Transacting Value: Portfolio Diversification in Tight Times is A Buffer Against Risk

Ed Kountz [Posted by Ed Kountz]

Since the collapse of Bear Stearns nearly a year ago--the first top-tier brick to crumble in the foundation of the modern US financial services industry --the changes that have hit financial services have been far-reaching and swift.

From Lehman to AIG down to institutions the size of little Integrity Bank (the Alpharatta, GA institution acquired by Regions Financial in Q3 08 after mortgage-related losses consumed its operations) few aspects of the banking and lending industries have been spared.

And card services units haven't been above the fray at many firms. As consumer exposure during an increasingly difficult economic environment has prompted increased late payments and defaults, and as firms have faced bottom-line problems across multiple product lines (from CDOs and swaps to mortgages, as well as cards), the subsequent retrenchment has hammered the bottom lines of leading card services organizations.

The warning signs bubbled up beginning more than a year ago.

In July of last year, regular readers of my previous blog will recall an entry regarding Q2 08 earnings at American Express, which were down 37% YOY vs. the 2007 period.  At the time, AmEx Chairman and CEO Ken Chenault reiterated a caution he had made since March 2008--noting that “the scope of the economic fallout was evident even among our longer-term superprime card members” during the quarter.

As a result, and after years of steady growth, card services has shifted from a profit center to a loss leader in many leading card-issuing organizations:

  • In Q4 2008, for example, Chase Card Services reported a loss of $371 million, or a $960 million drop from the $609 million earned during the year-earlier period. Excluding the WaMu acquisition charge volume was down 8%, while credit loss provisions were substantially higher.
  • Other issuers are seeking to tighten up their portfolios…AmEx recently made headlines for its efforts to buy out marginal cardholders with a $300 payment to “simplify their finances” (read: close their AmEx accounts).

At times like these, the value of portfolio diversification becomes clear. In particular as new market entrants enhance their positioning in payments--Wal-Mart recently slashed the cost of its Wal-Mart MoneyCard to $3 (for purchase, cash-reloads at the register and monthly fees)…sensing opportunity in the tightening credit standards and efforts of leading issuers to weed out risky or unprofitable customers.

In spite of the current troubles, issuers should expand efforts to position their portfolios and educational efforts in line with the emerging needs/ habits of American consumers:

  • Discover Financial Services, for example, has been expanding into new products (including a prepaid card providing parents with a suite of online tools to monitor teen spending, as well as online financial literacy efforts for younger adults).
  • Wells Fargo is also promoting online financial literacy with its credit card offerings aimed at college students.
  • My recent research and upcoming webinar on the topic of Payment Trends 2009 (11am ET on March 25, 2009…look for registration information here: Payment Trends 2009: Adapting To A New Spending Order indicate the value of a portfolio that includes debit and prepaid options in this environment, and the proliferation of online payment services suggests that, even online, strategic relationships can spread the risk and dampen the pain.

Of course, we first have to get through the current difficulties. But small banks who have maintained conservative market positioning are sensing opportunities to grow, and may be the best positioned to benefit:

  • UMB Financial has suggested that it views the current environment as a time to purchase Health Savings Account (HSA) portfolios from smaller institutions, in an effort to build its own scale in the space.

  • And Tennessee Commerce Bankcorp recently inked a deal with a unit of the Independent Community Bankers of America (ICBA) to provide financing for small companies’ equipement purchases.

The current environment may be one of the most challenging on record, but some institutions still spy…and are pursuing…opportunities for growth.