Is It Time For Community Banks To Get Back Into The Credit Card Business?

A decade ago credit card receivables were all the rage. Credit card companies grow like mushrooms, building receivables at an unprecedented speed, and banks wanted a piece of the action. Credit card solicitations transitioned from a rare occurance to a daily presence in America's mailbox; elaborate models were developed to identify the next best target and capture their growing unsecured debt needs; and Wall Street was giving huge premiums to those companies that showed the best growth patterns.

Community banks could not compete with the huge investment in database mining and management made by the credit card companies. Their alleged advantage was customer knowledge and a ready-made distribution network. They set upon building credit card portfolios to further leverage their branch network investment and build a profitable line of business.

The Mid and late nineties brought with them fundamental changes in consumer behavior. Bankruptcies became an accepted option to debt-laden Americans, and the credit card bubble burst with large losses and decelerating growth rates. Even the experts, the monolines, were humbled by consumer behaviors way outside the model, and their financial results showed it. With very few exceptions, such as Capital One and MBNA, many industry leaders were brought to their knees.

Throughout this process, community banks realized yet again that the lemming syndrome which characterized our industry for many years isn't the best way to go. When entering a new business, key business drivers and core competencies must be identified prior to entry, or failure is likely. Many managed to sell their portfolios for a hefty premium to 'the greater fool', but others ended up holding the bag.

The shakedown in the credit card business has brought about a more rational approach in recent years. Competitors still use tempting teaser rates, but the selection process is more stringent than ever. There are also fewer large players, and their quality is evident in the consistent results, coupled with continuous major investments in technology. As the waters calm down, is it time for community banks to reenter the credit card picture? Should they start holding the credit card receivables themselves again, rather than strategically align with others who take the credit and operational risk in return for minimal annual fee income?

The answer has to do with the strategic objectives of each bank and their core competencies. The first question is, what are you trying to accomplish. Are you looking for more spread income on receivables that are hard to build (since the average balance is so small)? Or perhaps some fee income generated by front-ending the margin income through portfolio sales in the future? The answer to this question will determine whether you originate to your own specifications or to the 'markets'. It will also define how centralized the process will be in your bank, and whether local markets will be able to override the credit decisions made by a central facility.

Are you willing to invest the necessary resources in building an unsecured underwriting and collections capability that is distinct from the other underwriting functions in your company? Will you buy a credit scoring vehicle, if you don't have one already, and customize it to your credit tolerance levels?

And another question: will your retail sales force be able to effectively leverage the retail customer base and your investment in the branch network? Will you be able to build a card base without getting your acquisition cost of each customer out of the acceptable range to assure profitability?

Last, can you compete effectively against the database miners? What competitive advantage will you bring to bear? Identifying your positioning is also important to success.

The bottom line is: determine what contribution is meaningful enough for your bottom line ($1 million of margin or fee income, for example), and then build the business and financial plan to achieve it in the credit card receivable business. It may indicate that your customer base is too small to make this business impactful enough for you; or it may show that this could be a business that will not only help your bottom line annually but can also be sold if needed to support occasional shortfalls.

Credit card receivables can be a versatile business that complements your existing portfolio, or it can be a money pit and a credit nightmare. Strategic clarity and execution focus will determine which one it will be.