Credit union credit card programs stand a very good chance of benefiting under the CARD Act of 2009 if they maintain their traditional consumer focus and conservative underwriting, according to a new research paper from the Filene Research Institute.
"The implications for credit unions are exciting. Large-scale issuers may retain the competitive advantages of sophisticated automated underwriting and efficient back-office operations," wrote Filene Chief Research Officer George Hofheimer in his introduction to "The CARD Act: Opportunities and Challenges for Credit Unions."
"The CARD Act now limits many fees and penalties that are unfriendly to consumers, so large issuers will likely develop new ones to reenergize their profits. The right strategic place for credit unions is to focus efforts on simplicity and transparency while doubling down on collaborative credit card efforts to improve efficiencies. Doing so will allow credit unions to pick off the current and future malcontents fleeing boorish bank behavior," he added.
The report's author, Adam Levitin, associate professor of law at Georgetown University Law Center in Washington, described how the act disrupts the business model that had come to dominate larger card issuers and thus favored the business model that most credit union issuers have used.
The large issuer's model for how to run card programs relied upon card offerings with very low up-front costs to the consumer, such as low introductory rates and low promotional rates, and higher and more profitable fees on the back end. These would often come in the form of late-payment fees, over-limit fees, and other practices such as universal default that penalized cardholder behavior. Universal default was the practice of raising a card's interest rate not because the cardholder was late on his or her own card payments, but because they were late on some other bill payment, whether for a utility bill, automobile or other consumer account, he wrote.
"This business model made credit very cheap for consumers to obtain initially, but it back loaded the costs. Back-loaded, contingent costs are much less salient to consumers than up-front, noncontingent costs because of a well-documented cognitive phenomenon known as hyperbolic discounting," Levitin wrote. "Thus, if two cards have the same net cost for the same transaction pattern, consumers are likely to select the card with the back-loaded, contingent costs because they perceive it as cheaper."
The CARD Act disrupts this business model in a number of ways, Levitin contended. First, it lock promotional rates in for six months, making it less profitable for large card issuers to widely offer initially cheap cards. Second, the CARD Act prohibits many of the fees and practices that larger issuers relied upon to make their initially low-cost cards profitable over time.
These changes forced by the CARD act will have a number of different effects. Among them will be some that favor a card-issuing model that is closer to that used by credit unions and other smaller issuers. For example, the changing model's restrictions on the use of fees is liable to make basic underwriting more important, forcing more attention onto the relationship with the cardholder (are they also a depositor, for example) and less attention on the FICO or other credit score, Levitin argued.
Second, the changing card environment may force large issuers to adopt a new set of fees to keep their card programs highly profitable. These new fees will likely remain legal but will also probably sharply annoy consumers such as fees for paper-statements, higher risk transactions (transactions with higher than average charge back risks), inactivity fees and even the annual fee.
The path for card success for credit unions lies in keeping their traditional approach to card issuing and to maintain a simple and transparent approach as other issuers adopt more fees and complex modeling, the report said.