M&A Process

Portfolio M&A Process

 

M&A Process Documents, A Simple Matter?

To the uninitiated, many think that if one sells or buys a credit card portfolio (or any business enterprise for that matter), after proper due diligence by each counter-party and acceptance of the counter-party’s final binding bid, you sign an agreement and that’s that.  Closing is imminent.  The M&A process is not quite that easy.  With a history of over 150 card valuations and card portfolio buy/sell merger transactions, here is what R.K. Hammer experience shows:

After a preliminary non-binding LOI (“Letter of Intent”) by bidders, on site due diligence for two or more finalists, and a final, binding LOI is agreed to, you then each “lawyer-up.”  This, to craft the S & P (“Sale and Purchase Agreement”), plus an Interim Servicing Agreement (post-closing, pre-conversion), and in most cases also an ongoing Agent Card Agreement (for generating new card accounts at the Seller’s, for which they receive a one-time per active account bounty of between $20 – $75; plus annually, some agreed bps on net cardholder sales volume for new accounts generated post-sale).

As an example of what all that activity means in terms of workload and time-burn, read on:

Our last card sale M&A process took fourteen days to get required NDA’s done, the written card deal Offering Memorandum out to interest bidders, and to see “preliminary non-binding offers” on the table.

Another fourteen days for offer negotiation, due diligence on site and “final binding offers” to come in.

The subsequent card Sale and Purchase Agreement was 49 pages long, plus 21 Exhibits.  Took ten days, non-stop back and forth “redline revisions” by both parties.

The Interim Card Servicing Agreement was 23 pages long, plus 12 Exhibits. Simultaneously, took five days to complete.  Lots of calls.

The Ongoing Agent Card Agreement was 24 pages long, and had 12 Scheduled Attachments. Simultaneously, took five days to complete.

That’s a lot of negotiating and “wordsmithing.”  Not nearly as simple as some may think.  You not only have to negotiate the initial and final Letter of Intent with the counter party, but then each side has their attorney craft or respond to the initial draft Agreements shown above (often multiple iterations before completion); a series of at least six Agreements/documents each of which have to be negotiated  line by line, word by word.  If you add a commercial card portfolio segment to the consumer card portfolio sale, then the contracts double in number to twelve.

So, start to finish (Letter of Intent to Closing) the quickest period involved for all the steps in any card deal we have been involved in was only 21 days (mortals can only go so long without REM sleep).  That was very unusual, though.  

More often it takes 45 – 60 days to get from LOI to Closing, and in our experience an average of another 120 days post-closing (the “Interim Period”) to finally transfer the portfolio’s card account servicing to the buyer’s accounting and data processing system (the deal “Conversion Period”).

Then – and only then – can you say the M&A process is really done.   Catching your breath, coming up for air, and saying “hello” to your family once again.  That’s the way I see it.

Never fear, if you forget any or all of this, your attorney and your investment banker will walk your team through every step of the way.

Robert Hammer is CEO at R.K. Hammer and Card Knowledge Factory®

Other Posts by Robert Hammer

Payment Cards – “Near-Prime”

Advisor R.K. Hammer has been studying and reporting on the performance and characteristics of all segments of the payment cards issuing business for over two decades. One other emerging category which has received far less scrutiny, though, is what we term “Near-Prime.” “Other than subprime issuers, everyone of course would much prefer a portfolio of Prime’s and Super Prime’s, but there are only so many of those to go around,” notes Bob Hammer, Founder and CEO at R.K. Hammer.

Payment Cards

What Are “Near-Prime” Accounts, and What Does it Mean for the New Payment Cards Applicant and Card Issuers?

Near-Prime new card account applicants live on the border of becoming Prime, they are just not yet there. FICO scores in the range of 650 – 699 in our models are below the threshold necessary to be considered Prime by many; though, they are also deemed above the quality of subprime accounts (< 650 FICO scores). This definition will of course vary by organization. Wikipedia lists it under “SubPrime lending”. This can also change positively over time; however, for those whose account behavior performance improves as the account seasons, becoming more stable, predictable and thus more creditworthy.

We calculate that roughly 12.2% of the adult population in the U.S. have FICO scores between 650 and 700. That equates to over 30,000,000 potential prospects in this bandwidth alone. Compare your existing card account market share with this population opportunity, and perhaps you can see lots of possibilities, whatever your regional or national marketing reach may be.

At initial card issuance, Prime card applicants can currently expect around 14.0% APR’s; that rises to 17.5% for Near-Prime, and 20%+ for subprime. Annual fees and other fees also vary widely between the varying quality segments.

Account “Graduation” Potential to Prime Status is the Critical Strategy

Savvy issuers have been examining this lesser known category for their growth and “graduation” potential. Every next million accounts of quality is harder and harder to find, so it seems clear that to expand one’s marketing push to include these borderline applicants can make sense. They must be properly priced and managed, though. In addition, an important part of the account maintenance for Near-Prime accounts is to have a well-defined “status graduation” program in place; an “educational marketing” strategy, as R.K. Hammer terms it. The more informed consumers are, the strategy goes, the better the overall portfolio risk profile will ultimately become.

Based upon usage and repayment behavior many issuers follow the progress of these accounts for potential to be graduated to Prime status, with higher resulting credit lines and lower resulting APR’s. Once their monthly FICO’s have crossed the threshold for Prime, however any given issuer may define that term internally, they will naturally begin to receive prime account offers from other issuers, too.

Not to graduate these accounts then to the higher level of account status and at better terms creates a negative self-fulfilling prophesy; they will simply and inevitably attrite to another issuer who gives them a better value proposition that they now deserve.

New Payment Cards Applicant Cut-Off Scores & Applicant-Decisioning Necessarily Vary by Institution

It is important to note that there is no one generally accepted risk management definition of Near-Prime accounts, nor is there any commonly accepted new card applicant cut-off score, below which the card application would otherwise be declined.

Most card lenders use varying version updates of FICO scores, plus data reported to the three credit bureaus, and accompanied by application information scores and other available internal information used to assess payment cards applicant risk.

Importantly, one can reduce account risk when going deeper into the FICO bandwidths: lower initial lines of credit, less cash availability in the first year or two, adjusting the APR’s upward to reflect taking more risk, and using what we term an “educational marketing strategy.” The more informed about wise credit use a new account holder becomes, the better performing they will be.

Test and Retest

You don’t alter new applicant cutoff scores lightly. As with anything new in the business model, you test it. Place these approved accounts in a separate agent grouping and follow the characteristics and performance of these accounts; in terms of initial activation, ongoing active rates, graduation rates, plus usage and repayment behavior, and ROA/ROE. Over time, you will see how the group behaves compared to your portfolio overall. Then you can make a judgement about the appropriateness of the test, and whether to expand it use in your marketing efforts.

What’s the best definition of Near-Prime? “Your data supported by your definition” is the short answer, notes R.K. Hammer. The takeaway is this: we are all looking for new quality card accounts – however one defines quality – and we believe that the payment cards segment which deserves a closer look is Near-Prime. Properly priced and closely managed, these accounts have opportunities to satisfy consumers who might otherwise might be declined, and then be given the chance to rise to Prime status (and better terms) if their usage and repayment performance is deemed satisfactory over time.

Hammer reports that some card organizations graduate these accounts as soon as the FICO snapshot hits a preset threshold target, while others wait to see if that improved performance is proven reliable over several months as a trend not just a snapshot before offering the improved product and pricing, raising the card account to Prime status.

Either way, it becomes a win/win for the consumer and the lender to spend management time better understanding and growing a file of Near-Prime accounts, and upgrading when possible. The foregoing describes one approach; I’d invite the readers to suggest others, as well.

Bank Card Consulting

Bank Card Consulting Overseas

It took over twenty-five years and still counting to create a bank card consulting practice with bank clients from over 50 countries on six continents. Maybe you would like to do the same.  Some of those clients took years to cultivate and develop earlier, though, as is often the case.  Business decisions with bank card clients abroad tend to be based on relationships, rarely first meetings, and good long term relationships simply take time.

Prepare yourself to invest a lot more time burn cost abroad than perhaps you do in the U.S.  It’s an investment in time and energy that I always welcome.

Where did a few of our bank card clients come from?

In Asia/Pacific:  Hong Kong, Australia, New Zealand, Philippines, Malaysia, China, Taiwan, Thailand, India, Indonesia, Bali, and Singapore.

In Europe: United Kingdom, Ireland, Germany, France, Portugal, and Spain.

In the Caribbean: Antigua, Puerto Rico, and the Dominican Republic.

In Latin America: Mexico, Columbia, Brazil, Ecuador, Chile, Costa Rica, Paraguay, Uruguay, Honduras, and Argentina.

In North America: All the top banks in the U.S. and Canada.

Here are ten of the important lessons learned from all those regions of the world, and what it may mean for your enterprise international expansion hopes, if you are inclined to do so.

First, get an experienced local host in each area we would visit for the first time or in which we would attempt to get clients. One never has to do everything for yourself.  Why would you, when someone there can show you the local ropes and customs?  Break a custom or known rule in a new culture and you have probably just equally broken your chances at getting any new business there.

Second, we always had a real curiosity about other lands, other people, other customs and other cultures.  If you aren’t truly interested in learning about other cultures and places, you may not like expanding abroad.

Third, abroad your ways are not necessarily or even often their ways.  One has to be prepared to adapt and learn new ways of doing things.  When in Rome…

Fourth, as communications with bank card clients and friends now transmit at the speed of light (or thought, as you wish), can be in many countries in the same day.  Even half way around the world is easy to accommodate – just as long as you are prepared to get up early or stay up late, with all the time zones between you and the recipient of your scheduled call.  With e-mail and text, it’s even easier.  The back and forth is rarely a problem.  Thanks again, to high tech.  LinkedIn included.

Fifth, if you have a true curiosity about other cultures, you will most likely really enjoy the experience.  We have very fond memories of being with new friends from across the oceans.  If one doesn’t really care or have such curiosity, stay home, as this may not be for you.  The language barrier? Very rarely a problem.  English is spoken virtually everywhere, and we found most international clients like to use it.

Sixth, fully prepare your itinerary, and pack accordingly.  We once spent two weeks going 24,000 miles all around the globe visiting many bank card clients and countries in the process, and only had to have one carry on to do so.  Travel experience will come back to help – or haunt – you.  Travel can be gruesome these days.  

Most of your fellow airline travelers are like that; very interesting people who love sharing what they have learned or know about the location you may be both going to.  That has been my experience in dozens of business trips around the globe.   If you enjoy listening to other points of view, you may just do well internationally.  Trouble is, we sometimes talk when we should be listening.

Seventh, Set your watch and become mentally and physically prepared to be on my client’s time zone the moment we step foot on the outbound plane, long before we land in another far away country.  Sleep along the way if you can.  

Eighth, devote much more to time doing pre-trip research than on the trip itself.  Who are the players? What are their successes?  What are there sustainable competitive advantages?  What are their possible organizational needs?  What seem to be their guiding values?  Who among the ranks are the future rising stars?  How do they differentiate themselves from their competition?  Are those solutions already in our wheelhouse?

Ninth, be prepared to experience meals like you’ve never seen or tasted before.  Delicacies for the palate at which you might first be a little surprised.  Enjoy trying new things, so dining out with international clients is a real treat.  

Tenth, taking a ten or eleven hour plane trip is not for everyone.  But oh my, when you arrive you can be in a very different and very fascinating world.  New friends, new cultures, new ways of doing bank card business.  How refreshing it can be, if you are interested.  It’s one way I think R.K. Hammer has such an international presence.  We work hard to earn that reputation every day all over again with our bank card clients, regardless of the continent or the country involved.

There is more, so much more than one could share, but perhaps this will at least get you thinking, get you started.  Also, review the International travel “Check List”. Good luck, my friends!   Got to run, folks, to LAX to catch another plane.  It’s been “banking without borders” for over 26 years now at R.K. Hammer.  I wouldn’t have it any other way, and thank my international friends for the experiences of a lifetime.

That’s the way I see it.

Robert Hammer is Founder and CEO of R.K. Hammer and

Card Knowledge Factory®

Credit Card Segments

Definitions of various credit card segments differ based upon what risk levels card organizations accept.  That can even change within an organization over time, as strategies change.  For example, the following bandwidth ranges are used by R.K. Hammer and others; but not all card issuers, as different card issuers don’t have identical risk appetites, which then set their own acceptable bandwidth definitions:

Credit Card Segments in the R.K. Hammer Model

Segment FICO
Super Prime: >760
Prime: 700 – 760
Near Prime: 670 – 699
Prepaid: 650 – 669
Private Label: 640 – 649
Subprime: <640

  
“FICO (NYSE: FICO) is a software company based in San Jose, California and founded by Bill Fair and Earl Isaac in 1956. Its FICO score, a measure of consumer credit risk, has become a fixture of consumer lending in the United States”- Wikipedia

Naturally, other factors in one’s credit policy will drive applicants to one segment or another, not just FICO’s.  These, too, vary by organization, as do their respective cardholder pricing models.

Might certain card organizations define these credit card segments differently?  Of course.  It all depends on their view of credit risk at the time, and their present and trending loan loss numbers.  Categories and associated FICO’s can also overlap for segments within the total portfolio, just as credit policy and criteria can evolve over time, too.   Revolving credit has become both art and science.

We have some prime card issuing clients who won’t touch an applicant with less than 720 FICO.  Others who like higher risk accounts (and the fee revenue that comes with them) want all the 640 FICO’s they can get in their subprime portfolio segment.  It just depends on their strategies, objectives, risk appetite and markets.  

No one is right or wrong; whatever gets their hurdle rates achieved for satisfying IRR and EBITDA.  The key, we believe, is “Your data and your definition, consistently applied.”

Payment Business – New Regulatory Costs

Four years ago we undertook a payment business study of what the possible costs of new regulation and legislation might be for Debit card Interchange swipe fees (2011 Durbin Amendment to Dodd-Frank) and the 2009 CARD Act.

As the chart below shows, our estimate at the time was $26.2 Billion every year in lost revenue for the card industry. That number still seems about right.

Proposed & Actual New Regulatory Cost Impact Per Year

Payment Business Graph

Total annual cost for banks, as forecast by industry analyst, R. K. Hammer:$26.2 Billion/Year 

Who will pay for all this?  Consumers…in the form of higher fees.

Don’t get us wrong, we believe that much of what was intended was useful, that card fees needed better more transparent disclosure, what we often coined at the time “The Educational Card Act.”  And in the years since enactment, we still believe much of what was intended produced favorable and important consumer education.

There have also been unintended consequences of these regulations and legislation to the payment business.

Our assertion today is that every action (read, Regulation and Legislation) produces an industry reaction (new and higher fees) to offset the cost of compliance with those new rules and regulations.  It’s just “Economics 101.”  

The jury is still out as to whether or not new card fees will fully offset the annual cost of these regulations – but there already have been and will continue to be new consumer card fees, an financial institutions seek ways to offset the cost of new regulation and legislation.

Some other estimates of new/increased card fees so far are around one-third of what the lost revenue is each year, or $8.6 Billion per year.

That figure will rise in the future since most issuers are going through extensive due diligence on what services are being provide free of charge, and what could be assessed if they chose to do so.

We recognize that some issuers use cards as a cross sell to other important products in their suite of customer services, and therefore may not elect to raise or charge new fees.

Others most certainly will as they treat cards not as a loss-leader but as free-standing profit center.  In fact the card business is often the most profitable product at many organizations, in terms of ROA, ROE, and IRR, if not EBIDTA.

That’s the way I see it.

Robert Hammer is Founder and CEO of R.K. Hammer and Card Knowledge factory ®