The Mechanics of Consumer Credit Expansion

 

Money is cheap. Not just a few basis points off the five-year average kind of cheap, but rather extraordinarily cheap. Some European banks even hit negative rates on mortgages as seen in Denmark, Spain, and Portugal. The realized results have been mixed. Denmark has taken it far more positively than Spain or Portugal. In the United States, the Federal Reserve rates have not gone negative, but have been near zero for almost seven years. Banks have been making little profit off of loans because of this. Mortgage rates are lower, and early-payment of debt has also been increasing, further hurting the bottom lines of consumer banks.

Background

In light of this challenging environment, other profit centers need to be expanded. One major area of expansion has been credit cards. Interest rates can be pushed lower while still making a large profit because of the low cost of money and the high interest rates in comparison to other lending products like student loans and mortgages. Travel awards programs were also able to be expanded for the same reasons.

Now that the opportunity and motivation were present to expand credit card issuance, the target audience and source of competitive advantage had to be addressed. The traditional marketing ploys that targeted some kinds of traps at poorer users had to be stopped because of the passage of the Credit CARD Act of 2009. The upper end of the spectrum is, and has been fairly card full. Additionally, the nature of the economy means that there are very few of them.

Expansion

Credit cards are extremely useful. They allow one to greatly reduce the amount of cash carried, carry a small amount of debt manageably as a holdover for a few weeks to month, and often offer fringe convenience benefits in the form of perks and rewards. One intangible use may outweigh the more utilitarian uses of credit cards, however. Oftentimes, credit cards are status symbols. The Amex Centurion has long been a symbol of extreme wealth and success in popular culture. The J.P. Morgan Palladium is of the same vein, albeit lesser known. Offering newly formed “elite” cards to a lower income segment attracts those who want to taste the life of the Centurion user. Aspirational spending by the middle and lower upper classes can provide a fruitful stream of revolving credit users who still have the ability to pay off their balances eventually.

This sub-elite tier offers the some of the cachet of the truly elite cards while still being manageable for above average earners. This tier is further subdivided by fees. The highest level is populated by cards like the Amex Platinum, Visa Black, and Citi Prestige with fees in the neighborhood of $495 per year. The next level is perhaps the most crowded with most annual fees around $95 per year, (although many waive the fee for the first year). The final level is populated by no annual fee rewards cards.

Signup bonuses and continued spending rewards are the main tools used to drive cardholder growth. Minimum spend requirements ensure the user has rotated it into regular use by the end of the bonus period. Inertia and a relatively high effort threshold often keep cards in the wallets of consumers longer than planned, and importantly for the issuers, keep them paying fees. A great deal of vigilance is required to avoid many of the pitfalls the befall those trying to maximize bonus rewards. The rewards structure was also designed to appeal the aspirant/above average earning audience.

Credit card travel and premier shopping awards are something to offer the taste of being ultra wealthy those who aren’t. Travel rewards are specifically a domain that is only worth anything to those with enough resources to travel in the first place. The main draw of travel rewards credit cards is to enable the cardholder to travel more than they otherwise would be able to.

 Future Outlook

Rising consumer sentiment and an incrementally improving job market have jointly worked to push an increasing number of people back into the range where they are comfortable spending money on non-essential items as well as maintaining a larger amount of revolving debt as opposed to the debt-avoidance that has been nearly constant since the start of the Great Recession. In fact, total credit card debt is currently surpassing pre-crisis levels. Travel is now an affordable activity for many who reverted to the “staycation” during the deepest depths of the crisis. This means that travel rewards credit cards are now worth a great deal more to a much higher number of people.

The decrease of other profit lines and the enlarged available market have pushed a vast number of players into the field. Next in this series: Travel Rewards Cards Market Players

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