Credit card investment banking consultant Robert Hammer is an internationally known card expert with decades of industry experience, whose work has been cited in major global financial, banking, and credit union journals. What “Red Flags” does R.K. Hammer look for in credit card investments?
You watch the card issuer’s reporting, financial statements, regulatory filings, listen to all the quarterly conference calls, and annual reports. You’re getting the full picture about early warning Red Flag risks, right? Hardly. More like looking at a space satellite photo view of an exploding Pacific Rim volcano.
It is a well-accepted maxim in the credit card investment banking business that “A loan loss taken early is most always lower than if delayed (for any reason) until later.” Exactly how does one identify those early warning Red Flags, earlier in the life cycle process, especially since so many of them are not found in financial statements or regulatory filings?
Credit Card Investment Banking Metrics
Risk One: watch Cash Advance use as a percentage of the total booked loans in the card portfolio.
These non-purchase draws against the card credit line are higher risk, pure and simple. That is why so many issuers charge a much higher APR for those loans; instead of the normal 14% APR for purchases, some rates for cash use go as high as 29.9%. It would take decades to pay off if using the minimum payment only each month. If that isn’t demonstrating high risk I don’t know what is. What is too much cash advance from a card portfolio risk profile perspective?
See below, the “Percentage of cash advances in a portfolio” in the R.K. Hammer model with green indicating “low risk” up to red being “high risk”.
If management never discusses these, ask them yourself. As with any metric, it is the trend line not the point in time that matters most. Of course we want to balance risk and reward; it is simply that at some point that ratio may turn against you. Examiners and card issuers and cardholders beware.
Risk Two: Certain Changes in Card Policies
Are all card policy changes bad? In a word, no.
The ones we are concerned about are those which could be used to conceal or mask true risk, or that delay the loan loss recognition protocol. Examples: any change which loosens controls, regardless of management’s rationale; reage policy, where a shorter number of delinquent cycles are used to define when a delinquent account has paid as agreed to classify it back now as “current/non-delinquent” (taking 3 cycles of paying as agreed as the benchmark down to only 2, for example; or 2 cycles down to only 1); delaying charge offs from bankruptcy notification; practices which do not match policies; reducing the new applicant cutoff score. Also any policy change just prior to a card portfolio sale may be suspect. “Trust but verify”, as Ronnie Reagan said.
There are bank card issuers who no longer exist today who had done much of the above. If you don’t see any of this discussed in any report or conference call, ask them for yourself. You won’t see these on any CD121 FDR/FDC system report, so ask.
Risk Three: Frequent card member address changes, Returned NSF payments, and First Payment Default (FPD) – the “Big Cahuna.”
Bells and whistles ought to be going off. Take the loss early, and it will be less than allowing it to roll through the delinquency queues to charge off. Find out what the figures are, especially FPD, by asking management. I have never seen this in any report or discussed in any conference call. Ask, especially about First Payment Defaults (FPD), as most of them are destined for charge off. Take your losses early. Close the account.
Risk Four: High Gross Card Member Attrition Rates.
A gross amount of 10 – 12% of the file may attrite each year; say, 4% for charge offs, and another 6-8% of card members voluntarily leaving/closing their account. So, you’ve got to book at least another 10-12% of high quality new accounts just to stay even Y/Y. What are some of the Red Flags? If the gross attrition rate climbs to higher than 12%, danger ahead. You may need to re-examine your value proposition. Customers paying down much greater than the typical 19-20% average monthly repayment rate, calls to customer service inquiring about the full payoff amount, and active card member suddenly becoming inactive. In credit card investment banking management needs anti-attrition strategies for each of these events. Ask yourself what those strategies are and the results of their execution, and keep asking until you get an answer you can believe.
Risk Five: High Credit Line Utilization Rates.
It not uncommon for an average card portfolio to have a 40-45% utilization rate. Higher than that, and our antennae go way up. Line usage by FICO bandwidth can reflect very wide rates. Higher risk accounts (and higher risk portfolios) tend to have far higher line usage. The portfolio yield looks very nice before the high risk accounts start rolling through to charge off at 120 – 150 DPD (“Days Past Due”); by then it’s way too late to correct. Plus, watch the rate of climb in any attrition or delinquency metric.
Risk Six: Watch the “30-day delinquency bucket” trend for changes, that’s the “leading indicator.”
The trends of “cure rates” and subsequent roll rates in the delinquency queues can be very revealing. Watch for changes to the trends early in the cycles. Make sure the credit card investment banking management exposes that to the light of day, including to you. Total delinquency by accounts and balances doesn’t give you the early warning risk profile you need to fully judge card portfolio quality. Watch that first bucket trend. “Total” delinquency in a portfolio doesn’t give you the total picture, and and may mask (unintentionally, or intentionally) the risks in your portfolio.
Risk Seven: Other Things to Verify
Repeated requests for line increases, frequent and wide loan balance swings, high unemployment regions, multiple card applications or inquiries being reported, frequent “open-to-buy” requests. Investors and others may not have the granularity in existing reports to find all of the above, but one should ensure that management does have each of those addressed and monitored. How they do the monitoring is what I would want to ask about and see for myself. I don’t think you won’t find these on any FDR/FDC CMO51 system report, either.
There are many Red Flags that do not appear on any system report be it TSYS or FDR/FDC, perhaps not even on monthly Board reports. Much of it is rarely discussed outside the Risk Committee, Policy Committee or Managing Committee; as an outside interested party or investor you’ve got to ask for the metrics and see for yourself. “Trust but verify” is pretty sage advice!
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