By now nearly every credit card issuer understands that the CARD Act and the new normal has changed the way credit card programs must be managed. What is only now coming into view is a special and material set of concerns related to merging credit unions. CARD Act rules, when combined with now-in-place accounting rules for merging credit unions, can together create long-term compliance and unanticipated financial risks for years to come.
When merging in a credit card program we urge all credit unions to think through the following issues carefully.
Fair Value Accounting Requirements. Under current standards merging credit unions must use the acquisition method in financial reporting. One of the credit unions becomes the acquirer and brings the other's assets and liabilities onto its balance sheet at fair value. This can include determining the fair value of an included credit card portfolio.
This can create a long tail of negative impacts for the credit union. Valuing a credit card portfolio is tricky. More so than for most other loan categories, valuing an open-ended, unsecured credit card portfolio requires product-specific considerations. In today's market, the value of any nearly any standalone credit card portfolio would be a discount to book value. The reason portfolios do sell at a premium is because of the value of the ongoing issuing partnership and brand value. But when valuing for merger purposes, those may not be the appropriate conditions to include. The costs of acquiring, transitioning and converting small portfolios overwhelms the income opportunities in most cases.
The impact of a too-high market valuation can be significant and long lasting. If a card portfolio is assigned a fair value above book value, the difference is carried on the balance sheet where it may be subject to future write-down as, for example, the portfolio deteriorates, as losses increase, or as new legislative events change the base economics of the business. Those write-downs are income statement events. Similarly, if the credit union would like to explore a potential card portfolio sale at a later date than carrying a too-high premium on the balance sheet, that could require recognition of a loss even if the actual purchase price is above book value. In fact, if a discount fair value can be reasonably supported there can be substantial potential future benefits to the credit union's financial statements in doing so.
CARD Act Requirements. The CARD Act has provisions that specifically impact merged credit cards. Several can be problematic. Our most immediate concern relates to the imminent Feb. 22 deadline for analysis and review of any past price increases. If you have merged in a credit card portfolio, those accounts are subject to this review requirement. Assuming you can identify all of the accounts that had a rate increase after Jan. 1, 2009 (often difficult), the rule requires that the criteria used for the reevaluation must be the same as those used by the original owner at the time of the rate increase. Do you have that documentation?
But in many cases the acquirer will not know whether repricing took place or, if they do, will not have sufficient records documentation or the account level details such a review requires. This is a substantial problem and the regulations are clear: There is no free pass for "we don't know what they did" responses. You own those accounts now, and you are expected to be compliant, no exceptions. CARD Act requirements are specific about this. Unless you have all of the information required, you must review the entire file of acquired accounts using your current underwriting and pricing rules. And those acquired accounts that would get a lower rate as a result must be given a lower rate. Those that would get a higher rate, though, must be left alone.
This raises several concerns and demonstrates why premerger due diligence must include review of these elements. First, the analysis of the merger should include reduced card portfolio yields and revenues if that will be the result of post merger repricing requirements. Second, such an account level review can be difficult because data elements you would normally use in underwriting may not be available or practical to use (such as cardholder applications). Third, and most frustrating, compliance may be impossible in certain situations. We specifically asked Federal Reserve attorneys what should be done if a variable-rate issuer takes in a fixed-rate portfolio and needs to review the entire portfolio after acquisition (old documentation insufficient). Following CARD Act rules would then lead to repricing of some accounts under current variable-rate underwriting rules, but this would then violate the prohibition against switching fixed- to variable-rate balances. Pick your poison, but swallow one of them. The Fed's reaction was, "The only way to ensure compliance is to not merge." Thanks.
NCUA-Supported Mergers. For those merging in credit unions at the request of the NCUA, these issues need to be fully vetted with the NCUA before the merger is completed. Agreement on book value of an often-impaired portfolio for a failing institution is critical. Identifying any required reduction of card account pricing in post-merger reviews must be factored into the terms of the merger and could impact the level of NCUA support you have the right to expect. And any compliance in impossible situations should be well-documented and accepted by the NCUA.
Obviously, these are complicated topics. Space here does not allow for more than a brief overview, but every merging credit union needs to consider all the elements related to acquired credit card programs. It's too easy to say, "It's small, we'll clean that up later." But later is too late.
Timothy Kolk is owner of TRK Advisors LLC.
603-924-4438 or firstname.lastname@example.org