The credit card M&A market is
slowly regaining traction, fuelled by a number of smaller deals
between mid-sized players – including some who are re-entering the
card issuance business after years away, says Charles
Davis
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Two ubiquitous variables – the new card
reforms and the economy – have worked in tandem to tamp down the
mergers and acquisition (M&A) market and depress premiums. A
comeback to the heady days of 2008 could be years in the making,
experts say, despite the latent demand underlying the market.
Yet, there are deals to be had, particularly
as some of the larger issuers seek to offload non-essential card
assets, and private label portfolios are generating renewed
interest after years of lackluster performance dampened enthusiasm
for them in the M&A market.
The attention-getter thus far in 2011 has been
the $30bn Capital One acquisition of HSBC’s US card portfolio,
distracting attention away from a number of smaller, but just as
interesting deals like Bank of America’s sale of its US$6.8bn
Canadian credit card business to Toronto-Dominion Bank.
These deals underscore a major reversal of
years past, as smaller banks and regional players take portfolios
back from the bigger players as prices reach the point where it
makes too much sense for the small issuer to re-establish a card
issuance relationship with its customer base.
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Retro feel
Robert K. Hammer, president and CEO of Hammer
& Associates, points to a pair of recent deals as examples of
the back-to-the-future feel of credit card M&A deals: Bank of
America’s FIA Card Services subsidiary’s deals to sell portfolios
to Regions FinancialCorp. and Santander’s Sovereign Bank.
In June, Bank of America, in its ongoing asset
offloading campaign, sold a $1bn Regions-branded credit card
portfolio back to the Birmingham, Alabama-based bank.
For Regions, it was an opportunity to get back
in the cards business, and regain control of a portfolio of 500,000
existing Regions consumer credit card accounts. Additionally,
Regions acquired a portfolio of 40,000 business credit card
accounts.
“This transaction accelerates Regions’ efforts
to improve the balance between our consumer and commercial loan
portfolios and further diversify revenue streams. We plan to grow
this business as part of an expanding suite of financial solutions
to better serve our customers,” says John Owen, senior
executive vice president and head of Consumer Services with
Regions.
In announcing the transaction, Grayson Hall, CEO and president
of Regions, says that much had changed since Regions initially
exited the issuance business.
“This transaction will help us bring greater
balance and diversity to our business while providing opportunities
for us to meet more of our customers’ borrowing needs,” Hall says.
“Our successful efforts over the past two years to attract new
checking customers gives us a strong platform for operating this
business successfully.”
Odysseas Papadimitriou, the CEO of Evolution
Finance Inc.’s CardHub.com, a lead generation website for credit
cards, says that the deals signal a realization among issuers
that had left the business that the days of huge profits from the
debit side may be nearing an end.
“They are coming back because they are
realizing that it was a mistake to exit in the first place,”
Papadimitriou says. “A credit card, unlike a loan, is a
transactional vehicle, a relationship builder, so it provides more
opportunities to deepen that tie and cross-sell.”
Profitable elements
Another element, he says, is
profitability.
“Credit cards are still a rich opportunity to
differentiate and make money,” Papadimitriou says. “Mortgages have
become a commodity, auto loans are also pretty commoditized. So
here is an unsecured loan that fosters creativity, and allows rich
access to a lot data.”
Of course, a return to the credit card
business will help Regions and other smaller banks find some new
revenue in the wake of the Dodd-Frank financial reform law. Banks
that left the cards business have profited mightily from debit
cards, only to find themselves in a less advantageous position once
the interchange caps kicked in. It certainly helps those looking at
coming back into card issuance that the pricing of portfolios is
dampened by the economy.
“The valuation dynamic right now is not
strong, and some sellers are re-evaluating from a sales position
several months ago,” says John Costa, managing director, Financial
Strategies, Auriemma Consulting Group. “Some of the smaller and
mid-sized issuers who were right on the verge of exiting the
issuance business saw the low premiums and they certainly don’t
want to sell them and take a loss. We thought there would be a
natural tendency by the smaller players to exit the business, but
they are being faced with illiquidity on the buyer side.”
BofA keeps turning
The M&A market would be fairly dormant if
not for Bank of America’s ongoing sales push, as it seeks to shed
the cards it issues in Canada and Europe, legacies of its 2006
acquisition of MBNA Corp.’s FIA Card Services. The bank also sold
its Spanish credit card business to Apollo Capital Management, its
$200m small-business card portfolio to Barclays PLC in and has
placed an additional $19bn of card assets in the UK and Ireland on
the sales block. The bank says it hoped its exit from the
international cards business would shore up its capital ratios.
“Our strategy is clear: We have been
transforming the company to deliver the franchise to our core
customer groups, and building a fortress balance sheet behind
that,” Brian T. Moynihan, the CEO, says in a statement. “While
the credit card remains a fundamental core product for our U.S.
customers, an international consumer card business under another
brand is not consistent with that strategy.”
While Moynihan says it intends to keep the
vast majority of its US portfolio, the bank also has shed a number
of legacy portfolios from previous acquisitions. Bank of America
also recently sold a Sovereign-branded portfolio it serviced back
to the Pennsylvania-based bank. The number of accounts included in
the portfolio was in the low six figures, Hammer says, typical,
with the exception of Cap One-HSBC, of the deals being made these
days.
“We’re a long ways from the frothy days of
2008, before the economic debacle,” Hammer says. “We’re seeing
prices slowly, slowly creeping back up to the mid-teens in terms of
premiums paid for portfolios, but you have to remember that
pre-2008 they were in the 20% range routinely.”
Thus far in 2001, there have been 13
general-purpose card portfolio sales worth $4.5bn announced or
completed so far this year, Hammer says. That does not count
private-label assets like the HSBC portfolio. The buyer of that
portfolio, Capital One, paid an 8.75% premium, or $2.6bn, for the
HSBC portfolio, which includes a mix of private-label retail and
cobranded credit cards.
The deal included HSBC’s MasterCard, Visa,
private-label and other credit card operations, including the
private-label portfolios of Best Buy, Neiman Marcus and Saks Fifth
Avenue. HSBC’s US unit will retain its $1.1bn portfolio of
general-purpose cards and will still offer credit cards to its
customers.
Costa says that one of the more obscure
factors slowing the M&A market are new capital standards and
higher underwriting standards in the wake of the subprime credit
crisis.
“The issuing side of the business requires a
lot of capital, and high reserves for potential losses,” Costa
says. “Issuers have to set aside a ton of capital, and that has a
lot of the bigger players re-evaluating capital holds, so they
aren’t going to get into a lot of risk-taking.”
Timothy Kolk, owner of TRK Advisors LLC, an
M&A adviser to banks and credit unions seeking to buy and sell
card portfolios, says that the slowdown in portfolio sales has
hit credit union issuers just as hard as banks.
Credit union
consolidation
Credit unions represent just 4% of the overall
US cards market, he says, but consolidation in the market was just
beginning to take off when the economy imploded.
“By now every credit card issuer understands
that the CARD Act and the economy have combined to create a ‘new
normal’ for the way credit card programs must be managed,” Kolk
says. “What is only now coming into view is a special and material
set of concerns related to merging credit unions. CARD Act rules,
when combined with now-in-place accounting rules for merging credit
unions, can together create long-term compliance and unanticipated
financial risks for years to come.”
Kolk says that a major factor in M&A
these days is the difficulty in portfolio valuation. The 15-20%
premiums of yesteryear are nearly impossible to find these days, he
says, and “squeaky clean” portfolios are yielding premiums in the
low teens.
Three variables confound pricing, Kolk says.
First and foremost is the portfolio’s underlying interest rate.
“Yield post-CARD Act is really critical
because where once you could simply acquire a portfolio, then
quickly reprice, now repricing is a three-to-four-year proposition,
so yield is huge,” he says.
Purchase volume is the second-most important
variable. In a soft economy, regional differences in cardholder
domicile are tremendously important. Cardholders in the Midwestern
farming areas are doing quite well, while portfolios centered in
depressed states such as Michigan, Florida and Arizona make
portfolio purchase volume stagnant at best.
Closely related is he third variable, average
balance per account, which dictates the would-be buyer’s expense
levels.
“If you spend $100 a year to run and manage an
account, and you buy a portfolio with average balances of $1000,
you are going to spend 10% of the account’s value just to run it,
and that’s too high,” Kolk says. “So if average balance is $2000,
then your expense is down to 5%. Return on balance is so important
because consumers are resisting new debt, no matter the offer.”
Value a portfolio too high, and the buyer will
be dealing with the aftereffects for years, he says. If a card
portfolio is assigned a fair value above book value, then the
issuer must carry the difference on its balance sheet where it may
be subject to future write-down as, for example, the portfolio
deteriorates, as losses increase, or as new legislative events
change the base economics of the business.
All this uncertainty has many issuers deciding
to keep their portfolios, Kolk says. Hammer agreed, adding that the
emphasis on relationship building will see a greater emphasis on
card-based marketing and a greater reliance on fee income as the
dominant revenue stream.
In fact, Hammer noted that fees in 2011 will
surpass interest as the payment card industry’s largest income
stream for the first time, representing 52.7% of total revenue.
This represents a dramatic reversal from as recently as 2003, when
the payment card industry generated 67% of its revenue from
interest and 33% from fees.
“This was bound to happen,” Hammer says. “As
soon as the interchange legislation hit the boos, issuers responded
by adjusting their pricing, and consumers will adjust accordingly,
either by consolidating balances to avoid such fees, changing their
purchase behavior, switching banks or staying put.”
The effects on the M&A market may be
unintended consequences of the regulation, but they are here to
stay.
“It will never be what it was,” Kolk says.
“There just isn’t the same promise of profitability out there for
issuers.”
