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Klarna is the UK’s Top Buy Now, Pay Later Provider, But How Can Competitors Gain Market Share?

(London, UK): Klarna is the leading Buy Now, Pay Later (BNPL) provider in the UK with 13 million customers using its products and services, but the Swedish FinTech reported $1bn of losses in 2022, its largest ever, adding to the strain of incoming regulation following the UK Government’s draft legislation in February.

Despite losses, the UK giant continues to have a strong foothold in the marketplace. According to Auriemma Group’s latest issue of Cardbeat UK, 50% of BNPL users say they prefer Klarna to other BNPL brands. Clearpay comes in a distant second at 16%, with the remaining providers such as Laybuy in single digits.

Klarna and its competitors offer similar services, including 0% interest on instalment purchases, and weekly or monthly repayment plans. One of the key differentiators, however, is each provider’s portfolio of merchant partners where customers can utilise the competing services.

For example, ASOS, one of the UK’s largest online retailers with 8.9 million customers, lists Klarna and Clearpay as BNPL options at checkout, while major sports retailer JD Sports has deals with Klarna and Laybuy. So, is it really just availability at checkout that drives usage?

Auriemma Group’s research found that 31% of BNPL users have previously tried Clearpay and 12% tried Laybuy, compared to 50% who have tried Klarna. Furthermore, while 45% of BNPL users have only used one BNPL provider, a notable 36% have tried two or more, highlighting a willingness to use alternative providers even if they are not preferred. This open tendency could play to the advantage of regulated entities following February’s draft legislation.

“Though Klarna remains the top BNPL provider for the majority of cardholders, a considerable portion have tried other options,” says Jaclyn Holmes, Director of Research at Auriemma Group. “This shows that accessibility can take priority over brand loyalty, highlighting an opportunity for the competition.”

While availability at checkout plays a large role in BNPL selections, familiarity with a provider is also important. 42% credit cardholders say they would use Klarna if presented the option at checkout because of familiarity with the brand. This supersedes user experience (23%), attractive rates (15%) and customer service (10%). More generally, 34% of credit cardholders say that familiarity with the provider has the greatest influence on BNPL usage though the strength of the terms and conditions (33%) are also a notable factor.

As regulated entities like NewDay with NewPay and Zopa make headway in the space, the focus on consumer awareness will be as critical, if not more, as product strength and customer experience.

“Regulation may require changes from Klarna and others that disrupt their current customer journey, opening the door for competitors already accustomed to regulation,” says Holmes. “If new players can quickly build brand awareness and availability at the point-of-sale, we could see Klarna more readily challenged as consumers’ top choice.”

Auriemma Group will continue to monitor this space closely in upcoming Cardbeat studies and within its Customer Service Roundtable groups.

Survey Methodology

This Auriemma Research study was conducted online within the UK by an independent field service provider on behalf of Auriemma in October 2022, among 80o+ adult credit cardholders. The number of interviews completed on a monthly basis is sufficient to allow for statistical significance testing between sub-groups at the 95% confidence level ± 5%, unless otherwise noted. The purpose of the research was not disclosed nor did the respondents know the criteria for qualification.

About Auriemma Group

For more than 35 years, Auriemma’s mission has been to empower clients with authoritative data and actionable insights. Our team comprises recognised experts in four primary areas: operational effectiveness, consumer research, co-brand partnerships and corporate finance. Our business intelligence and advisory services give clients access to the data, expertise and tools they need to navigate an increasingly complex environment and maximise their performance. Auriemma serves the consumer financial services ecosystem from our offices in London and New York City. For more information, visit us at www.auriemma.group or call Jaclyn Holmes at +44 (0) 207 629 0075.

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How High Street Banks May Benefit from Incoming Buy Now, Pay Later Regulation

(London, UK): Incoming FCA regulation could add restrictions on how consumers can use Buy Now, Pay Later (BNPL) services, but these changes may be welcome. According to Auriemma Group’s latest issue of Cardbeat UK, there was an 80% increase in negative experiences with BNPL plans between September 2020 and July 2021.

The increase is uniform across customer segments, including different age groups, household income, and levels of familiarity with BNPL, signalling concerns around the product itself, rather than new or unfamiliar user experiences.

“Our research shows that the few who have negative BNPL experiences most commonly attribute it to unexpected fees or issues it’s created for their other finances,” says Will Moody, Manager at Auriemma. “With a growing segment of consumers turning to BNPL options for borrowing, regulation may play a role in maintaining positive customer sentiments for the product.”

Auriemma’s latest findings show an increase in negative experiences using BNPL or instalment plans–from 5% in September 2020 to 9% in July 2021. While 9% remains the minority, it represents a large community when considering that 17 million UK consumers have used BNPL services as of November 2021.

“This sentiment is being reflected within other markets too,” says Moody. “In the US, a market where over half of adults have used a Buy Now, Pay Later service, about one-third had a negative experience. This rapid growth has caught the attention of the CFPB, and surprisingly enough, half of BNPL users in the US agree these plans should be more regulated.”

Klarna is the leading BNPL and instalments provider in the UK with 16 million customers using its products and services, but the Swedish FinTech reported a round of substantial losses in H2 2021 to add to the strain of incoming regulation.

Many of the UK’s High Street Banks and lenders already have products in market, such as NewDay with its NewPay product. Moreover, regulated FinTechs such as Monzo and Curve also joined the BNPL space in 2021, with Revolut soon to follow.

“Auriemma expects that BNPL regulation will put significant strain on compliance resources for unregulated players such as Klarna,” says Louis Stevens, Director of Roundtables. “This, in turn, could impact innovation, development and growth, opening the door for regulated lenders such as High Street Banks and credit card issuers to step in.”

Could the future of BNPL in the UK rest with traditional players integrating instalments into their existing product sets? And will this be the solution to reversing the rise in poor customer experience? Auriemma Group will continue to monitor and discuss BNPL in upcoming Cardbeat studies, and within its Customer Service Roundtable groups when they next meet June 16-17 at the Sheraton Grand in Edinburgh, Scotland. Email research@auriemma.group to learn more about our consumer studies and roundtables@auriemma.group to inquire about our forums.

Survey Methodology

These Auriemma Research studies were conducted online within the UK by an independent field service provider on behalf of Auriemma from in September 2020 and July 2021, among 80o+ adult credit cardholders. The number of interviews completed on a monthly basis is sufficient to allow for statistical significance testing between sub-groups at the 95% confidence level ± 5%, unless otherwise noted. The purpose of the research was not disclosed nor did the respondents know the criteria for qualification.

About Auriemma Group

For more than 35 years, Auriemma’s mission has been to empower clients with authoritative data and actionable insights. Our team comprises recognised experts in four primary areas: operational effectiveness, consumer research, co-brand partnerships and corporate finance. Our business intelligence and advisory services give clients access to the data, expertise and tools they need to navigate an increasingly complex environment and maximise their performance. Auriemma serves the consumer financial services ecosystem from our offices in London and New York City. For more information, visit us at www.auriemma.group or call Will Moody at +44 (0) 207 629 0075.

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Challenging Transition Ahead for Lenders as HMT Breathing Space and Payment-Holiday Conclusions Near

(London, UK) Collections Departments faced unprecedented challenges throughout the COVID-19 pandemic, from embracing remote working to managing significant payment holiday volumes. And now, they must take action on HMT Breathing Space while transitioning from payment holidays. Auriemma Group’s Collections and Recoveries Roundtable has been discussing these events and their corresponding strategies amongst the UK’s top financial institutions. These two deadlines are quickly approaching, and along with the unpredictable macroeconomic environment, lenders must leverage learnings from the last year to prepare for the likely spike in volume ahead.

“Payment holidays have been the primary focus since the beginning of the pandemic, but with the extension of support schemes, that has now switched, and priority is on HMT Breathing Space,” says Louis Stevens, Director of Roundtables at Auriemma Group. “However, the payment holiday conclusion date is looming, which could mean a significant strain on Collections teams.”

In 2020, lenders quickly learned the need for automation and additional headcount to manage volume spikes, and they are now applying these learnings to prepare for the coming months. On average, lenders intend to increase their collections teams by 42% throughout 2021. Additionally, 86% of lenders have invested in their automated decisioning and digital channels to prepare for volume spikes.

Are Lenders Prepared for HMT Breathing Space?

On 4th May 2021 HMT Breathing Space (Debt Respite Scheme) will go into effect, giving consumers in problem debt the right to legal protections from their creditors. The Debt Respite Scheme has two paths: either through “standard problem debt” or through “a mental health crisis” referral. During this moratorium, lenders cannot communicate with customers and must stop interest from accruing.

According to Auriemma Group’s Collections and Recoveries Roundtable, as of April 1st,69% of lenders indicated that they feel somewhat prepared for the regulation, and the remaining 31% still feeling somewhat unprepared. There are a number of remaining concerns affecting preparedness, including the delay of the creditor portal, ambiguity in the regulation and unknown volumes.

To try to estimate the volume of customers who could potentially enrol in the scheme, lenders are utilising data from payment holidays, debt-advice charities and usage rates of other types of breathing space (e.g., CONC). They are also slightly increasing forecasts due to the worsening economy, payment holiday conclusions and the ceasing of furlough programs.

38% of lenders have already, or are planning to, increase their teams due to HMT Breathing Space. Initially, most lenders will use a combination of manual and automated processes to manage the regulation with the hopes of further automating as they get a better grasp on volumes.

How Will Payment Holiday Conclusions Affect Operations?

Although the deadline to enrol in payment holidays was 31st March, consumers have the option to extend their payment holidays until 31st July as long as it is within their six-month allowance for both secured and unsecured products. The number of customers returning to contractual payments after a payment holiday has remained strong; however, 92% of lenders are anticipating an increase in delinquency volumes following the conclusion of payment holidays.

“The primary watchout is the cohort of customers working in particularly hard-hit sectors, such as travel, tourism and food service. As the support ends for these sectors, we could see significant increases in delinquency volumes as many of these businesses are currently overstaffed,” says Stevens. “The magnitude of volume is contingent on the ability of the economy to bounce back and if predictions, such as the travel boom, come to fruition.”

Customers needing additional support will likely look to long-term forbearance plans, which have caused lenders to focus their attention on that process. Investments have been made in streamlining income and expenditure assessments and digitising the forbearance enrolment process as well as increasing the size of Vulnerable Customer teams.

Auriemma Group’s Collections and Recoveries Roundtable is tackling these challenges head on through our executive meetings, workshops and benchmarking exercises. Within the next three months, the group will be meeting six times with two sessions dedicated to HMT Breathing Space. If you are interested in attending any of these sessions, please reach out via roundtables@auriemma.group.

About Auriemma Group

For more than 30 years, Auriemma’s mission has been to empower clients with authoritative data and actionable insights. Our team comprises recognised experts in four primary areas: operational effectiveness, consumer research, co-brand partnerships, and corporate finance. Our business intelligence and advisory services give clients access to the data, expertise and tools they need to navigate an increasingly complex environment and maximise their performance. Auriemma serves the consumer financial services ecosystem from our offices in London and New York City. For more information, call Louis Stevens at +44 (0) 207 629 0075.

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As CECL Adoption Nears, Implications for Credit Card Issuers Mount

(New York, NY):  As the time for Current Expected Credit Loss (CECL) implementation draws closer, most credit card issuers are working feverishly to develop workable models by the relevant deadline – 2019 for SEC filers, 2020 for non-SEC filers. CECL is intended to better capture the inherent credit loss exposure within a loan by measuring the total expected credit loss over the entire life of the loan, as opposed to other time frames, such as the next 12 months.

While the CECL standard applies to lending broadly and will not be overly burdensome for many types of loans, the new standard presents an unusual challenge for credit card issuers. The heart of the problem is the calculation of the “life” of a credit card loan. Since credit card accounts are revolving facilities, determining the life of a credit card receivable requires adoption of certain modeling positions. While the industry has not reached firm conclusions on modeling conventions for CECL, issuers have been discussing the implementation’s challenges at Auriemma’s Card Accounting Roundtable, where CECL has been a continual agenda item for the last two years.

Some of the major considerations currently under review by issuers include:

Allocation of payments. While the CARD Act stipulates certain rules for the allocation of payments, issuers are looking at other payment allocation methods for CECL. Under the CARD Act, principal payments are directed at the highest outstanding interest rate balances first (a credit card loan may have certain balances at higher rates than other balances – e.g., a 0% teaser rate for a purchase, but a 16% interest rate on other outstanding amounts). While this statutory principal allocation is intended to give the most benefit to the consumer, it can needlessly complicate the sizing of the credit loss reserve. An alternative payment allocation method called FIFO (First In, First Out) would allocate principal to the oldest balance first.

Portfolio segmentation. Any credit card portfolio is comprised of thousands (in some cases, millions) of individual accounts. Some of these cardholders will always pay the minimum amount due, some will pay the entire outstanding balance, and some will pay an amount between the minimum and the entire balance. (Using the average payment amount in a portfolio-wide calculation may give a distorted result: a portfolio with 50% minimum payers and 50% transactors will likely have more risk than a portfolio where everyone pays 50%.) While the correlation between payment amount and credit risk is not perfect, there is the general understanding that minimum payers are likely to produce a higher rate of loss than cardholders making more than a minimum payment.  Most issuers, therefore, will want to calculate a loss exposure on multiple segments.  Segmenting into the three categories mentioned (minimum, full, partial) would seem to be the most basic level of analysis and some card issuers will stratify their accounts into numerous payment cohorts (deciles).  Beyond payment amount segmentation, issuers are also considering segmenting by other characteristics: months on book (longevity of customer), credit score, origination channel, etc. The CECL for the entire portfolio would be the sum of each CECL value for each segment. Further complexity is created by combining variables – for example, payment amount and FICO score.

The current lack of industry standards or modeling conventions has created great uncertainty among card issuers. This lack of consensus makes issuer comparisons fraught with complexity. While the original impetus behind CECL may have been a desire to create additional loan loss reserves, the lack of standards may result in widely divergent loss assessments for portfolios of comparable credit quality.

In addition to CECL modeling challenges, there are other concerns for issuers, such as governance and oversight.  Should responsibility for CECL rest with credit risk, accounting, both or elsewhere?  Generally, capital issues are managed at the enterprise level for large, multi-line banks.  For these banks, CECL governance may be distant from the individual lines of business, increasing the likelihood that the modeling does not reflect the idiosyncrasies of the credit card business.

CECL will also have an impact on credit card portfolio M&A. In many instances, portfolio purchasers will have limited historical loss information for an acquired portfolio. Since the CECL model is based on historical loss experience, an acquirer will need to look for similar quality assets to derive a loss proxy.  This additional ambiguity may result in a wider range of market prices for a given credit card portfolio.

Since increases in the loan loss allowance reduce operating income, the CECL adoption may have the unintended consequence of reducing lending capacity.  Moreover, for an issuer with a growing credit card business, the CECL adoption is not a “step change” function but will be continuous.

Finally, issuers are preparing for a period of “parallel testing” where the loan loss reserve is calculated under CECL and under the previous methodology.  But this begs the question: why a parallel run?  It suggests that comparing the outcome of the CECL levels to levels under the prior methodology may lead to further mischief.  If a card issuer calculates a lower level of loan loss allowance under CECL, will regulators require the pre-CECL methodology? A loan loss “ratchet” might be in the offing, just as the Collins Amendment became a “floor” under the new Basel III regulatory capital rules.

These are just some of the considerations that credit card issuers are weighing in the CECL implementation planning.  Auriemma is involved in these matters in multiple ways including, notably, its Card Accounting Roundtable, writing comment letters to FASB, as well as bespoke consulting work.

About Auriemma Group

For more than 30 years, Auriemma’s mission has been to empower clients with authoritative data and actionable insights. Our team comprises recognized experts in four primary areas: operational effectiveness, consumer research, co-brand partnerships, and corporate finance. Our business intelligence and advisory services give clients access to the data, expertise and tools they need to navigate an increasingly complex environment and maximize their performance. Auriemma serves the consumer financial services ecosystem from our offices in New York City and London. For more information, call John Costa at (212) 323-7000.

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How to Best Prepare for GDPR Compliance

(London, UK):  Since the European Parliament adopted a new standard to improve data protection for individuals within the European Union (EU) in April 2016, firms have faced massive fines for non-compliance. In the UK alone, the fines doubled year on year. Bring on May 2018 and a new set of standards set by the General Data Protection Regulation (GDPR) which aim to provide predictability and efficiency for organisations and offer all EU residents increased data protection rights.

The potential fines for non-compliance are unprecedented: Fines range between €10 million (£7.9 million) or 2 percent of an organisation’s global turnover (whichever is greater) up to €20 million or 4 percent of turnover (whichever is greater). For many businesses, fines could result in severe cash flow problems, insolvency or even bankruptcy/closure. The Information Commissioner’s Office (ICO) fines are currently capped at £500,000 which GDPR will override.

GDPR applies not only to EU domestic business, but to worldwide companies targeting goods and services to European citizens. Some of the key requirements include: increased rights for data subjects, the development of security-first software, encryption of personal data, secure data processing and a 72-hour notification for data breaches containing personal data. The UK Government have confirmed that Brexit will have no impact on the adoption of GDPR.

But many organisations are not yet ready, according to a recent poll one in three of all businesses in the UK are not familiar with GDPR. Many also believe that the regulation does not apply to their business. At Auriemma’s latest slate of Industry Roundtables, anxiety was expressed about the amount of work remaining to be ready by the deadline. Some of the most widely talked about components of GDPR compliance at the recent Auriemma events include:

  • Increased rights for data subjects (i.e., the right to “be forgotten” and data portability)
  • Software to be developed with security in mind (privacy by design and by default)
  • Pseudonymisation or encryption of personal data (privacy by design and by default)
  • Secure processing of data
  • 72-hour notification for breaches of personal data

To account for these changes, most organisations will have to fundamentally change the way they manage and protect data. A shift of this size will need buy-in from the board level and firms should be endeavouring to make sure all employees are aware of the requirements.

To help financial service firms best navigate the GDPR and PSD2 landscape, Auriemma will be holding a UK regulatory Roundtable in London on the 26th January.

We are fast approaching the end of two-year adoption period and 25th May 2018 is when the ICO expect all to be GDPR ready. Organisations should be adjusting their policies, internal and external procedures for data security breaches and considering the new rights of the EU citizens. It will be necessary for all to analyse its current privacy policies, security measures, and underlying operational processes. Firms will also need to identify areas for which process improvements and redesigns are required to ensure compliance with GDPR.

About Auriemma  Group

Auriemma is a boutique management consulting firm with specialized focus on the Payments and Lending space.  We deliver actionable solutions and insights that add value to our clients’ business activities across a broad set of industry topics and disciplines.  Founded in 1984, Auriemma has grown from a one-man shop to a nearly 50-person firm with offices in New York and London.  For more information, contact Louis Stevens at +44.(0) 207.629.0075.

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The Challenge of CECL for Credit Card Issuers

For many years, the credit card industry calculated the loan loss allowance (the ALLL) as an estimate of losses projected over the next ten to twelve months.  This long-standing practice is now about to be overturned. While card issuers have not disclosed the likely impact of the new approach, a doubling of the loss allowance would not be far-fetched. This change in methodology will only magnify the recent acceleration in credit losses.  It is imperative for card issuers to start communicating with the investment community about this change now, before the financial impact is felt.  Without a proper understanding of the accounting rule change, investors will conclude an increase in the loan loss allowance is a signal that credit quality is deteriorating, which may or may not be the case.

Why did the accounting profession feel compelled to change a long-standing practice? Back in 2008, when the world was trying to come to grips with the global financial crisis, the Financial Accounting Standards Board (FASB) embarked on a project to improve the estimation of a lender’s credit exposure.  The theory was that by moving from an incurred loss model to one which captured the expected credit loss associated with a loan exposure over its complete term, banks and other lenders would be better prepared to endure a future credit crisis.  FASB conducted a long evaluation and comment period which ended in June 2016.  The result, Accounting Standards Update (ASU 2016-13) Financial Instruments – Credit Losses (topic 326), is not yet adopted.  The new standard has far reaching implications and FASB has provided a long lead time for implementation (essentially 2019 or 2020 depending on the classification of the reporting entity).

One of the core concepts of the new ASU was the “Current Expected Credit Loss” standard – or CECL.  CECL requires that the lender estimate the expected credit loss over the life of the loan exposure.  While this is challenging for any lender, it is easier for amortizing term loans than for revolving loans.  In particular, for credit card issuers, determining the “expected life” of a credit card receivable (loan) is inherently complex.  What is the life of a credit card loan? One month, one year, ten years?  Since credit cards give the borrower a payment option (minimum, partial or full), determining the life of a loan exposure is challenging.  Quite obviously, CECL could result in a much higher loss allowance if the life of the average credit card loan were deemed to be longer than one year.

After receiving numerous comment letters from industry participants, the FASB created the Transition Resource Group for Credit Losses (the TRG) so that FASB and the industry could develop practical conventions for implementation of the proposed new standard.

The TRG worked on the knotty problem of the “life of loan” for credit cards.  One of the key areas of focus became the application of principal payments.  Beyond the borrower’s right to vary the payment amount, there was also the question of the allocation of principal payments received by the issuer.  Prior to the Credit Card Accountability Responsibility and Disclosure Act of 2009 (the CARD Act), issuers used various payment allocation methods to prioritize the distribution of principal payments.  CARD Act, among many other changes, required issuers to apply principal payments to the outstanding balance with the highest interest rate first, until the high rate balance was reduced to zero or the principal payment was fully utilized.  Applying principal this way was clearly designed to benefit consumers by having the highest rate balances amortize faster than lower or teaser rate balances.

When card issuers began to consider how to implement CECL for their business, they faced a quandary: allocating principal payments according to the CARD Act could make the estimation of the life of loan even more complicated. Should an issuer assume that the life of a current card loan outstanding can vary with subsequent purchase activity, even if the issuer is not legally obligated to fund future activity?

In June 2017, the FASB reviewed a paper (and examples) prepared by the TRG to propose one of two possible solutions to the credit card payment allocation problem.    The first suggestion, “view A,” was a first in, first out (FIFO) allocation where the oldest balance received the principal payments until it was completely paid (or charged off).  This had the virtue of simplicity and consistency.  The second suggestion, “view B,” was more complicated but attempted to closely follow the CARD Act allocation.  While this may have the theoretical advantage of more accurately reflecting the life of a loan, the complexity of this approach was obvious.

The FASB concluded that while it could see no reason to prohibit either approach, it did see View A as more practical.  The staff also recognized that View A was more consistent with the intent of CECL that the loan loss estimate was for the balance at a point in time.  Moreover, since credit card lines are unilaterally revocable by the issuer, including future purchases would essentially change this from a “life of loan” calculation to a “life of loans” calculation.  At a meeting of the TRG on October 4, 2017, the Board agreed to provide further guidance on the acceptability of both views in a future new guidance Update 2016-13.

The credit card industry has enjoyed years of record profitability and near historic lows in both interest expense and credit loss expense.  Now, as credit losses have begun climbing, the move to CECL will have a compounding effect on the loan loss allowance.  In addition to the advance warning and education that issuers should be starting, perhaps there will be other actions that issuers can take post-adoption.  For example, should issuers calculate the allowance using the old methodology as a “non-GAAP” additional metric to be included in the MD&A section of financial statements?  For some long-time industry analysts, this would have the benefit of allowing easier comparisons to prior reporting periods.  Perhaps after one or two years of reporting under the new standard the old calculation can be dropped but including it for at least a transition period would no doubt be helpful.

There has been much media attention paid to the rising loss rates for card issuers, but there has been little discussion about the coming impact of CECL on card issuer profitability.  The credit card business will remain the most profitable lending area for US banks, but expect the future levels of profitability to “reset” at a lower level. The onus is on the card issuers to help investors understand that, at least in this case, the change in profitability may be more a function of convention than credit.

 

About Auriemma Group

Auriemma is a boutique management consulting firm with specialized focus on the Payments and Lending space.  We deliver actionable solutions and insights that add value to our clients’ business activities across a broad set of industry topics and disciplines.  Founded in 1984, Auriemma has grown from a one-man shop to a nearly 50-person firm with offices in New York and London.  For more information, contact John Costa at (212) 323-7000.

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Bolstering Credit Card Profitability Despite Challenging Economic Indicators

(New York, NY): It’s been quite a while since the U.S. credit card industry has had to worry about profitability.  Nearly a decade of close-to-zero funding cost and below-trend losses were the perfect mix for very healthy margins, even after increasing both consumer rewards and co-brand partner compensation.  But lately, new data is emerging that suggests the good times may be waning.

From 2012 to 2016, US credit card issuers experienced a gradual erosion of profitability.  Net income as a percentage of average assets fell from a high of 6.6% to 2.7%, according to the FDIC.  In this context, the results of the 2017 stress tests, in which credit card assets represented the largest potential credit risk for the large bank holding companies, seems more understandable.

While a net return on assets (ROA) of close to 3% is still a healthy profit margin by banking standards, the downward trend is unmistakable. (It’s particularly noteworthy that this erosion was concurrent with historically low interest rates.) And there are new risks to profitability: data from Auriemma’s Industry Roundtables indicate that the top 11 U.S. card issuers’ average quarterly loss rate increased 13.4% between the fourth quarter of 2016 and the first quarter of 2017, signaling that the increasing credit loss trend has not yet abated.

While these trends are gathering force, it’s important to note that the credit card industry has seen difficult times before and has always been able to adjust and rebound.  Here is a potential roadmap for this situation.

The first step for all players, regardless of size, is to conduct a deep-dive portfolio review. By identifying which segments are most vulnerable to deterioration, an issuer can more closely tailor possible solutions.  Ideally, the segmentation should be more than just a FICO or risk segmentation and would include profitability metrics as well. While the CARD Act has essentially eliminated the ability to re-price for credit migration, calculating profitability for each FICO band (or other risk metric) is still a critical step in evaluating the portfolio.  This analysis can be optimized with segmentation by either origination vintage or by origination campaign. Of particular importance: vintage analysis for any change-in-terms (CIT) portfolio actions. Establishing the link between underwriting changes and credit outcomes is critical to an honest assessment.

After the portfolio review, there are many possible paths to follow. Here are a few strategies for issuers to consider.

Take no action. If the portfolio review suggests that the credit trend is anomalous or is likely to revert to a better level, then taking no action and continuing to monitor the portfolio may be the best course. One month does not a trend make.

Be the counter-puncher – and aim for growth. Being aggressive when others play a conservative hand is a time-honored, but high-risk way to grow. (Warren Buffett famously said, “Be fearful when others are greedy and greedy when others are fearful.”) Some issuers will see the market deterioration as an opportunity to gain market share as more conservative issuers pull back. This approach is not for the faint of heart, and the challenges it presents are obvious.  But for a highly capitalized, sophisticated, credit-savvy issuer this can be a tremendous opportunity.

Change underwriting standards. For an issuer that has seen some portfolio deterioration but is not expecting a default tsunami, reducing credit exposure on newly originated accounts with tightened underwriting may be all that is needed. In addition to modifying credit selection and market solicitation criteria, issuers will also want to revisit line assignments (both for the existing portfolio as well as for the new accounts), collection entrance parameters, servicing and collection strategies among other operating levers.

Conduct a portfolio segment sale. One possible outcome of the portfolio analysis, depending on the issuer’s outlook, may be to sell a segment of the portfolio which effectively transfers a disproportionate share of the total portfolio credit risk. While this type of pruning is not always possible, the current market appetite for consumer credit risk makes this a feasible strategy. (A recent example is Barclaycard US’ reported sale of $1.6 billion worth of subprime credit card receivables to the Credit Shop this year.)

These are just a few of the possible avenues to explore in the current environment.  Auriemma has a deep institutional memory about prior challenges and the creative ways in which successful issuers responded.

Ultimately, the strategy selected may be less important than the quality of the portfolio review; a strategy premised on a superficial analysis may be more dependent upon luck than execution. If, after a thorough portfolio review, an institution concludes that no change is needed, that may be a viable choice made with eyes wide open.  Heading into a challenging credit environment, however, it’s safe to say that inertia without analysis is hardly a wise choice.

About Auriemma Group

Auriemma is a boutique management consulting firm with specialized focus on the Payments and Lending space.  We deliver actionable solutions and insights that add value to our clients’ business activities across a broad set of industry topics and disciplines.  For more information, contact John Costa at 212-323-7000.

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EU Pullbacks Haven’t Axed Rewards Payment Cards—They Still Rule

(London, UK):  One year after the implementation of Interchange Fee Regulation (IFR), the majority of British consumers continue to favor payment cards that reward them with points or miles for their spending, according to recent research by Auriemma Group.  The EU-mandated cap on credit and debit card interchange fees reduced the revenues earned by card issuers, prompting many to scale back their rewards schemes in 2016. Despite these cutbacks, over half of UK credit cardholders in the Auriemma study say they earn rewards for payment card usage, and they respond enthusiastically by concentrating their spending on those cards.

As part of its ongoing UK Cardbeat research, Auriemma surveyed 400 UK adults who own rewards payment cards.  Almost a quarter (23%) reported a change to their rewards programme in the past year—78% of them saying the change decreased the overall value of the card. Still, more than half of that same group say their usage was not affected by these changes, and 82% say a payment card that earns rewards is their most frequently used card.

The most widely held type of rewards payment card is cashback (37%), followed by supermarket (33%), and airline (21%). Despite their smaller market share, airline miles seem to be the most powerful reward, as these cardholders spend more in total and report higher satisfaction overall.

“Airline and hotel rewards are big-ticket and aspirational” noted Marianne Berry, Managing Director of Auriemma’s Payment Insights practice, which conducted the study. “Most consumers who have an airline co-branded card are consciously banking their miles earned toward a free ticket for a vacation or personal travel, so they’re very motivated to use that card to pay for everything.”  On average, cardholders say they need to spend £8,325 to redeem points for a flight, compared to £3,386 for a hotel room.

This perception of rewards’ intrinsic value translates into much more spending. On average airline rewards cardholders spend more per month (£1,182) on their airline rewards cards than retailer/grocery (£606) and cashback (£564) cardholders do on those cards combined. And 62% of their spend is outside the card’s partner brand (vs. 52% retailer/supermarket cards), suggesting a purposeful effort to earn miles with a range of purchase types. They also ascribe a higher value to their airline miles earned. About half (46%) of airline rewards cardholders believe a mile is worth £0.05 or more, while only one-quarter (24%) of their retailer/grocery counterparts believe a point earned is worth the same.

“Ultimately, industries vary in how they structure their rewards payment card programmes,” says Berry. “Those with airline cards spend more and have to wait longer to redeem, while those with retail or grocery cards get more frequent, but lower-value rewards. These rewards schemes appeal to different types of cardholders.”

On February 22, these findings (and more insights on UK rewards payment cards) will be presented by Berry at the 2nd Co-Brand EMEA conference in London, entitled, “Is Your Marketing Bold Enough?” Auriemma’s Director of International Partnerships, David Edwards, will act as Chairman for the event. Those interested can visit www.airlineinformation.org to learn more.

Survey Methodology

This study was conducted online within the UK by an independent field service provider on behalf of Auriemma Consulting Group in September 2016, among 400 adult rewards cardholders. The number of interviews completed on a monthly basis is sufficient to allow for statistical significance testing between sub-groups at the 95% confidence level ± 5%, unless otherwise noted.

About Auriemma Group

Auriemma is a boutique management consulting firm with specialised focus on the Payments and Lending space.  We deliver actionable solutions and insights that add value to our clients’ business activities across a broad set of industry topics and disciplines.

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Auriemma Analysis: Insight Into the OCC’s Proposed Fintech Charter

(New York, NY):  Last month, the Office of the Comptroller of the Currency published its proposal to debut a national bank charter specifically for fintech companies and invited public comment on potential implications of the measure.  Auriemma responded to the OCC’s request with a comment letter assessing the proposal’s possible effects on non-bank lenders, payment companies as well as traditional banks.

The core of the OCC proposal is offering a national banking charter to a segment of fintech companies, such as payments technology and marketplace lenders, that provides recipients with the ability to forgo deposits (and skip the FDIC insurance process), while still having the advantages of a national bank charter. For fintech companies with consumer lending businesses, this is especially useful in simplifying pricing, as a national bank charter would allow such companies to select one domicile for determination of rates and regulations and to “export” them to consumers in other geographical areas.

Currently, non-bank lenders are often in contractual relationships with “originating” banks as a way to indirectly achieve national bank advantages, such as avoiding the “state-by-state” regulatory compliance model historically used by non-bank finance companies. The new charter would eliminate the need for an originating bank and allow the OCC to more directly regulate these activities.

Fintech firms would be primarily regulated by the OCC, but this proposal makes clear that all other relevant regulators would still be involved (e.g., a public company would still be regulated by the SEC also).  If a fintech bank elected to be an FDIC depository, for example, the FDIC would also be a key regulator. (Among the most unique features of the charter is that the FDIC insurance is not a requirement, but rather an election.)

Should the proposal move forward, it could also signal a flow of new equity capital moving into the banking sector. (Many institutional equity investors had been sidelined by the current interplay of the Bank Holding Company Act and the FDIC insurance requirement.) This would mark a return of the same investors who flocked to the non-bank fintech companies to participate in consumer credit without these regulatory impediments.

Still up in the air: the appropriate level of regulatory capital that would be needed by a fintech bank. While a non-FDIC insured institution presents no risk to the FDIC guaranty fund, it may still present systemic/contagion risks. Similarly, a non-FDIC insured institution would not fall under the Community Reinvestment Act, but the OCC will still expect fintech companies to address financial “inclusion.” It remains to be seen how this could be addressed outside of the CRA framework.

Since the OCC published its proposal, political opposition has emerged.  Some state Attorneys General and Senators Sherrod Brown (D-Ohio) and Jeff Merkley (D-Ore) are questioning the new charter, saying it is a way to avoid state usury and compliance laws.  Although the OCC did not expect this to become a partisan issue, it now appears likely to become one.

Ultimately, we view this proposal as the OCC offering fintech companies national bank preemption in exchange for direct supervision.  While fintech companies have always had the option of becoming a bank, the new charter makes this more acceptable to institutional equity investors while simultaneously safeguarding the insured deposit base.  Clearly, the OCC is open to revisiting some traditional bank regulatory matters from a new vantage point.

 About Auriemma Group

Auriemma is a boutique management consulting firm with specialized focus on the Payments and Lending space. We deliver actionable solutions and insights that add value to our clients’ business activities across a broad set of industry topics and disciplines. For more information, contact John Costa at (212) 323-7000.

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FCA to Focus on Repayment Behaviour, Persistent Debt in Follow Up to Credit Card Market Study

(London): The FCA is conducting research on consumer repayment behaviour to alleviate persistent debt in anticipation of a new package of remedies. The additional research follows the Credit Card Market Study Final Findings released in July.

Everything from behavioural cues to statement presentation could potentially influence payment behaviour, an FCA representative said during a Q&A session at Auriemma’s Card Finance Roundtable in October. While at the meeting of card issuers, the regulator detailed some of the hypotheses it is testing, including how different consumer segments react to behavioural nudges around suggested repayment amounts, the impact of minimum payment “anchoring,” and how the presentation of amortisation can stimulate repayment habits.

Six months of data will be used in the analysis to assess the study’s impact on consumer behaviour and monitor for unintended consequences.

The FCA also detailed an additional study in collaboration with The UK Cards Association, focussed on further conceptualising early intervention and establishing a set of escalation tools firms will follow to encourage consumers out of persistent debt.

“The FCA has acknowledged that behavioural nudges may not work for all customers, as some may be in financial difficulty,” said Matt Bethell, Senior Associate of Auriemma’s UK Industry Roundtables. “The output of these additional studies will be remedies that incentivise firms to escalate intervention around persistent debt, without damaging customer service.”

The follow-up studies directly respond to some of the FCA’s more significant conclusions from the July study, including the identification of two consumer groups requiring attention:  those carrying debt for longer than three years (most likely due to habitual minimum payments) and those moving rapidly from acquisition to problem debt within one year. To identify these groups, the FCA requested significant data sets from issuers and ran analysis across the product lifecycle. The FCA compared the returns of credit card products for both low- and high-risk consumer segments and found that, between 2010 and 2014, returns were typically six percentage points greater on high-risk segment products. One quarter of accounts taken out in 2013 by consumers within the high-risk segment were in severe or serious arrears by 2014.

“While the FCA concluded that the market is working well for the majority of consumers, and that product cross-subsidisation was not materially impacting competition, it also believes firms have fewer incentives to address consumers with persistent levels of debt and should be intervening earlier,” Bethell said.

While the full implications of the results of these studies are not yet known, issuers are anticipating changes to their portfolio economics and, potentially, value propositions. These developments will be key agenda items at the Card Finance Roundtable in the year ahead.

About Auriemma Group

Auriemma is a boutique management consulting firm with specialised focus on the Payments and Lending space. We deliver actionable solutions and insights that add value to our clients’ business activities across a broad set of industry topics and disciplines. For more information, please contact Matt Bethell at +44 (0) 207 629 0075.

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