Payment Cards Analyst

Advisor R.K. Hammer has been a payment cards analyst for decades while reporting on the performance and characteristics of all segments of the issuing business . 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.

Payment Cards Analyst

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 payment cards analyst 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

As a payment cards analyst 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 analyst 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.

Payment Business Analysis – New Regulatory Costs

Four years ago we undertook a payment business analysis 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 Analysis

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.

Payment Business Analysis

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 ®

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.”