Today, TransUnion released credit card industry origination data for the last three months of 2014, and the results are startling. In a country that is already heavily saturated with plastic, 14.41 million new cards were opened in Q4 2014, an increase of 7.1 percent from Q4 2013. Sub-prime customers (defined by TransUnion as customers with a VantageScore below 601) now represent 16.5 percent of originations, an increase of 26.7 percent compared to the previous year. In a world of low interest rates, credit cards remain an extremely profitable asset class for banks and financial institutions. As bankers look for growth, they will inevitably consider expanding their credit risk appetite, chasing more customers with lower credit scores.
We have a credit risk system that guarantees amnesia every seven years. Most negative credit information drops from credit reports after seven years. After the financial crisis of 2008, banks wrote off a significant amount of debt. The charge-offs left scars on millions of credit reports that are slowly fading away. In many cases, the same people are coming back and banks are ready to lend to them.
Credit card companies do have a new set of competitors during this lending cycle. Marketplace lenders, like Lending Club , are looking to steal market share by targeting the most profitable customers with dramatically lower interest rates on fixed installment loans. However, credit card companies have well oiled marketing machines that are roaring back to life and aggressively signing up new customers. And the product remains unique. Sold as intelligent ways to spend, credit cards slowly lure you into debt and create a nation of accidental borrowers. Marketplace lenders are making rational appeals to borrowers, hoping to save them money. Credit card companies are tempting people to spend more. And based upon the Q4 2014 account origination data, the temptation seems to be working.
Credit Cards Remain Extremely Profitable
In a world of low interest rates, credit card businesses are uniquely positioned to generate significant returns. Banks enjoy very low funding costs. But the benefit of the low funding costs is not being shared with consumers. Even worse, most of those customer rates are variable. As funding costs increase, the borrower’s interest rate will increase. For example, Capital One still generates a 16.93% net revenue margin, which has remained resilient.
You just have to think about how credit cards are sold to understand the resilience of the net revenue margin. Cards are typically sold as smart ways to make payments. You are tempted with generous sign-on bonuses, frequent flier miles or discounts at the checkout counter. Because the marketing focus is on rewards for spending, few people pay attention to the interest rate. And even fewer people think they will end up borrowing money on their credit cards.
However, credit limits are much larger than a customer’s monthly income. Large credit lines are there to tempt people into spending more than they should, and it often works. Accidental borrowers do not compare interest rates. Even if someone wanted to shop for the best interest rate, it would be…
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