By Ray Birch
PETERBOROUGH, N.H.—For the first time since the 1990s, losses on credit cards at credit unions are now higher than those at banks.
That’s concerning because it signals a shift in the credit card war between big and small issuers, giving the big shops an even greater competitive advantage, according to Tim Kolk, principal at TRK Advisors.
The scenario also places credit union card portfolios at greater risk of losing cardholders to banks, said Kolk, who explained the lower loss ratios have traditionally given CUs the funds needed to compete against big banks by adding value to keep accounts.
The trend in portfolio losses is likely to continue, Kolk told CUToday.info, given credit unions’ 18% rate cap and banks’ ability to offer more robust rewards programs.
“We’ve measured the data going back into the 1990s and credit unions have always had lower credit loss rates, lower charge-off rates, than banks,” Kolk said. “Sometimes, they have been substantially lower. For example, during the Great Recession bank industry charge-off rates for credit cards were between 9% and 10%. Credit unions were about 4% at the high. That's a real advantage, because that goes right to the bottom line and it allows credit unions to compete.”
No More Offsets
Moreover, Kolk noted credit unions are typically at a disadvantage versus banks in numerous areas, such as operating expenses, sophistication and resources.
“But if your charge-off rates are half of what your competitors have, that helps offset those things where you trail,” he said.
Kolk said that coming out of the Great Recession the charge-off rates at all issuers declined. At credit unions, the charge-off rate dropped to their historical averages in the 2% to 3% range, while banks also saw declines to historic lows that were above those being seen at credit unions.
“Since the Great Recession the difference between bank and credit union charge-off rates has been consistently narrowing. In 2015 it dropped to less than 100 basis points, and it kept squeezing and narrowing,” Kolk explained.
Closer and Closer And…
In 2022 the banking industry’s credit card charge-off rate was about 2.2%, matching credit unions’ numbers, Kolk reported. And card charge-offs at banks continued to decline through last year, while the charge-off ratio at credit unions rose until it surpassed that of banks’.
“Now, in the first quarter of 2023, bank charge-off rates were 3.0% and credit union charge-off rates were 3.4%,” Kolk said. “That long-time, critical competitive advantage over banks is gone.”
Tim Kolk
Kolk termed the situation “a fundamental change in the competitive positioning of credit unions. And, as I mentioned in a previous report, credit unions can't charge market-level interest rates because of the 18% cap,” Kolk said.
Kolk said his organization is concerned that going forward credit unions have lost what used to be considered a “permanent, irrevocable” advantage.
Why is This Happening?
Why is all this happening? Kolk pointed to more than one reason.
“This is speculative, and we are trying to piece together reasons…Because banks have the strongest rewards propositions, in recent years they have attracted a disproportionate number (compared to credit unions) of cardholders at the top end of the credit quality spectrum,” Kolk explained. “These are the highest spenders, the people who pay in full, the people who are the lowest risk. Therefore, the banks have created a pool of accounts that is safer than credit unions because of their strong rewards propositions.”
If credit unions continue to be forced to constrain their reward propositions because of the rate cap, this pressure will continue, leaving CUs to pick cardholders from the middle range of credit risk, not the strongest, lowest-risk segments, Kolk said.
Another reason for the lower credit losses at banks is their scale and expertise, added Kolk. “We are talking about basic skill and scale advantages,” Kolk said.
The Cost of Change
Kolk also believes that as credit unions have moved away from a traditional source of membership, they have lost some of their ability to know their members and their associated risks.
“Credit unions are getting less tied into member relationships, and they're attracting new members that are on average like a typical bank new customer,” Kolk said. “With SEGs, CUs attracted members through highly controlled channels. Members are now more average looking.”
What Should be Done
What should credit unions be doing?
“Every credit union needs to do a deep profitability analysis on their individual products and each pricing tier within each product because when you have pricing tiers that start to hit the 18% interest rate cap you will find the profitability in those tiers goes down very quickly,” Kolk said. “They are going to have to make tough choices about constraining card delivery to some members. For example, it's very easy to envision that it will become unprofitable to offer a rewards credit card to someone who isn't in the top tier of a credit risk spectrum.
“So, you will have lower score members that ask the organization for its rewards card, and the credit union will have to decide whether to give it to them and lose money.”