How to navigate asset risks & evaluate your card program

Effective credit card program management can only happen with a thorough and ongoing examination of how changes in interest rates affect both what is owned (assets) and what is owed (liabilities). This analysis is extremely important for ensuring your financial institution has enough money to cover its obligations and maintain financial stability. If your assets are mismatched, your credit union could be headed for trouble. Reviewing interest rate sensitivities of both assets and liabilities is critical to understand potential liquidity stress that can cause a mismatch in market value.

From a liquidity perspective, a mismatch happens when anticipated deposits aren’t forthcoming and interest rates are rapidly rising, or the cost of funding and operating credit card lending outweighs deposit growth.

With credit cards, the value of the loan asset is impacted by the fact that only a portion of the revenue can be hedged against rising interest rates — interest income — but not fully because it’s an open-ended revolving line of credit. The other revenue streams (fees and interchange income) are not correlated with interest rates.

The latest publication from Elan Credit Card outlines the risks of unbalanced assets, credit card program management costs, and factors to consider when evaluating whether an in-house credit card program can maintain profitability.

Risks of asset mismatch

At its heart, liquidity is about the current availability of cash to purchase assets or meet current liabilities and the ability to convert assets to cash without materially impacting the asset’s value during the conversion to cash (sale for cash).

As interest rates rise, asset values fall, and the cost of funding assets increases. For long-duration assets, such as credit card receivables, cautious financial institutions use match funding strategies and evaluate interest rate forecast scenarios.

Variable interest rate loan pricing is a key component of managing risk; financial institutions that offer low fixed interest rates on long-duration assets may feel pressure from depositors demanding higher interest rates on their savings and checking accounts.

Failure to evaluate all assets and liabilities from a risk management standpoint can easily lead to asset mismatch. One often overlooked liability is the cost of initiating and maintaining an in-house credit card program.

Costs of a credit card program

From staffing to adjusting for Current Expected Credit Losses (CECL), associated costs of managing a credit card program in house continue to rise.

Questions to ask when evaluating your card program:

• Is your card program set with fixed or variable rates?
• How has adjusting for CECL impacted profitability?
• What operating costs have been impacted by inflation?

It is impossible to control a macroeconomic environment, but financial institutions can manage their response by implementing strategies to mitigate risk and keep capital and liquidity levels evenly matched.

Program assessment

Operating a credit card program internally while maintaining profitability is a tricky balance. In some cases, credit card programs can end up costing more to run than they create in revenues, particularly if the customer base is prone to leveraging any rewards offered to an unsustainable extent.

Key performance indicators (KPIs) that should be considered when managing products, creating new products, and designing a growth strategy include weighted average APR, net interest margin, and more.

Using these KPIs to build a picture of capital adequacy, liquidity, and profitability can assist in determining product strategy and pricing. View a full list of KPIs and liabilities to consider in an evaluation here.

Profitability

Credit cards are high-maintenance, highly regulated, and complex, and not all credit unions are fully equipped to manage the cost of origination and servicing. When considering overall profitability, qualitative decisions drive quantitative results to continue incoming revenue without incurring risk.

The value of card issuing can swiftly burden the overall enterprise if the formula is not correctly developed to reduce exposure. This formula is an ongoing balancing act.

The remainder of 2023 will continue to present credit card product exposure and risk challenges.

Credit card loans have a higher risk profile than any other loans on the balance sheet. Now is the time to perform due diligence on your credit card assets. Review product returns and consider the value being driven to the cardmember. Does the value outweigh your risk? 

If you’re contemplating the challenges and opportunities above, read this to learn more about how to evaluate your credit card program.