The pandemic’s economic upheaval is unprecedented, but previous downturns offer insights on how credit card portfolios might respond.
In many ways, the economic impact of the COVID-19 pandemic bears little resemblance to the circumstances that produced the Great Recession of 2008-2009. Still, credit card managers can apply some lessons learned from the last downturn to short-term forecasts and planning to manage their portfolios.
Realistically, credit unions should prepare for lower revenue generation from their credit card portfolio for at least the next two years, cautions Tim Kolk, owner of TRK Advisors, Peterborough, New Hampshire. He cites a variety of factors behind this forecast: The prime rate is down 225 basis points from the end of 2018, which means yields have decreased 200 basis points on average. Even before the pandemic, credit unions’ charge-off rates had been creeping up for years, from 2.5% to the range of 3 to 3.5%.
“Credit risk is up. Yield is down. And depending on how quickly people rebound their spending and balances, that too will impact revenue,” Kolk says. “Credit card spending was nearing pre-COVID levels by the end of 2020, so interchange revenue may be back to close to where it was, but everybody’s balances are lower than they were before the pandemic. Ninety-five percent of credit unions had smaller credit card portfolios heading into Q3 2020.”
After the Great Recession, it took nine years for balances to get back to where they were in the preceding boom, he adds.
Managing Credit Risk ‘Baked Into’ the Portfolio
Amid continued economic uncertainties in the current environment, Kolk recommends that card managers monitor credit risk by applying rule-based systems to portfolio, core system and other data that generate information based on the criteria they set: Are members’ balances increasing or declining? Is their spending behavior changing? Did their direct deposit stop? Are they late on another loan? Has their credit score declined?
Regular check-ins with these systems can help guide collections practices by identifying which accounts require attention and which are likely safe even if some indicators are trending in the wrong direction.
“On the margin, this type of monitoring can help, and this is a business that’s won or lost on the margin so successful issuers do it,” he says. And if collections volumes increase, properly prioritizing the accounts that require attention can be the most impactful near-term skill for a credit union.
In the balance, though, “credit card portfolios are baked pies,” Kolk notes. “By and large, there’s very little you can do to change the credit risk of your portfolio in the next 12 to 24 months because you already baked your pie over the last three to 30 years. As we saw in the last recession, there’s a lot that can’t be controlled. You can do things to make it worse, but there’s not much you can do to make it a lot better. Grab the reins and hold on.”
Managing credit limits may be helpful to a limited degree, but oftentimes cardholders suffering financial setbacks have tapped much of their available credit by time indicators of increased credit risk send up red flags, he says. It is possible to identify when utilization rates have increased substantially over the last two cycles, “but trying to guess whose credit is going to go bad and close their lines is a very fraught game for a relationship-based institution.”
Closing dormant or unused accounts might head off some credit losses, he adds. “If those members start pulling out their cards now, that’s probably bad. These practices might help you on the margin, but there are no silver bullets.”
Learning From Successful Programs
Effective credit risk management is proactive, Kolk maintains, as reflected in the everyday practices of the 20% of credit card programs in the movement that grew faster than the market average in 2019, as identified by a TRK Advisors analysis of National Credit Union Administration industry data.
Those practices include staffing card programs with professionals with payments product expertise, maintaining a strong and supportive processor relationship, committing to annual marketing for both new accounts and existing account usage promotions, and developing product lines that appeal to members’ evolving expectations with a strong rewards proposition being the first priority for any credit union looking for growth.
“The one in five credit unions whose portfolios are performing well stay on top of these aspects of card management,” he says. “Among those that are doing middling or worse, when times are good, they tend to pay little attention to managing their programs. They ride the market up with some growth and decent profitability. Then when the bad times come, they say, ‘What can we do now?’ And the answer is always: ‘The things you should have done three to five years ago.’”
Despite what he describes as a “measured concern” for credit card profitability across the industry, Kolk adds, “Credit unions should not lose heart. Success has been proven to be possible, and there are hundreds of credit union success stories. It’s just not automatic.”
Karen Bankston is a long-time contributor to Credit Union Management and writes about lending, operations, technology and membership growth. She is the proprietor of Precision Prose, Eugene, Oregon.