Acquiring credit card portfolios is a relatively straightforward process. When a portfolio seller chooses to exit or trim down business exposure, they can sell their interest to another party. The buyer will value the portfolio, assess the risk, and determine if the receivable lines up with their strategies. There are plenty of roadblocks that might upset a deal, such as overstated FICO scores, transacting rather than revolving accounts, out of service area accounts, and unfavorable credit policies.
There have been relatively few portfolio acquisitions since the Great Recession because the card business performed so well. Still, now with the uncertainties surrounding COVID-19, we may see some acceleration as financial institutions tune up their books and tighten reserves.
Here is a real-time example of a planned acquisition and how the deal unraveled.
Ally Bank, formerly GMAC, is a $200 billion asset lender specializing in auto finance, online banking, and related consumer-facing products. Its origin dates back to the Great Recession when General Motors needed to clean up its balance sheet and separate the financing entity from the manufacturing business. In a recent attempt to diversify more into consumer credit, it began to court CardWorks, the parent company of Merrick Bank. Merrick is a sub-prime card company with 2.8 million active accounts, generating $277 million in pre-tax profits in 2019. According to Forbes, the average credit score at Merrick is a FICO 630, well below the standard definition of sub-prime.
Merrick Bank finances its receivable differently than top banks. Top banks can find cheap money in Asset-Backed Securitization markets, in contrast to middle-market credit card issues that can lend from their balance sheet. Merrick Bank uses an engaging, legal technique known as brokered deposits, which can be more expensive than the other two options.
What Ally Bank brings to the deal is the ability to have cheap funding through deposits made in its virtual bank. By knocking out the middleman, Ally would be able to reduce costs, control risk, and position for growth.
Now with the uncertainty of COVID-19, Ally needed to reconsider the essential points which are at risk. If the chargeoffs do slip from 4% to 10%, there will not be enough savings to cover the risk. That is the reason Wall Street applauded the unraveling of the Ally-CardWorks deal, as The Street reports. The deal was excellent in its original design, but timing and current events make both sides wary.
We do not think this will be the last portfolio sale as the card industry surfs through COVID-19. Depending on the term of the downturn and the breadth of unemployment, there will be plenty of acquisition opportunities in the coming months.
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group