DES MOINES, Iowa—Rising rates may bring an end to many credit unions' fixed-rate card programs.
Industry insiders say the CARD Act makes fixed-rate plastic tough to manage in a rising-rate environment. That's because existing balances don't keep steady pace with climbing rates, and it can be a slow, hard-and in some cases extremely difficult-process to switch gears and increase the rate on new balances.
"All signs seem to point to rates going up," said Ben Rempe, vice president of business development at TMG Financial Services. "If CUs with fixed-rate cards are not prepared as rates rise, and their funding costs increase, they may find themselves feeling trapped with a fixed-rate product."
While many CUs have adopted adjustable rates, a number still offer fixed-rate cards. Industry analysts agree that before the CARD Act and prior to the recession, a fixed-rate product was a differentiator for credit unions because it stressed to members that the deal would not change-appealing marketing at a time when consumers were becoming wary of large issuers' adjustable-rate deals.
Also, the sustained low-rate environment brought on by the recession may have taken credit union card issuers' eyes off the potential for rising rates, say industry insiders.
"Some credit unions ... think you sign up for a certain rate and it stays that way forever," said Chris Joy, director of credit card consulting at Advisors Plus in St. Petersburg, Fla. "Unfortunately, the economy, market rates and market funding costs don't keep that same promise. You have to ask yourself, is the credit union protected from a margin and capital perspective with its credit card pricing?"
Card Act Protections
To protect consumers, the CARD Act does not allow financial institutions to change the APR on existing balances, except in a few limited situations. In addition, FIs cannot change the rate on new transactions without first notifying cardholders 45-60 days (depending on the state) in advance of the change.
The rules also prevent some fixed-rate programs from ever changing their rate, which experts say could present a significant threat to a credit union's capital.
"Issuers have lost their insurance policy of being able to change terms at any time, for any reason," said Joy. "What happens if interest rates and funding costs reach 1982 levels again?"
With no repricing mechanism permitted for existing balances, the only available exceptions to reprice now include: expiration of a previously disclosed introductory rate; variable rate exception if a publicly available index changes; delinquency of 60 days past due with 45 days advance notice; completion or failure of a loan workout program; and the end of a Servicemembers Civil Relief Act qualification, said Joy.
CUs Lulled To Sleep?
Experts contend that some credit unions have been lulled to sleep by the ongoing low-rate environment and now need to pay attention to how the CARD Act can impact credit card pricing.
"Because rates have not really changed much in the last five years, credit unions have not encountered this big effect of the Card Act," noted Rempe. "If they are not paying attention they may get stuck behind the eight ball."
Due to the time it takes now to switch to a new rate, and the inability to change the rate on existing balances that may take years to pay off, experts say credit unions must get out ahead of this potential ongoing margin problem and switch to an adjustable rates now.
"You charge 8.99% fixed and your cost of funds goes up 2.5% and charge-offs are 3.5%, well that 8.99% turns into 2.99%," said Rempe. "Now you have a very narrow margin and you still have to pay for overhead, processing and cover fraud losses. And you know EMV is going to be more expensive. All of a sudden that 8.99% you are making a nice yield on today is completely eaten up."
Rempe explained that TMGFS has experience with the CARD Act impacting credit card rate adjustments, having purchased portfolios and changed pricing since the rules took effect.
Factoring in the time it takes to change to a new rate and then the time it takes for existing protected balances to pay off, Rempe said most credit unions can expect about three years to pass before the new rate goes into effect for the majority of balances. "It takes that amount of time to effectively reach your new target rate."
There is a concern, too, that some financial institutions cannot change their rate, not even for new balances, unless they cancel their current card and start a new program.
Tim Kolk, owner of cards consulting firm TRK Advisors in Peterborough, N.H., explained the CARD Act contains specific terminology around fixed and variable credit card pricing-"variable APR," "non-variable APR," and "fixed APR"-and urged CUs to pay attention to what each mean.
"This is a new terminology that I am not certain all credit unions with fixed-rate credit cards have paid attention to or maybe have forgotten about," said Kolk.
Under the CARD Act, if the financial institution's marketing uses the term "fixed," or any language stating the rate will not change, and does not state an end date for the current rate, then that fixed-rate card program's rate can never change, analysts explained. The only way out is to cancel the program and start a new one.
"Imagine telling cardholders you are closing their account and they are welcome to apply for a new card," said Kolk. "How do you think that will go over?"
What the CARD Act considers non-variable, sources explained, is when the financial institution simply advertises the APR, not stating whether the rate is fixed or variable. "In these instances the financial institution can change pricing on new balances after giving members proper notice," said Kolk.
Decision Time
Joy said that it's decision time for many credit unions with fixed-rate cards, having to balance concerns over upsetting members with protecting the capital base.
"Some will eventually have to decide when it's time to stop digging the hole deeper. I recommend the credit union go to variable pricing-and the sooner the better."
Now is a good time to make that move, analysts advise, with rates appearing to hold steady after rising when the Fed initially announced it would begin tapering its bond purchasing. "Better to make the change when rates are stable than when they are volatile," said Joy, who recommended softening the blow to cardholders by providing a slightly lower adjustable rate than members' current fixed rate.
But one credit union with a fixed-rate card has a different perspective. Greg Smith, CEO of Pennsylvania State Employees CU in Harrisburg, Pa., said the CU's 9.9% APR card will not see changes if rates rise. The plastic is not risk priced, is popular with members and is one way the $4.1 billion CU gives back to its owners.
"Yes, a rapidly rising interest rate environment could put the card under pressure and the CARD Act does severely limit how an FI can raise rates on the card," said Smith. "We're OK accepting that as a business risk at this point. I'll take that risk much sooner than I will take the risk of holding 30-year fixed-rate mortgages at 4.5%."
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