Credit unions reassess their hand as buy now, pay later, digital issuance and even cryptocurrency affect the strength of their cards.
Among the COVID-19 casualties was Americans’ love affair with credit cards, which provided an easy way to satisfy shopping urges and worry about paying for them later. Shaken consumers are now wary of perpetual debt and turning to their own cash (typically via debit cards).
“Spending patterns have changed along with lifestyles and work arrangements after COVID,” says Tom Church-Adams, SVP/pay products for CUES Supplier member Co-op Solutions, Cucamonga, California. “CUs need to adjust their marketing, incentives and tools to align with those changes.”
Buy Now, Consolidate Later
One product that aligns with those changes is the buy-now-pay-later loan. When such loans displace credit card purchases, issuers lose business.
BNPL was pioneered by Affirm and Klarna, Church-Adams reports. “They partnered with a bunch of merchants. It’s basically a fintech product delivered through merchant channels that could be settled through credit cards.”
BNPL options have proven popular, says Brian Scott, chief growth officer of CUESolutions provider PSCU, St. Petersburg, Florida. “PSCU’s most recent Eye on Payments study shows that 61% of the people who know about BNPL plan to use it,” he reports.
BNPL can be a competitive threat or a growth tool, Scott suggests. A merchant program triggered at a point of sale is a loss for the card issuer. If it’s a POS card transaction that is converted to a credit union consumer loan, that’s revenue kept by the CU and a relationship-builder as a member extends financial management to their card.
A credit card portfolio typically has two very different user groups, observes Caroline Vahrenkamp, program manager of Raddon, a Fiserv company. (Fiserv is a CUES Supplier member based in Brookfield, Wisconsin.) One group uses the cards for transactions and pays off their balances each month. The other group uses the cards to borrow money they intend to pay back later. “Borrowers are interested in BNPL offers; transactors aren’t,” she notes.
CUs do have two options that let them at least limit their losses, notes Vahrenkamp, who came to Raddon from CU executive positions in Oregon and Wisconsin. First, as proposed by Scott above, they can hope the member pays with their card at the POS and then converts that transaction to a loan with the CU.
That’s a great strategy when it works, Vahrenkamp observes, but it requires the member to make two transactions, and it still may not get the member a better rate. So it’s not an easy sell.
The second option occurs when members take too many BNPL offers, making them ripe for loan consolidation. “Many BNPL users have multiple accounts with multiple vendors and multiple due dates,” Vahrenkamp notes, “making it easy to fall behind.”
That happens. A Raddon survey found that more than two-thirds of the respondents had multiple BNPL loans. Another survey found that 31% of users have missed a payment on a BNPL loan and 36% expect they might. Among millennials, 47% have missed payments.
Members who go for too many BNPL offers could damage their credit scores, warns CUES member Bill Vogeney, chief revenue officer of $8.9 billion Ent Credit Union, Colorado Springs.
Most of those missed payments come because there are insufficient funds in the checking account set up for automatic payments, causing overdrafts at depository institutions and exposing them, eventually, to some of the risk for credits they lost at the point of sale.
So credit unions definitely have an opportunity, Vahrenkamp says, to counsel members who have overindulged in BNPL deals, help them consolidate their loans and bring them back to the CU. “They can use a tested product to reengage members,” she notes.
If BNPL is a double-edged sword for CUs, Scott and Church-Adams are bullish on the opportunities. “Every CU should offer a BNPL product,” Scott says. “It provides optimal convenience and tools for smart financial management members can apply later.” According to the Experian Global Insights Report, 80% of consumers subsequently convert eligible card transactions to BNPL, he notes.
BNPL is the right tool to allow members to segment their debt and manage it discriminately, says Church-Adams. With BNPL, they can carry a credit card balance and also make a large purchase that they decide to pay off in a few monthly installments. When members have a regular payment plan, he notes, they’re likely to follow it. Having BNPL as an option can increase spend on associated cards, he adds.
Card issuers, Vogeney points out, have crippled themselves in the BNPL race by pushing ever more costly rewards programs. The resulting high rates have encouraged some fintechs to get into BNPL financing. The only way CUs can realistically compete, he agrees, is to offer efficient ways for members to convert card charges of a certain size to a short-term payment plan incorporated into the credit card billing.
Raising member awareness of such an offering is relatively easy, Scott notes. “Members review their transactions in their mobile banking app where eligible ones are flagged and members are given the option to convert those to BNPL. All they have to do is click.”
But persuading members to use their CU credit card to initiate a BNPL loan is challenging. A credit card gives borrowers a viable buy-now-pay-later option, but a point-of-sale option with no interest or finance charges if the buyer pays off the purchase in four monthly installments could be more attractive, Vahrenkamp points out. So CUs are losing business to the BNPL vendors—Klarna, Affirm and PayPal. And they can’t really compete on price.
The losses are substantial. Vahrenkamp reports seeing statistics that 91% of the POS loan originations in California in 2020 were BNPL loans. She has used BNPL herself and says it was a good experience.
BNPL works because merchants who object to 2-3% interchange rates on card transactions are willing to pay 7-9% to the BNPL middlemen to move merchandise. “They see all those abandoned online shopping carts,” Vahrenkamp observes, “and want push shoppers to buy. When buyers see that they can pay later with reasonable payments, they’re more likely to go ahead.”
$7.2 billion Redwood CU, Santa Rosa, California, is preparing to offer BNPL, reports COO Tony Hildesheim. “We envision the loan being created at the cash register in a single transaction,” he notes, or as a credit card charge that is later converted to a loan. “We’re researching that now, and it looks like consumers want it all done at the point of sale.”
Once a BNPL loan is made or converted, Hildesheim envisions, it will likely be a portfolio loan with its own interest rate based on underwriting. Payments will be made from accounts like other loans. Normal delinquency notices and collection practices would apply, and the service will have top and bottom limits.
Trends away from credit card use and phenomena like BNPL impact profitability strategies. Will profits fall? Current portfolio performance ranges all the way from a positive 6% ROA to a negative 5%, reports Steve Wofford, CEO of Kohl Analytics Group, Scottsdale, Arizona.
Credit cards may carry a 16% interest rate, Wofford notes, but the net portfolio return will be more like 7-8% because of members who pay off their full balances every month. But even that net rate won’t make a portfolio profitable without interchange.
“You really can’t make a net profit on interest income,” Wofford says. “You need fees and interchange income that come with swipes. A Walmart swipe of around 70 basis points interchange doesn’t help nearly as much as 2% interchange at a convenience store.”
Card profitability does depend on interchange, agrees Scott. But even with interchange compression, a credit card portfolio is far and away the highest earning asset for the CUs that have them, he says, and that justifies taking risks to grow it.
“CUs can be too risk-averse,” he warns. “They can control the risk of issuing cards to a broader base of members with tools like lower limits, potentially higher rates and more proactive delinquency management. CUs that have less than 30% of their members holding their credit cards are lagging and missing opportunities.”
CUs looking to drive card growth should try to get as many cardholders as possible and then push them to make the CU card top-of-wallet, he advises. “The biggest hurdle is to get a member to accept the card. Once they’ve accepted the card, it’s easier to persuade them to use it more, even make it their preferred card.”
Fraud should not deter aggressive issuing, Scott says. “Fraud has grown, but the tools for managing fraud have grown even faster. The biggest risk in fraud mitigation is not credit losses but a member having a card declined,” he insists. “That will turn off a cardholder for a card that didn’t work. CUs can avoid declining a legitimate but unusual transaction.”
How? Predictive analytics are good at providing context for an out-of-the-ordinary transaction, Scott explains. People are creatures of habit, so a deviation in spend is reason for the system to be alert. A hotel room charge in a foreign country might look suspicious, but if the cardholder previously purchased an airplane ticket to that destination, it’s not suspicious at all. But a refrigerator would be suspicious in that case, he illustrates.
Once, credit and debit cards were referred to as “plastic.” No more. Redwood CU saw the writing on the wall when Apple introduced ApplePay linked to its popular smartphones, Hildesheim recalls. “We saw that payment transactions would need to work smoothly with phones and that pieces of plastic would lose ground to virtual cards embedded in phones using near-field communication. In 2017, we converted our card portfolio to Visa DPS Direct, and we started visiting and paying attention to what Visa was doing in its San Francisco innovation lab.
“We wanted to learn what it would take to issue virtual cards that would actually be used,” he recounts. “The more we saw, the more excited we became.
“If a card could be instantly issued digitally over the credit union’s mobile app, it made no sense for most members to wait for a piece of plastic,” he continues. “Visa had a solution through their Visa app; it was a separate download that could be used by our members.
“We wanted it to work through our own app, to give our members the easiest access possible to a digital card on the app they are used to using,” he says. “So we decided to build it directly into our app using Visa’s APIs. According to several reports, we were one of the first financial institutions in the country to offer virtual cards through our own mobile banking app.”
For Redwood CU members, it takes one click to download the virtual card onto their mobile device and one click to upload it to a digital wallet. A watch or other wearable would work the same, Hildesheim adds. Virtual cards work best with digital wallets—something that over 80% of Redwood CU’s members have. “You can have the card on your phone without a wallet,” he says, “but then there’s not a lot you can do with it unless you manually key in a number.”
Digital cards are meant to work in tandem with plastic cards, not replace them, Church-Adams notes. Besides instant availability, digital cards are well suited for use in digital wallets and wearables, he points out. They will work in any purchasing situation unless a merchant terminal requires a physical card, he says.
Redwood CU did all its programming in-house. It did a small friends-and-families beta test followed by a soft rollout. Now all of the CU’s credit and debit cardholders have both plastic and virtual counterparts in their mobile app. For every plastic card, there is a virtual card in the Redwood CU database, accessible through its mobile banking app.
Issuing virtual cards is not expensive, Hildesheim says, but it does take time and talent, especially if you’re a pioneer doing your own programming instead of adopting a vendor’s. “You have to work through your core system,” he explains, to go direct to Visa and Mastercard. Cards have to be activated on a network. “Our biggest challenge was working with our core provider, Symitar (a division of Jack Henry, San Diego, California). Their processes were still based on assumptions around physical plastic. We had to get them to rethink how a virtual card could be issued.”
Most of the virtual card activity is reissue due to a lost or stolen card, Hildesheim reports. A member can log in to the Redwood CU app, which over 80% of members use, and see their cards, with options to report one lost or stolen. Then they can tap once to trigger a reissue, which shows up immediately on the mobile app. They can tap once more to load the new card into their mobile wallet, and they’re good to go, he reports—all with two taps in maybe a second or two, and all on the Redwood CU app, which can also be used to dispute unauthorized transactions.
Getting members to accept the virtual card through the app is easy, he reports. Getting them to move it from the app to their wallet is a greater challenge, he concedes.
Issuing virtual cards is popular, but does it actually increase profitability? Hildesheim thinks so. “It’s great for retention. Knowing the functional card is there regardless of the plastic gives members a great sense of security. The more they like and trust your card, the more likely they are to move it to the top-of-wallet position. It’s helping our transaction volume grow slowly.”
Hildesheim has two bits of advice for other CUs that might be considering virtual issuance: Don’t underestimate the work you’ll have to do with your core provider to get the service running, and show members a visual image of the card when they click on it in your app. “This isn’t technically necessary,” he reports, “but we tested it and members prefer to see a card image instead of just the number.” cues icon
Richard H. Gamble writes from Grand Junction, Colorado.