On the Block

  Ever since he was hired in 1998, Chris Fitzgerald, president and CEO of Albuquerque, N.M.-based Rio Grande Credit Union, worked hard to run Visa and MasterCard credit card programs alongside the institution's traditional auto and home-lending activities. But in the last several years, he began to see problems.
  "We were just having a very difficult time competing against the bigger credit card [issuers]," he says.
  The Rio Grande card did not offer any rewards for its use, even though most experts consider such perks a must to compete in an increasingly saturated card market. "We are a blue-collar credit union," Fitzgerald says, noting many of its 14,000 members work for the local city or county government or are members of area Catholic parishes. So a rewards program was too "cost prohibitive for us to get into it," he says.
  But Rio Grande hit upon a solution. By August, the credit union had sold its entire card portfolio to TNB Card Services, the institution's Dallas-based payment processor.
  Neither TNB nor Rio Grande would disclose the exact terms of the agreement, but Fitzgerald says the credit union received not only the value of the portfolio but a sizable premium as well. Moreover, TNB signed a multiyear agreement that guarantees the credit union regular marketing fees based on how many new members it signs up.
  More importantly, Fitzgerald says, Rio Grande unloaded a program that was more trouble than it was worth. The sale "allowed us to get back to what we do well," he says.
  Experts point out that credit unions are perhaps the last bastion of independent credit card programs. But they probably will not sell off their portfolios as quickly to banks as big retailers have, and banks may find themselves as disadvantaged buyers. As such, banks will have to find ways to convince credit unions that taking over their card programs can help them to become more, not less, competitive with banks.
  Indeed, most credit unions that sell do not feel they have the scale or expertise to compete with larger issuers in offering card products, especially reward programs that provide points for airline tickets or hotel rooms, says Tim Kolk, managing partner of Brookwood Capital LLC, a Peterborough, N.H.-based brokerage firm that coordinates portfolio sales.
  Without those incentives, "80% of your members will rule out your product in favor of [the card offers] that fill their mailbox," he says.
  Fitzgerald noticed that trend. "[Members] stopped using the [Rio Grande] card and closed out their credit card account," ensuring that lower-income members who bought little on credit formed an even bigger portion of the union's portfolio, he says.
  Moreover, Fitzgerald saw Rio Grande's mission as getting its members a slice of the American Dream, and most of the money deposited at the credit union was loaned out to members buying cars or their first homes. "Overall, we were helping out our members and making a good profit doing it, but I did not have enough liquidity" to support credit card loans, he says.
  The nation has about 9,000 credit unions, and about 2,100 of those have card portfolios with more than $1 million in receivables. In the first half of 2006, 30 sold off their portfolios (see chart below). That sets the pace at about even with 2005, when 65 credit-union portfolios with $481 million in total receivables were sold to larger players, Kolk says.
  FOLLOWS A TREND
  Experts say the movement by credit unions to sell off portfolios follows a similar shift within the last 10 to 15 years by smaller banks and retailers. Just this year, the Fort Worth, Texas-based home-furnishings retailer Pier 1 Imports sold its private-label portfolio to J.P. Morgan Chase & Co. for $155 million, and in 2005 the giant Federated Department Stores sold its portfolio to CitiGroup's Citi Commerce Solutions division for $4.6 billion.
  There are not many big private-label card programs like those left to buy. According to SourceMedia's 2006 Card Industry Directory, Citi, GE Consumer Finance and HSBC Retail Services own just over 80% of private-label retail card receivables, up from 68% in 2003.
  While retailers and credit unions share many of the same pressures to sell their portfolios, such as the need to raise capital to build additional locations, most of their portfolio buyers are banks, which often compete with credit unions, Kolk says. That is one reason Brookwood advises one-third to one-half of its credit-union clients to refuse offer from banks for their portfolios, he says.
  One of the most common problems occurs when the organization that wants to buy a credit union's portfolio has branches right across the street from the credit union's. Some credit unions may find such situations disconcerting.
  "Some feel they'd be selling to [someone] whose mission every day is to steal [their] members," Kolk says. "That's a pretty big stumbling block, even if all of the other numbers make sense."
  Perhaps the most important factor in pushing companies and institutions to sell their card programs is the intense competition for credit customers, experts say. "Is there anyone that does not have a credit card?" asks Brian Riley, senior analyst with TowerGroup, the Needham, Mass.-based market-research unit of MasterCard Worldwide.
  Portfolio owners, whether blue-collar credit unions with a few million dollars in assets or nationwide retail chains, have begun to find it more difficult to increase their card bases or the amounts cardholders purchase with their cards, Riley adds.
  Many retailers seem reluctant to discuss how their card portfolios are managed. In a written statement, Target Corp., one of the few large merchants that still owns and manages its own card program, stated that it wants "to keep as much proprietary information as possible confidential." Others, including Circuit City and Kohl's, whose card portfolios recently were sold to Chase, also declined to comment.
  Most of the buyers also were reluctant to discuss in detail exactly how to turn around private-label card programs. "You're kind of asking us for the secret sauce," says Dusty Bowers, TNB senior vice president.
  However, most buyers were comfortable sketching at least the broad outlines of how they have come to dominate the private-label market.
  "We're at a scale that is many times that of any retailer," says Richard Klesse, managing director of client relations at HSBC, which has about $17 billion in receivables. Most of the retailers' programs HSBC snapped up, which include those of Best Buy, Neiman Marcus and Saks Fifth Avenue, "weren't maximizing the value of all of their cardholder base," Klesse says.
  HSBC's greater experience in data mining allows it to examine records and figure out which customers can handle bigger lines of credit. "We try to approve as many customers as possible with the largest lines [of credit]," Klesse adds.
  In the past few years, Wall Street investors generally "frowned upon" retailers who held onto slow-growing portfolios. They prefer retailers that concentrate on boosting overall sales or sales per location, says Jay Adelsberg, marketing senior director at Chase Card Services. While retailers have been reluctant to invest in new credit card technologies such as data mining, "Chase has invested billions," he adds.
  So even retailers with vast resources, such as Federated, eventually find a reason to ditch their portfolios, says Steve Jacowitz, managing associate with Auriemma Consulting Group, a Westbury, N.Y.-based consultancy.
  LOYALTY BENEFITS
  Federated built up a plethora of loyalty benefits for its in-store card. But in 2005, the department-store owner completed the $18 billion purchase of May Department Stores. It was not a coincidence it sold its portfolio to Citi the same year, Jacowitz says.
  Federated needed the cash, and however big the retailer, an organization such as Citi can run it more efficiently, Jacowitz says. "It's a burden that's been lifted," he says.
  And for credit unions, that burden can be even greater. Running a card program means someone has to worry about servicing a debt, which involves a constant cycle of collecting payments, factoring in interest rates, and deciding when a member can't pay off a debt, notes TowerGroup's Riley.
  "For a small credit union, that's a lot of things to administer," says Riley, noting that two or three workers often manage a credit union. "The collection guy is frequently the loan manager on a Wednesday, while CitiGroup "has ten million VPs," he quips.
  Under those circumstances, most credit unions find it difficult to build a portfolio. And besides lacking the expertise or manpower to dig deep into their cardholders' financial histories and accurately deduce how much credit to extend, credit unions' members typically are clustered in one small region, Kolk says, leaving them exposed to local disasters or economic downturns.
  "If you're Citi, what happened [with Hurricane Katrina] is a pain, but it won't destroy your organization," he says.
  Kolk says the most important task for Brookwood is negotiating how the credit union, its members and the buyer would continue to work together to manage the portfolio. "It's not a transition you do and then it's over," he says. "There's an ongoing relationship."
  Many credit union members joined their organizations explicitly because they distrusted banks, and allowing a bank to take exclusive control of their portfolio could be jarring, Kolk adds. "You don't want the cardholders to notice a change," he says.
  Even though a bank might legally purchase a portfolio, Brookwood almost always puts together multiyear agreements that keep the credit union's name on its cards and on any statements issued to customers.
  Indeed, Bank of America, the nation's largest card issuer, has acquired about 80 credit-union portfolios in the past five years, and "the Bank of America brand does not come into play," says Jeffrey M. Fincher, senior vice president at the Charlotte, N.C.-based bank. "When you look at a [credit] statement, it will still carry the credit-union brand."
  Similarly, Rio Grande's card still carries the old credit-union logo, Fitzgerald says. And if members want cash advances on their cards, they still get the money by going down to one of Rio Grande's four branch offices.
  Of course, members of a credit union whose portfolio was bought by a more powerful financial institution should notice some changes for the better, Kolk points out. Banks, for example, typically offer cardholders higher credit lines and better online information.
  Still, partnerships between banks and credit unions can get tricky, Kolk says, since each has a very different mission.
  Banks only look at their bottom lines, while credit unions serve their members, who also own the institution and select its board of directors. And many credit unions that hire Kolk as a consultant refuse to sell their assets to a bank no matter how sweet the deal.
  "Some [credit unions] say, 'you could walk in here with a Brink's truck,'" but if the potential buyer says it will begin to charge members high late fees, which few credit unions do, the institution will refuse to sell, Kolk says.
  But BofA's Fincher says credit-union officials should ask whether "they are providing the best product to their members."
  Some of the smaller credit-union portfolios BofA acquired only established lines of credit for members when they walked into one of their branches and asked for one, says Fincher. Today, however, their members can sign up online and also receive direct-mail appeals. Their cardholders also now can build up points toward airline flights, hotel stays and discounts on merchandise, things "a smaller credit union does not have the infrastructure or buying power to make available," Fincher says.
  A SLOW PROCESS
  Fincher adds that BofA generally signs agreements that pay their partners a regular fee based on usage. So if BofA successfully increases the use of a credit union's credit cards, that institution gets a boost in revenue.
  Credit unions' bylaws usually require that, before they sell off an asset, their directors and members decide beforehand how they will invest any premium. "They've got to take those funds and invest them at a comparable rate of return," Fincher says. "I understand that credit unions will tend to be a little bit cautious."
  It is not necessarily a bad thing if the nation's credit unions sell off their portfolios slowly, some experts point out. "A lot of good people with bad credit have jobs associated with credit unions," and these institutions historically have served them even though they might get turned down for bank loans, says TowerGroup's Riley. "The whole objective of [a credit union] is to serve their members," he says.
  And although many credit unions obviously have cut deals that improve their financial standing and resources, Riley adds, "it would be a shame to see them divest all of those portfolios."
  As banks snap up the last of the big retailers' card portfolios and begin to look eagerly at those of credit unions, some credit unions have begun to look for something different.
  "Credit unions came to us and said we want another option," says Jay Kurian, another senior vice president of TNB, whose status as a card processor owned by credit unions might be unique. About 40 state-chartered credit unions own TNB, he says, and four years ago TNB began buying credit unions' card portfolios.
  Fitzgerald says that history made it easier to sell his credit union's portfolio to TNB. "We're about providing service at a local level, and it's very personable," he says. "We have members who have had credit issues in the past, but we just don't turn them down.
  Kurian says TNB is not looking to become a big credit card company. "We're looking to service credit-union members," he says. "We have the same DNA."
  For example, TNB will not charge anyone more than $29 in late fees, even though bank late fees can average from $39 and $45, Kurian says.
  Now, one of the nation's largest credit unions is about to throw its hat in the ring. Several weeks ago, California's Department of Financial Institutions decided to allow Pasadena-based Wescom, a credit union with about 292,000 members and $3.6 billion in total assets, to buy up other credit-union portfolios, says Brad Wylie, Wescom's vice president of credit card acquisition.
  Although Wescom has not decided on a fee structure, Wylie says the credit union will commit to low late fees and other policies it considers less harsh than those instituted by banks. He adds that because of its financial strength and investment in new card products, such as a Visa Platinum card, and reward programs such as gift certificates for travel, Wescom has, in just four years, doubled the size of its own card portfolio to $140 million in receivables.
  "We will now be in competition with the other bank acquirers, but we can offer credit unions the option to divest their portfolios and keep it within the credit-union movement," Wylie says.
  Credit unions' card portfolios are likely to become hot commodities as retail card programs dry up. Credit unions in the buying market, though, might give banks a run for the money.
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