Following the Money - Jonathan Gelfand
Often retailers and other organizations don’t understand how banks make money on credit products offered to their customers (like private label and cobrand cards tied to loyalty programs) and how value is created. This gap in understanding limits the value partners can realize over the short and long term. In this series of articles, I will explain some of key drivers of profitability, and how to use performance metrics to assess if your program is working as hard as it can to support your objectives. The articles will provide information about how banks make money on payment products and best practices to increase program value. In this column, I will discuss the profitability of credit card programs and how bank economics affect retailers and other partners to banks. Over the last twenty years, the credit card market has changed drastically. In the early 1990’s, several entrepreneurs realized that credit cards were the most profitable part of banking and started the credit-card only banks (i.e. MBNA, First USA, Advanta, CapitalOne, First Deposit). As traditional economic theory dictates, the market became more competitive and with more players in the industry, profits decreased. At the same time legal changes occurred, driving overall profitability of credit cards down further and the credit card banks were absorbed back into the large retail banks like Bank of America and Chase/JP Morgan.
Since the great recession, banks have become very concerned with the credit quality of their customers in order to manage future loss rates. Banks don’t share their credit information unless they are required to by law. Credit information is viewed as one of a bank’s crown jewels. Therefore, it is rare to get insight into how banks manage the extension of credit. Recently American Banker (Thursday, February 14, 2013, page 16) published a summary of the credit profiles at major issuers for their securitized portfolios. Since the banks lump together a portion of the credit portfolios into a tradable security that investors can buy, there are reporting requirements about the included accounts that is very useful in understanding the different bank strategies. A note of caution is that banks selectively include accounts in the securitized portfolios so these accounts may not be representative of any single bank’s credit strategy. With that caveat, there is significant value in interpreting and understanding this rich information as insight into both industry and individual bank strategies.
The headline is that banks are increasingly moving up market in their credit strategies. A couple of examples:
Bank of America increased the share of balances in their securitized portfolios with FICO scores over 720 to 50% in 2012 from 35% in 2007. This change has come entirely from a reduction in the proportion of balances held with account FICO scores less than 660. Between Q1 2008 and Q4 2012 the new accounts opened have dropped from 2.5MM a quarter to just under 1.0 MM. This drop is the result of acquiring only very high FICO score customers as well as customers with low FICO scores exiting from the portfolio via attrition. We have observed an increase in Bank of America acquisition during Q1 2013, but the increase is small and on a very low base compared to historical performance. They continue to be very selective in acquisition. The upshot to partners is that Bank of America is a potentially great partner to cobrand partners that can aggregate high credit score, or “positively selected”, prospects for the program.
Another very large issuer, Citi, has a similar shift from just over 40% of the portfolio with FICO scores above 720 in 2007 to 55% of the portfolio balances having FICO scores over 720 in 2012. This is a big concern for potential partners and makes the move of the BestBuy portfolio from Capital One to Citi especially interesting. Capital One has relatively stable share of the portfolio at 45% over a 720 FICO and 25% below 660. Citi is now at about 12% below 660. For a partner like BestBuy, with a broad customer base, what might be a more stringent set of credit requirements might be offset by better POS retail acquisition capabilities when compared to Capital One. The key point is that when evaluating the right issuing partner, it is important to consider the credit quality of the customer base and to avoid any misalignment.
The flip side of the bias towards higher credit quality customers comes with a price, however. These customers are expensive to acquire and may not be profitable because they tend to revolve (i.e. borrow) less, and when they revolve, it is at lower interest rates. Also, the rewards expense required to attract these customers can be very high, hurting profitability. So while these customers may not create credit losses for the issuers, they may be marginally profitable.
So, as a partner, what can you do to align your objectives with those of the issuer? First, ensure you are fully in sync on the served credit spectrum. If you are misaligned around the kind of customers you want to serve, the program will suffer. Also, make sure you are doing all you can to acquire new card customers at a favorable cost per account. This may be the single most important way you can create value. All three partners – the issuer, the cobrand partner, and the actual customer – need to come out ahead in a balanced way. The next set of articles will dive more into the detail around how banks make money, and best practices for creating a thriving program.
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