Financial adjustments after a sale can make a difference from what the portfolio seller originally expected to receive.
After the due diligence has been completed, final bids compared, and the winning bidder for the credit card portfolio selected, the selling organization usually breathes a collective sigh of relief. The process, however, is far from over. There are a number of items which are not typically included in the Letter of Intent, and some not even in the final Definitive Agreement, which nevertheless must be forecast by the seller.
Most of the discussion (indeed, most of the financial impact) centers on the premium paid for the current card assets. Also included in the agreement are discount values for the following categories: delinquent balances (and the contractual definition of exactly what is considered delinquent), closed accounts and values for other “Statused” accounts (lost/stolen, revoked, bankrupt and other charge offs).
An initial premium of 20% for current/open balances, for example, might be reduced by as much as 5% or so by the discounted balances, creating a Gross Transaction Value of 15%. From this amount, the seller must computer other adjustments, which will impact what is ultimately booked into income. The following listed is not intended to be all inclusive, but does cover major adjustments to the premium you might expect as a Seller.
1) Deconversion Expense. The cost you incur to transfer the sold accounts to the buyer’s system
can be large. Many portfolio sellers have no prior experience divesting, and therefore limited working knowledge of the deconversion costs involved. In addition to the financial exposure (which can run into the hundreds of thousands), there will be an extraordinary “time drain” which will occupy your best data processing people’s time…time which could have been spent on normal production work, required regulatory system changes, and other day-to-day operating matters. To minimize the dollars or time required to successfully deconvert puts you at risk. For portfolio sellers who use an outside, third-party processor, there still may be termination penalties which need to be taken into account as well.
2) Operating Write Offs. There will also be a number of related assets which must be written off when you sell your credit card portfolio, items no longer needed. Forms, plastics and certain supplies are examples of those write offs. Assuming you didn’t have a large lead time when the decision to sell was first made, you may be surprised at the amount of stock you have on hand. When supplies are originally purchased, in anticipation of remaining in the business, your people would naturally have taken advantage of quantity buying and put one or two years’ worth into inventory. Since the buyer cannot assume the use of those items (with the card issuing owner’s name on the forms and at least on the reverse of the plastics), their value will be zero. You will even have to pay to have them destroyed. You should prepare for, and estimate, the financial adjustment required for this category.
3) Legal Counsel. Whether you use outside counsel, or allocate the cost of internal counsel, you should forecast the expected cost, and deduct that amount together with other adjustments from Gross Transaction Value. It is not uncommon for several weeks to as much as many months work to be involved in the Definitive Agreement and post-closing Interim Servicing phases of your negotiations. The complexity of each deal is different, and therefore the time involved varies.
4) Unamortized Premiums. If the selling organization previously acquired other credit card
portfolios, there will probably be premium expense incurred during those purchases which have not yet been fully amortized. The remaining unamortized premiums must be applied against the gain when you sell.
5) Escrow Fees. While not every deal involves use of an escrow agent, for those which do, this
expense must also be calculated in advance and included in adjustments.
6) Intermediary Fees. If an investment banker, broker, or other middleman was used, their
advisory fee needs to be included when computing transaction value.
7) Reserve Pulldown. On a positive note, the excess reserve can be pulled into income, and can
serve to offset some of the selling expenses, based upon the excess available.
8) Post-Closing Settlement. In most Definitive Agreements, there will be a period of time following the close of the transaction during which the seller will be responsible for certain expenses. Often limited to three to six months, this period covers items such as: charge backs, charge offs, bankruptcies and other sundry losses which should have been taken by the seller before the closing, but weren’t identified until after the closing. If your collection area lags in the charge off reporting process, there could be a considerable “hit” taken in this category, with bankruptcies and charge offs not showing up until a month or two later, for which the seller can be responsible.
9) Severance and Retention Pay. These two areas can be quite large, and should be carefully determined well in advance. As the result of the sale, and as with any volume-driven business, certain employees will inevitably be dislocated. The cost of severance and bonus for retaining those employees through to a successful deconversion is sometimes split between buyer and seller, based upon negotiation prior to the closing.
10) Liability Accruals. In a credit card divestiture, there may be a mix of certificates and others funding vehicles at various maturities which can now be terminated. Any penalties incurred as a result of early termination would also need to be taken into account when adjusting the Gross Transaction Value.
The total of all adjustments are then netted against Gross Transaction Value to identify the Pre-tax Net Value of the deal. After a deal is done, every seller ultimately identifies these various costs: however, the key is to identify and prepare for expected costs prior to the closing. In this manner, what management and the Board may be expecting, in terms of ultimate P/L impact, will be closer to the actual than if costs are identified “as incurred” during the post-closing period.