Inside the Black Hole

There has been a lot of buzz in the blogosphere about the sustained rise in U.S. credit card interest rates. In mid-December CreditCards.com – a website that conducts weekly surveys to calculate the average credit card annual percentage rate (APR) in the U.S. – reported the highest level they’d ever measured and the rate has only marginally decreased since then. Moreover, the average penalty rate has also increased, according to the website, even as many cards no longer have penalty rates.

So what’s causing this jump in interest rates? From what I’ve read, most commentators cite the CARD Act of 2009 as the chief culprit, because, by placing various restrictions on banks’ ability to charge fees and raise interest rates on existing accounts, it led to a substantial fall in card revenues, which issuers then had to find ways to make up for. I agree with this explanation, but I think it doesn’t tell the whole story and it doesn’t answer the question why the APR rise is so steep in recent months. I think that there is another reason for the more recent increase in average APR, one that hasn’t received any attention: issuers’ renewed interest in sub-prime borrowers. Let me explain.

Current Credit Card APR Levels

First, though, let’s take a look at the current CreditCards.com APR calculations. Here are the results from the website’s latest report (Jan. 4, 2012):

So what are we seeing here? While the national APR average has risen by 0.39 percent in the past six months, five of the nine categories that comprise it have registered a decrease for the same period and two have shown no change at all. Only two of the constituent categories have produced an APR increase. Additionally, only two of the categories – “instant approval” and “bad credit” – have an APR that is higher than the national average.

How Sub-Prime Drives APRs Upwards

So, our observations tell us that the only way the national average could have increased in the past six months would’ve been if the weight of the “instant approval” and “bad credit” categories had increased. So let’s examine these categories.

A look at CreditCards.com’s list of “instant approval” credit cards reveals that these are actually prepaid cards, so I’m not sure why they are included in a credit card list in the first place. Moreover, while the website tells us that approval for such a card usually requires “good to excellent credit,” each of the prepaid card offers they’ve listed explicitly states that “No Credit Check” is required, which is consistent with rules for prepaid card issuance. Prepaid is a type of card specifically designed to appeal to the “unbanked” and, far from requiring excellent credit, it is as sub-prime as it gets, which is why its average APR is higher than the national average. And we do know from Federal Reserve and other sources that prepaid is by far the fastest-growing type of non-cash payment methods in the U.S.

The “bad credit” category is much more unambiguously designating sub-prime card issuance. Here again we have plenty of data showing that there has been a huge increase in the number of cards issued to sub-prime borrowers. For example, Equifax – a credit reporting agency – told us that, while the total number of new credit cards issued in the first half of 2011 rose by 27 percent on a yearly basis, the number of cards issued to sub-prime borrowers (those with credit scores below 660) spiked by 64 percent for the period.

The Takeaway

So the data clearly tell us that the issuance of sub-prime credit cards is increasing at a much faster rate than the issuance of non-sub-prime cards (whose APRs are falling), pushing up the average national APR in the process.

Again, I’m not saying that the rise of sub-prime accounts for the entire post-CARD Act APR increase. It does not. Issuers clearly raised interest rates in anticipation of the CARD Act side effects and then kept doing it for a while. However, sub-prime card issuance is the primary driver behind the current APR rise.

Learn how to lower your card acceptance cost

Learn how to accept credit and debit cards at the lowest processing costs. The Payment Card Acceptance kit contains a video and an e-book:

• Video – Card Acceptance Best Practices for Lowest Processing Costs (18 min).
• E-Book – Payment Card Acceptance Guide (19 pages).

Citibank has launched a Facebook app that allows its customers to share their credit card rewards, the bank is telling us in a press release. This is by far the boldest step a major bank has taken in the direction of socializing a rewards program to date and one that will surely provoke a response from Citi’s rivals.

Up until now the big issuers have been quite tentative in their experiments with the possibilities of any interplay between credit card and social media accounts. The only similar move that I can think of is American Express’s decision to allow its cardholders to sync their card and foursquare accounts, but that is a much more modest, campaign-based strategy, which actually leaves out the social element that makes Citi’s move so interesting. Let’s take a look.

What Does Citi’s Facebook App Do?

Citi’s Facebook app

[M]akes it quick and easy for ThankYou(R) Rewards members who are Facebook friends to pool their points together, and use their points’ collective value towards a shared goal or reward. ThankYou members on Facebook can combine their points to make a charitable donation, or choose from millions of rewards on www.thankyou.com, from travel to electronics.

To help convince customers to start using the app, Citi is giving away 2,500 ThankYou points to the first 4,000 customers who download the app and link their card account to their personal Facebook page.

What’s In It for Consumers?

Citi’s app is a truly social media tool. It lets everyone in a group of friends to participate in a shared project. Such a project could take the form of a donation to a charity or a payment for an event everyone is participating in. Additionally, a pool of rewards points can be seen as a virtual gift card that can be used on Citi’s www.thankyou.com rewards website.

Of course, there is an obvious limiting factor to this type of a point-sharing program: participation is restricted to Citi cardholders. From a consumer point of view, and we have advocated for this approach on multiple occasions before in regards to mobile payments, it would be far preferable to have access to a program that does not discriminate among different card issuers and rewards programs. To extend the gift card analogy, such a program would look very much like an open-loop prepaid card. To be fair to the issuer, though, such an open-loop program would be much harder to design for a point-sharing social project than for an m-payment one. And anyway, Citi’s perspective is rather different.

What’s In It for Citi?

Launching such a program is a very smart move on Citi’s part on at least two levels. Firstly, they are testing a totally new approach to building a social media presence that no other big bank has tried out before. Point-sharing among Facebook friends makes sense and even if it doesn’t work as well as the bank hopes, there really isn’t anything the bank can possibly lose from giving it a try.

But there is another aspect of this new program, one that is more subtle and that has nothing to do with social media. This experiment can be seen as another attempt by a major issuer to drive customers away from using their debit cards by giving them an incentive to use their credit cards. I don’t know whether the Citi guys have thought of that when designing their point-shar­ing program, but we do know that processing debit transactions in the post-Durbin world is much less profitable for them than credit card payments.

The Takeaway

I expect that the other big issuers will soon launch similar social media programs of their own. They may or may not use Citi’s approach as a template, but I think that the ability for joint user participation in shared projects will be at the heart of the most successful among them. After all, sharing and collaboration is what social media is about.

Learn how to lower your card acceptance cost

Learn how to accept credit and debit cards at the lowest processing costs. The Payment Card Acceptance kit contains a video and an e-book:

• Video – Card Acceptance Best Practices for Lowest Processing Costs (18 min).
• E-Book – Payment Card Acceptance Guide (19 pages).

Hundreds of thousands of Americans have done just that last year, we learn from WSJ’s Jessica Silver-Greenberg. On the face of it, this proposition sounds quite oxymoronic. After all, debt collectors’ sole raison d’être is the collection of money, not offering it. So what are we to make of this story?

Well, as we will see below, debt collectors have discovered that providing fresh credit to debtors whom no other lender would ever work with, has proved a reliable strategy to recover some extra revenue from old debts that would otherwise have gone totally uncollected. Not to mention the revenue from the credit card program itself. Now, I don’t think that anyone doubted that debt collectors were motivated by more than just altruism when they launched their card issuing programs. But what about their debtors? How are these debt collector credit cards working for them? Well, I think that potentially the benefits of opening up such an account far outweigh the cost of doing it. Let’s take a closer look at these programs.

How Debt Collector-Issued Credit Cards Work

The concept behind these cards is quite simple. As Greenberg explains, a debtor is offered a new credit card on the condition that she agrees to use a portion of the new credit line to repay an old debt. In the example given by Greenberg in her piece:

To get the new credit card, Mr. Carpenito agreed to repay $400 on a seven-year-old debt that had expired under New York’s statute of limitations.

The statute of limitations sets a time limit on a lender’s ability to legally pursue the collection of a debt. Or, to put it another way, once the statute of limitations has expired, a debtor is under no legal obligation to pay back the debt. So, for all practical reasons, once the statute of limitations has expired, a debt is dead.

That does not mean, however, that it is illegal to accept payments on an expired debt. Far from it and that makes the program at issue possible. Other than the agreement to repay an old debt, these cards work just as their regular-issue counterparts.

What’s In It for the Issuer?

As Greenberg reminds us, there are plenty of U.S. card issuers that are now eager to extend credit to as wide a range of consumers as they can get their hands on. Banks have been on the case for a while now, issuing 5.4 million new cards to consumers with credit scores below 660 (which is Equifax’s definition of sub-prime).

Now, the debt collector type of card lowers the credit score bar quite considerably, (talking about sub-prime!), but the concept is still the same. The size of the credit line and the interest rate are determined according to the calculated risk level, which means that for this type of cards the former metric will be much lower than the average, while the latter will be higher. In another Greenberg example:

Ms. Weaver has a $300 credit limit that can go up if she stays current with her monthly payments. Her credit card carries an annual interest rate of 19%, compared with an average rate of 13.7%.

As you see, the card issuer is rather stingy with the credit line and lavish with the APR. And yet, debtors like the arrangement.

What’s In It for the Debtor?

As already mentioned, no regular lender would ever extend new credit to a consumer with a debt collection account on their credit report, even under a sub-prime program. Debtors know that full well. “No one else wanted to even work with me,” Weaver tells the WSJ.

Opening up a card, even with a $300 credit line, gives a debtor an opportunity to repair her credit much faster than she would otherwise have been able to. If she can consistently make her monthly payments on time, eventually her credit line will be lifted and she will attract the attention of other lenders who will be willing to extend credit to her on better terms.

But there is another aspect to having a credit card that many debtors find every bit as appealing – the sense of normalcy it brings with it. As one debtor tells Greenberg, without a credit card he felt “like dirt, especially when out on dates.” His assessment: “It was totally worth it.”

The Takeaway

As Greenberg points out, there is plenty of controversy surrounding debt collector-issued credit cards. For example, issuers have been accused of not clearly communicating to the recipients of their offers the fact that debtors are not legally required to repay debts for which the statute of limitations has expired. It is also true that the statute is renewed when there is a payment of any amount on an expired debt. And yes, these things should be made very clear in the card agreements.

Yet, it is also true that in the real world this type of lending is just about the only legally available avenue for debtors to get access to fresh credit and to start repairing their financial history. It should be kept wide open to allow issuers to give debtors the chance to prove that they are more trustworthy than their previous record indicates.

Image credit: FirstCredit.Net.

Learn how to lower your card acceptance cost

Learn how to accept credit and debit cards at the lowest processing costs. The Payment Card Acceptance kit contains a video and an e-book:

• Video – Card Acceptance Best Practices for Lowest Processing Costs (18 min).
• E-Book – Payment Card Acceptance Guide (19 pages).

Slowly but surely the EMV (also known as chip-and-PIN) credit card technology is coming to the U.S. JPMorgan Chase has just rolled out its third such product, co-branded with British Airways and designed specifically for Americans traveling abroad who’ve long had issues getting their magnetic stripe cards accepted outside the U.S.

All three of Chase’s chip cards are actually hybrids – they also feature a magnetic stripe, which makes them acceptable in the U.S. where the vast majority of pint-of-sale (POS) terminals do not at present support the chip-and-PIN technology. That, however, is about to change, fast.

The Chase / BA Card and the Issue with EMV

The new Chase / BA card will surely appeal to globe-trotting Americans, whose European credit card acceptance travails have been well documented, including on this blog. The issues began in the early 2000s when the EMV technology first made its appearance in the U.K. and then quickly displaced the older and less secure mag-stripe cards across Western Europe.

The problem was that cards issued by U.S. banks still relied exclusively on the magnetic stripe. They could still be accepted through EMV terminals if fallback procedures were followed, but in real life most European merchants either did not know how to do that or simply didn’t want to.

As a result, many Americans found themselves unable to use their cards in Europe. In 2008 alone, U.S. issuers lost $447 million in revenues, because 9.7 million Americans could not use their cards abroad, according to a report from Aite Group, a research and advisory firm. Moreover, U.S. issuers were missing out on a huge cost-cutting opportunity in the form of lower fraud losses. Their U.K. peers were enjoying a decline in in-store credit card fraud from £218.8 million ($342.3 million) in 2004 to £98.5 million ($154.1 million) in 2008, according to data from the U.K. Payments Administration.

Why then, you may ask, haven’t U.S. banks taken steps to resolve the issue and save themselves well over half a billion dollars a year in the process? Well, it turns out that the wholesale switch to EMV would have cost issuers a lot more, close to $3 billion, according to one estimate by the Mercator Advisory Group, a consultancy. Apparently the banks thought that was a bit too much and just kept swallowing their losses. All that changed, however, with the arrival of yet another payment technology – near-field communication or NFC.

Visa: All U.S. Processors Must Support Chip Transactions by April 2013

NFC is the technology behind Google Wallet, Isis and many other new mobile payments services that many studies predict are about to take the world by storm in the coming years. It allows payments to be made by waving chip-containing phones by NFC-enabled POS terminals, which communicate wirelessly between each other to complete a transaction.

As Google and most of its rivals, as well as all big U.S. telecommunications companies, began developing their NFC platforms, which clearly were encroaching in Visa’s territory, the credit card giant decided to step into the fray and mandate that all of its processing banks “support merchant acceptance of chip transactions no later than April 1, 2013.” In case you somehow misunderstood what that meant, Visa spelled it out for you:

The adoption of dual-interface chip technology will help prepare the U.S. payment infrastructure for the arrival of NFC-based mobile payments by building the necessary infrastructure to accept and process chip transactions that support either a signature or PIN at the point of sale.

It is clear that Visa is hoping to lay down an NFC standard, so that all POS terminals can communicate with chips containing Visa card information, regardless of whether the customer uses Google Wallet, Isis or any one of the many other platforms that are soon going to be in use.

The Takeaway

Visa’s sudden NFC push is actually good for consumers and, in a case of a benign side effect, it is also helping to cure Americans’ card-induced headaches in Europe. Of course, in time EMV cards will displace mag-stripe ones altogether, but that day is still some way off.

The Chase / BA card comes with another feature that is sure to be greatly appreciated by its users. It charges no foreign transaction fees, unlike all older Chase cards, mine very much included, which cost you additional three percent of the sale’s amount when you use them abroad. I hope other banks will now take a page of Chase’s book.

Learn how to lower your card acceptance cost

Learn how to accept credit and debit cards at the lowest processing costs. The Payment Card Acceptance kit contains a video and an e-book:

• Video – Card Acceptance Best Practices for Lowest Processing Costs (18 min).
• E-Book – Payment Card Acceptance Guide (19 pages).

Reuters’ Linda Stern has a nice report on the huge ramp up of credit card rewards programs in the run-up to this year’s holiday season. Of course, the current rush to get customers to spend more heavily on their credit cards started months ago and we’ve been tracking its progress along the way on this blog as well.

In her piece Stern does a nice job of documenting the accelerating pace of beefing up credit rewards programs, while asserting that, as we’ve also been saying, it is not the imminent holiday season that’s causing it. In fact, she begins by quoting an expert stating that the recently enacted Durbin Amendment, which limited the amount of the fees issuers can charge merchants for accepting debit cards for payment, has much more to do with it. I agree.

Credit Card Rewards Get Much Better

Stern gives us a preview of a list of “best cards for holiday shopping,” compiled by lowcards.com, a website providing credit card information. It is really impressive. Here are some of the listed rewards programs:

• Capital One Cash offers a 50 percent anniversary bonus on cash earned on purchases in the previous year and a one-time $100 bonus once you spend $500 in the first three months.
• Chase Freedom gives you $200 cash back after you spend $500 in your first three months.
• Chase Sapphire lets you earn 25,000 bonus points after you spend $5,000 in three months.
• Citi Thank You Preferred gives you 10,000 bonus points after $500 in purchases within the first three months, which is good for a $100 gift card.
• Continental Airlines One PassPlus card offers 25,000 bonus miles the first time you use this card, which is enough for a round-trip ticket within the United States and Canada.

There are several other cards on the list offering various types of really attractive incentives. In fact, I can personally testify for the hugely improved quality of card rewards programs. I have just opened up a Chase Ink card that is giving me a $250 cash back bonus after my first purchase. I have never before been offered anything remotely close to that.

So what’s driving issuers to beef up rewards? After all, better rewards programs are costlier for issuers to maintain.

Why Are Issuers Raising Credit Card Rewards?

Rewards programs are indeed costly for issuers. However, the new limit on debit interchange fees is making credit cards a far more profitable revenue source for banks than debit cards. So much so that issuers are evidently willing to pay consumers hundreds of dollars just to open up a credit card account and run the risk that, once the bonus is collected, the account will be closed or unused and will generate a hefty loss, rather than a profit.

To understand why issuers are willing to take such a gamble, we need to look into the numbers. Let’s compare the profits an issuer can make from transactions involving a debit card and a Visa rewards card.

As you see, issuers profit a great deal more from credit than from debit card transactions and the difference only grows bigger as the transaction size increases. So banks evidently have calculated that the difference is substantial enough to be worth offering a huge additional incentive to help convince a debit card user to switch to a credit card.

The Takeaway

The ramp up of credit card rewards programs currently under way is hugely beneficial for consumers, particularly for those with higher credit scores. In addition to the very attractive sign-up bonuses, many cards also come with improved ongoing reward terms. So you should take advantage of it, if you can.

Merchants, on the other hand, will experience these developments very differently. They fought hard to get debit interchange fees slashed and won. If enough customers switch to credit cards, however, merchants may actually end up being worse off than they were before the Durbin Amendment was enacted, because the interchange fees for rewards cards are much higher than even the old debit interchange fees.

Well, in reality issuers will not be able to convert a high enough number of debit users to realize the above scenario, so on aggregate merchants will still be net winners in the post-Durbin Amendment world. Whatever revenues they cannot recoup through having customers switch to credit cards, however, banks will do in some other way (e.g. pushing prepaid cards, discontinuing debit rewards programs, introducing new or increasing existing bank fees, etc.). So they too will not be net losers. Guess who will end up footing the bill at the end?

Learn how to lower your card acceptance cost

Learn how to accept credit and debit cards at the lowest processing costs. The Payment Card Acceptance kit contains a video and an e-book:

• Video – Card Acceptance Best Practices for Lowest Processing Costs (18 min).
• E-Book – Payment Card Acceptance Guide (19 pages).