By Ray Birch
PETERBOROUGH, N.H.—Rising credit card delinquencies and charge-offs have yet to spur major concerns among lenders, but one analyst cautions that rising rates could be masking deeper problems.
“We are watching escalating charge-offs. They are slow but steady,” said Tim Kolk, principal at TRK Advisors. “So far the increase in the prime rate has been greater than the increase in charge-offs. And as long as you have a variable rate product you have been fine.”
But Kolk wonders what will happen to card profitability if rate increases don’t keep pace with charge-offs.
Although delinquencies remain at relatively low levels, the national delinquency rate has been slowly rising since 2015. Quarterly write-offs of bad credit card debt hit their high at nearly $19 billion in the first quarter of 2010 and fell to $5 billion in 2015. But over the last three years those numbers have turned north again to more than $8 billion.
In addition, last month the Federal Reserve Board of Governors’ annual report on credit card banks’ profitability showed a return on assets falling in 2017 for the fourth year in a row—at 3.4% it’s one-third lower than it was in 2013.
“If the rate increases stop and charge-offs move up faster, that will begin to assert a lot of pressure on card programs’ profitability,” said Kolk. “Many credit unions’ cards programs are 25%-35% of their total profitability. If that falls under significant pressure there could be some real issues for credit unions.”
Being Vigilant
That’s why it’s imperative credit unions become vigilant for signs of trouble before the obvious indicators appear, such as a marked increase delinquencies, according to Kolk.
“Credit unions need to keep an eye on the path of their credit risk,” he cautioned. “The easiest way to do that is by watching delinquency and charge-off levels. But those are backward-looking indicators of risk. You already have that risk. To keep on top of this you need ongoing analysis of credit score drift among your cardholders, and look for other measures of potential difficulty within a member’s relationship with you. So, things like delinquencies on other products they have with you, a marked decrease in their average deposit level. Things like that, things that give you greater insight into a member’s risk profile beyond the obvious signs.”
Kolk acknowledged that the risk in the portfolio was there when the credit union approved each cardholder.
“But when things are under pressure every little bit (of caution) helps,” he said.
Many Aren’t Waiting
Tim Kolk, TRK Advisors
Many financial institutions are not waiting to act. A previous report in CUToday.info revealed that some big banks are cutting back on the number of new card offers and getting stricter with their standards for approval.
“But delinquency rates are still at good levels,” said Kolk. “But, if these rates keep ticking up we will get to levels where we will be really concerned.”
Also looming is a forecast by many economists that the country will experience a recession in the next one to three years.
“And recessions tend to double charge-off rates,” noted Kolk.
Portfolio Sales Ahead?
Could the threat of a recession and greater charge-offs lead more credit unions to sell off their portfolios?
“There is always some interest in selling the portfolio. Over the last five years I have helped a half-dozen credit unions do that,” said Kolk. “Now, I don’t have any data to support this, but it feels like selling is becoming a little more interesting to some. Throw in the escalating price of rewards, and just the daily work to be good at this, along with concerns about a possible recession, and I think some people are looking ahead.”
Kolk noted that it is difficult to enter, leave and re-enter the credit card market, saying that timing the moves right is not easy.
“I have helped credit unions who sold their portfolios in 2005-2006, just ahead of the recession, start a new one after the downturn,” Kolk said. “They got out of the game, avoided the tough recession years, got back in and are doing great.”
Between 2000-2007, about Kolk estimates that 500 credit unions sold their portfolios.
“And I think if everyone in 2006 would have clearly seen what was ahead for the next five years about another 1,000 credit unions would have stepped out of cards. But keep in mind that when things are going great credit cards are highly profitable—4%-6% ROA.”
The Better Strategy
Kolk said that instead of trying to time moves in and out of the market, especially since building a strong credit card portfolio can take many years, it’s better to try to make the most of the great times and survive the lean years.
“When times are really good the credit union should be doing all it can to make the most of those years because times won’t always be great. You just have to understand that when your portfolio ROA is down to 0.12%, that is the price for being in the game when ROA is 6%.”