Tag Archive for: Credit card portfolio

(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.

John Costa, Managing Director of Auriemma Finance, has published an article in American Banker’s BankThink section. The piece focuses on large banks downsizing through a sale or spinoff of their credit card business.

You can read the full story here: Why Big Banks Would Do Well to Spin Off Credit Cards

For more information, contact John Costa at john.costa@auriemma.group or 212-323-7000.

(New York, NY):  Auriemma Group, a nationally recognized credit card valuation agent, has identified several factors which it believes will cause credit card valuations to decline.  The drivers of this anticipated reduction in market value are both changes in card business models as well as regulatory and accounting rule changes.  While Auriemma remains bullish on the credit card business over the short – intermediate timeframe, we expect to see the value reductions appearing in earnest by 2017.

Of the threats to the business model for traditional card issuers, Auriemma is focused on the following:

  • The inevitable increase in delinquency and bad debt expense as the business reverts to the long term mean for consumer credit performance
  • The gradual erosion in underwriting discipline which we are anticipating based upon the entrance of new issuers into the subprime arena
  • The change in “lifetime” value of a customer brought about in part by the change in perception about use of credit cards versus debit cards among millennials
  • The proliferation of alternative payment channels which will exert pressure on traditional card income as newer players enter the market and demand revenue participation.

Several of these are long term trends which we have been watching/anticipating and see signs of acceleration.  With regard to the impending regulatory and accounting changes and the anticipated change in market value, Auriemma is focused on the following:

  • FASB’s new methodology for loan loss allocation which we believe will have an exaggerated impact on credit card issuers versus other consumer lenders
  • The changes in both the composition of common equity tier 1 (CET1) capital and in the specific new capital treatment of purchased credit card relationships (PCCR) intangible assets.

Both the anticipated changes to the loan loss reserving methodology and to the new capital treatment for PCCR will result in very significant pressure on regulatory capital for the industry and will likely slow down future portfolio consolidation.  Auriemma’s expectation that market values will decline does not mean the card industry will become unprofitable; rather, the increase in the amount of capital necessary will result in a significantly lower return on equity.

There are multiple strategies that an issuer may pursue to position itself for these challenges.  Such strategies can allow for both aggressive and defensive postures.  Similarly, investors in credit card equities need to understand how their portfolio companies will address these issues.  Auriemma is prepared to assist our clients both in developing strategies and implementing plans to align their goals with the changing environment.

 About Auriemma Consulting 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. Auriemma has been providing credit card portfolio valuations for over two decades and is a nationally recognized valuation agent. For more information, please contact John Costa at (212) 323-7000.

John Costa, Managing Director of Auriemma Finance, has published an article in American Banker’s BankThink section. The piece focuses on how Basel III rules have magnified the importance of regulatory capital in the decision-making process to buy or to sell a credit card portfolio.

You can read the full story here: Basel III Makes Credit Card Portfolios a Buyer’s and Seller’s Market

For more information, contact John Costa at john.costa@auriemma.group or 212-323-7000.

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