Credit card portfolio valuations are set to decline and the value reductions will appear in earnest by 2017. Driving the change are both changes in card business models as well as regulatory and accounting rule changes.
Auriemma Consulting Group (ACG), a credit card valuation specialist, says remains bullish on the credit card business over the short – intermediate timeframe, but not long-term.
ACG says threats to the business model for traditional card issuers include:
1. The inevitable increase in delinquency and bad debt expense as the business reverts to the long term mean for consumer credit performance
2. The gradual erosion in underwriting discipline which we are anticipating based upon the entrance of new issuers into the subprime arena
3. The change in “lifetime” value of a customer brought about in part by the change in perception about use of credit cards versus debit cards among millennials
4. The proliferation of alternative payment channels which will exert pressure on traditional card income as newer players enter the market and demand revenue participation
With regard to the impending regulatory and accounting changes and the anticipated change in market value, ACG notes:
1. FASB’s new methodology for loan loss allocation which we believe will have an exaggerated impact on credit card issuers versus other consumer lenders
2. The changes in both the composition of common equity tier 1 (CET1) capital and in the specific new capital treatment of purchased credit card relationships (PCCR) intangible assets
Both the anticipated changes to the loan loss reserving methodology and to the new capital treatment for PCCR will result in very significant pressure on regulatory capital for the industry and will likely slow down future portfolio consolidation. ACG’s expectation that market values will decline does not mean the card industry will become unprofitable; rather, the increase in the amount of capital necessary will result in a significantly lower return on equity.
There are multiple strategies that an issuer may pursue to position itself for these challenges. Such strategies can allow for both aggressive and defensive postures. Similarly, investors in credit card equities need to understand how their portfolio companies will address these issues.
Founded in 1984, ACG has grown from a one-man shop to a nearly 50-person firm with offices in New York and London.
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