Sales of portfolios, a primary driver of bank card consolidation, have accelerated significantly in recent years.
More than $7 billion of receivables changed hands in 1996, close to $10 billion in 1997, and more than $3.5 billion in the first six months of 1998. Some recent major transactions include Chase Manhattan Corp.'s purchase of the $4.4 billion remaining in Bank of New York's portfolio, Providian Financial Corp.'s of two packages of $1.1 billion each from First Union Corp., and Prudential's sale of $1 billion of nonrelationship accounts to GE Capital.
Larger strategic transactions have included: Banc One Corp.'s acquisition of First USA Inc. in the first quarter of 1997 ($22.4 billion of receivables), Advanta's sale to Fleet in the fourth quarter of 1997 ($11.2 billion), and Citicorp's purchase of AT&T Universal Card in the fourth quarter of 1997 ($14.2 billion).
As they assess their strategic options, many card executives are asking: What has caused this increase in activity? Which issuers are buying portfolios and why? How much are they worth, and what factors determine their value?
Of four key industry trends, two have primarily influenced sellers, and two influenced buyers. The convergence of these-increased competition, adverse retention rates, strategic focus, and lower overall growth rates- has dramatically altered the relative effectiveness of various bank card strategies as well as portfolio transaction volume.
Competition for bank card accounts reached a high point in 1995, with 2.7 billion solicitations mailed. A wide spectrum of banks and monoline issuers were competing for what had been one of consumer banking's most profitable assets, with after-tax returns over 2%. (Solicitations fell to 2.4 billion in 1996 and peaked at three billion in 1997.)
In their zeal to grow, many issuers relied too much on credit bureau risk scores, offered firm credit lines to prospective cardholders, or focused almost exclusively on maximizing response rates and revenue characteristics. As many people who accepted solicitations in 1995 fell behind on payments, high delinquencies and double-digit loss rates led to marginal account profitability.
As profitability has eroded, many banks have chosen to divest their out- of-market, nonrelationship portfolios. Consumer finance specialists such as Associates First Capital, GE Capital, Providian Financial, and Metris Cos. have been buyers of these higher-risk portfolios, hoping that repricing would bring revenue yield into line with risk.
In addition to their solicitation woes, many regional issuers saw a rise in voluntary attrition of cardholders, even those in core banking relationships. Sophisticated monoline marketers systematically lured away banks' profitable and lower-risk accounts with targeted solicitations promoting teaser rates and balance transfers.
In a phenomenon that my firm refers to as "adverse retention," banks tended to hold onto accounts that had high risk and no other available credit, and hence a greater likelihood of default. Many banks that experienced significant adverse retention have chosen to exit the card- issuing business.
Strategic focus is perhaps most evident in cobranding. Initial enthusiasm sparked by the General Motors and AT&T Universal cards has waned for some issuers because of unfavorable economics.
But others aggressively target cobranding.
The sale of First Omni Bank's $350 million Bell Atlantic portfolio to Chase Manhattan in the third quarter of 1997, Citibank's purchase of AT&T Universal, and Chase's recent purchase of Marine Midland Bank's $325 million Continental Airlines portfolio are three examples.
Buyers view growth of their portfolios and size in a particular market segment, for example, cobranding as strategic and necessary to appeal to the capital markets. The purchase of AT&T Universal propelled Citibank to $63.5 billion of outstandings at Dec. 31, 1997-a 16% market share-and probably assured Citibank would retain the No. 1 position for the foreseeable future.
Since buyers typically assume their economies of scale and analytical sophistication will squeeze greater value out of a given portfolio, they are often willing to pay more than the accounts may be worth to the seller. A buyer can put its stamp on a portfolio with repricing and risk-based pricing, credit-line management, retention of profitable accounts, activation programs, and collections.
A capital markets arbitrage opportunity may also exist, particularly for publicly traded issuers, because receivables they buy at a modest premium over par value may be assigned a higher value by stockholders in keeping with the existing portfolio.
Perhaps the single most important value determinant is the net credit loss rate. In general, for every one-percentage-point difference in loss rate, a portfolio's premium can change by up to five percentage points. A portfolio valued at a 15% premium with a 3% annual loss rate may be worth a 10% premium with a 4% loss rate.
In addition, voluntary attrition can affect value because those cardholders who leave usually have other attractive credit available to them and are typically the most profitable and least risky.
It is important for the credit card manager to remember that account management is not as straightforward as adjusting one value driver to reap a benefit. Many changes can lead to second- and third-order ripples.
For example, although risk-based pricing can improve near-term revenue, it may also lead to more voluntary attrition of profitable cardholders, adverse retention, and higher delinquency and loss rates. These trade-offs underscore the importance of testing any value-enhancing strategy before rolling it out broadly.
For any issuer, portfolio valuation is just one part of a sound portfolio management policy. The intrinsic value of a portfolio should be considered in the context of any business planning or strategic assessment process.
Many issuers have discovered that their card portfolios are worth more to the market than to them. Any prospective buyer should carefully weigh any value-enhancing adjustments they think they can achieve with a given portfolio and analyze the degree to which improvement may be mitigated by other components of a portfolio's value.
As the bank card industry continues to consolidate-the top 10 issuers had 71.3% of the market in the first quarter of 1998, up from 45% at yearend 1989-portfolio supply and demand will remain strong. Regional bank issuers will refocus on their core credit card relationships or leave the business because of concerns about skill, scale, competition, market share, and strategic positioning.
The key for buyers is to purchase accounts for less than it would cost to originate them. Potential sellers need to consider whether the proceeds of a sale would earn a higher return than the projected profitability of their existing bank card business.