Banks Merge, Anxiety Grows

  When two credit card companies become one, a la Bank of America's planned $35 billion marriage to MBNA Corp., the theory holds that collection agencies are paralyzed with fear. The giant credit card issuer, for many, is the ogre atop the beanstalk mocking Jack.
  Will the colossal card issuer cut the number of collection agencies it uses? Will it squeeze prices and servicing terms? Will only the largest agencies have the skills and capacity needed to handle work from the biggest issuers?
  Opinions are mixed. The only certainty is that the giants hold all the cards, if you will. Ten issuers control 90% of the card-issuing business, up from just more than 50% in 1994.
  Ten issuers. Thousands of collections agencies. Tough odds.
  And they are getting tougher. Less than a month before the BofA bombshell, Washington Mutual announced it will pay about $6.45 billion in cash and stock for card issuer Providian Financial Corp. In August, HSBC Holdings revealed plans to pay $1.59 billion for subprime issuer Metris Companies.
  For the collection business, here is what is known: Fewer card-issuing banks builds competition among collection agencies. Issuers then can better dictate pricing and servicing terms.
  "Concentration at the top of the issuing world means the heavyweights, the largest card companies, have significant leverage over the collection agencies," says Gregory Hagood, managing director of investment banking with SunTrust Robinson Humphrey. "It becomes a tougher and tougher game for collectors."
  Bottom line: Issuer consolidation, an industry trend for 15 years, is not always kind to credit card collectors. Issuers often find the post-merger climate a good time to reassess the agencies they use by comparing recovery rates. To make matters worse, margins for collection agencies already are shrinking. And there is more: "[Issuers] are more likely to keep the best paper for their internal collectors and let the outside collectors battle for the scraps," Hagood says.
  Clearly, when two organizations combine, they do not need two of everything. Back-end recovery operations inevitably are pared, and dropping or not renewing contracts post-sale are two easy ways to help an acquirer pay for a deal. Collection agencies caught in the mix must scramble to recoup lost work or convince the revamped issuer they should keep the work.
  Michael Ginsberg, president and chief executive for industry merger-and-acquisition advisor Kaulkin Ginsberg, says that typically when a credit grantor is sold, the collection agencies servicing the seller lose business to those servicing the buyer.
  With the recent deals, the worst impact, adds Hagood, will come from BofA's purchase of MBNA because BofA's commission structure is "brutal and thin." BofA officials declined comment. Card executives at several other major issuers, including Citigroup and Chase, also declined comment about how issuer consolidation affects the collection business.
  Hagood, however, puts it bluntly: "It's very hard to be a small or mid-size collection agency right now if you focus on credit cards. If that's your business, the future looks bleak."
  But for almost every opinion, there's a counterpoint. Robert K. Hammer, an investment banker and nationally known credit card industry expert, notes that consolidation represents an opportunity to show you can outshine others. "If I was an agency or vendor working with MBNA, I would have been on Bank of America's doorstep the morning after they announced the merger," says Hammer, who is based in Thousand Oaks, Calif., where he tracks and brokers credit card portfolio sales.
  While there is no doubt collection agencies will face added pressure on margins, and issuers are certain to keep pitting agencies against one another to compare recovery numbers, the strong performers will have an advantage, says Scott Strumello, an associate with Auriemma Consulting Group. "If you're better at it than everyone else, you can command top dollar," he says. "There's no way that will change, ever."
  Pat Carroll, chief executive and president of Nationwide Credit Inc., an Atlanta-based top-tier collection agency, goes so far as to celebrate the potential impact issuer consolidation has on collections. "I don't see consolidation as a threat, at least not a great one. I see an opportunity," he says. "The market play becomes less about new business recruitment and more oriented toward growing your share through statistical performance and high levels of service. That can be a good thing.
  "In the case of MBNA going to BofA, MBNA's work goes from the left pocket to the right pocket. If I'm working with the organization that acquired MBNA, then I certainly have the chance to acquire the new business."
  Of course, sometimes agencies are not given the chance to vie for a large issuer's accounts. Ignored, they either accept cheap rates to stay in the credit card game or push into other debt classes to survive. "If you're a small to mid-size agency, and an issuer says its going to ratchet down contingency rates, you have to cry uncle and accept it," SunTrust's Hagood says. "There's probably not another client waiting in the wings."
  Michael Flock, former president of D&B Receivables Management, agrees that issuer consolidation sometimes can make business difficult for collection agencies, but he is optimistic that opportunities remain limitless for top performers.
  "If you're a leading agency doing a good job for your card company, you've done well and they like your service, then you're going to benefit by getting more work from the restructured, merged company," says Flock, president and chief executive of Focus Receivables Management, an Atlanta-based collection agency. "Those not doing well will be vulnerable."
  Adds NCI's Carroll, a 42-year collection business veteran, "It's important to remember that business isn't just going away when two giants merge. There's still a need to collect that debt."
  Ultimately, many insiders argue, it is the largest agencies-those with the structure to handle huge amounts of pre- and post-chargeoff loans such as NCO Group, Outsourcing Solutions Inc., IntelliRisk Management Corp. and NCI-that will emerge from rampant issuer consolidation unharmed.
  "The mega-issuer is going to want to deal with people that can handle their scale," says Vikas Kapoor, president and chief executive at IntelliRisk, one of the largest collection and recovery firms, according to research from Collections & Credit Risk, a C&P sister publication. "We're a year or two away from having essentially a handful of major credit card companies. And in my view it's creating a tectonic shift in collections."
  Many smaller agencies now focusing on credit cards might be better served finding a niche or specialty, perhaps small-balance card debt from credit unions, regional utility accounts or equipment leasing contracts, to cite a few examples. "Larger pieces of a smaller pie," Kapoor says.
  Hammer believes speculation that a mass exodus from the collections industry will occur in the wake of issuer consolidation, is off the mark. "We're not going to see one giant collection agency doing all the work. We're not going to see anything close to that," Hammer says. "Banks prefer, and always will, ... to take five or 10 vendors, compete them against each other, keep the best three and not renew the other contracts when they're up."
  The consolidation trend, Hammer says, is occurring across all lines, not just among issuers but also among vendors, processors and agencies.
  Deals to Continue
  Kapoor believes issuer consolidation ensures that deals will continue in the collection space, steady now for about a decade and strengthening in the past two years. Last year, merger-and-acquisition activity in the collection and recovery business broke records. And volume in the first half of 2005 exceeded $350 million in 26 transactions, Kaulkin Ginsberg reports.
  Meanwhile, given the run of deals among issuers, insiders have taken to speculating about who is next. The likely candidate? Capital One Financial Corp. If it happens, Ginsberg believes the fallout for the collection business will be unique. Typically, when a credit grantor is sold, collection agencies servicing the seller lose business to those servicing the buyer.
  With Cap One, the opposite could occur. "Capital One has honed its collection practices to a point where it is envied by many larger financial institutions and has even been replicated by some," Ginsberg says. That means Cap One's collection network should come out on top after any sale.
  Cap One officials would not discuss sale rumors.
  Fear the giant issuer? Not necessarily. Watch it closely, and be ready to either befriend the giant or take steps to avoid being crushed. Your business' survival depends on it.
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