Credit Card Processing Blog

The average interest rate on existing credit cards reached 14.7 percent in the second quarter, up from 13.1 percent a year earlier, according to a study by Synovate, a market research firm owned by the Aegis Group. It is the highest level since 2001. The interest rate increase looks even more dramatic when you measure the spread between the prime rate – the benchmark against which card rates are set – and average credit card rates. Currently, the gap is 11.45 percent, the largest in at least two decades, according to Synovate.

Why are credit card interest rates at record highs at a time when other rates are at record lows? Well, for the WSJ at least, the answer is fairly straightforward:

It was among our safest predictions that reduced credit to consumers would result when the Federal Reserve announced new credit-card rules in 2008, and then Congress followed up with the Credit Card Accountability, Responsibility and Disclosure (CARD) Act of 2009. By limiting the ability of banks to increase rates on delinquent borrowers and to charge fees on unprofitable customers, Washington encouraged card issuers to be more selective in advancing credit and to demand higher rates when they do.

It’s a simple equation. If politicians make it more difficult and expensive for banks to lend, customers will find it more difficult and expensive to borrow.

Well, there is truth in that, but the equation is far from simple. Yes, the CARD Act is costing credit card companies a lot of money by preventing them from charging some fees, while placing caps on others and restricting their ability to increase interest rates. But there is another factor driving up interest rates and it is the economic crisis.

Credit card defaults and late payments were at record highs throughout 2009 and are still above historical averages today. Issuers simply couldn’t afford to offer credit to anyone but the safest borrowers and credit card offers plunged.

The trend is beginning to reverse, however, and the number of new credit card offers in the first quarter was up by 29 percent over the same period in 2009, according to Synovate. This doesn’t mean that interest rates are falling, though. Most credit card offers now come with variable interest rates, which add a certain percentage to the prime rate.

Now, the prime rate can’t go much lower and will eventually start rising as the economy recovers, pushing up interest rates on variable cards along with it. Does that mean that consumers are condemned to high credit card interest rates for the foreseeable future? Well, that would depend largely on the pace of recovery. The bank card industry is a very competitive one and, once it starts to look as if things are getting back to normal, credit card offers will become more attractive and interest rates will go down.

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The third and final batch of credit card rules, passed by Congress last year in the form of the Credit Card Accountability, Responsibility and Disclosure (CARD) Act, went into effect on Sunday. The Act was designed to protect card users from certain “unfair” practices used by credit card companies.

The final provisions ban card issuers from charging more than $25 for late payments, under most circumstances, and from charging cardholders fees for not using their cards. Issuers are now also prevented from charging multiple fees for the same violation and from increasing interest rates without explanation. Additionally, issuers are now required to review interest rate increases imposed after January 1, 2009, and lower rates for consumers in good standing. Gift cards will now be good for no less than five years.

The CARD Act represents a truly comprehensive reform of how credit card companies do business and it really is a big win for consumers. Here is a list of its key features, as summarized by the White House on the day President Obama signed the Act:

• Bans Retroactive Rate Increases: Bans rate increases on existing balances due to “any time, any reason” or “universal default” and severely restricts retroactive rate increases due to late payment.
• First Year Protection: Contract terms must be clearly spelled out and stable for the entirety of the first year. Firms may continue to offer promotional rates with new accounts or during the life of an account, but these rates must be clearly disclosed and last at least 6 months.

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• Ends Late Fee Traps: Institutions will have to give card holders a reasonable time to pay the monthly bill – at least 21 calendar days from time of mailing. The act also ends late fee traps such as weekend deadlines, due dates that change each month, and deadlines that fall in the middle of the day.
• Enforces Fair Interest Calculation: Credit card companies will be required to apply excess payments to the highest interest balance first, as consumers expect them to do. The act also ends the confusing and unfair practice by which issuers use the balance in a previous month to calculate interest charges on the current month, so called “double-cycle” billing.
• Requires Opt-In to Over-Limit Fees: Consumers will find it easier to avoid over-limit fees because institutions will have to obtain a consumer’s permission to process transactions that would place the account over the limit.
• Restrains Unfair Sub-Prime Fees: Fees on subprime, low-limit credit cards will be substantially restricted.
• Limits Fees on Gift and Stored Value Cards: The act enhances disclosure on fees for gift and stored value cards and restricts inactivity fees unless the card has been inactive for at least 12 months.

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• Plain Language in Plain Sight: Creditors will give consumers clear disclosures of account terms before consumers open an account, and clear statements of the activity on consumers’ accounts afterwards. For example, pre-opening disclosures will highlight fees consumers may be charged and periodic statements will conspicuously display fees they have paid in the current month and the year to date as well as the reasons for those fees. These disclosures will help consumers make informed choices about using the right financial products and managing their own financial needs. Model disclosures will be updated regularly based on reviews of the market, empirical research, and testing with consumers to ensure that disclosures remain clear, useful, and relevant.
• Real Information about the Financial Consequences of Decisions: Issuers will be required to show the consequences to consumers of their credit decisions.
  • Issuers will need to display on periodic statements how long it would take to pay off the existing balance – and the total interest cost – if the consumer paid only the minimum due.
  • Issuers will also have to display the payment amount and total interest cost to pay off the existing balance in 36 months.

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• Public posting of credit card contracts: Today credit card contracts are usually available only in hard copy and not in plain language. Now issuers will be required to make contracts available on the Internet in a usable format. Regulators and consumer advocates will be better able to monitor changes in credit card terms and evaluate whether current disclosures and protections are adequate.
• Holds regulators accountable to enforce the law:  Regulators will be required to report annually to the Congress on their enforcement of credit card protections.
• Holds regulators accountable to keep protections current:
  • Regulators will be required to request public input on trends in the credit card market and potential consumer protection issues on a biennial basis to determine what new regulations or disclosures might be needed.
  • Regulators will be required either to update the applicable rules, or to publish findings if they deem further regulation unnecessary.
• Increases penalties: Card issuers that violate these new restrictions will face significantly higher penalties than under current law, which should make violations less likely in the first place.

  
  Cleans Up Credit Card Practices For Young People at Universities. The act contains new protections for college students and young adults, including a requirement that card issuers and universities disclose agreements with respect to the marketing or distribution of credit cards to students.

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• Video – Card Acceptance Best Practices for Lowest Processing Costs (18 min).
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This past Sunday a new rule went into effect, banning banks from processing over-the-limit debit card and ATM transactions, and charging overdraft fees for the service, unless consumers sign up for it. The rule was hailed as a big win for consumers and it is. In 2008 alone, banks and credit unions collected $23.7 billion in overdraft fees, an increase of 35 percent from 2006, according to a study by the Center for Responsible Lending. From the Washington Post we learn that in 2009 the figure was $37.1 billion, as estimated by Moebs Services, a research firm for the financial industry.

So it comes as no surprise that many banks are unhappy with these developments and are looking for ways to make up for the losses. While Bank of America already dropped its overdraft program for debit card transactions and Citibank has never had one, smaller banks are seeing an opportunity, the WaPo article tells us. According to the Moebs report, “about 7 percent of banks have begun offering overdraft programs, compared with about 6 percent that eliminated them” and there is more to it:

[A] research by the Center for Responsible Lending, a consumer advocacy group, found that some industry consultants are encouraging these banks to target the most frequent overdraft offenders. The Federal Deposit Insurance Corp. found in 2008 that multiple offenders held only 9 percent of the accounts at banks that it oversees but generated 84 percent of the fee revenue.

In response, the FDIC has decided to make the rules even tougher:

The FDIC last week proposed more stringent overdraft guidelines for the roughly 5,000 community banks in its jurisdiction. They would strictly prohibit banks from encouraging frequent offenders to enroll in overdraft programs without clearly informing them of alternatives. Banks also could be required to contact customers with six or more overdrafts in a year and offer them other options.

The guidelines would mandate that banks place an “appropriate” limit on overdraft fees, such as limiting the dollar amount or the number of times the fee is assessed, a provision that has long been sought by consumer groups but was not included in the Federal Reserve’s regulations that took effect this week. Finally, the guidelines call for a review of the order in which banks process checks to limit overdraft fees. The deadline for public comment on the proposed rules is Sept. 27.

When passed, these new rules will certainly convince many other banks to follow Bank of America’s example and phase out their overdraft programs. It is now clear that they will have to look for other sources to make up for the lost revenues and there are signs that this is already happening.

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Federal Reserve data tell a story of a huge shift in consumer attitude toward debt that started when the financial crisis first hit a couple of years ago. Since September 2008, when Lehman Brothers collapsed, outstanding balances on consumer credit cards have fallen by $144.9 billion, or 14.85 percent, according to the Federal Reserve. The average U.S. household eliminated $2,683 of credit card debt during this period, although a substantial portion of it was charged-off by issuers as uncollectable, rather than paid off by cardholders.

The WSJ now tells us that cardholders “paid back 19.02% of their balances on average in June, up from 17.1% a year earlier, according to a Fitch Ratings index, which tracks about $231 billion of credit card loans.”

Now, it is great that consumers are making a sustained effort to reduce their credit card debt and it does look like it is not going to be just a blip on the radar screen, as it has been going on for almost two years now. But what about the credit card companies, how is this new trend affecting them? More importantly, what will be the implications for consumers?

According to the WSJ:

Lower card loan balances took a bite out of income for issuers in the second quarter. At Capital One, revenue fell 9% in the second quarter from the first quarter to $3.9 billion as average loan balances declined 4.5%.

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For J.P. Morgan, revenue at its credit card unit fell 13% in the second quarter from a year ago to $4.2 billion. Its card balances fell 16% to $146.3 billion during the same period.

However, not all issuers are struggling. Again from the WSJ we learn that:

For American Express, consumers paying off their card balances more quickly may prove to have a silver lining as the company issues charge cards, which must be paid off each month, as well as credit cards that allow customers to carry a balance. AmEx’s revenue rose 13% to $6.86 billion in the second quarter, aided in part by higher cardholder spending. That was offset by lower card balances, which fell 9% to $57.3 billion during the period.

So what should we expect from issuers in response to this new trend? After all, it is not very likely that they will just sit idly by, while their revenues shrink.

It is unlikely that issuers will be able to offset the drop in revenues with higher fees or interest rates, partly because cardholders are becoming more disciplined in making payments on time and are generally more conscious of penalty fees, but mostly because the recently passed CARD Act restricts the issuers’ ability to raise interest rates, while preventing them from charging certain fees. For example, credit card companies are no longer allowed to charge overdraft fees, unless cardholders explicitly opt in for overdraft protection. Moreover, beginning this coming Sunday, late payment fees will be reduced from $35 to $25, while inactivity fees will be banned altogether.

Credit card companies seem to have realized that reliance on traditional card products will no longer be enough and have started to get creative. As the above American Express example shows, charge cards were the first sign of their creativity, and they are now also offered by Chase and other issuers. Requiring cardholders to pay in full each month is a sure way to boost revenues. More innovations are certain to be unveiled in the coming months and it will be very interesting to see what form they will take.

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).

A recent report from the Federal Reserve Bank of Boston concluded that America’s lower-income consumers are in fact subsidizing the cost of credit card rewards programs, while the benefits are largely reaped by those who need them the least. Here is the gist of the report:

Merchant fees and reward programs generate an implicit monetary transfer to credit card users from non-card (or “cash”) users because merchants generally do not set differential prices for card users to recoup the costs of fees and rewards. On average, each cash-using household pays $151 to card-using households and each card-using household receives $1,482 from cash users every year [a total transfer of $1,633 from the average cash payer to the average card payer]. Because credit card spending and rewards are positively correlated with household income, the payment instrument transfer also induces a regressive transfer from low-income to high-income households in general.

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On average, and after accounting for rewards paid to households by banks, when all households are divided into two income groups, each low-income household pays $9 to high-income households and each high-income household receives $434 from low-income households every year. The magnitude of this transfer is even greater when household income is divided into seven categories: on average, the lowest-income household (< $20,000 annually) pays a transfer of $23 and the highest-income household (> $150,000 annually) receives a subsidy of $756 every year. The transfers among income groups are smaller than those between cash and card users because some low-income households use credit cards and many high-income households use cash. Finally, about 83 percent of banks’ revenue from credit card merchant fees is obtained from cash payers, and disproportionately from low-income cash payers.

Now, in order to make sense of these numbers, we need to understand how processing fees are assessed. Every time a bank card is used for payment, the merchant is charged a processing fee, which can range anywhere from less than one percent to as high as 3.5 percent or higher, depending on how the payment is accepted (swiped, key-entered, submitted online, etc.) and the type of credit card used. Generally, debit cards are cheaper to accept than credit cards, and regular credit cards are, in turn, cheaper than rewards credit cards.

So the report points to the fact that, for credit card sales, merchants only get paid 97 percent – 99 percent of the sale’s amount, while they get 100 percent of the cash sales. Moreover, accepting rewards card costs about 0.10 percent – 1.50 percent more than accepting regular credit cards, depending on the pricing model.

The authors then make the assertion that, because merchants are not allowed to surcharge card transactions, prices are higher for everyone. The upshot is that everyone pays 1 percent – 3 percent higher prices, but those paying with rewards cards are getting some of it (or more than that) back.

Earlier this year, the big retailers used this very argument to convince Congress that the high processing fees card issuers charge are paid indirectly by consumers through higher retail prices. They succeeded and the result is that the Federal Reserve is now charged with regulating the interchange fees on debit card transactions. Interchange fees make up the bulk of the total processing fees.

Now, if you take the merchants’ argument a step further, you would have to conclude that, once interchange fees go down, retail prices would have to fall accordingly. Unfortunately, it is far more likely that the banks’ lobbyists would be justified in their skepticism and any fee reduction would be mirrored by an equal rise in the merchants’ revenues. Not only are prices unlikely to fall but, if merchants have their way and win the right to add a surcharge to card transactions, prices will rise for cardholders. If that is the case, lower-income cash users will pay just as much as they do now, however using cards will become costlier. Moreover, the “monetary transfer” from the poor to the rich will be reduced, but it will not be eliminated.

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).