For six years, Town North Bank in Dallas has been buying up credit card portfolios from credit unions, but now it is shedding this lucrative business to raise capital.
Unlike some other banks, the $1.3 billion-asset Town North is not having loan trouble. Instead, hefty impairment charges on its mortgage-backed securities portfolio during the past four quarters have thinned its capital cushion, and the prospect of more charges has left it with few options.
The bank announced last week that it had agreed to sell $295 million of credit card assets to U.S. Bancorp's Elan Financial Services in Minneapolis. The price was not disclosed.
"This was a painful pill to swallow," said John C. Reap, the president and chief executive officer of Town North and its parent company, CU Bank Shares Inc., which is owned by credit unions.
He said the bank decided to part with such a revenue generator only out of necessity.
Though it had easily raised $60 million of capital from its credit union shareholders in 2006 — an infusion it used to ramp up the credit card business — it would be very difficult for the cash-strapped industry to help out now, several observers agreed.
"This is absolutely the worst time in history to go to credit unions and say, 'We need more capital. Do you have some?' The industry is undercapitalized," said Tim Kolk, a managing partner at Brookwood Capital LLC, a card consulting company in Peterborough, N.H.
Reap characterized Town North's credit card sale as a temporary exit. The bank intends to begin acquiring credit card portfolios again in a few years.
Town North is hardly alone in making such tough decisions lately.
Clark Locke, a vice president and the head of Texas investment banking operations for Hovde Financial Inc., said that many banks need to increase their capital ratios and that selling assets often makes more sense than selling stock.
Stock sales dilute shareholders, he said, and for companies that have issued stock in recent years, issuing more now would probably require an unappealing discount.
"I think you would find that they would weigh both — sell assets or stock — but it is going to depend on the value they are going to get for each," Locke said. "A lot of stock offerings are done right now because a lot of folks can't sell assets for what they think they are worth so they are pushed into the stock offering."
Though in many ways Town North operates as a typical community bank, its credit card unit — which had issuing relationships with more than 350 credit unions — has been a primary business line.
Credit cards account for roughly 40% of the bank's overall loans, and Reap said that the business — including credit card processing — historically contributed about 60% of the bank's profits.
But Town North has taken a series of hits on its investment securities lately. It had other-than-temporary impairment charges of about $67 million last year and $14 million in the first quarter, said Steve McDonald, the chief financial officer for the bank and parent company.
As a result CU Bank Shares posted a loss of $29.9 million in 2008 and a loss of $11.4 million in the first quarter. (It had earned $8 million in 2007 and $2.9 million in the first quarter of 2008.)
Town North and its parent company remain well capitalized by regulatory standards, but their total risk-based capital ratios are edging close to the 10% minimum. At the end of the first quarter the bank's ratio was 10.27% and CU Bank Shares' ratio was 10.33%.
Reap said he would feel more comfortable with higher ratios, given that $162 million of the bank's assets are in mortgage-backed securities.
"While we do feel good about where we are in the securities portfolio and where the economy is now, we have mortgage-backed securities and want to operate at higher ratios of capital," he said.
Industry watchers said traditional bank assets are selling at a discount these days but credit card portfolios can fetch a premium.
Robert Hammer, the chairman and CEO of the bank card advisory firm RK Hammer in Thousand Oaks, Calif., pegged the typical premium at roughly 15% to 22% — suggesting that Town North might have gotten a price in the $340 million to $360 million range.
Still, fewer buyers exist at a time when more are considering selling these assets, and Hammer said this puts downward pressure on prices.
Town North initially entered the credit card business by offering processing services to credit unions — which it plans to continue doing. It has 400 credit union customers for that service.
"Our processing business doesn't require hardly any capital," Reap said. "It's not assets on our balance sheet — just people — and it's fee-based."
It was only in 2002 that Town North started acquiring credit card portfolios. By the end of March, it had 168 portfolios, all of which are being sold.
Elan will become the new issuing partner for those credit unions when the deal closes, which is expected to be in November.
Reap said selling the portfolio made sense now because it was the quickest and easiest way to raise capital. "If you look at the balance sheet for our company, that was the most marketable asset," he said. "It was expeditious and something that can be done very easily. We didn't like doing it. Obviously, it was a profitable business for us, but it was something we needed to do to come up with the capital."