Understanding How Banks Value Your Program Is Challenging, but Necessary for Growth -Jonathan Gelfand
How your bank crunches the numbers to determine the profitability of your credit card program is incredibly important to sponsors because the way that banks value programs directly influences their investment in the program and payments to their partners. It can add up to a mutually beneficial partnership or it could mean a marginally satisfactory relationship. It is well worth the time it takes to understand how they do it and how you can use those measurements to increase the value of your program.
Factors that affect how banks count the profitability of credit cards include:
•Credit loss profile of cardholders
•Percentage of new accounts
•Individual account performance
•Performance of blended segments
Credit Loss Profile
Since they have had to write off high losses in recent years, banks have become more averse to taking risks. That means that it’s very likely that many “good” customers aren’t being approved, and your program may not be as valuable as it could be.
For example, although 30-day delinquent accounts are usually paid eventually and banks collect fees and higher interest rates on past-due accounts, they are also a harbinger of credit losses to come. It’s the first sign of trouble.
When banks decide that they really can’t collect from their customers, they write off the balance due as a loss. As a result, banks are being more cautious about issuing credit cards, and the percentage of cardholders who are 30-days delinquent in their payments is declining. According to an American Bankers Association report published in April this year, the number of cardholders who were 30 days late on their payments sank to 2.47%. It hasn’t been that low since 1994! The record high was 5.01% in 2009.
As the number of 30-day delinquent accounts declines, credit card programs should become more profitable to banks. Here’s why. Accounting and banking rules require banks to reserve funds for future loan losses. So, even though losses haven’t actually occurred, these estimated losses affect the bottom line and are reflected on profit and loss statements.
The income generated by your program determines how much a bank is willing to invest in it. As your program increases in value, the bank may be willing to provide more incentives for customers, offer direct mail opportunities, invest in technology to improve customer acquisition or help you grow your program in other ways.
As a partner, asking about and understanding the credit performance of your portfolio will enable you to better maximize its value. Your bank should be able to tell you the percentage of accounts that are 30-days delinquent and the trend, as well as the charge-off rate and trend. Many banks don’t like to share this information, but it is important and worth pushing for as it directly relates to future investment.
Measuring the value of a new account over time is also challenging. It is very expensive for banks to acquire new accounts. The payoff, which is highly uncertain, occurs over many years. Since credit cards tend to have a life span of over 10 years, it is important to understand that average metrics and profitability measured at a specific point in time are very poor indicators of a program’s value.
A new portfolio that is adding numerous new accounts will have sub-par measurements that hide its long term value. It will also have disproportionate losses, such as estimated reserve funds, that will not look favorable. On the other hand, a vintage portfolio- one with only about 10 percent new accounts-- will spin off significant value to the bank. Portfolios become more valuable over time as cards are used and the number of delinquent accounts declines through attrition.
Although old accounts are more valuable than new accounts, you need to keep adding new cardholders. Their accounts will eventually become more valuable. If you stop acquiring new customers, you won’t be able to increase the number of tenured accounts you will have in the future.
Understanding the lifecycle of accounts and not just its value at a given point in time is important to maximizing the value of your program. You may think that the banks are expert at this, but unfortunately in my experience there are significant gaps in managing and understanding this cycle. Frequently like many organizations, banks are very short-term focused.
Individual Account Performance
Looking occasionally at performance on a per account basis is another important tool that can be used to determine areas where performance can be improved, especially if you compare it to accounts in alternative segments or to a control offer.
Per account analysis can be performed at a point in time by vintage – accounts that were acquired at the same time by the same method -- or based on a longer term measure using a tool like Net Present Value (NPV), which takes into account and discounts the future value of an account.
For example, if you sent prospective cardholders an email offer that said they would receive $100 if they spend at least $1,000 on an initial purchase, you can evaluate just the accounts that were acquired a year ago through that promotion to determine if the email offer did well enough to consider repeating.
Ideally, you should compare that vintage to another vintage to determine which offer is better, but just understanding the profitability of one vintage can be valuable.
If you also analyze those accounts using NPV, then you will learn if the costs associated with the promotion will create long term value and if it is a good investment. You can determine the long term value of those accounts based on the expense of the promotion versus potential future revenues. That can be compared to the expected performance of a different promotion.
We encourage you to have your bank partner share with you the per account value for them, but also to calculate this value for you. This type of analysis will help you to prioritize and determine the opportunities your cobranded credit card offers so that it will attract more attention in different marketing situations online or inshore.
In many cases, especially if a program isn’t performing, it is hard to justify investing in new account acquisition because the scale isn’t profitable in the short term. On the other hand, if you look at it from a per account basis, it may be a very profitable long term investment.
Performance of Different Segments
Another challenge with respect to determining profitability is the blending of different account types and segments together. Accounts are commonly segmented by current credit quality, credit quality at acquisition, spending behaviors with the program sponsor, spending behaviors overall, and balance behaviors to name a few. When these segments are viewed separately, you can identify how different segments are actually performing and which accounts are driving profitability. The sources of value become clear and the bank and partner can work to maximize future profitability.
For example, if you can identify who your best customers are, you can invest more money in efforts to get them to be even better customers. For instance, if a customer is purchasing shoes from your store, you may be able to convince them to also buy jackets by offering incentives such as discount offers mailed with their credit card statements. Or, if a customer is buying a limited amount of a product such as gasoline, you could provide an incentive to make them buy more using your card.
Synchronizing Bank and Sponsor Objectives
So, as a partner, what can you do to align your objectives with those of your bank? First, ensure you understand and are correctly valuing the profitability of the program for you in both the short and long-term. Once you understand your profitability and what drives it, it is important to understand the bank’s profitability so that the value created can be shared more transparently.
Measuring profitability isn’t simple. In banking, it is very complex and will require an investment in time and energy to understand how it works, the different perspectives, and implications. But it’s well worth it. When you are fully in sync with your bank partner, real growth can be unlocked.
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