND IN MICRERY, LOUISIANA Jills MEDERMOTT, WASHINGTON U.S. HOUSE OF REPRESENTATIVES DAVE CAMP. MICHIGAN GERALD D. KLBCZKA WISCOMEN - RAMST D. MINNESOTA JOHN LEAS, GEORGIA WASHINGTON, DC 20515-8348 - NUBSLE. IOWA REHARD a. MEAL, MARCACHUSETTS copies 3AM JOHNSON, TEXAS MICHAEL a MENUSITY. NEW YORK INSURA DUNNER WASHINGTON WILLIAM J. JEFFERSON. LOUISIANA MAC COLLINS. GEORGIA JOHN 6. TANNER TENNESSEE RDB FORTHAN, OMIO Me studies HAVER SICERRA CALIFORNIA PREP 1 ENGLISH, PENNSYLVANIA KAREN L THURMAN FLORIDA June 24, 1998 - ENGIGHT NEVADA JON CHRISTENSEN NEBRACKA wes WATKING OKLAHOMA 1.9 HAYWORTH ARIZONA JUNY WELLER, ELINOIS KENNY NULSHOP, NISSOURI L BANDLETOR CHEEF OF STAFF JANICE MAY& MINORITY CHIEF COUNSEL TO Nicole- The Honorable William J. Clinton This is and Then important The President The White House lusue we should follow Washington, D.C. 20500 the Dear Mr. President: As you and the Vice President continue your public discussions on the future of Social Security, we urge you to address the issues facing women. Women retiring in the next 20 years will have less than one-third the income necessary to retire comfortably, a situation that is greatly exacerbated for women of color. Several Social Security proposals under consideration would only make this situation worse. The majority of Social Security recipients are women and yet, so far, the various reform proposals' specific effects on women and their life choices have not been highlighted. We want to make sure American men and women understand these effects as they make choices about their Social Security system. Too few young women today understand that the job decisions they make when they enter the workforce can have a devastating impact on their lives in retirement. They mistakenly believe that the increased number of women holding better jobs means that their lives will be different. Unfortunately, that is not the case. Three out of five women are still in low-wage jobs that offer few benefits, including pensions, and they work in much greater numbers than men in part-time and contingent jobs. The situation is not expected to change well into the future. When these women retire, even if they have worked full time and take до time out of the workforce, they will most likely have little retirement income other than a meager Social Security benefit. Most women, however, do take time out of the workforce- 11.5 years on average - - to raise their children or care for ailing parents or spouses. During that time, when they are taking responsibility for the well-being of their families. they are receiving no credit in their Social Security accounts. penalizing them further when the amount of their benefits are being computed. PHOTOCOPY HRC HANDWRITING CLINTON LIBRARY PHOTOCOPY Meeting w/ Advocates 9/25/98 CONSUMER BANKRUPTCY PRIORITIES FOR CONFERENCE COMMITTEE I. ADOPT THE SENATE MEANS TEST WITH SEVERAL MINOR IMPROVEMENTS Correct the Senate's definition of median income for single family earners to avoid penalizing the elderly; Strike the protection from liability for creditors with claims under $1,000 that file a motion under the means test to coerce reaffirmation of debt; Eliminate potential personal liability for lawyers representing debtors on motions under the means test; the Senate provision creates irreconcilable conflicts of interest for lawyers representing clients in tough cases. II. PROTECT CHILDREN WHEN THEIR PARENTS FILE BANKRUPTCY Strike all provisions which would expand non-dischargeability of credit card debts; debts that survive bankruptcy will inevitably compete with child support obligations; Protect against redirection of family income in chapter 13 to defend meritless claims of fraud; Strike provisions that would allow creditors to claim an interest in household goods worth less than $400; Allow tenants who can resume payments to their landlords to continue to use bankruptcy to preserve their families' shelter; tenants should have the same bankruptcy protections as homeowners; Eliminate provisions designed to increase the cost of chapter 13 repayment plans including: new requirements that debtors repay car lenders and retailers more than those lenders could recover by repossession and resale of collateral; requirements for unsupervised adequate protection payments to secured creditors. III. PRESERVE SENATE 'S CONSUMER PROTECTION PROVISIONS (TITLE II OF THE SENATE BILL). Balance and fairness require protection in this legislation against unfair and overreaching lender practices. Debtors and careful lenders are hurt when irresponsible lenders use marketing tactics designed to encourage consumers to incur barely manageable debts at high interest rates. Honest creditors are hurt when aggressive creditors enlarge their share of a limited pie by coercing reaffirmation agreements and settlements of meritless dischargeability claims. IV. ELIMINATE TRAPS FOR UNWARY DEBTORS WITH LIMITED FUNDS Consumers with no ability to pay their creditors should not be forced to pay for a pre- bankruptcy debt repayment plan which is doomed to fail; Strike provisions that provide for automatic (non-discretionary) dismissal for inadvertent failure to meet new filing requirements; provide debtors with an adequate opportunity to remedy errors; Provide for better notice to creditors without eviscerating the automatic stay and other important bankruptcy protective provisions; Strike provisions which can be used abusively by creditors to coerce reaffirmations; Enact Senate provision that allows waiver of filing fees for indigent debtors. Nicole R. Rabner 09/25/98 12:24:25 PM Record Type: Record To: See the distribution list at the bottom of this message CC: Katharine Button/WHO/EOP, Shannon Mason/OPD/EOP Subject: Bankruptcy Meeting Today Today's meeting at 3pm in Room 100 OEOB with outside groups on bankruptcy reform legislation will include: Jonathan Yarowksy, Trial Lawyer's Association Wade Henderson, US Conference on Civil Rights Brady Williamson, former Exec. Dir. of the National Bankruptcy Commission Melissa Jacoby, also formerly of the Bankruptcy Commission Elizabeth Warren, Professor, Harvard Law School Norma Hammes, National Association of Consumer Bankruptcy Attorneys (NACBA) James Shulman, NACBA Mary Reuleau, Consumer Federation of America Joan Entmacher, National Partnership for Women and Families Donna Lenhoff, National Partnership for Women and Families Gary Klein, National Consumer Law Center Frank Torres, Consumer's Union Gene Kimmelman, Consumer's Union Henry Sommer, Professor, Conusmer Bankruptcy Assistance Project Maureen Thompson, Hastings Group (a part of NACBA coalition) Message Sent To: Sally Katzen/OPD/EOP Sarah Rosen/OPD/EOP Roger S. Ballentine/WHO/EOP fran.m.allegra @ usdoj.gov @ inet Maria Echaveste/WHO/EOP Maureen T. Shea/WHO/EOP 10-12-1998 39PM FROM SIDLEY AND AUSTIN NY 912129062747 P.2 NATIONAL BANKRUPTCY CONFERENCE (a voluntary organization composed of persons interested in the Officers improvement of the Bankruptcy Code and its administration.) Past Chairs-- 10NARD M. ROSEN BERNARD SHAPIRO Chair-- October 12, 1998 1. RONALD TROST Vice Chair-- DOUCLAS BAIRD Secretary-- Via Facsimile 202-456-6244 JEFFREY W. MORRIS Treasurer-- Ms. Hillary Rodham Clinton JOEL 8. Zwenti Office of the First Lady Conferees The White House MERBERT H. ANDERSON PAUL H. ASOFSKY DOUGLAS BAIRD Washington, DC JOHN A. BARRETT R. NEAL BATSON DONALD S. BERNSTEIN Attn: Ms. Melanne Verver H. BRUCE BERNSTEIN GEORGE BROOY RICHARD F. BROUDE Assistant to the President and Chief of Staff to the First Lady STOPHEN H. CASE DAVID H. COAR MICHAEL 1. CRAMES Dear Ms. Clinton: RONALD DEKOVEN BERNICE B. DONALD MURRAY DRABKIN DAVID C. EPSTEIN LEON S. FORMAN The National Bankruptcy Conference, a non-partisan public interest group CHAIM). FORTCANC LLOYD GEORGE that has been assisting the Congress with bankruptcy legislation since 1933, urges ROBERT E. CINSHERO MARCIA GOLDSTEIN you to reject any overtures from the leadership of the House or the Senate with ROBERT A. GREENFIELD THAD CHUNDY respect to passage of bankruptcy legislation which is the subject of the House CLORGE A. HAHN BARBARA HOUSER Conference Report. We have previously expressed to the Congress and to the THOMAS H. JACKSON 10HN}. JEROME President our strongest possible objection to the consumer provisions of the HERBERT KATZ LAWRENCE P KINC legislation as well as to a number of business provisions that will adversely affect the KENNETH N. Kitt JONATHAN M. LANDERS ability of small businesses to rehabilitate themselves. Our Conference is committed JOE LEE RICHARD LEVIN to bankruptcy reform, but there are many provisions in the legislation that passed RALPH R. MABEY MORRIS W. MACEY the House that are punitive in nature. ROBERT MARYIN HARVEY R. MILLER HERBERT P. MINKEL, JR. JEFFREY W. MORRIS We urge the President to continue his opposition to the current bankruptcy GERALD F. MUNITZ PATRICK A. MURPHY legislation and to reject any last minute deals with the Congressional Leadership as NORMAN H. NACHMAN SALLY SCHULTZ NEELY part of a solution to the budget crisis. CHARLES P. NORMANDIN HAROLD $. NOVIKOFT RANDAL PICKER ALAN N. RESNICK Our organization, which is composed of 66 academicians, judges and STEFAN A. RIESENFELD LTONARD M. ROSEN lawyers, stands ready during the 106th Congress to work with the President and MARY DAVIES SCOTT MORRIS G. SHANKER Congress on true bankruptcy reform. If there are any questions that you or your staff BERNARD SHAPIRO RAYMOND L. SHAPIRO might have please contact me directly at (212) 906-2332. MYRON M. SHEINFELD GERALD K. SMITH LAWRENCE K. SNIDER HINRY 1. SOMMER Most respectfully, RICHARD S. TODER GEORGE M. TREISTER J. RONALD TROST R. PATRICK VANCI ROBERT M. VILES ELIZABETH WARREN J. Ronald Trost, Chair JAY L. WESTBROOK ROBERT WHITE National Bankruptcy Conference 10E1 B. ZWEIBEL CC: Dean Douglas G. Baird Conferees University of Chicago, School of Law Emeritus 10HN R. COPENHAVER VERN COUNTRYMAN DANIEL R COWANS DIAN M. GANDY RUSSELL L. HILLER JOHN D. HONSBERGER FRANK R. KENNEDY PIERRE LOISEAUX HARRY A. MARGOLIS HAROLD MARSH, JR. 09/29/98 TUE 15:57 FAX 16174966118 HARVARD LAW 001 HARVARD LAW SCHOOL CAMBRIDGE . MASSACHUSETTS 02138 To: Nicole Rabner. Organization: Location: Washington, D.C. (202) 456-2878 Fax Number: From: Prof, Elizabeth Warren HLS Address: HA 200 Phone: (617) 495-3101 Total Number of Pages (including cover sheet) 32 Description Notes 09/29/98 TUE 15:57 FAX 16174966118 HARVARD LAW 5 002 GKM Banking June 11, 1996 Industry Report GERARD George M. Salem, CFA Aaron C. Clark KLAUER (212) 885-4031 MATTISON BANK CREDIT CARDS: LOAN LOSS RISKS ARE GROWING PERSONAL BANKRUPTCIES A MAJOR CATALYST Recently Escalating Credit Card Loan Losses Are The Result Of An Explosion Of Credit Availability In 1993-1995. We think the industry has probably brought this problem upon itself. Growth of losses cannot be blamed on the healthy business cycle. Card Issuers Appear To Have Focused On Marketing Cards And Increasing Volume, Perhaps At The Expense Of Proper Underwriting Standards. For example, the industry seems not to monitor the ratio of card lines or total debt to income. In bankruptcies, card debt commonly amounts to 50%-150% of debtors' annual incomes, with many filers possessing 10-20 cards. Our report attempts to analyze the genesis of this situation, investigates the status of appropriate controls, and assesses the implications. Our Recent Survey Suggests Personal Bankruptcies And General Card Write-offs Are Changing Structurally. Models based on past trends and borrower behavior are less valid as card proliferation now figures more prominently in analyzing loan losses. According to our informal survey of personal bankruptcy attorneys, bankruptcies are escalating due to easy and excessive credit, greater awareness of the simplicity of bankruptcy and the declining stigma attached to it. Loan Losses Can Go Much Higher This Cycle. Although we do not see a recession this year, loan losses are almost as high as they were at the peak of the 1991 recession. The trends cited could add up to disappointing loan losses and perhaps some disappointing banking company earnings ahead in 1996 and 1997. We Believe Credit Cards Are The Number One Risk In Banking. Although we are not changing estimates or ratings, we advise increased focus on this topic. In our universe, companies with the greatest exposure are: First Chicago/NBD (HOLD) and Citicorp (BUY). Companies with moderate potential risk are: Banc One (HOLD); Bank of New York (BUY); Chase Manhattan (BUY); and Wachovia (HOLD). Gerard Klauer Mattison & Co., LLC The information contained herein has been obrained from sources we believe to be reliable. but its accuracy is not guaranteed. Gerard Klauer 529 Fifth Avenue Mattison & Ca. LLC and/or its officers. directors, employees or stockholders, may at times have 2 position In the securities described herein and New York New York 10017 may sell them to or buy chem from customers. Copyright © 1996 Gerard Klauer Maccison & Co., LLC. All rights reserved. No part of this report Telephone 212/885-4000 may be reproduced. stored in a retrieval system or transmitted in any form or by any means, without the express written permission of Gerard Facsimile 212/338-8990 Klauer Mattison & Co., LLC. 09/29/98 TUE 15:58 FAX 16174986118 HARVARD LAW 003 TABLE OF CONTENTS Page Key Investment Considerations 3 Our Thesis Versus Conventional Wisdom 8 Analysis of Card Exposure of Individual Banking Companies 11 Our Survey Asks: Why Are Personal Bankruptcies Rising Now? 19 Credit Cards Are Inherently Riskier Than Most Other Bank Loans 24 Bankers' Views on the Card Business: They've Been Caught Off Guard 26 INDEX OF EXHIBITS Exhibit No. Page 1. Earnings Sensitivity to a 100 BP Increase in Net Loan Losses 4 2. Net Loan Loss Ratios 1989-1996 (1Q) 6 3. Credit Card Managed Outstandings 1992-1995 12 4. Credit Card Commitments and Cards Outstanding 1992-1995 13 5. Credit Card Delinquency and Charge-Off Trends 14 6. 1Q96Reported Card Loss Ratio vs. Loss Ratio Lagged to 1Q95 Outstandings 15 7. Quarterly Consumer Bankruptcy Filings (1Q94-4Q96E) 20 8. Annual Consumer Bankruptcy Filings (1982-1996E) 20 9. Bankruptcies as a Percentage of Gross Card Losses Mar 91 - Mar 96 21 10. Debt-Service Payments as a Percentage of Disposable Personal Income 28 11. Largest General Purpose Card Portfolios In The US 3/31/96 versus 3/31/95 29 Important disclosures on inside back cover. 2 004 09/29/98 TUE 15:58 FAX 16174966118 HARVARD LAW Gerard Klauer Mattison & Co., LLC KEY INVESTMENT CONSIDERATIONS Aggressive Lending With Incomplete Borrower Information--A Formula For Trouble. Over the last 30 years, banks have moved cyclically from crisis to crisis with respect to bad loans. In hindsight, the best indicator of trouble ahead was rapid growth in loans outstanding. In other words, too much of a good thing often leads to loose lending standards while chasing higher earnings. Surprisingly, there are now 7,000 VISA and MasterCard issuers, $360 billion of bank card debt, and growth in outstandings from 1992-1995 were over 20% per year. Many companies grew well above 20% annually (Exhibit 3). We Believe Credit Cards Will Clearly Be The Most Troubled Loan Category For US Banks In 1996 And 1997, And The Pressure Can Only Intensify If We Have An Economic Recession. Compared to some of the troubled loan categories of the recent past, credit cards should, in our view, impact the industry less severely than LDCs, commercial real estate or energy loans. And, we believe the number of lenders likely to experience a material adverse earnings impact will be smaller than in the 1980s. However, there are several major bank holding companies--and non-banks--with significant card exposure that could sce a more measurable earnings impact, one that could escalate substantially in a recession. We do not expect crippling types of losses where earnings are severely impacted or creditworthiness of the card issuers is undermined materially. Investment Strategy: We Recommend Increased Skepticism. Although we would advise caution based upon our research, we are not reducing our estimates or ratings at this time because: - Sufficient evidence does not currently exist to support large loan loss increases, the need for higher loss reserves or major earnings estimate revisions. - Bankruptcy and economic trends seem too preliminary for strong conclusions. - Bankers could take action to improve loan quality in this area--if not too late. Moreover, the relative exposure of banks is difficult to assess since: - Each bank has used different credit criteria to build its portfolio. Some portfolios have been very conservatively underwritten while others are more at risk due to unsatisfactory underwriting. - Loss reserve levels are different from bank to bank. - Lending rates could be raised to offset rising loan losses. - Some managements can absorb the card risk and still report respectable earnings because of good earnings in their other business lines. However, if loan quality data on cards deteriorates sharply during the second quarter and beyond, we would revise EPS estimates and stock ratings, where appropriate. (See next section of this report and accompanying exhibits relating to sensitivity of each company's earnings to its credit card exposure--Exhibit 1). 3 Exhibit 1: Earnings Sensitivity to a 100 BP Increase in Net Loan Losses (12 Selected Banking Companies and 4 Monoline Credit Card Companies) Bank Credit Card Outlook Credit Card Total Managed Card Net Inc. EPS Sensitivity to a 100 BP Card Loans as of March 31, 1996 Securitized Loans as % of X 225 bp** % of Total Increase in Net Losses' On Books Securitized Total Managed % of Total Total Managed (Millions) 1995 Effect on 96E % of 96E (Millions) BHCs CCI $15,900 $26,200 $42,100 62% 22% $947 30% $0.50 7% 09/29/98 TUE 15:58 FAX 16174966118 CMB 13,700 9,400 23,100 41 15 520 19 0.31 4 FCN 9,700 7,600 17,300 44 24 302 (a) 27 0.32 7 ONE 7,300 4,400 11,700 38 16 263 21 0.16 5 BAC 8,900 None 8,900 I 6 200 9 0.14 2 BK 8,800 None 8,800 : 23 162 (a) 18 0.25 5 NB 5,700 2,200 7,900 28 6 178 9 0.16 2 WB 4,000 600 4,600 13 15 104 17 0.16 4 WFC # 3,900 None 3,900 -- 11 88 9 0.50 2 NOB 1,600 None 1,600 -- 4 36 4 0.03 1 PNC 975 None 975 - 2 22 5 0.02 1 BOAT 600 None 600 2 14 3 0.02 1 HARVARD LAW MONOLINES + KRB $4,300 $22,500 $26,800 84% 96% $353 100% $0.72 36% FUS 3,400 14,900 18,300 81 100 227 100 1.64 39 ADVNA 2,600 9,100 11,700 78 83 125 91 1.57 40 COF 2,400 7,700 10,100 76 100 127 100 0.91 39 Note: Managed basis = sum of on-the-books and securitized. Our 100-basis-point increase is NOT intended to be a forecast or worst-case scanario. It is merely a reference point for earnings simulations and interpolations. "We assume for this analysis that all banking company card portfolios had ROAs of 225 BP in 1995. (a) Actual. # Pre-First Interstate. + Monaline net incomes (column 6) are actual except for ADVNA, which is estimated. Source: Gerard Klauer Mattison & Co., LLC estimates and corporate reports. Gerard Mattison & Co., LLC 005 09/29/98 TUE 15:59 FAX 16174986118 HARVARD LAW 006 Bank Credit Card Outlook Gerard Klauer Mattison & Co., LLC Watch Out For The Contagion Effect. A clear risk to investors in companies with significant card business is for one or two companies to report a negative quarterly earnings surprise. This could be caused by a management decision to build loss reserves, regulatory requirements, a rating agency request, or other causes. Under this scenario, investors often worry about who will be next and many stocks sell off in sympathy. The card business lends itself to this risk at the present time and this phenomenon has been manifested during the last few years. We believe forecasting card losses is one of the most difficult loan quality and earnings surprise challenges facing investors. Who Is Vulnerable? As our data show, First Chicago and Citicorp are the most vulnerable in our universe (Exhibit 1). CCI has more earnings momentum outside the card to bolster earnings but both have above-average underwriting sophistication. In the moderate-risk tier arc Banc One, Bank of New York, Chase and Wachovia. Wachovia is known for its excellent lending skills, while BK (processing) and CMB (merger) seem to have the best offsets to card risk. In a low-exposure category are: BankAmerica (BUY). NationsBank (BUY), Norwest (BUY), Wells Fargo (BUY), PNC (HOLD) and Boatmens (HOLD). JP Morgan (BUY) and Bankers Trust (HOLD), are not in the card business. Finally, the card specialty companies, which we do not follow, are more vulncrable than all of our bank holding companies because of their 80%-100% reliance on cards. These are: Advanta, Capital One, First USA and MBNA. The vulnerability of these companies would seem heightened by their growth stock P/Es. All Chasing the "Golden Goose." During 1994, 1995 and 1996, cards became the fastest form of loan growth. The motivation was clear--high returns on equity of 50%+ and ROAs of 250-300 basis points. These returns were pursued because few, if any, businesses in banking are as attractive. Exhibit 3 shows that card loans grew 47% on the books of these banks in the three-year period ended 12/31/95, while the specialty companies grew five times as fast-or 272%. During 1994, our universe aggregate expanded 17% to $112 billion, while the specialty companies "monolines" (companies with a single dominant line of business) grew 66% to $44 billion. In 1995, growth was similarly high--19% for our BHCs and 48% for the monolines. Neither the economy nor personal income nor bank loans in general grew anywhere close to these rates--a sign of potential overborrowing. We do acknowledge, however, that the card has been growing faster than consumer spending and borrowing due to its great convenience and other positive attributes, but the card growth still appears excessive. Card Growth Driven By Direct Mail. Most of the card growth was achieved through mailings, although affinity groups and co-branding are in a slightly different category of growth. Over the last two years (1994-1995) five billion card solicitations were mailed. This is equal to 32 invitations in 24 months to every American (160 million) between the ages of 18 and 64. We estimate persons receiving 32 invitations actually have been offered about $130,000 of lines of credit each. Our research indicates that the majority of individuals solicited either: (a) had more than enough credit; or (b) could never have enough, effectively making them a write-off or bankruptcy candidate. 5 09/29/98 TUE 15:59 FAX 16174986118 HARVARD LAW 007 Bank Credit Card Outlook Gerard Klauer Mattison & Co., LLC EXHIBIT 2: NET LOAN Loss RATIOS 1989-1996 (1Q) AVERAGE FOR SIX SELECTED BANKING COMPANIES * 8% 7% 6% 4.87% 5.02% 5% 4.32% 4.37% 4% 3.58% 3.70% 3.66% 3% 3.21% 2% 1% 0% 1989 1990 1991 1992 1993 1994 1995 1Q96 *Plots are annual averages except for 1Q96. Companies included in averages are CCI, CMB, FCN, BAC, ONE and WB. Source: Gerard Klauer Mattison & Co., LLC and corporate reports. 6 09/29/98 TUE 15:59 FAX 16174966118 HARVARD LAW 008 Bank Credit Card Outlook Gerard Klauer Mattison & Co., LLC No let-up in 1996 The actual totals of US card solicitations mailed, according to Behavioral Analysis Inc., were: 1995 1994 1993 1992 2.7 billion 2.4 billion 1.5 billion 900 million Also, in 1Q96 solicitations were sent at a 2.6 billion annual rate. Thus, two key observations can be inferred from these findings: (1) there is no let-up in the rate of credit card solicitations; and (2) owing to the heavy recent mailings, and the typical two- year lag before cards go bad, it is likely that high loss rates on card portfolios will continue well into 1997--even without a recession. Insufficient Scrutiny At Underwriting Level. With 7,000 card issuers, overworked credit bureaus, and not all debt recorded by the credit bureaus, card issuance has taken on the character of mass-mailed advertising or promotion rather than a loan. Some of the major underwriting flaws, in our opinion, are: - Credit bureau data are not complete. Often home mortgage debts are not recorded, as well as credit union and some retail credit, among others. Often the individual's employment status or name of employer were not known or verified. - Incomplete total annual income and total debt data. In effect, loans were being made without knowing the borrower's ability to repay. - Number of cards held was not considered: most mailings went to persons that already had several cards. Recently, only 1% responded to mass mailings. - It is hard to detect changes in borrower status after an initial loan. How has the borrower's debt picture changed? Is he/she still employed? Still married? Our research indicates that the banks usually don't know. In sum, while there were many sophisticated, technology-driven approaches to choosing potential cardholders, we believe the competitive situation, overcapacity and drive for business led most issuers into very aggressive loan underwriting practices. Also, we believe the degrees of underwriting sophistication of the largest issuers are not that different. Finally, exacerbating this situation, the issuers, in our opinion, have chosen to extend credit to individuals in a lower stratum of the creditworthiness spectrum compared with prior cycles. A Federal Reserve Survey shows that 24% of families earning under $10,000 per year had card debt in 1992 compared to 11% in 1983 and 13% in 1989. Similarly, families in the $10,000-$25,000 bracket rose from 27% in 1983 to 43% in 1992. By contrast, card usage by families earning over $25,000 to $50,000 was flat and over $50,000 card usage declined. This trend to more card usage in lower income brackets is contributing to today's higher losses. These persons don't handle credit well, and/or qualify for little credit based on capacity to repay. 7 09/29/98 TUE 16:00 FAX 16174966118 HARVARD LAW 009 Bank Credit Card Outlook Gerard Klauer Mattison & Co., LLC OUR THESIS VERSUS CONVENTIONAL WISDOM The consensus view regarding the 1995-1996 rise in card loss ratios is to attribute it to the economic cycle, the weak economy, unemployment, divorce, medical expenses, uninsured car accidents, small business failure--and escalating bankruptcies. We think the proliferation of cards issued is the principal reason behind the escalating card losses. In our opinion, too Too much much credit was issued with too little information and not enough control on the part of credit was issued issuers. This is a classic formula for rising losses-regardless of the business cyclc. Some with too little cardholders accumulated 10-20 cards, ran them up to the limit and then had no choice but to information seek bankruptcy. We believe bankruptcies are escalating in 1995-1996 because of the heavy 1994-1995 credit card mailings which are only now showing up with a lag as loan losses. It takes time to use all of one's cards to their maximum credit limit. Many of these cards arrived "preapproved," requiring only a signature and some minimum data in order to receive the card. We believe this era of rising card losses marks a fundamental departure from prior eras in that there is more willingness to choose bankruptcy and more credit than incomes can service. We see no evidence that any of the other factors are escalating. We think economists should examine debt service-to-income ratios by income levels. We believe this would show higher ratios for the middle class with incomes from, $20,000-$40,000, where card debt seems most burdensome, and lower ratios at higher income levels--say above $75,000. Thus, the widely- followed consumer debt-to-income ratios, even though rising, are somewhat misleading as to where debt burden truly lies. Exhibit 10 shows the debt-service ratio for 1960-1995. Note that the fourth quarter of 1995 was just below 17%, while the historic high was 17.6% in the final quarter of 1989. Bankruptcy: An Escalating Trend We believe bankruptcy is an escalating trend for the following reasons: Debt burdens are rising due to loose bank credit. There is now greater awareness of the ease of filing for bankruptcy. The traditional stigma of filing has declined. We expect bankruptcies to rise steadily in 1996-1997 and as a percentage of net loan losses, at annual rates of increase well above the 12% reported in 1995. Most attorneys we surveyed cited credit cards as the main cause of the escalation of bankruptcy. Bankruptcies now account for 40%-50% of net losses at large card issuers--a rising ratio for many. Dollar amounts of bankrupt debt are rising commensurately. Bankruptcies Exhibits 7 and 8 show quarterly and annual bankruptcy filing data for individuals. to rise 31% Historically, personal bankruptcy rates have coincided with economic recessions. As Exhibit in 1996 versus 8 illustrates, the peak annual increase in personal bankruptcies of 21% coincided with the 12% in 1995 recession of 1991 and was followed by absolute declines in 1993 and 1994. However, in our opinion, the cyclical pattern has been broken, and we project increases of 31% in 1996 despite the strong economy, Exhibit 7 shows year-over-year increases rising from a modest 3% for 1Q95 to an actual 26% in 1Q96, with higher projected figures later in 1996. (See Exhibit 9 for the 1991-1996 ratio of bankruptcies to gross card losses.) These industry data are lower than the data for specific companies within our universe, many of which are based on net loan losses. Our companies are now experiencing 40%-50% bankruptcies to net card losses. It could be that 8 09/29/98 TUE 16:00 FAX 16174966118 HARVARD LAW 010 Bank Credit Card Outlook : Gerard Klauer Mattison & Co., LLC our large banking companies have higher bankruptcies because they sent more preapproved mass mailings. Quarterly breakouts in Exhibit 7 show the acceleration in growth rate in late 1995. Non-Bankruptcy Losses Should Not Be Underestimated. Our thesis regarding rising card losses relates equally to non-bankruptcy credit card losses. These are also rising, in our opinion, due to lax credit standards by the banking industry. It just happens that bankruptcics are outpacing an existing and rising general card loss escalation. It appears that bankruptcy is quicker, and its appeal is growing. A New Leading Indicator? Based on our analysis, we believe Federal Court data on bankruptcy filings lead bank charge-offs by one to two quarters due to the delays in booking bank losses. Also, court notifications to lenders can take up to two weeks to be sent. The Past Is No Guide To The Future. Forecasting The Peak In Write-offs Is Very Difficult When trying to forecast current card losses, we would not look to the past as a guide. If a correlation were made, losses should be lower now because we are not yet in a recession. We also believe that the past should not be used as a guide to computer models that predict consumer borrowing and default behavior in sophisticated credit scoring models such as those of Fair, Isaac Company (a credit scoring firm) and internal lender models. We have listed below a number of factors that we believe make this cycle different from prior cycles, thus rendering traditional tools and rules less reliable. Number of card holders is at record levels. Number of cards per borrower is up significantly. Greater acceptance of cards encourages greater borrowing. Airline milcage plans are very enticing and increase card usage and debt. Higher ratios of card lines to net income. Many cardholders are less creditworthy (higher credit risks) than in the past. Many cardholders are without jobs. Among these are heavy mailings to college and high school students. Marketing of bank cards seems significantly more aggressive. Intense competition--there are 7,000 issuers of bank cards, many of which intensified their involvement in recent years. Hundreds of first-time issuers in the 1990s eager for market share in this high-profit business segment. Companies with single business lines (monolines) and other non-bank financial institutions were minor players in prior cycles. Now three of the top five, and seven of the top 10 card issuers are non-banks (See Exhibit 11). Affiliated with some of these non-bank (and bank) competitors are large, well-respected companies such as Sears, AT&T, Household Finance, American Express, American (and other) Airlines, Ford and GM, whose presence has brought marketing and financial muscle to the industry. 9 09/29/98 TUE 16:01 FAX 16174966118 HARVARD LAW 011 Bank Credit Card Outlook Gerard Klauer Mattison & Co., LLC We believe current high loss rates can be attributed to the issuing banks. Our rationale is that if lines of credit were fewer and lower, then losses would by definition be lower. In other words, we think a person earning $30,000 is probably entitled to a $5,000 line of credit-- which he could likely handle. However, when encumbered with $25,000 in credit lines (and debt), it is much more likely that he will go bankrupt from inability to service debt or simply default. We believe that the highest credit card loss rates will not be known until after the next recession. And, that could be 200 basis points (or more) higher than current levels of 400- 500 basis points--levels that could reduce earnings of exposed companies materially. Political risks We recognize that it is the borrower who does the defaulting, not the banks. While growing undisciplined borrowers are clearly major culprits in the present debacle, we believe if the banking industry had been monitoring this situation more closely there would not be such a proliferation of excessive levels of credit. This is a clear political risk. Consumer oriented members of Congress could go public at any time with criticism of the card lenders for: (1) allowing borrowers to accumulate debt far faster than the growth of their incomes; and (2) the use of "teaser" rates--which less educated borrowers probably do not understand to be only temporary rates which can triple overnight. In our view, all participants in the card lending business should review their strategies and tighten underwriting in light of the loan quality and profitability challenges facing the industry. Some Potential Blindside Risks Here is a list of major potential risks facing card lenders: Capital Adequacy. Regulators and/or rating agencies may ask for more capital for card risks--especially off balance sheet. More risk requires more capital. Loss Reserves. Banks and monolines are generally weak in this area. Regulators, rating agencies and the SEC could make statements here to beef up reserves. Jawboning. Regulators could call for a slowdown of growth of cards and tighter credit. In short, the card business is now at a state where such regulatory surprises are a growing likelihood. 10 09/29/98 TUE 16:01 FAX 16174966118 HARVARD LAW 012 Bank Credit Card Outlook Gerard Klauer Mattison & Co., LLC ANALYSIS OF CARD EXPOSURE OF INDIVIDUAL BANKING COMPANIES Clearly, cards are a portfolio "concentration" at some banks, and thus a potential credit and earnings risk. Five Key Criteria For Analyzing Card Vulnerability Size. In this context, size refers to outstandings (and commitments) as a proportion of loans and earnings. (See Exhibits 1, 3 and 4.) They can be found under the category "managed loans," which are the sum of on-the-books and securitized loans. Securitized loans are a large percentage of the total for CCI (62%), FCN (44%), CMB (41%) and ONE (37%). For the monolines, this ratio is about 80%. Exhibit 1 shows the proportion of each company's loans represented by cards on a managed basis. The range is wide, with three above 20%: FCN (24%), BK (23%) and CCI (22%). More important than card proportion of loans is card proportion of earnings. Exhibit 1 shows the estimated proportion of 1995 income assuming all card portfolios have ROAs of 225 basis points (FCN's and BK's are actual 1995 card earnings). The leaders here are CCI (30%) and FCN (after its merger with NBD) (collectively 27%). Card commitments (the sum of used and unused lines of credit) are also a measure of size. These are shown in Exhibit 4. For example, Citicorp has card lines of $143 billion, of which $45 billion, or 31%. were drawn and outstanding. Exhibit 4 also illustrates that CCI's commitments as a multiple of outstandings have risen sharply--from 1.4x in 1992 to 3.2x in 1995. On a cards outstanding basis, CCI has the highest loan doncentration in this area at 2.4x common equity, FCN is 2.2x. For total commitments FCN is almost 12x equity and CCI is 8x. We realize that commitments will never be fully drawn, but the lines are there and could be drawn upon to a greater degree, especially given management's limited capacity to restrain it. Finally, with so much unused credit, it seems obvious to us that the industry should slow their marketing of new cards. WB, ONE and Growth. WB had the highest growth in outstandings for the three-ycar period at (105%), FCN grew fastest followed by ONE (102%) and FCN (86%). Large players with relatively low growth include BAC (10%), CCI (30%) and CMB (45%). The slow growth was not all planned but was due, at least in part, to the unwillingness to cut rates to compete and loss of market share. Exhibit 4 shows commitment growth for 1992-1995. However, WC would reiterate that our analysis reveals that there is a strong correlation between high growth and the subsequent degree of problem loans throughout banking history. Loan Quality. Delinquencies and charge-offs are the basic data generally analyzed for signs of bad loans. (See Exhibits 5 and 6.) Delinquency ratios have been rising, but at a low rate, since year-end 1994. Banks with the largest increases relative to one-year ago are BK (62 basis points (bp), ONE (52 bp) and FCN (47 bp). CMB is down and CCI is up modestly. Monoline numbers are up 102 bp on average versus 28 bp for the bank holding companies. We believe that delinquencies are less reliable as early indicators of loan trouble today than they were historically. We believe this relates to the proliferation of bankruptcies, which often occur without delinquency. Also, charge-offs reduce delinquencies. Charge-offs up Charge-offs are far more important since they affect the loss reserve and, usually, dollar- across the board for-dollar, the income statement. Exhibit 5 shows charge-offs for the year 1994 and by quarter since 1Q95. None of the 10 companies shown has escaped the sharp adverse change--more evidence, in our opinion, that this is a structural problem. Versus 1Q95, average charge-offs at the six bank holding companies are up 95 bp, or 26%, to 4.60%. The monolines deteriorated faster-by 113 bp, of 51%, to 3.34%. 11 09/29/98 TUE 16:01 FAX 16174966118 HARVARD LAW 013 Bank Credit Card Outlook Gerard Klauer Mattison & Co., LLC EXHIBIT 3: CREDIT CARD MANAGED OUTSTANDINGS 1992-1995* (Millions) (12 Bank Holding Companies (BHCs) and 4 Monolines) % Change to At December 31, 12/31/95 from: 1992 1993 1994 1995 1992 1993 1994 BHCs CCI $34,100 $34,000 $38,500 $44,200 30% 30% 15% CMB 16,300 17,400 19,700 23,700 45 36 20 FCN 9,400 11,400 13,100 17,500 86 54 34 ONE 5,700 6,900 8,400 : 11,500 102 67 37 BAC 8,300 7,500 8,000 9,100 10 21 14 BK 5,200 6,200 7,600 8,700 67 40 14 NB 4,400 4,900 5,900 7,400 68 51 25 WB 2,200 3,100 4,100 4,500 105 45 10 WFC 2,800 2,600 3,100 4,000 43 54 29 NOB 1,700 1,800 2,500 1,700 (a) 0 -6 -32 PNC 730 730 840 1,000 37 37 19 BOAT 380 460 550 540 42 17 -2 Total $91,210 $96,990 $112 290 $133,840 47% 38% 19% Monolines KRB $9,900 $12,400 $18,700 $26,700 170% 115% 43% FUS 2,900 5,400 11,000 17,500 503 224 59 COF 1,900 4,800 7,400 10,500 453 119 42 ADVNA 2,700 3,900 6,500 10,000 270 156 54 Total $17,400 $26,500 $43,600 $64,700 272% 144% 48% - Includes on-the-books and securitized. (a) Decline caused by sale of loans. Source: Gerard Klauer Mattison & Co., LLC estimates and corporate reports. 12 Exhibit 4: Credit Card Commitments and Cards Outstanding 1992 1995* (Millions) (10 Bank Holding Companies (BHCs) and 3 Monolines) Multiple of 12/31/95 Com. Equity Year-End Credit Card Commitments' Multiple of (Managed Basis): Outstandings Bank Credit Card Outlook At December 31, Commitments to Outstandings Cards Total Card as a % of 1992 1993 1994 1995 1992 1993 1994 1995 Outstanding ** Commitments Commitments BHCs CCI $98,800 $105,800 $114,600 $142,500 1.4x 3.1x 3.0 x 3.2 X 2.4 x 7.9x 31% CMB 53,300 62,300 67,200 71,300 3.3 3.6 3.4 3.0 1.2 3.7 33 FCN NA 60,700 78,100 94,200 NA 5.3 6.0 5.4 2.2 11.7 19 09/29/98 TUE 16:02 FAX 16174966118 ONE 22,000 23,700 42,600 61,700 3.9 3.4 5.1 5.4 1.4 7.2 19 BAC 33,200 31,000 36,100 43,600 4.0 4.1 4.5 4.8 0.5 2.4 21 BK NA 17,300 23,100 27,600 NA 2.8 3.0 3.2 1.6 5.1 32 NB NA 12,800 15,900 21,000 NA 2.6 2.7 2.8 0.6 1.6 35 WB 7,000 6,800 10,100 11,600 3.2 2.2 2.5 2.6 1.2 3.1 39 WFC 13 8,100 8,600 10,900 12,600 2.9 3.3 3.5 3.2 1.1 3.5 32 MONOLINES KRB $60,000 $70,200 $82,800 $116,400 6.1x 5.7x 4.4x 4.4x 7.6x 32.9x 23% FUS Not available HARVARD LAW COF 4,200 10,500 16,400 23,700 2.2 2.2 2.2 2.3 17.5 39.5 44 ADVNA 11,700 16,000 24,700 33,300 4.3 4.1 3.8 3.3 14.9 : 49.5 30 Includes on-the-books and securitized credit card outstandings. ** See Exhibit 3 for year-end 1995 card outstandings. NA - Not Available. Source: Gerard Klauer Mattison & Co., LLC estimates and corporate reports. Gerard Klauer Mattison & Co., LLC 014 Exhibit 5: Credit Card Delinquency and Charge-Off Trends--10 Selected BHCs and Card Companies Days Past Delinquency Ratios Average Charge-Off Ratios Due Chg. (bp) to incr. (bp) to Bank Credit Card Outlook Period End 1Q96 from: 1Q96 from: BHCs 12/94 3/95 6/95 9/95 12/95 3/96 4Q95 1Q95 1994 1Q95 2Q95 3Q95 4Q95 1Q96 4Q95 1Q95 90 CCI 1.64% 1.71% 1.55% 1.57% 1.66% 1.80% 14 9 3.95% 3.59% 3.74% 3.72% 3.89% 4.38% 49 79 90 CMB 2.47% 2.28% 2.12% 2.23% 2.36% 2.15% -21 -13 4.30% 3.92% 4.09% 3.98% 4.18% 4.66% 48 74 30 FCN * 5.20% 5.07% 5.07% 5.53% 5.78% 5.54% -24 47 3.60% 3.80% 4.00% 4.00% 4.40% 4.80% 40 100 09/29/98 TUE 16:02 FAX 16174986118 30 BK 3.09% 3.23% 3.19% 4.00% 3.90% 3.85% -5 62 2.68% 3.34% 3.17% 3.31% 3.95% 4.48% 53 114 60 BAC 1.91% 2.14% 2.00% 1.91% 2.08% 2.23% 15 9 4.50% 3.84% 4.41% 4.28% 4.20% 4.62% 42 78 30 ONE 3.77% 3.93% 3.77% 4.01% 4.22% 4.45% 23 52 3.52% 3.42% 3.84% 3.82% 4.44% 4.64% 20 122 MONOLINES 30 FUS 2.50% 2.80% 2.96% 3.29% 3.57% 4.04% 47 124 3.22% 2.13% 2.21% 2.88% 3.10% 3.36% 26 123 14 30 KRB 3.03% 3.00% 3.23% 3.58% 3.70% 3.85% 15 85 2.59% 2.64% 2.64% 2.71% 2.74% 3.28% 54 64 30 COF 2.95% 3.12% 3.07% 3.37% 4.20% 4.51% 31 139 1.48% 1.88% 2.10% 2.35% 2.58% 3.53% 95 165 30 ADVNA 2.00% 2.10% 2.00% 2.30% 2.60% 2.70% 10 60 2.50% 2.20% 2.40% 2.50% 2.60% 3.20% 60 100 HARVARD LAW AVERAGES 6 BHCs 3.01% 3.06% 2.95% 3.21% 3.33% 3.34% 0 28 3.76% 3.65% 3.88% 3.85% 4.18% 4.60% 42 95 4 Monolines 2.62% 2.76% 2.82% 3.14% 3.52% 3.78% 26 102 2.45% 2.21% 2.34% 2.61% 2.76% 3.34% 59 113 All 10 Cos. 2.86% 2.94% 2.90% 3.18% 3.41% 3.51% 11 57 3.23% 3.08% 3.26% 3.36% 3.61% 4.10% 49 102 * FCN's delinquency ratios are from a securitized pool Master Trust II and may not be representative of entire portfolio. ** BK's delinquency ratios for 12/31/95 and 3/31/96 are our estimates. Source: Gerard Klauer Mattison & Cc., LLC estimates and corporate reports. Gerard Klauer Mattison & Co., LLC 015 09/29/98 TUE 16:02 FAX 16174966118 HARVARD LAW 5 016 Bank Credit Card Outlook Gerard Klauer Mattison & Co., LLC EXHIBIT 6: 1Q96 REPORTED CARD Loss RATIO Vs. Loss RATIO LAGGED TO 1Q95 OUTSTANDINGS 1Q96 Net Net Loan Loss Ratios* Card 1Q96 losses Increase (bp) Losses 1Q96 to 1Q95 Avg. Using Lagged (Mil) Reported ** Outstandings + Method BHCs CCI $467 4.38% 5.04% 66 CMB 270 4.66 5.60 94 FCN 206 4.80 6.46 166 ONE 150 5.09 7.07 198 BAC 103 4.62 5.35 73 BK 96 4.48 5.21 73 NB 53 3.22 4.67 145 WB 32 2.82 3.18 36 WFC 81 8.25 10.37 212 PNC 11 4.58 5.64 106 BOAT 7 4.33 4.72 39 MONOLINES KRB $222 3.28% 4.60% 132 FUS 151 3.36 5.27 191 ADVNA 84 3.20 5.02 182 COF 91 3.53 4.75 122 . Loan loss data is on a managed basis. ** 1Q96 losses (annualized) divided by 1Q96 average card outstandings. + 1Q96 losses (annualized) divided by 1Q95 average card outstandings. Source: Gerard Klauer Mattison & Co., LLC estimates and corporate reports. 15 09/29/98 TUE 16:02 FAX 16174966118 HARVARD LAW 017 Bank Credit Card Outlook Gerard Klauer Mattison & Co., LLC Among bank holding companies, ONE experienced the sharpest year-over-year deterioration at 122 bp or 36%. For the monolines, COF was the worst and KRB, the best. Last quarter, both deteriorated an average of about 50 bp versus the past three months. All in all, we think this paints an ominous picture. The "Lagged" Charge-off Ratio. Many investors remove credit card portfolio growth in the latest year when calculating the charge-off ratio. Growth artificially reduces the ratio (of losses to average loans) since losses develop only after about two years. Thus, when growth occurs the numerator of the equation does not change, but the denominator does. Exhibit 6 shows how much higher the loss ratio would be on a lagged basis. On this basis, WFC (pre-FIB) at 212 bp, or 26% higher, is the worst, followed by ONE (197 bp), FCN (166 bp) and NB (145 bp). The monoline average is 160 bp higher than as reported. Clearly, this growth calculation is a useful analytic tool for forecasting write-offs. It also is a more realistic indicator of where charge-offs are right now. FCN and ONE are well above 6% on this basis--a level which is likely to crode the profits of the card business, and overall profits for their companies. The card business is very profitable at loss rates of 300-400 bp; at 600 bp. we believe earnings disappointments are likely to appear. Finally, as soon as growth of loans slows, actual net loss ratios should escalate. Credit Culture. We believe this is the most important factor in assessing a loan portfolio's quality but the most difficult to measure because it is intangible. It can only be known over time as it measures the entire process of risk assessment (its conservatism or aggressiveness), including the credit review processes after loans are made. It is more difficult to differentiate one bank from another when it comes to credit card issuance. We think the best approach is to analyze their underwriting standards. The proof will bc in the loan losses, once the cycle is fully played out. Finally, while "high-tech" underwriting is supposed to be an advantage, we believe that this is an overrated method of loss prevention. In our opinion, these techniques are designed more to generate loans than to avoid losses. Loss Reserve Adequacy: Caution Is Advised Are delinquent Many investors use the reserves-to-nonperforming-loans ratio to measure reserve strength. cards NPLs? We think this can be misleading since delinquent cards are not part of NPLs. Thus, high card delinquencies are not reflected in the NPLs/loans ratio and can allow reserves to appear stronger than they really are. Perhaps 90-day card delinquencies should fall under NPLs. How Card Deterioration Could Affect Earnings While card profits of 50% ROE and 250-300 bp ROA were once common, current figures are well below those now--and we believe still headed lower. If the card, for example, is now earning only 200 bp ROA it would not take much loan loss erosion to cut that in half--about 150 bp more loan losses (pretax) to be precise. We think that could happen. 16 09/29/98 TUE 16:03 FAX 16174966118 HARVARD LAW 018 Bank Credit Card Outlook Gerard Klauer Mattison & Co., LLC Effects on Bank Earnings of Growth in Card Losscs Unfavorable Favorable Rising losses translate directly to the Introductory "teaser" interest rates roll loss provision and earnings reduction. up to permanent (go to) rates. Securitized losses also directly impact Teasers could be discontinued on new earnings. loans, lifting portfolio yields. Loss reserves may need building, i.e., Weak credits are priced up (on APR provisions exceeding losses. basis) by 400-500 bp. Securitized pools may need larger Less marketing expense for new loans. credit enhancements. Fees are increased for lateness, Interest non-accruals grow, reducing exceeding credit limits, etc. net interest income. Slower growth means less earnings. Collection expense grows. Earnings Sensitivity: An Interpolation Tool Exhibit 1 shows the after-tax EPS effect on 1996 earnings estimates of a 100 bp increase in card net loan losses. FCN and CCI appear to have the highest risk. These are not forecasts but data to put 100 bp of loss in perspective. If it were 200 bp for CCI, for example, yearly earnings would be reduced $1.00 per share, other factors being equal. Note also that 100 bp annually takes four quarterly reductions of $0.125, to total $0.50 annually. If, in addition, Earnings threat loss reserves of 50 bp needed to be built that would be another $0.25 per share. Exhibit I is material shows that the card threat is not a disaster looming but an earnings growth challenge for our but not life 12 BHCs. For the monolines, the effect of 100 hp higher losses could be disastrous since the threatening effect is five times as severe as the worst bank. This is especially true since these companies are known for their low loss reserves--and low equity capital on a fully-managed basis. Although Exhibit 1 assumes all companies are equal, several, in fact, have offsets to card deterioration. Citicorp has powerful earnings from emerging markets. Bank of New York has extremely profitable securities processing plus it might sell 40% of its card business in 1Q97 (see our report dated April 9, 1996). Chase has its positive merger scenario, as does Wells Fargo. BankAmerica and NationsBank also have strong earnings momentum. Even Advanta and First USA have non-card earnings to draw from. FCN and ONE Seem Most Vulnerable. Our analysis suggests First Chicago/NBD and Banc One are most vulnerable to the card threat. They have grown rapidly, have large exposure and not enough other earnings momentum. In the case of FCN, we believe their credit underwriting is more sophisticated than ONE's. 17 09/29/98 TUE 16:03 FAX 16174966118 HARVARD LAW 019 Bank Credit Card Outlook Gerard Klauer Mattison & Co., LLC Securitization: Hidden Risks Exhibit 1 lists lenders with securitized loans. The following facts regarding securitized card loans have been verified with rating agencies, regulators and some bank managements. They are not sold; they are only off the balance sheet as a financing device. They are part of the bank income statement. Many Rising losses from securitized loans impact banks' income statements to exactly the same pitfalls degree as on-balance-sheet loans; they are merely recorded in a different place on the here income statement. Rising securitized loan losses reduce non-interest income while on- balance-sheet losses impact the loss provision. There should be equal loss reserves for securitized and on-balance-sheet card loans. Yet, in fact, there are far fewer reserves taken for securitized card loans. A check of each company's specific reserves, would show that the monolines are especially weak here. Equity capital in full should be provided for securitized loans. Again, monolines are weaker. Higher losses on securitized pools of loans could result in expensive additions to credit enhancements which secure the bonds backed by the cards. Under a very pessimistic scenario, the cards could come back on the books of an issuer--thus clearly manifesting the need for capital and reserves and negatively impacting earnings as well. Finally, such additional enhancements are embarrassing to the card issuer and can severely tarnish its credit rating. Complex Analysis We believe card loan quality will be an issue this year and for a number of years to come. Our focus in the future will be on individual companies as they face the significant challenge represented by the deterioration of card loan quality. Perhaps the SEC should introduce disclosure rules for the benefit of shareholders of BHCs and other financial institutions where the credit card is a material business. 18 09/29/98 TUE 16:03 FAX 16174966118 HARVARD LAW 020 Bank Credit Card Outlook Gerard Klauer Mattison & Co., LLC OUR SURVEY ASKS: WHY ARE PERSONAL BANKRUPTCIES RISING NOW? During the last three to six months, most banks have noted that the proportion of total credit card losses attributable to bankruptcies is rising. At the same time, total losses were escalating as well. Regarding bankruptcies, bankers have no explanation for the rise, or forecast for which accounts would go bad. As a result, we conducted an informal survey of approximately 30 personal bankruptcy attorneys in five large states asking the question: Why are personal bankruptcies escalating now? Initially, we spoke to a number of leading law professors with expertise in bankruptcy law. We followed that with either a telephone call or in-person survey. A Deviation From The Historical Norm Historically, bankruptcy and card losses have followed a cyclical trend, essentially tracking rises in unemployment, as well as other contributing causes. Exhibit 8 illustrates that Attorneys: increases in 1990 and 1991 were cyclical. The vast majority of attorneys surveyed attributed Easy bank credit the cause of escalating current personal bankruptcies to the case of obtaining credit, in behind amounts well beyond the individual's annual income. Blizzards of pre-approved credit cards bankruptcy have saturated the mails in recent years. Creditworthiness took a back seat to marketing escalation cards, in many cases to persons already possessing five to 10 cards. Not Caused By the Business Cycle. We believe casy credit has contributed to the rise in bankruptcies--irrespective of the business cycle, which has been rather steady in 1995-1996. It seems obvious to us that if the person earning $30,000 annually were not allowed to have credit in an amount equal to or greater than his/her annual income in credit card lines, the likelihood that he would go bankrupt would be severely diminished. Monthly debt service payments for individuals at this income level became impossible to meet in 1995-1996. In sum, the historic correlation between bankruptcies and the business cycle has now been broken (Exhibits 7, 8 and 9). We believe the rise in 1985-1986 bankruptcies might be a predecessor of today's situation. There were heavy card mailings at that time as well. Reap What You Sow. It normally takes 18 months from the time a card is issued until it goes into default. An extended period of time must now be factored into that year-and-a-half general rule of thumb, because multiple cards and higher credit limits allow borrowers to delay, but usually not prevent, the day of judgment. Thus, the heavy 1994-1995 mailings are just now being harvested, and we would expect loss ratios to rise from first-quarter levels (Exhibit 5)--even without a recession--through 1997. Bankruptcies should continue to rise as a percent of losses, but non-bankruptcy charge-offs should rise as well because some debtors do not want to declare bankruptcy. Structural Change With No Past Reference Point. To sum up, banks and other credit card issuers flooded the nation with credit, and this has produced a not-so-surprising rise in charge-offs--from both bankruptcies and defaults not connected to bankruptcy. This is a structural change from the past. In our opinion, the past can no longer be used as a guide to future losses in the card business. 19 09/29/98 TUE 16:04 FAX 16174966118 HARVARD LAW 021 Bank Credit Card Outlook Gerard Klauer Mattison & Co., LLC EXHIBIT 7: QUARTERLY CONSUMER BANKRUPTCY FILINGS (1Q94-4Q96E) Three Consumer % Change Months Filings * From Year From 3 Mos Ended (000) Prior Prior 3/31/94 193 NA NA 6/30/94 203 NA 5% 9/30/94 196 NA -3% 12/31/94 189 NA -3% 3/31/95 199 3% 5% 6/30/95 222 10% 11% 9/30/95 221 13% 0% 12/31/95 232 22% 5% 3/31/96 252 26% 9% 6/30/96 E 280 26% 11% 9/30/96 E 295 33% 5% 12/31/96 E 320 38% 8% NA - Not available. Source: Gerard Klauer Mattison & Co., LLC estimates and The Administrative Office of the US Courts' records. EXHIBIT 8: ANNUAL CONSUMER BANKRUPTCY FILINGS (1982-1996E) Full Consumer % Change Year Filings* From Prior Total (000) Year 1982 311 NA 1983 287 -8% 1984 284 -1% 1985 341 20% 1986 449 32% 1987 496 10% 1988 550 11% 1989 616 12% 1990 718 17% 1991 872 21% 1992 901 3% 1993 813 -10% 1994 781 -4% 1995 875 12% 1996E 1,147 31% + Consumer fillings represent over 90% of total bankruptcies and exclude business filings. They include Chapter 7 (majority) and Chapter 13. NA - Not available. Source: Gerard Klauer Mattison & Co., LLC estimates and The Administrative Office of the US Courts' records. 20 09/29/98 TUE 16:04 FAX 16174966118 HARVARD LAW 022 Bank Credit Card Outlook Gerard Klauer Mattison & Co., LLC EXHIBIT 9: BANKRUPTCIES AS A PERCENTAGE OF GROSS/CARD LOSSES MAR 91 TO MAR 96 50% 40% 30% 20% 10% 0% Mar-91 Jun-92 Jan-93 April July Oct Jan-94 April July Oct Jan-95 April July Oct Jan-96 Source: RAM Research Group. 21 09/29/98 TUE 16:04 FAX 16174966118 HARVARD LAW 023 Gerard Klauer Mattison & Co., LLC Bank Credit Card Outlook Our Bankruptcy Survey Findings The Bankruptcy Law Has Not Become More Favorable To Debtors. Contrary to conventional wisdom, the 1994 revisions to the Federal bankruptcy law strengthened creditors' rights to disallow all debts incurred within 60 days of filing. Although the bankruptcy statute is Federal law. each state dictates the amount of exempt property that creditors cannot claim. Florida and Texas are the most debtor-friendly states. The Stigma of Bankruptcy is Diminishing. With so many doing it, and morality in the US down, more are willing to declare bankruptcy. It costs about $700-$1,000 to go through personal bankruptcy proceedings. and the 7-10 year wait which creditors say one must endure for credit to be restored seems not to be a deterrent or even true. In fact, the real wait for new credit is 1-3 years, owing to the abundance of lenders willing to take on a person with a clean start. One attorney told us that two national department stores even show up in court to grant new credit to filers. There are 10,000 consumer lenders in the US. Individuals who have gone bankrupt usually get credit in one to two years after filing. There are also examples of second filers for bankruptcy--six years apart--which proves you do get credit a few years after filing. Lawyers Are Aggressively Advertising. Radio, TV and newspapers today are filled with ads detailing the ease of bankruptcy and how you can extinguish all of your debt, keep possessions and regain credit. From start to finish. it takes two to three months to complete a bankruptcy. Some lawyers seek out weak debtors to convince them that bankruptcy should be pursued--the burden of payment being too painful for them to handle. Banks don't spend much time or money trying to collect from debtors who have gone bankrupt--it is expensive and futile. Few Are Refused. Lawyers tell us that judges approve over 99% of bankruptcy filings. The law is very consumer friendly and designed to give overburdened debtors a fresh start in their finances. Many Have No Choice. As mentioned earlier, many debtors cannot possibly begin to pay back what they owe. They find a bankruptcy attorney quickly, and the bankers do not even contest their claims in court. Attorneys instruct debtors to stop servicing debt as soon as bankruptcy is sought, which helps to explain why bankruptcy occurs so much on performing loans. Debtors Calculate That Bankruptcy is the Better Route. Many could never get out from under their debt burden without bankruptcy. Fraud Not a Major Factor. We explored this issue and found strong agreement that most people declaring bankruptcy under Chapter 7 liquidation of assets (70% of cases), or Chapter 13 for the repayment of some debts over, say, five years, could be characterized as well-intentioned people, whose purchases were household items, not luxuries. Although there is some fraud, the basic culprit appears to be too much credit and the ease of availability. A Leading Indicator of Bank Card Losses. Data are available quickly from Federal courts regarding the number of personal bankruptcies filed per week, and per month. It is our belief that by the time the creditors are notified, record, and actually charge-off a claim, it could take several months. Thus, we believe the escalation in filings in 1Q96-- plus our gathered data for April and May--will show up as higher charge-offs on the lenders' books in 2Q96, 3Q96, etc. Profile of a Personal Bankruptcy Filer Based on our anecdotal survey, here are some key attributes of personal bankruptcy filers: 22 09/29/98 TUE 16:05 FAX 16174966118 HARVARD LAW 5 024 Bank Credit Card Outlook Gerard Klauer Mattison & Co., LLC Age Range. 30-40. Annual Income. $30,000. Credit Card Debt. $25,000-$40,000, but often 50%-150% of annual income. Number of Cards. 10-12 or more, with full credit line drawn at about $4,000 per card. Clearly Debt Service. Assuming gross salary of $30,000, $1,650 monthly disposable income, too much debt and $25,000 in card debt at 15% APR; debt service monthly is $312 interest and $750 for income level principal--assuming 3% of debt (minimum) must be paid per month. Total = $1,062 or 64% of disposable income, leaving $600 monthly for all other bills, including mortgage and auto. Solicitations Continue. Several attorneys reported to us that even while in the process of filing bankruptcy, unsolicited card offers were still arriving in their clients' mailboxes. Many Do Not Lose Possessions. Under a Chapter 7 (liquidation) it is quite common for a debtor to come away losing no assets while newly debt free. This is especially true of renters, not homeowners. Chapter 13 bankruptcies involve future scheduled payments of some debts in order to retain assets, such as homes, autos, etc. However, the vast majority of personal bankruptcies are Chapter 7s. Record Levels of Bankruptcy. Several attorneys told of record monthly business in early 1996, which they attribute directly to the flood of credit cards. Proliferation of cards may have delayed the bankruptcies but they ultimately drove the horrower into the attorney's office. Our anecdotal data for April and May 1996 indicate a continuation of year-over-year (versus 1995) increases of 25%-35%. 23 09/29/98 TUE 16:05 FAX 16174966118 HARVARD LAW 025 Bank Credit Card Outlook Gerard Klauer Mattison & Co., LLC CREDIT CARDS ARE INHERENTLY RISKIER THAN MOST OTHER BANK LOANS The more traditional, conservative senior bank credit executives were never fond of credit card lending. They think credit card lending is a risky form of loan that produces losses well above the loss rates of other consumer and commercial loans. Some Rewards Are Worth The Risks Over time, the pleas of the purists and traditionalists were overwhelmed by the alluring profitability of the card business, namely ROAs in the 300 basis points (oΓ more) range and ROEs above 50%. Just about everyone jumped in. Who could resist? Without cards, banking is a close to 100 basis point ROA business today. In other words, returns on cards were triple those of all other businesses together. Declining card profitability is thus a threat to industry profitability. Many risks Card fans in bank management believed that although losses were multiples above other bank bankers failed loans, at lending rates of 18%-20%, a loan loss of 3% or so was merely a manageable to foresee business expensc. The exposure they failed to sec was that: (1) the loss rate could escalate beyond expectations; (2) lending rates and annual fecs could erode due to competition; (3) operating expenses relating to marketing and collections could rise sharply; and (4) growth rates in outstandings above 20% per year could not go on forever. The result has been a severe erosion of profitability-in some cases by 50% in 1996 versus the 1993 peaks. The key point is that there remains some further risk of escalation of loan losses which could take ROAs to 150 basis points and ROEs to 18%--or even lower in 1996. We believe the pendulum is swinging to extremes not expected within the industry. Particularly, ROEs could drop as regulators ask for more equity in the card business. The Unique Risks In Cards It is our thesis that bank card losses in 1996-1997 could well exceed most worst-case expectations. Examining the risk characteristics of card lending should help us understand why loan losses could reach unprecedented highs for the industry over the next few years. Unsecured. There is no collateral to protect the lender. Only 10% is recovered. Impersonal. With national card solicitation, cards arrive in mailboxes from banks whose names are often hard to find on the literature. There is no customer relationship or loyalty with the bank (which could discourage default). There is no personal banker. Often no other products of that bank are used. Card is Low Priority In Mind Of Debtor. If a borrower is in financial difficulty most of his "junior debt" debts have higher priority than his card payment. Mortgage, car, home equity loans, insurance, etc., all come first. Thus, we could characterize the card as de facto "junior debt" with no collateral. Many borrowers even view their card lines of credit as present or potential "unemployment insurance funds." Lack of Effective Control. This is a large problem. Lending is done without full. verified, information on the borrower's total income, debts, employment, etc. Preapproval is very risky. Borrowers can obtain additional huge lines of credit after a bank makes what it believes is a prudent loan. Say Bank A lends $5,000 to a person earning $35,000 annually--a prudent loan. But six months later he could have six cards with $25,000 in total credit. The original loan now looks weak. Other reasons why banks are not in full control of card lending are: (1) cards lack a maturity date; (2) it is hard to call in such a loan; and, (3) bankruptcy is easy and cannot be anticipated or prevented. 24 09/29/98 TUE 16:05 FAX 16174966118 HARVARD LAW 5. 026 Bank Credit Card Outlook Gerard Klauer Mattison & Co., LLC Documentation Is Not Thorough. We have learned that many card lenders do not verify or even ask for employment status. This also applies to annual income, which one banker told us was "too expensive" to verify. Thus, lenders have no debt/income ratios-- the essence of how to know if any borrower has too much credit. And, credit bureaus are unable to pick up all debts of individuals, e.g., from credit unions, 401Ks, mortgage companies, smaller retailers, loans from individuals, etc. In sum, the card business is low documentation, or no documentation, lending. Too Much Reliance on Technology-Driven Scoring Systems. Good "old-fashioned" credit underwriting with verification of key data seems less common today than 10 years ago. Revolving Nature. Banks discourage large pay-downs of principal, giving borrowers a signal that they should not do so. Minimum monthly payments of only 2% of principal are common. In short, amortizing loans are far better for bank loan quality because if the borrower needs more credit, he has to reapply and be underwritten again. It's been calculated that at 2% per month it could take 34 years to pay off a $2,500 loan with total payments of over 300% of original principal. Too Many Lenders. With roughly 7,000 VISA and MasterCard issuers, borrowers have easy access to excessive card credit. High rates of return in cards have attracted too many players, flooding the market and making default more likely. Consider how many other ways there are for consumers to get credit. Other Consumer Credit On a relative basis, the following loan categories are far less risky for lenders: First mortgages Second mortgages (amortizing) or home equity loans (revolving) Auto loans--direct and indirect Boat loans Student loans Amortizing installment loans (unsecured) Revolving credit lines attached to checking accounts Other types of collateralized loans using real estate, marketable securities, etc. 25 09/29/98 TUE 16:06 FAX 16174966118 HARVARD LAW 027 Bank Credit Card Outlook Gerard Klauer Mattison & Co., LLC BANKERS' VIEWS ON THE CARD BUSINESS: THEY'VE BEEN CAUGHT OFF GUARD In today's environment, bankers face the dilemma of either expanding this declining profitability business or curtailing it-also with adverse earnings implications. Bankers are concerned with long-term market-share ramifications versus the nearer-term challenges that may come from slower growth. But recent high growth could create new waves of losses in 1997-1998. Cards are likely to grow in importance in our payments and credit systems. Industry executives now seem to be divided into three camps: Business As Usual. No problem facing their own card strategy and outlook. This could be 10%-20% of the industry. It's Time For Caution. While no crisis is on the horizon, it is time for slowing card growth, underwriting loans more conservatively and reducing objectives regarding ROA and ROE, in the card business. This school of thought says the best days of card profitability are gone and more "defensive" and less "offensive" measures are called for. This is the developing industry consensus. A Loan Quality Crisis Looms. Still a minority, but a credible one in our view, is the group that is aggressively planning to reduce growth, raise lending standards and "cleanse" the existing portfolio to reduce the odds of heavy loan losses. This thinking assumes in part that a recession is not too far away and in part simply is concerned with the sharp rise of loan losses despite very little economic change and lending rate competition. It is obvious to us that the market is saturated and has too much capacity now. Too much growth invites trouble. Interestingly. few large or even medium-sized players in the card business have exited completely by selling their portfolios. This is the best sign that fear is not yet rampant or growing in lenders' minds despite the clouds we see on the horizon. What Should Bankers Do, If Our Thesis Is Correct? Here are our recommendations to the larger participants in the credit card business--those doing business nationally or outside their natural customer base or geographic territories. There could be from 50 to 100 of these. We recommend Recognize the New Realities. Card lenders must accept that the card business has lost tighter lending its luster and high profitability. Greater caution is called for. We believe given the nature standards and levels of card losses, an adverse structural change is taking place, and the past can no longer be used as a guide to future losses in the card business. Make Loan Loss Control the Number One Objective of Credit Card Management. In our view, these types of actions are the most appropriate in protecting the earnings and overall financial health of credit card issuers. As Exhibit 1 shows, potential earnings reductions are likely to be material if losses should escalate from current levels. And this strategy will save money on the marketing of new cards. Reduce Loan Growth Objectives. True, this would reduce earnings, but by a lesser amount than if volume grew at historic 20%-plus annual rates and resulted in very high net loan losses in a year or two. We believe there is no choice but to cut loan growth. Consider Outright Sale of Card Loan Portfolios. We have already seen examples of this practice, which hastens disposal of lower-grade loans. Norwest now has some loans on the market for sale, and BK will likely be selling its AFL-CIO card in 1Q97. 26 09/29/98 TUE 16:06 FAX 16174966118 HARVARD LAW 028 Bank Credit Card Outlook Gerard Klauer Mattison & Co., LLC Stop Preapproved Mailings. These seem to be fraught with risk due to the reduced amount of screening and because the market is already saturated with cards. We have found that credit bureau data is incomplete, and in-house credit underwriting is far from rigorous and somewhat outdated. Reprice Delinquent Borrowers. Some lenders have begun to raise lending rates on weaker credits by 400-500 basis points in order to be compensated for higher perceived risk. We think this could be an imprudent move, since it could drive good customers to other lenders with lower rates or it could force a borrower into default or bankruptcy due to a rapid escalation of his monthly interest payment. For example, a 400 basis point increase from a 14% APR, to 18%, is a 29% increase in interest expense per month. Generally, we believe it is best to reduce rates for overextended borrowers. Reduce Lines of Credit. Most card holders actually borrow well below 50% of their lines of credit (sec Exhibit 4). Cutting back on these, selectively, could reduce the amount of loss, should the person be headed for bankruptcy or default. Cutting unused lines could remove a lot of the slack in credit availability. Review the Portfolio More Often. Getting credit bureau reports more frequently would be very helpful, for example, in identifying multiple card holders who formerly had fewer cards and who have undergone other changes. More Underwriting and Less Marketing. There are many manifestations of more cautious card loan underwriting. In our view, cards have been too heavily marketed in recent years and not sufficiently underwritten. We think the need now clearly exists for the pendulum to swing sharply toward underwriting, "preventive maintenance" which wc believe will pay off handsomely. If this were done, the lenders' balance sheets and earnings would be stronger, and the borrowers would have discipline forced upon them. There would be fewer bankruptcies, and the national economy would be in better balance with respect to consumer spending not being artificially stimulated by loose bank credit--or consumer spending reduced by banks' heavy-handed tightening of card credit. Some More Prudent Than Others We are not suggesting that all credit card lending is done with- limited care and prudence. Good times don't Many lenders spend heavily on selecting the better credits to solicit--and do it well. Some test bad lending banks get updated credit bureau information on borrowers annually, some semiannually, some quarterly, and a few truly prudent banks every month. These measures can limit losses somewhat, but not enough to allow any major participants to come through the current cycle unscathed. We believe credit cards are simply high risk and we are in the process now of realizing their implications--and which lenders execute well and not as well. We believe that poor lending practices cannot be tested or revealed in good times. We believe that lenders will soon realize that the good times are gone. 27 09/29/98 TUE 16:06 FAX 16174986118 HARVARD LAW 029 Bank Credit Card Outlook Gerard Klauer Mattison & Co., LLC EXHIBIT 10: DEBT SERVICE PAYMENTS As A PERCENTAGE OF DISPOSABLE PERSONAL INCOME 18 18 With Lease Payments 17 17 16 16 Total 15 15 14 14 13 13 12 12 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 - Debt service includes consumer installment, first mortgage payments. All plots are quarterly (last plot 4Q95): estimated lease payments start at 1Q91. Source: Gerard Klauer Mattison & Co., LLC estimates and The Federal Reserve Board. 28 09/29/98 TUE 16:07 FAX 16174966118 HARVARD LAW 030 Gerard Klauer Mattison & Co.. LLC Bank Credit Card Outlook EXHIBIT 11: LARGEST GENERAL PURPOSE CARD PORTFOLIOS IN THE US By Receivables at 3/31/96* Outstandings Change Rank Issuer (billion) vs. 3/31/95 1. Citibank $42.6 +10% 2. Discover 27.3 +20 3. MBNA America 26.3 +37 4. Chase Manhattan 23.1 +17 5. First USA 18.3 +53 6. First Chicago/NBD 17.0 +42 7. AT&T Universal 13.4 +13 8. Household Bank 12.8 +21 9. Advanta 11.7 +69 10. American Express 10.2 +23 11. Capital One 10.1 +27 12. Bank One 9.6 +35 13. Bank of America 9.0 +15 14. Bank of New York 8.8 +18 15. NationsBank 7.7 +36 16. First Union 5.7 +40 17. Wells Fargo 5.0 +36 18. Providian 4.9 +44 19. Chevy Chase FSB 4.8 +25 20. Wachovia Bank 4.6 +13 21. Associates National 4.5 +26 22. First Bank System 4.0 +17 23. USAA Federal Savings 3.4 +14 24. Mellon Bank 2.9 +21 25. First National of Omaha 2.6 +11 *Managed basis. Source: The Nilson Report. 29 09/29/98 TUE 16:07 FAX 16174966118 HARVARD LAW 1 031 Bank Credit Card Outlook Gerard Klauer Mattison & Co., LLC The following companies were cited in this report: Price Company Ticker (close 6/10/96) Rating Advanta ADVNA 52.13 Not Rated Banc One ONE 36.25 HOLD Bank of New York BK 53.38 BUY BankAmerica BAC 76.00 BUY Bankers Trust BT 75.50 HOLD Boatmen's BOAT 40.25 HOLD Capital One COF 30.13 Not Rated Chase Manhattan CMB 72.13 BUY Citicorp CCI 83.50 BUY First Chicago/NBD FCN 42.50 HOLD First USA FUS 57.75 Not Rated MBNA KRB 31.00 Not Rated JP Morgan JPM 85.63 BUY NationsBank NB 82.13 BUY Norwest NOB 34.75 BUY PNC Bank PNC 30.50 HOLD Wachovia WB 43.63 HOLD Wells Fargo WFC 244.63 BUY Other Publicly-Owned Card Issuers Among the Top 25 (not rated): Price Company Ticker (close 6/10/96) American Express AXP 45.63 Chevy Chase FSB CCSBP 30.25 Dean Witter Discover DWD 60.87 First Bank System FBS 59.00 First Union FTU 60.63 Household International HI 70.25 Mellon Bank MEL 58.00 30 09/29/98 TUE 16:07 FAX 16174966118 HARVARD LAW 032 Gerard Klauer Mattison & Co., LLC is a market maker in the security of this company and may have a long or short position. ADDITIONAL INFORMATION ON SECURITIES MENTIONED HEREIN IS AVAILABLE UPON REQUEST Although the Information in this material has been obtained from sources that Gerard Klauer Mattison & Co., LLC (the Firm) believes to be reliable, we do not guarantee its accuracy and such information may be incomplete or condensed, All opinions and estimates herein constitute our judgment as of this date and are subject to change without notice. This information is not Intended to be used as the primary basis of investment decisions, and because of individual client objectives it should not be construed as advice designed to meet the particular investment needs of any investor. This material is for Information purposes only and is not an offer or solicitation with respect to the purchase or sale of any security. The Firm makes a market in the securities of many of the companies mentioned in this material. From time to time, the Firm and/or its directors, officers, employees, or members of their immediate families may have a long or short position in the securities mentioned herein and may, as principal or agent, buy or sell such securities, or derivatives (including options) thereof. The Firm (or persons related thereto) may from time to time perform investment banking or other services for, or solicit investment banking business from, any of the companies mentioned for a fee. For some of the companies mentioned, the Firm has acted as a manager or co-manager of public securities offerings within the past three years. ©COPYRIGHT 1996 GERARD KLAUER MATTISON & CO., LLC file UNIVERSITY VERSITAS bankemple 7878 R CREIGHTON UNIVERSITY School of Law June 30, 1999 Ms. Nicole Rabner Special Assistant to the President on Domestic Policy The White House 2nd Floor, West Wing 1600 Pennsylvania Avenue Washington, D.C. 20500 RE: S. 625 Bankruptcy Reform Dear Ms. Rabner: We applaud Hillary Clinton's work on bankruptcy reform and hope the enclosed materials will be of some help. S. 625's advocates claim that many consumers who could repay their debts instead abuse the bankruptcy system by filing Chapter 7. S. 625's draconian provisions, some say, are necessary to curb this widespread abuse. No one disagrees that those who can pay should. However, the truth is that "can-pay debtors" are few and far between, as our original research shows. With funding from the American Bankruptcy Institute, we applied means-testing to a random sample of more than 1000 Chapter 7 cases from seven districts across the nation. We found that only 3.6% of the sample debtors would have been barred from Chapter 7 under the legislative formula. Ninety-six percent of the debtors were clearly unable to repay even 20% of their unsecured debt under the creditors' own formula. This outcome casts doubt on the wisdom of imposing complex and costly new burdens on all Chapter 7 debtors, their counsel and the courts, in order to catch so few apparent abusers. We enclose a copy of our recent article on means-testing, as well as a short piece which recently appeared in Creighton's Windows magazine. One feature of the law review article which may interest you is Appendix A at pages 62-72, where we profile each "can-pay" case in the sample. These profiles put a human face on the numbers, and show that some of these alleged abusers are unlikely to succeed in Chapter 13. 2500 California Plaza Omaha, Nebraska 68178 (402) 280-2872 FAX: (402) 280-2244 (800) 282-5835 http://www.creighton.edu/CULAW Ms. Rabner June 30, 1999 Page 2 We would be happy to answer any questions you or Mrs. Clinton may have. Our phone numbers are (402) 280-3154 (Culhane) and (402) 280-5515 (White). Yours very truly, Marianne Culhane Marin B. Culture Professor of Law Michaela m. white Michaela M. White Professor of Law Enclosures Clinton Presidential Records Digital Records Marker This is not a presidential record. This is used as an administrative marker by the William J. Clinton Presidential Library Staff. This marker identifies the place of a publication. Publications have not been scanned in their entirety for the purpose of digitization. To see the full publication please search online or visit the Clinton Presidential Library's Research Room. AMERICAN BANKRUPTCY INSTITUTE LAW REVIEW TAKING THE NEW CONSUMER BANKRUPTCY MODEL FOR A TEST DRIVE: MEANS-TESTING REAL CHAPTER 7 DEBTORS Marianne B. Culhane Michaela M. White Published in conjunction with St. John's University School of Law VOLUME 7 NUMBER 1 SPRING 1999 Clinton Presidential Records Digital Records Marker This is not a presidential record. This is used as an administrative marker by the William J. Clinton Presidential Library Staff. This marker identifies the place of a publication. Publications have not been scanned in their entirety for the purpose of digitization. To see the full publication please search online or visit the Clinton Presidential Library's Research Room. CREIGHTON UNIVERSITY SPRING 1999 CRISIS LOOMING? Nursing Shortage Becomes Critical Bankruptcy and 'Means-Testing' Back to the Big Bang? Santee Dentist BASIC PRINCIPLES OF BALANCED BANKRUPTCY REFORM This year, approximately 1.4 million families will file for consumer bankruptcy, a statistic that may be puzzling at first glance given the thriving economy. But, the reality is that not all Americans are sharing equally in these economic good times. While many upper-income families have benefited, the incomes of middle- and lower-income families have stagnated and even declined in real value. Too many working-class Americans live from paycheck to paycheck (or close to it), vulnerable to any unforeseen calamity that easily can lead to insolvency. Academic research reveals that, as a group, the debtors who file for bankruptcy in the mid-1990s are worse off than their counterparts who filed in the early 1980s. Their incomes are lower, and their debt loads are higher. Consider, for example, the 41.7 million Americans with no health insurance and the 31 million Americans that have inadequate coverage. Just one accident or significant medical emergency can mark the difference between solvency and insolvency. For the millions of Americans facing stagnating wages, the loss of a job, or re-employment at lower wages, simply making ends meet can be a daunting challenge. And, for families facing divorce or separation, the cost of maintaining two households can force economic failure. As these working families carry more short-term, high interest debt, they are more at risk of financial failure. Because they have virtually no savings and already have incurred as much debt as they can repay, they have no cushion to help them through a crisis. For a family with debt, any set-back -- the loss of a job, an uninsured medical emergency, or a divorce -- can put them over the edge of financial stability. The bankruptcy system is designed to work for these honest, hard-working Americans who face extraordinary financial difficulty. Why then, is Congress rushing through H.R. 3150 and S. 1301, sweeping bankruptcy reform measures that would deny the protection of the bankruptcy system to these working class people who so desperately need it? In an open letter to Congress, 110 bankruptcy judges raised this very issue when they wrote, "we believe that these bills are too important and their proposed changes too sweeping to be acted upon without thorough consideration. We are alarmed by how little study appears to have been given to the pending bills " Fifty-seven leading law professors from across the country wrote a similar letter, asking Congress to conduct a more careful study of the far-reaching effects of the pending legislation. Standards for Balanced Bankruptcy Reform A fundamental tenet for any major reform initiative is that Congress should not create more problems than it solves. In order to determine whether the pending bankruptcy reform proposals (S. 1301 and H.R. 3150) meet this test, the bills should be considered in the context of the following basic standards: The reform should not effectively deny access to bankruptcy relief for honest debtors. The proposed measures, which would introduce into the bankruptcy system for the first time the concept of "means testing," would make it much more difficult for financially distressed lower- and middle-income Americans to obtain bankruptcy relief. For example, S. 1301 would establish a bright line test under which a court would be required to consider, among other factors, whether a debtor could afford to repay at least 20 percent of his or her debt. If so, the debtor would have to make the payments. The means testing under H.R. 3150 is even more onerous. If the means testing requirements are adopted as proposed, they will give the credit industry enormous leverage over debt-laden consumers, threatening them with challenges to the test as a way of trying to force payment. Furthermore, the means test will work against honest, lower income people while potentially working to the advantage of well-advised, wealthier debtors. These people may be in a position to incur more debt, adjust expenses or walk away from their jobs in order to circumvent the means test. The reform should not encourage abusive litigation tactics that will add to the cost of the bankruptcy system. A top priority of this Congress is reducing the litigious nature of American society. Contrary to that clear policy objective, S. 1301 and H.R. 3150 would significantly increase the litigation associated with bankruptcy by, for the first time ever, permitting creditors to file motions challenging debtors' ability to pay, and to litigate even frivolous claims of fraud in Chapter 13 cases. Although creditors can easily absorb the cost of this increased litigation, financially-strapped debtors cannot. Creditors may use their considerable leverage to force debtors into repayment agreements, no matter how slim the chances that the debt will be repaid. Debtors will not be able to respond to the sophisticated legal maneuvers that can be made on behalf of mammoth financial institutions. The result? Many debtors will have to forgo the bankruptcy system and risk losing their homes, automobiles and other possessions as they are forced to pay off other debts. At the same time, the increased litigation encouraged by S. 1301 and H.R. 3150 will drive up the costs of the bankruptcy system to the American taxpayer. The reform should not expand or create new and inefficient government bureaucracies. The significant increase in consumer bankruptcy litigation that would result if the pending measures are adopted would impose tremendous new burdens on the judicial system. The elaborate investigation into every aspect of a debtor's income and expenses contemplated by the legislation would cost enormous sums of money to administer. The number of judges, trustees, court clerks and attorneys would increase accordingly. Dramatically increasing the bottomline will be the costs associated with the audit provisions of the bill. Section 307 of S. 1301 calls for no fewer than one in 50 cases in each judicial district to be randomly selected for audit by independent certified public accountants or independent licensed public accountants. (Even the IRS audits only one in 1,000 tax returns.) Congress should carefully consider whether it is prepared to have the taxpayers of this country essentially foot the bill for having the U.S. government serve as the collection agency for the banking industry, particularly since this industry is fully capable of changing its own lending practices to reduce losses caused by high risk lending. The reforms should not reward irresponsible lending practices. The fruits of irresponsible lending practices are being harvested in the form of increased bankruptcy filings over the last several years. Under the pending measures, a significant portion of credit card debt would be immune from bankruptcy. As has been pointed out by economists, such a major shift in bankruptcy laws would remove all normal economic disincentives for engaging in high-risk lending. As it now stands, creditors are fully capable of reducing their bankruptcy losses without government intervention. The problem is that high-risk lending is high- profit lending. Banks borrow money from the federal government at rates ranging from 3.5 to 6 percent and then lend it out to consumers at rates of 15 and 20 percent. This means is that creditors are encouraged to seek out people who are most likely to carry big balances -- the bigger the balance, the more interest they pay. While that kind of lending may pay off in the short term with higher profits, credit issuers know that it cannot be sustained. The reform should not eviscerate the privacy rights of debtors. The American public is rightfully concerned about the loss of privacy and the threat of identify theft due to technological advances and other business practices. The bankruptcy reform proposals under consideration by Congress will create new opportunities for the invasion of privacy and for identity theft by mandating that tax information (including the return and all schedules) be made publicly available during the course of a bankruptcy proceeding. The reform should not further penalize families in crisis. Academic research demonstrates that those who turn to the bankruptcy system are the most vulnerable among American families. They have been the hardest hit by economic reversals and use bankruptcy as a way to avoid slipping even further down the economic ladder. The bankruptcy system should not further penalize them with the threat of losing their homes, of being evicted from their rental housing, or of losing the land of their family farm. S. 1301 and H.R. 3150 may very well create any one of these untenable scenarios. By putting credit card debt on equal footing with child support, alimony, mortgage arrears, and back taxes, America's most vulnerable families will be at further risk. ***** By any objective measure, S. 1301, the "Consumer Bankruptcy Reform Act of 1997" and H.R. 3150, the "Bankruptcy Reform Act of 1998," fail to meet the standards for balanced reform. These proposals should be rejected and Congress should undertake careful and deliberate study of their effect on the honest American families who turn to the bankruptcy system for relief. Solutions should be designed to target well-documented abuses, rather than unfairly burdening honest consumer debtors. FOR MORE INFORMATION, CONTACT: Mary Rouleau, Consumer Federation of America, 202/387-6121 Maureen Thompson, National Association of Consumer Bankruptcy Attorneys, 703/276-1116 April 1998

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Bankruptcy Reform - External Documents [1]

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url	https://catalog.archives.gov/id/24822259
naId	24822259
levelOfDescription	fileUnit
otherTitles	42-t-7763278-20121035S-003-010-2015
recordType	description
ocrSource	nara-archive

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