Every day we read about how difficult it is to be a credit card issuer: credit losses at all time highs, CARD Act requirements are difficult to implement, marketing money is hard to come by, and on and on.
While all of these difficulties exist, this market has created a significant and unique opportunity for one surprising segment of the credit union market. Believe it or not, this is the perfect time for credit unions that have sold their credit card portfolios to reenter the business.
In the past decade approximately 450 credit unions sold their portfolios, with total card balances of $3.3 billion. While the sale of those portfolios generated strong feelings, it is only fair to acknowledge that those institutions by-and-large made a great financial decision. Credit card portfolio valuations, which had often generated 20% or greater premiums over book value, have dropped precipitously and today many portfolios cannot be sold at any price.
Further, in addition to generating a financial windfall, those credit unions have avoided getting swept away in this raging river of consumer credit risk as well as avoiding all the expenses and complexities required of all issuers by the CARD Act. In short, those management teams that sold are in many ways looking like the smartest people in the room. But things have changed, and staying smart is no easy task.
Why Start Over?
One hallmark of effective leaders is that they do not assume yesterday's decisions remain best for tomorrow; they revisit the underlying principles and premises from time to time. Sometimes they reaffirm previous decisions and stay the course. Other times they recognize that the world has changed and it's time for a new approach. Now is just such a time: the assumptions that made a credit card portfolio sale smart in the past have changed enough that some credit unions would be well suited to reverse the decision.
This can make sense because those that sold their credit card portfolios have the following advantages:
1) They are not burdened with an existing portfolio. All issuers these days are trying to overcome high-risk portfolio segments (if not entire portfolios!), and working your way out of existing credit issues is arduous. Starting over means no you have legacy portfolio to fix and a credit union can develop fair and competitive products without having to pay for past mistakes.
2) The CARD Act has placed substantial burdens on current credit card issuers. The transitions required by the CARD Act have been difficult, expensive, and fraught with potential for mistakes. By reentering the business now a credit union will come in after the new rules have been fully vetted and implemented and without a need to transition existing portfolios (some of which will not be profitable for years).
3) Popular opinion and press has turned decidedly against large card-issuing banks. In the past year large issuers have raised rates and fees, creating a marketing opportunity for smaller, nimble credit union competitors. Our clients have seen relationship-based marketing yield very strong results, allowing them to generate new accounts, deepen relationships, and strengthen their card programs with their most credit-worthy members. New issuers can focus their credit card resources 100% on this opportunity.
Getting Started: Key Considerations
Just because starting to issue credit cards again could make sense does not mean it is simple or a certain path to quick profits. Any issuer thinking through this opportunity needs to:
1) Understand the substantial changes seen in the consumer credit markets over the past two years. Underwriting approaches have evolved substantially, risk-control tools have become more important, spending patterns are changing, and the expectations of the credit card seeking population are substantially different than they used to be.
2) Structure a program that has fair rates and fees. This does not mean lowest priced. Consumer credit costs have been increasing driven both by the overall economic environment and constraints imposed by the CARD Act.
3) Accept how profitable a card program can become in this "new normal." In the past our clients were advised to target a credit card portfolio ROA of between 2-5%. In this new environment ROAs of 1-3% are going to be the norm. These are still fine returns and most credit unions would love to get these ROA levels on any other loan product, but returns are lower than in the past. Be realistic.
4) Develop the management skills, tools and discipline required to manage a card program. These needs have escalated dramatically from the past. Managing a card program is not a part-time job for a junior staff member. It requires specialized knowledge and ongoing management support. A credit union can either recruit staff with that expertise or consider outsourcing some of the skills required to a third party. Depending on program size, either option might be the most cost effective.
The Cost of Getting It Wrong
While we firmly believe that this opportunity cannot be ignored, it is important that credit unions consider the risks of getting this decision wrong. Consider the case of Eastern Financial Florida CU. In 2005 they reentered card issuing amid great fanfare and industry support. Within three years they succeeded in growing a portfolio of more than $40 million in balances and were the subject of continuing positive press. What was not reported was a portfolio in real trouble from the beginning: by 2007 their credit loss rates were more than two times credit union averages, by 2008 they were north of an 11% charge-off rate. In 2009 card charge-off rates were above 15% and the institution was taken over by the NCUA.
Certainly there were other factors at play, but a badly managed reentry into credit card issuance played an important part in Eastern's failure. Having a loose evaluation process, failing to gather all available intelligence, trusting in conventional wisdom, and making this decision without a full business plan can lead to a terrible outcome. Growth is easy; getting all the program components working together is not.
Reentering the credit card issuing business entails risk, but also creates opportunity. Doing it well can generate substantial long term value for a credit union. But a cavalier and cursory approach can lead to some truly awful outcomes. If you would like to consider become an issuer again we encourage some very deep thinking, engagement of the entire management team, development of fully detailed multi-year strategic plans with operational milestones, and creation of performance scorecards and financial benchmarks from the very beginning. The rewards can be worth it, and now is the time like never before.
Timothy Kolk, President of TRK Advisors, has worked with credit card issuers for more than 15 years and has analyzed hundreds of credit card programs. He can be reached at email@example.com or (603-924-4438).