It is not too strong to say that the Credit Card Accountability Responsibility and Disclosure Act of 2009 has changed the basic premise of issuing unsecured, revolving consumer credit. But right now, believe it or not, is exactly the right time for more card programs. Members will benefit and CU bottom lines can be strengthened with the right mix of fairness, discipline and commitment.

How Have Credit Unions Done?

While there is a tendency to look first at the difficulties credit union card programs are facing these days, let’s start with some good news:

• Credit unions’ card program charge-offs are about half the level of the entire industry. This provides a lot of room to provide fairer rates and fees than banks.

• Bank issuers are shrinking. Some of this is by design as they purposely reduce lines and close accounts, but meaningful numbers of cardholders are trying to find alternatives. Some are coming to credit unions. In the past two years credit unions have added about 13 percent in card balances to reach an all-time high of about $35 billion.

• In addition to adding balances, credit unions have added about 500,000 accounts to their member relationships in the past three years.

• Credit unions continue to offer better rates and fees than banks. The average bank-issued credit card these days has rates of about 15 percent; credit unions average about 11 percent (though for some, this is too low to be profitable, as we will discuss).

While these are important strengths, we also need to be realistic about some of the challenges in our programs. Often first in every issuer’s mind these days (as it should be!) is working to make sure credit risk is well controlled. Indeed, credit union loss rates have increased to twice their historic levels, with few signs of improvement over the foreseeable future.

At the same time that credit losses have been increasing, the average credit union has been reporting ever-lower interest rates for its cardholders. Since 2000 the average credit union APR has decreased from about 13 percent to 11 percent. Luckily, cost of funds has come down even more and helped protect spreads a bit, though eventually funding costs do have to come back up. Forward-looking credit unions are starting to prepare for that in their card programs.

Credit losses have also had a material impact on credit union program performance. If we reduce interest spread by actual credit losses, then credit union card programs are seeing more downward pressures on their program bottom lines. In fact, note that:

• Once operating expenses, reward costs and other elements are taken into account, about one in four credit card programs is losing money. Few credit unions have room in their income statements and capital ratios to sustain money-losing programs.
• Whereas the average return on assets for card programs had been in the 3 percent to 5 percent range for years, today the expected returns are more in the 1 percent to 3 percent ROA range. Economic stresses and CARD Act implications have removed 200 basis points from the average bottom line and, for many, the costs have been even more dramatic.
• Most industry analysts forecast this change to become permanent; profitability in card programs is never again expected to return to pre-2007 levels.

We strongly recommend that the first thing a credit union must do is to make sure it understands its current program’s profitability. Include all the program elements, both revenue items and costs. Many issuers are surprised the first time they look at the results, but without this information it is impossible to prioritize resource use or feel confident that new card accounts are not damaging the credit union’s overall performance.

CARD Act Implications

A full analysis of CARD Act implications would require reading a document longer than this entire magazine. The text of the specific rules runs to hundreds of pages—and even so is still incomplete. While many of these requirements impact almost no credit unions, every issuer has had to make at least some changes. Those changes have required tremendous amounts of energy, time and resources.

For the purposes of this article I seek to highlight what I have found to be the most critical bottom-line issues for our clients, though please understand that in this venue the best I can do is offer highlights.

Impacts on Pricing & Payment Allocation (and Bottom Line)

Nearly everyone understands that the CARD Act prohibits repricing existing balances. The most an issuer can do now is reprice new purchases (after 45 days’ notice) and then allow the cardholder to pay down old balances (at a presumably lower rate) over time. Functionally this means that any credit union that decides that it needs more yield in its card portfolio will face about a four-year horizon to get to the new price level it is seeking. For example, if you are priced at 8.9 percent (very low) and realize you need to be at 11.9 percent to be profitable (still darn low in this market), your total portfolio yield will only get to that 11.9 percent after several years of cardholder payments.

This is because of the new payment allocation rules. Current rules force you to allocate principal payments (after interest and fees and the remaining “minimum” amount) to the highest rate balances first (the 11.9 percent portion). The effect of this is that very small portions of the 8.9 percent balance gets paid down each month, as most principal goes against the 11.9 percent balances. At a 3 percent minimum payment, the math works out to maybe 45 months to get rid of that low-rate principal. Does your interest rate forecasting and asset/liability modeling currently recognize this?

This is of special concern to fixed-rate issuers, because not only must a fixed-rate issuer consider if its pricing is appropriate and profitable in general, it must also start to incorporate long-term interest-rate forecasting into its credit card and overall asset/liability forecasting. If a credit union issues a fixed-rate card and its cost of funds increase (inevitable, eventually) it will have to increase rates at some point. Unless the credit union is perfect at predicting when to do this, it leads to compressed margins, profitability erosion and possibly repeated, sequential rate increases. Repeated, sequential rate increases require related cardholder communications, compliance tracking and servicing issues—with all that implies.

Fee Changes

Earlier components of the CARD Act rules effectively eliminated over-limit fees from the industry, which had important negative consequences on some bottom lines. The CARD Act rules just published go even further with material impacts on other penalty fees, which for credit unions mostly relate to late fees and inactivity fees.

For late fees credit unions will find it important to understand the “safe harbor” rules set by the act. But in general late fees will be limited to $25 per incident. Many credit unions are at or below that level, but for those that aren’t, resetting to the $25 level is likely required. (Exceptions that are far too detailed to parse in this article exist, but will be relevant to very few credit unions).

Also critical is understanding that late fees are now limited to “no more than” the minimum payment due. What this means is that if you have a minimum payment lower than your late fee, you have to be very careful. For example, if your minimum payment is 3 percent/$15 and the minimum payment due is $15, then you cannot charge a late fee of more than $15 regardless of your disclosed late fee. What’s more, if a cardholder is late because the payment check bounced, you cannot charge both a late fee and an NSF fee; you are limited to one penalty fee per incident.

Another change is the elimination of inactivity fees, which are fees that some issuers charge for having a card but not using it. Many came to implement such fees to help cover the costs of maintaining such accounts. Those fees are now disallowed, including any fee set up as an annual fee that is waived for card usage.

Repriced Account Tracking

One still unclear element of the CARD Act relates to the requirement that all issuers continue to monitor and report on all accounts repriced to higher rates since Jan. 1, 2009. Many issuers went through account-level repricing since that date and the rules now require that each such issuer continually track the identity of those accounts and potentially return those accounts to lower price points in the future. Again, the details are too detailed to cover here, but make sure your organization is in a position to do this. We are not operating in an environment where we should count on regulator dispensation; if the banks get wind of the National Credit Union Administration being gentle in ensuring CARD Act compliance, things will get very interesting very quickly.

Interchange Regulation

It may feel like the credit card industry dodged a bullet in recent interchange legislation, but it did still result in serious long-term implications to interchange revenues for all issuers. Credit card interchange will not, at least for now, come down to the degree that debit card interchange can be expected to, but once everything sorts out we can expect continued downward pressure on credit card interchange.

Even without the new regulation, long-term trends had purchase volumes migrating from credit to debit cards, particularly among the demographic segments most represented in many credit unions. To add to that, the new legislation will allow merchants to explicitly favor certain payment channels through such practices as providing discounts for non-credit card purchases or setting minimum and maximum charge amounts. As budget season is upon us, it is important that all issuers keep realistic expectations for credit card interchange. We recommend forecasting slight reductions year over year at this point.

A secondary impact will be that all issuers will need to re-evaluate the profitability of their reward credit cards. In our opinion there remains a need for reward programs in the credit union market, but we view it as a mistake to have placed a reward program on all card accounts.

One might gather from the above that we are pessimistic about the place of credit cards in credit unions. Quite the opposite! Now is a chance like never before to claim back this part of your member relationships. We offer these thoughts in an effort to help all credit unions understand the challenges that need to be met, so that, once met, each can grow its card programs prudently and profitably. Charging ahead blindly can send one off a cliff. But doing some analysis, creating a sound plan and then charging forward is the path to victory. And we want to see many victories.

Timothy Kolk, owner of TRK Advisors, has worked with credit card issuers for more than 15 years and has analyzed hundreds of credit card programs, including advising on credit card portfolio sales throughout the nation. He can be reached at tkolk@trkadvisors.com or 603.924.4438. More information is available at www.trkadvisors.com.