The Financial Brand Insights - Winter 2023

Consumers who make regular purchases and pay the statement balance in full each month carry a long-term loan (the average balance) while never paying interest. The credit card issuer only receives interchange revenue that is many times reduced by rewards program costs. Fixed vs. Variable Rates Often a financial institution will market a fixed- rate credit card, believing it offers a competitive advantage over other issuers who only have variable interest rate products. However, pricing revolving lines of credit with variable interest rates (credit cards) is a risk mitigation strategy, not a marketing strategy. Market stability is essential if you’re considering switching to a variable rate. For example, if your average annual percentage rate (APR) is 12% and prime is at 8.25%, you only have a 3.75% margin. If prime were to go back to 3.25%, your APR pricing would be 7%. In that scenario, we are likely in a recession and credit charge-offs would increase. Maintaining fixed rates and facing accelerated inflation and interest rates is a risk. Even if a financial institution has a variable APR, interchange and other fee yields provide no hedge against high- interest rates because they act as a fixed revenue yield. Repricing new balances is an option, but an uncertain one. It takes time to build and you cannot predict the reaction of all cardholders. Changing interest rates from fixed to variable can alter how consumers use credit cards and pay down their balances. The worst-case scenario is credit card default, which means interest rate hikes must be carefully considered before implementation. Adjusting for CECL Capital adequacy hinges on multiple factors. Current secured and unsecured loan portfolios can impact capital adequacy negatively if most of the lending is stuck at a fixed interest rate. However, changing to a variable rate during significant rate hikes can cause additional credit losses due to increased charge-offs

Program Assessment Operating a credit card program internally while maintaining profitability is a tricky balance. In some cases, credit card programs can end up costing more to run than they create in revenues, particularly if the customer base is prone to leveraging any rewards offered to an unsustainable extent. Key performance indicators (KPIs) that should be considered when managing products, creating new products and designing a growth strategy include weighted average APR, net interest margin and more. Using these KPIs to build a picture of capital adequacy, liquidity and profitability can assist in determining product strategy and pricing. Profitability Credit cards are high-maintenance, highly regulated and complex, and not all community banks and credit unions are fully equipped to manage the cost of origination and servicing. When considering overall profitability, qualitative decisions drive quantitative results to continue incoming revenue without incurring risk. The value of card issuing can swiftly burden the overall enterprise if the formula is not correctly developed to reduce exposure. This formula is an ongoing balancing act. The months ahead will continue to present credit card product exposure and risk challenges. Credit card delinquency is expected to increase as consumers face cash shortfalls from the prolonged high inflation environment, slower wage growth, the end of pandemic stimulus funds and expected increases in unemployment.

However, capital reserve increases to cover CECL erode available capital, impeding program growth and directly impacting net income. Community banks and credit unions face additional operational expenses related to credit card products and servicing, including: • Per account origination costs • Per account processing (fees paid to processors) • Per account services (both internal and external costs) • Professional services (including analysis, compliance and legal oversight) • Activity-based costs across accounts and cardholders Financial organizations are seeking to gauge future credit needs and how to anticipate and meet those needs in a rising rate environment. How higher credit costs impact capital adequacy and liquidity is part of this equation. consider the costs it takes to operate a program, such as: credit losses, fraud costs and servicing expenses. With the challenges of a potential recession and ongoing inflation, many issuers are trying to focus on reducing costs rather than making the investments they need to stay competitive . The biggest concern we’re hearing is around margin compression and liquidity. These institutions, particularly credit unions, fund their card loans from deposits. To keep depositors happy, they have to raise rates, which raises funding costs. There are going to be challenging years ahead from a profitability perspective. — Mitch Pangretic SVP and Director of Strategic Partnerships at Elan Credit Card Card issuers will have to work diligently to remain profitable in this environment and carefully

Credit card loans have a higher risk profile than any other loans on the balance sheet. Now is the time to perform due diligence on your credit card assets. Review product returns and consider the value being driven to the cardmember. Does the value outweigh your risk? It’s Time to Act Inflation rates, projected cardholders’ debt, CECL requirements, methodologies and the risk of increased credit card exposure should encourage leadership to reevaluate how to manage credit card issuance and servicing. If you’re contemplating the challenges and opportunities above, a credit card program evaluation is essential. View sources and a full list of KPIs and liabilities to consider when evaluating your credit card program at . ▪

The Risks of Unbalanced Assets and Credit Card Program Management

Learn about the risks of unbalanced assets, costs of credit card program management, with KPIs and liabilities to consider when evaluating your program’s profitability by downloading The Risks of Unbalanced Assets and Credit Card Program Management .

and other consumer behavior shifts. The CECL implications for a financial

organization’s credit card portfolio should be thoughtfully predicted and accounted for on the balance sheet. This capital must be reserved in accordance with the most recent financial accounting standards.






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