Understanding Cards' Real Costs

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In this market, it has become inevitable that we all must look to expense management as a critical element of long-term strategic planning.

Product-level profitability measurement is mandatory. In our many years in the industry, and analysis of hundreds of credit card programs, we often find that too often issuers make common errors in measuring card program profitability. These often include:

Only Counting Some of the Costs

Credit card processing costs lie across many functions, yet we find that internal analysis often only includes limited cost for a few card support staff, or only the direct expenses charged by a third-party servicer.

Other times we see institutions assign cost based on overall CU averages. For example, if non-interest expenses average 2% of assets overal, some issuers assume that figure for the operating expense for every loan category. With credit cards this will invariably and significantly underestimate expenses. Cards have low, per-account balances compared to other products, generally have higher rates of delinquency and resulting collections resources, and are more complex to service than most other loan products.

Other times we see expense figures that blend balance-driven expenses, such as funding costs, with unit- (account-) driven expenses like underwriting expenses or transactional costs. This creates different figures that cannot be effectively used to evaluate potential changes in the program.

The Right Way to Measure Expenses

What is the right way to set up expense measurement systems for credit cards? We advocate developing your own system or acquiring one from an expert third party that is based on a few simple principals.

Start first by breaking out balance-driven costs and keep them separate from unit- and transaction-driven costs.

Next, determine your total servicing expense, i.e., collection and other (non-collection) servicing costs for the existing accounts and translate that into a dollar-cost-per-active account (e.g. $150 per year per active account). Collection expense is best allocated based on late loans, whereas the cost to process payments can be adequately estimated on number of accounts. Outside expenses unique to credit cards, as well as accrued estimates of award costs, should be ID'd by product. Finally, employee-related costs associated with the unique requirements of cards should also be estimated and assigned based on units or usage, including the time of senior management.

Then, separately, count your new account marketing and origination costs, including underwriting and related set-up functions. This will allow you to estimate the cost per year by dividing the total cost to originate a loan by the loan type's average expected life (expect between six to seven years). Without this it will be impossible to determine if marketing dollars are well spent and if overall new account ROI is sufficient.

Operating expenses can consume a tremendous amount of a card program's bottom line.

Hard Time Making Money

In our work we often find that the cost to operate a credit card program can run from $125 to over $300 per year per existing account. If we then analyze what that means at various balance levels, we see that low-balance programs have a hard time making money. For example, if you spend at the lowest level ($125) and have a program with only a $1,500 average balance, you will be spending 8.3% of balances simply to run the program, plus whatever you incur per year in net charge-offs. This is almost always a money-losing proposition, unless you can get expenses down.

Inaccurate measurement of the credit card program can mean long-term damage to the entire CU. And once in place those mistakes are harder than ever to reverse (thanks CARD Act!)

Michael Kohl is president / CEO of Kohl Advisory Group and can be reached at mkohl@kohlag.com or 480-483-9013. Timothy Kolk, owner of TRK Advisors, can be reached at tkolk@trkadvisors.com or 603-924-4438.

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