Why more issuers see profit in secured credit cards

February 21, 2020 10:30 AM

Ally Financial's recently announced $2.65 billion cash-and-stock deal for CardWorks, which offers unsecured credit cards among other products, places a high price tag on a traditionally risky product.

The market for secured credit cards, which require a deposit and set a relatively low spending limit, generally ebbs and flows with the economy. Banks aren't the only ones to take notice that the time may be right to reinvest in thin-file borrowers.

Amazon.com's entry into the secured card market, as well as increasing competition from fintech startups, demonstrate there's an opportunity to offer credit to consumers who may not have had other opportunities to establish credit.

This story was compiled from reporting by PaymentsSource writers including John Adams, Kate Fitzgerald, David Heun, Michael Moeser and Daniel Wolfe. Kevin Wack and Laura Alix also contributed reporting.

Ally Financial

Growing Ally

Ally Financial’s $2.65 billion bet on the subprime credit card business is drawing skepticism from Wall Street — Ally’s stock price plunged Wednesday by more than 11% — with investors raising concerns about the strategy and timing of the auto lender’s decision to embrace riskier unsecured consumer loans.

Detroit-based Ally announced an agreement Tuesday to acquire the parent company of Merrick Bank, which provides high-priced revolving credit to consumers who typically do not qualify for mainstream plastic.

It is a lucrative business. CardWorks, the Woodbury, N.Y.-based parent company, recorded $277 million in pretax income last year on assets of less than $5 billion. Merrick Bank’s return on assets in the first nine months of last year was more than four times higher than the average across the U.S. banking industry.

Ally executives said that the acquisition will enable the auto lender, which also offers deposit products through a digital bank, to provide an expanded product set to its existing customers. Over time, Ally will likely offer a credit card for consumers with higher credit scores than those who would typically apply for a card from Merrick Bank, they said.

Amazon Subprime?

Targeting consumers with poor or thin credit, Amazon launched its Credit Builder Card in June 2019, enabling those who put down a security deposit to shop online — while earning rewards on par with those offered to mainstream cardholders.

Amazon Prime members with the secured card earn 5% back on all Amazon purchases, the same reward provided by Amazon’s private-label credit card and by its open-loop card. Amazon Credit Builder is one of the industry’s first private-label secured cards, according to Synchrony, which issues the new card.

Amazon Credit Builder typically offers customers a credit limit of $500, and consumers who make several consecutive on-time payments may be upgraded within seven months to a regular Amazon store card.

Navy Federal vs. the fintechs

Justin Zeidman, head of credit card products at Navy Federal Credit Union, said his company took a renewed interest in secured credit cards after seeing fintechs encroach on that market.

Navy Federal increased its marketing outreach to this audience, but didn't see any increase in secured card acquisition, Zeidman said at Arizent's Card Forum in 2019. Then it realized that its minimum deposit requirement of $500 was too high for those members.

"They didn't have a lot of deposits on the books with us," Zeidman said. "On average we saw $700 … you're asking them to shove over 75% of their savings, just so they can establish credit."

To make its card more appealing, Navy Federal lowered the secured credit line to a $200 deposit — and acquisitions nearly doubled.

Its next step was to look at graduation. Most of the secured cardholders, upon graduation, were applying for a different Navy Federal card. The credit union chose instead to upgrade those members to its standard cash-back card.

"I know it's no secret secured credit isn't the most profitable place to play, but when you think about the lifetime value of being the first issuer to lend to someone — and then the value of that loyalty over the course of years and years — for us it made a lot of sense," Zeidman said.

A bank for the underbanked

Regions Financial in Birmingham, Ala., launched a secured credit card in 2017, aimed at consumers eager to repair damaged credit or build credit histories.

Regions already offered a line of banking products, called its Now Banking Solutions, specifically tailored to unbanked and underbanked consumers. That product suite includes a prepaid Visa debit card and a savings account with no minimum required balance, as well as check cashing, money orders, money transfers and bill payments offered in partnership with Western Union. The bank also offers secured loans and lines of credit to this customer base.

Once upon a time, it even offered a deposit advance product, but Regions, and several other banks in that business, discontinued that product amid regulatory scrutiny.

Discover goes downstream

Back in 2016, Discover Financial Services made an aggressive bid for consumers who can't qualify for a traditional credit card.

Though the card would likely appeal to a limited pool of potential borrowers — applicants are required to deposit at least $200 in order to open an account — it offered a new way for Discover to build its loan portfolio.

That is not to say that the Discover card offers cheap credit. Annual percentage rates on purchases made with the card are 23.24%. For cash advances the APR is 25.24%.

But unlike a competing product from Capital One Financial, the Discover It Secured Card offers cash rewards of 1% to 2%. And in contrast with a secured card from Citigroup, the Discover offering does not carry an annual fee.

In addition, users of Discover's secured card have free access to their credit scores, a feature that Discover has been offering to customers since late 2013.

For roughly two years before the product's 2016 launch, Discover had quietly been offering the secured card to certain customers who get turned down for the company's other credit cards.

From subprime to superprime

More issuers are coming to the realization that there is an untapped market for secured credit cards, and that many of the potential users of secured cards would be good long-term customers once they establish a credit history.

"Twenty-five percent of them are considered superprime once they have demonstrated some credit performance," Larry Santucci, senior research fellow for the consumer finance institute at the Federal Reserve Bank of Philadelphia, said at Card Forum in 2019.

Graduating these consumers to a standard credit account simply means releasing the security deposit. As a result, "a lot of the issuers are reporting these cards not as secured cards but as regular credit cards," Santucci said.