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As CECL Adoption Nears, Implications for Credit Card Issuers Mount

(New York, NY):  As the time for Current Expected Credit Loss (CECL) implementation draws closer, most credit card issuers are working feverishly to develop workable models by the relevant deadline – 2019 for SEC filers, 2020 for non-SEC filers. CECL is intended to better capture the inherent credit loss exposure within a loan by measuring the total expected credit loss over the entire life of the loan, as opposed to other time frames, such as the next 12 months.

While the CECL standard applies to lending broadly and will not be overly burdensome for many types of loans, the new standard presents an unusual challenge for credit card issuers. The heart of the problem is the calculation of the “life” of a credit card loan. Since credit card accounts are revolving facilities, determining the life of a credit card receivable requires adoption of certain modeling positions. While the industry has not reached firm conclusions on modeling conventions for CECL, issuers have been discussing the implementation’s challenges at Auriemma’s Card Accounting Roundtable, where CECL has been a continual agenda item for the last two years.

Some of the major considerations currently under review by issuers include:

Allocation of payments. While the CARD Act stipulates certain rules for the allocation of payments, issuers are looking at other payment allocation methods for CECL. Under the CARD Act, principal payments are directed at the highest outstanding interest rate balances first (a credit card loan may have certain balances at higher rates than other balances – e.g., a 0% teaser rate for a purchase, but a 16% interest rate on other outstanding amounts). While this statutory principal allocation is intended to give the most benefit to the consumer, it can needlessly complicate the sizing of the credit loss reserve. An alternative payment allocation method called FIFO (First In, First Out) would allocate principal to the oldest balance first.

Portfolio segmentation. Any credit card portfolio is comprised of thousands (in some cases, millions) of individual accounts. Some of these cardholders will always pay the minimum amount due, some will pay the entire outstanding balance, and some will pay an amount between the minimum and the entire balance. (Using the average payment amount in a portfolio-wide calculation may give a distorted result: a portfolio with 50% minimum payers and 50% transactors will likely have more risk than a portfolio where everyone pays 50%.) While the correlation between payment amount and credit risk is not perfect, there is the general understanding that minimum payers are likely to produce a higher rate of loss than cardholders making more than a minimum payment.  Most issuers, therefore, will want to calculate a loss exposure on multiple segments.  Segmenting into the three categories mentioned (minimum, full, partial) would seem to be the most basic level of analysis and some card issuers will stratify their accounts into numerous payment cohorts (deciles).  Beyond payment amount segmentation, issuers are also considering segmenting by other characteristics: months on book (longevity of customer), credit score, origination channel, etc. The CECL for the entire portfolio would be the sum of each CECL value for each segment. Further complexity is created by combining variables – for example, payment amount and FICO score.

The current lack of industry standards or modeling conventions has created great uncertainty among card issuers. This lack of consensus makes issuer comparisons fraught with complexity. While the original impetus behind CECL may have been a desire to create additional loan loss reserves, the lack of standards may result in widely divergent loss assessments for portfolios of comparable credit quality.

In addition to CECL modeling challenges, there are other concerns for issuers, such as governance and oversight.  Should responsibility for CECL rest with credit risk, accounting, both or elsewhere?  Generally, capital issues are managed at the enterprise level for large, multi-line banks.  For these banks, CECL governance may be distant from the individual lines of business, increasing the likelihood that the modeling does not reflect the idiosyncrasies of the credit card business.

CECL will also have an impact on credit card portfolio M&A. In many instances, portfolio purchasers will have limited historical loss information for an acquired portfolio. Since the CECL model is based on historical loss experience, an acquirer will need to look for similar quality assets to derive a loss proxy.  This additional ambiguity may result in a wider range of market prices for a given credit card portfolio.

Since increases in the loan loss allowance reduce operating income, the CECL adoption may have the unintended consequence of reducing lending capacity.  Moreover, for an issuer with a growing credit card business, the CECL adoption is not a “step change” function but will be continuous.

Finally, issuers are preparing for a period of “parallel testing” where the loan loss reserve is calculated under CECL and under the previous methodology.  But this begs the question: why a parallel run?  It suggests that comparing the outcome of the CECL levels to levels under the prior methodology may lead to further mischief.  If a card issuer calculates a lower level of loan loss allowance under CECL, will regulators require the pre-CECL methodology? A loan loss “ratchet” might be in the offing, just as the Collins Amendment became a “floor” under the new Basel III regulatory capital rules.

These are just some of the considerations that credit card issuers are weighing in the CECL implementation planning.  Auriemma is involved in these matters in multiple ways including, notably, its Card Accounting Roundtable, writing comment letters to FASB, as well as bespoke consulting work.

About Auriemma Group

For more than 30 years, Auriemma’s mission has been to empower clients with authoritative data and actionable insights. Our team comprises recognized experts in four primary areas: operational effectiveness, consumer research, co-brand partnerships, and corporate finance. Our business intelligence and advisory services give clients access to the data, expertise and tools they need to navigate an increasingly complex environment and maximize their performance. Auriemma serves the consumer financial services ecosystem from our offices in New York City and London. For more information, call John Costa at (212) 323-7000.

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Three Ways Walmart App Features Can Combat the Draw of Apple Pay at the Point-of-Sale

(New York, NY): Walmart shoppers who can use Apple Pay and have a mobile payment preference are twice as likely to choose Apple Pay over Walmart Pay, according to new research from Auriemma Group’s Mobile Pay Tracker. But discount- and shopping-focused app features could give Walmart and other merchants a competitive edge over Apple Pay, according to Auriemma’s study, which examined Walmart, Target, and Kohl’s shoppers’ use of merchant apps and mobile payments. The study also revealed how merchants can migrate more customers to proprietary mobile payment options embedded in commerce apps— and that there is a compelling reason to do so. Walmart Pay shoppers spent an average of $319 in the past month with the merchant compared to $291 for Apple Pay users, both representing a significantly higher spend than shoppers who have never used the Walmart app.

Here are three ways merchants can leverage app features to increase engagement and differentiate their mobile payment offering from Apple Pay.

Emphasize features that offer savings or promotions. Shoppers want deals at their fingertips. Walmart customers who don’t have the Walmart app installed would be most interested in using the app to find coupons, view sales, exclusive offers, and rewards, and/or to use the Savings Catcher feature. These features are also the most used by those who have the app, highlighting their importance in both promoting app adoption and habitual usage. Leading with these value-enhancing benefits can not only boost adoption, but also drive increased satisfaction with the app as a whole. Ultimately, shoppers come to the Walmart app to save money at the point-of-sale, but highlighting mobile payment functionality will create a captivating experience that competitors like Apple Pay cannot currently match.

“Satisfaction with a merchant’s app is an indicator of wider mobile payment adoption,” says Jaclyn Holmes, Director of Auriemma’s Payment Insights practice. “A seamless merchant app/payment experience that leverages the features shoppers love, such as coupons or rewards, could be the tipping point needed to get them excited about downloading and using a merchant’s app and payment functionality over the competition.”

Focus on features that elevate the shopping experience for customers. For merchants to increase their app and mobile payment usage, customers will need to feel that it adds something extra to the shopping experience. While it’s unsurprising that customers without the Walmart app would be interested in using it to shop for items, it is notable that a near equal proportion reported that they would want to check an order status or scan item barcodes for information in-store using the app.

“Features that keep shoppers engaged with Merchant apps during the real-time shopping experience are important in the transition from shopping to purchasing,” says Holmes. “While discounts and promos may get shoppers to open the app, finding ways to engage shoppers for the duration of their shopping experience will help form new habits that ultimately lead to Merchant Pay usage, particularly in-store.”

Create a sticky shopping experience that smoothly transitions to checkout. In general, mobile payment users tend to find the experience easy, fast, and convenient, regardless of whether they are using Walmart Pay, Apple Pay, or a similar digital wallet. The former, however, has an opportunity that Apple Pay does not. By featuring all the ways the Walmart app enriches the overall shopping experience (including payment functionality), Walmart, and other merchant apps/payments, can set themselves apart from device-centric wallets, whose main draw is specific to the payment experience and not the shopping experience as a whole.

“The desire for a universally accepted wallet poses a threat to single-merchant wallets,” says Holmes. “Finding opportunities to drive value, customize the shopping experience, and positively influence each aspect of the customer journey—from discovering new items and deals, to reserving items, to applying coupons and building loyalty through rewards—is a key differentiator.”

Survey Methodology

This study was conducted online within the US by an independent field service provider on behalf of Auriemma Consulting Group (Auriemma) in April-May 2018, among 921 US adults who made a purchase from Walmart, Target, or Kohl’s within the past 6 months. All respondents were also screened to have a general purpose credit, debit, or store card, own a smartphone, and have made a purchase on their phone. Each shopper was classified as an ‘App User’ or ‘App Non-User.’ All shoppers were also classified as a ‘Pay User’ if they have ever used the Merchant Pay functionality (Walmart Pay, Target Wallet, Kohl’s Pay) on the merchant app. A minimum of n=150 Merchant App Users, n=150 Merchant App-Non-Users, and n=50 Pay Users were recruited to take the survey.

About Auriemma Group

For more than 30 years, Auriemma’s mission has been to empower clients with authoritative data and actionable insights. Our team comprises recognized experts in four primary areas: operational effectiveness, consumer research, co-brand partnerships, and corporate finance. Our business intelligence and advisory services give clients access to the data, expertise and tools they need to navigate an increasingly complex environment and maximize their performance. Auriemma serves the consumer financial services ecosystem from our offices in New York City and London. For more information, call Jaclyn Holmes at (212) 323-7000.

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Revolvers Who Miss Payments Are Probably Going to Cancel Your Credit Card

(New York, NY):  Credit cardholders can be divided into two groups based on their payment behavior—revolvers and transactors. And while this distinction often identifies key differences between those who carry a balance and those who do not, revolvers are not all created equal. Recent research conducted by Auriemma Group compared on-time revolvers (i.e., those who carry a balance but haven’t missed a payment in the last 12 months) to late payment revolvers (i.e., those who skipped/missed a payment on at least one card in the past 12 months) with the aim of understanding the demographic factors that differentiate the groups from one another. In comparing the two groups, the research found that late payment revolvers are a serious retention risk, and that their card experience will need to be deeper than just paying off an outstanding debt to prevent them from cancelling their card.

Revolvers represent 56% of the credit cardholder population, with 38% qualifying as on-time revolvers and 18% as late payment revolvers. Late payment revolvers tend to be younger (34 vs. 46 average age), more highly educated (70% vs. 57% college degree or more) and employed (86% vs. 66%) when compared to their on-time revolving counterparts.

While those demographics would be a welcome addition to an issuer’s portfolio, these customers don’t tend to be especially loyal to specific cards. Most have cancelled (52% vs. 6% on-time revolvers) and/or acquired (55% vs. 14%) a new card within the past year. These customers also tend to have competing financial responsibilities—72% are parents of a minor (vs. 34%), 50% hold a mortgage (vs. 42%), and 36% hold a student loan (vs. 22%).

Because of these competing priorities, this group is motivated to consolidate outstanding balances they have on their cards—creating the opportunity to acquire these customers.

“To better manage their credit card debts, half of late payment revolvers have taken a balance transfer,” said Jaclyn Holmes, Director of Auriemma’s Payment Insights practice. “This is in comparison to just 9% of on-time revolvers, which showcases one way to get these customers into your portfolio.”

While there is ample opportunity to convert late payment revolvers to new customers via balance transfers, the real challenge is keeping them engaged with the product. Late payment revolvers have more inactive cards in their wallet—only 43% have used all their cards (compared to 58% of on-time revolvers), demonstrating a consolidation of spend. And while an attractive balance transfer offer could entice late payment revolvers to acquire a new card, the likelihood of abandonment is high, with more than half of this population cancelling a card in the last 12 months.

Issuers must also contend with the group’s general sentiments toward credit cards as a product. Most (52%) prefer debit over credit. They also tend to have lower average FICO scores than their older on-time revolving counterparts (570 vs. 720), partly due to having limited credit histories. The group also has lower credit lines and lower average outstanding balances ($2,640 vs. $4,446).

“We know from previous research that cardholders’ top reasons for cancelling a card are paying off the balance or getting a new card,” says Holmes. “It is critical for issuers to entice cardholders to want to spend with their cards and not just chip away at an outstanding debt, especially as the balance gets closer to zero. For late payment revolvers to become loyal to a product or brand, they must first develop a more positive relationship with credit generally. Offering incentives to these cardholders that encourage spend and develop loyalty will be the best chance issuers have at retaining the customer.”

Survey Methodology

This study was conducted online within the US by an independent field service provider on behalf of Auriemma Consulting Group among 800 US adult credit cardholders in March 2018. The number of interviews completed for both is sufficient to allow for statistical significance testing among sub-groups at the 95% confidence level ±5%, unless otherwise noted. The purpose of the research was not disclosed, nor did respondents know the criteria for qualifying. The average interview length was 25 minutes.

About Auriemma Group

For more than 30 years, Auriemma’s mission has been to empower clients with authoritative data and actionable insights. Our team comprises recognized experts in four primary areas: operational effectiveness, consumer research, co-brand partnerships, and corporate finance. Our business intelligence and advisory services give clients access to the data, expertise and tools they need to navigate an increasingly complex environment and maximize their performance. Auriemma serves the consumer financial services ecosystem from our offices in New York City and London. For more information, Jaclyn Holmes at (212) 323-7000.

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Second Look Offers Potential Benefits for Issuers and Brand Partners Alike

(New York, NY):  The battle for market share among branded credit card programs seeking prime and superprime customers has been fierce. Rewards have grown ever richer and, as the cost per acquired account rises, marketing efforts come with diminishing returns for both brands and issuers.

In contrast to the proliferation of products targeting prime and superprime customers, there has been relatively little product innovation for customers with less developed credit profiles, whose access to credit tightened as a result of the recession and some of the sizable regulatory changes that occurred soon afterward. But, increasingly, both issuers and brands are considering “second look” programs, which use different underwriting criteria to reevaluate declined applicants for credit with separate terms. For the benefit of brands and issuers, second look programs can approve more credit applicants and drive incremental sales by expanding credit access to customers who have lower FICO scores or thin credit histories.

“This segment of under-served customers is a significant opportunity for issuers and brand partners,” said Steve Serra, Senior Director of Partnerships for Auriemma Consulting Group. “With the intense competition now underway for each new cardholder, portfolio growth is a pressing concern, and issuers cannot afford to ignore any sizable pool of potential customers.”

At a time when many brands may be experiencing portfolio stagnation, second look programs can expand the penetration rate of a given co-brand or private label card by underwriting customers who would otherwise be declined for the primary credit program.

These second look programs layer onto an existing primary credit program, often in partnership with a second issuer. Second look programs can be seamlessly integrated into the application flow within existing point-of-sale (POS) technology to provide a smooth customer application experience.

“Previously, these customers would have been declined at POS and forced to look outside the brand for quality financing options,” Serra said. “These second look programs provide a better customer experience, strengthen a brand’s relationship with its retail customer and make store employees more comfortable offering credit.”

Brand partners that use second look programs can drive significant uplift in their credit application approval rates – typically 10 to 20 percent of customers who are declined for a primary program can be approved by a second look program. More approvals also translate to more loyalty – having a branded card motivates shoppers to spend and shop more, with 30 percent of co-brand and private label cardholders saying they have increased their spending with a retailer after being approved for its branded card, according to Auriemma Cardbeat research. A second look program can also drive incremental sales for a brand – in some cases, up to 10 percent year-over-year – according to a recent Auriemma case study.

Given the significant potential to increase approval rates and drive sales growth, brands should incorporate second look issuing rights into their issuer co-brand and private label agreements to ensure that the opportunity is available to them at any point in their contract term.

The benefits of second look programs are also manifold for card issuers. Issuers that build second look capabilities can increase the size of their card portfolios and gain greater market share. Additionally, many brands are looking for deeper underwriting as they have deep pools of under-served customers with an appetite for credit, and most major issuers do not offer second look services today. Thus, the ability to offer second look services can be a major point of distinction for issuers seeking to win brand partnerships.

“Second look programs are beneficial for customers and card programs alike,” Serra said. “Through collaboration, brands and issuers can better serve their customers, improve the acquisition experience and drive more loyalty and sales.”

With over 30 years of experience crafting profitable, long-lasting partnerships in the Cards and Payments industry, Auriemma is well-suited to facilitate these collaborations between issuers and brands. For more information, please contact Steve Serra at 212-323-7000.

About Auriemma Group

For more than 30 years, Auriemma’s mission has been to empower clients with authoritative data and actionable insights. Our team comprises recognized experts in four primary areas: operational effectiveness, consumer research, co-brand partnerships, and corporate finance. Our business intelligence and advisory services give clients access to the data, expertise and tools they need to navigate an increasingly complex environment and maximize their performance. Auriemma serves the consumer financial services ecosystem from our offices in New York City and London. For more information, call Steve Serra at (212) 323-7000.

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34% of Those Eligible Are Using Mobile Payments, But Few Would Recommend Them

(New York, NY):  After a year of celebrity following its release in late-2014, Apple Pay had to share the spotlight with Android Pay and Samsung Pay. Since then, the market has grown even more crowded, with merchants, such as Walmart and Kohl’s, developing Pay options for their consumers to use at the point of sale. But according to Auriemma’s Q1-2018 Mobile Pay Tracker, usage of Apple, Google (formerly Android), and Samsung Pay has still managed to grow five points (to 34%) compared to Q1-2017. While this growth is a positive for mobile payments, a declining proportion of these users would recommend the service, signaling trouble ahead.

“The influx of new players makes the future of the Big Three uncertain,” says Jaclyn Holmes, Director of Payment Insights at Auriemma. “Being first to market hasn’t given Apple, Google, or Samsung a leg up on mobile payment newcomers. Providers who are able to deliver a more positive, reliable Pay experience are most likely to encourage continued Pay usage, while others may struggle in the years ahead.”

Problems at the point of sale can prevent even the most enthusiastic Pay users from developing the habit of paying with their mobile device. This, in turn, lessens the opportunity and likelihood for recommending the service. In fact, 42% of mobile payment users wouldn’t recommend the service, up 11 points compared to last year (31%).  And because these sentiments are strongest among the most inactive Pay users (87% very inactive vs. 6% very active), it’s clear developing the habit is key to the success of mobile payments. But this routine could be more easily developed with merchant mobile payments, which have more control over their Pay experience and can eliminate many of the barriers that trouble Apple, Google, and Samsung Pay users.

Merchants have an advantage over the Big Three: a guarantee of acceptance across all its stores and a uniform in-store experience. While most of Apple, Google, and Samsung Pay users think in-store acceptance has improved since these mobile payments launched, reported issues at the point of sale have remained the same compared to last year. Among the issues, unfamiliar cashiers and an inability to complete the transaction come out on top, with a plurality of in-store Pay users who quit and decide to swipe their card instead. All of this could potentially be avoided with a well-conceived Merchant Pay option.

“Merchants have the power to create a frictionless mobile payment experience,” says Holmes. “They can train their store employees to become Pay champions who promote the payment option, offer assistance, and do so in a way that keeps lines moving and customers smiling.”

Survey Methodology

This study was conducted online within the US by an independent field service provider on behalf of Auriemma Consulting Group (Auriemma) in January/February 2018, among 1,527 mobile pay eligible consumers. Respondents were screened to own an iPhone 8/8+/7/7+/6/6+/6s/6s+/SE/X or Apple Watch (in combination with an iPhone 5/5C/5S) – a Samsung Galaxy S8, S8 Edge/Edge+, S7, S7 Edge, S7 Active, a Samsung Galaxy S6, S6 Edge/Edge+, S6 Active or Galaxy Note 5, Note 7 or Note 8 – Gear S2 or S3 watch (in combination with an Android/iPhone smartphone) – and/or other Android phone with KitKat (4.4) OS or newer. All respondents also have a general-purpose credit card in their own name.

About Auriemma Group

For more than 30 years, Auriemma’s mission has been to empower clients with authoritative data and actionable insights. Our team comprises recognized experts in four primary areas: operational effectiveness, consumer research, co-brand partnerships, and corporate finance. Our business intelligence and advisory services give clients access to the data, expertise and tools they need to navigate an increasingly complex environment and maximize their performance. Auriemma serves the consumer financial services ecosystem from our offices in New York City and London. For more information, call Jaclyn Holmes at (212) 323-7000.

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Equifax Breach Hasn’t Eroded Trust in Banks

(New York, NY): Following its breach more than six months ago, Equifax is the least trusted credit bureau, according to new data from Auriemma Group. While this may be a natural outcome of such a high-profile event, the research shows there has been a ripple effect that has weakened trust in Experian and TransUnion, sparking consumer skepticism about how credit bureaus are protecting data. But while consumers’ trust in credit bureaus has been damaged by the breach, they continue to express confidence in their banks’ and issuers’ ability to protect their financial information—82% of cardholders believe their financial accounts are secure and about 80% reporting confidence in their bank’s and/or credit card issuer’s ability to protect their financial information.

Although the Equifax breach wasn’t the largest data breach of all time, the bureau received increased scrutiny from government officials and consumers alike for not having the same regulatory oversight on data protections as banks, issuers and other financial institutions. In January, senators introduced a bill to create mandatory penalties for data breaches at credit reporting agencies. While the political reality of such measures is unclear, it could be championed by the public: According to Auriemma, 78% of consumers believe credit bureaus should be subject to greater regulation. Recent news places the Equifax investigation on hold, however, as sources recently said interim director Mick Mulvaney has yet to request subpoenas against the reporting agency, or sought sworn testimony from its executives.

Consumers’ trust in Equifax has been eroded—31% believe they were impacted by the Equifax breach, which also likely affected trust for all credit bureaus, according to Auriemma. One-quarter (25%) say they have don’t trust any of the reporting agencies with their financial information. Only 10% of cardholders say they trust each of the credit agencies a lot. Equifax falls at least 10 points behind TransUnion and Experian in credit cardholders that have at least a little trust in each respective credit agencies.

“While levels of trust with TransUnion and Experian are near equal, Equifax is likely suffering from the handling of its recent data breach,” says Jaclyn Holmes, Director of Auriemma’s Payment Insights practice. “The level of distrust is even more stark among those who believe they were impacted by the breach – just over half of those individuals no longer trust Equifax with their financial information.”

More than half (53%) of respondents believe the Equifax breach was handled poorly by the company, likely due to the delayed response and remediation efforts. But Equifax’s eventual efforts to communicate with and provide ID theft protections to impacted consumers did not go unnoticed by the remaining 47% of respondents, who say the bureau responded at least somewhat well.

While Equifax offered web-based tools to help consumers post-breach, a very low proportion (38%) of respondents who believe they were impacted used these tools. Impacted consumers opted to check their credit report themselves more frequently than those not impacted (46% versus 21%), began monitoring their existing credit and bank accounts more closely (46% versus 18%), enabled two-factor authentication where possible (23% versus 6%), and placed fraud alerts and credit freezes on file (21% versus 3%).

“Even among those who say they’re certain they were impacted, only half say they visited www.equifaxsecurity2017.com to see if they were exposed, which speaks to a general weariness for Equifax’s online portal and their response to the breach,” says Holmes.

Survey Methodology

This study was conducted online within the US by an independent field service provider on behalf of Auriemma Consulting Group among 800 US adult credit cardholders in November 2017. The number of interviews completed for both is sufficient to allow for statistical significance testing among sub-groups at the 95% confidence level ±5%, unless otherwise noted. The purpose of the research was not disclosed, nor did respondents know the criteria for qualifying. The average interview length was 20 minutes.

About Auriemma Group

For more than 30 years, Auriemma’s mission has been to empower clients with authoritative data and actionable insights. Our team comprises recognized experts in four primary areas: operational effectiveness, consumer research, co-brand partnerships, and corporate finance. Our business intelligence and advisory services give clients access to the data, expertise and tools they need to navigate an increasingly complex environment and maximize their performance. Auriemma serves the consumer financial services ecosystem from our offices in New York City and London. For more information, call Jaclyn Holmes at (212) 323-7000.

 

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While Holiday Shopping Hit Record-Setting Numbers, Consumers Don’t Expect to Continue the Trend Throughout 2018

(New York, NY):  Retailers saw one of the biggest jumps in consumer spending during holiday 2017, bringing cheer to retailers and issuers alike. But while holiday spending is typically indicative of consumer confidence and purchasing plans for the upcoming year, new research from Auriemma Group reveals that consumers don’t plan to increase their spending from 2017 levels. According to the new research, consumers generally feel positive about the country’s financial outlook, but enthusiasm for increased spending and borrowing on credit cards has waned compared to October 2016.

For example, 21% of consumers say they are likely to increase their monthly spend (down from 37% in 2016), only 16% plan on taking out a loan (down from 31% in 2016) and only 14% plans to increase borrowing on credit cards (down from 28%). When asked which purchases consumers anticipate making in 2018, the intention to spend in several categories decreased. For example, 43% of consumers plan to spend on vacations (down from 48%), 21% plan to spend on electronics (down from 36%), and 21% plan to purchase cars (down from 29%).

“Increased spending around the holiday season is normally predictive of greater consumer confidence and increased spending overall,” says Jaclyn Holmes, Director of Auriemma’s Payment Insights practice. “But these results show that merchants will need to be aggressive to court increased spending in 2018.”

The good news is that consumers generally feel that the U.S. economy is stable, with 43% of cardholders believing that the U.S. economy will be in the same condition one year from now, and 32% believing the economy will be better off. While the proportion who say the economy is good/excellent is comparable year-over-year, the proportion who describe it as “excellent” has decreased by half. A notable 25% percent believe the economy will be worse off one year from now. Although sentiments on the future of the US economy are, for the most part, positive, enthusiasm for borrowing is not.

Among all respondents, 69% say they are just as willing to borrow from banks in 2018, but only 7% are more willing to borrow from banks over this period, down from 14% who were more willing to borrow from banks in 2017. This appetite for borrowing becomes even more stark when considering the respondents’ future outlook on the economy.

Of those who feel the economy will improve in the next year, 16% said they were more likely to borrow in 2018, with 11% saying they were less likely to borrow. On the other hand, of those who believe the economy will worsen, 4% are willing to increase borrowing in 2018, and 53% say they are less likely to borrow.

“While the holiday season seemed indicative of more robust spending in 2018, it’s important that issuers have the right expectations for the new year,” says Holmes. “There are also many ongoing developments that will shape consumer spending in 2018, such as tax reform, which will need to be monitored closely.”

Auriemma plans to conduct further research in 2018 to provide the latest snapshot on consumer confidence and planned spend.

 Survey Methodology

This study was conducted online within the US by an independent field service provider on behalf of Auriemma Consulting Group among 800 US adult credit cardholders in November 2017. Comparative data was fielded in a October 2016 study among the same population. The number of interviews completed for both is sufficient to allow for statistical significance testing among sub-groups at the 95% confidence level ±5%, unless otherwise noted. The purpose of the research was not disclosed, nor did respondents know the criteria for qualifying. The average interview length was 20 minutes.

About Auriemma Consulting Group

For more than 30 years, Auriemma’s mission has been to empower clients with authoritative data and actionable insights. Our team comprises recognized experts in four primary areas: operational effectiveness, consumer research, co-brand partnerships, and corporate finance. Our business intelligence and advisory services give clients access to the data, expertise and tools they need to navigate an increasingly complex environment and maximize their performance. Auriemma serves the consumer financial services ecosystem from our offices in New York City and London. For more information, call Jaclyn Holmes at (212) 323-7000.

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Auriemma Conducts Parallel Study of Mobile Pay Usage in the US and the UK

(New York, NY): In both the US and the UK, a growing ecosystem of mobile pay providers hope to become consumers’ go-to payment method at checkout. But the future of mobile payments appears more positive across the pond, where contactless payment technology has made familiarity with tapping at the point of sale more prominent.  Auriemma Group recently conducted a parallel study among cardholders in both the US and UK markets, aimed at learning about mobile payment adoption, satisfaction, and how comfort with contactless technology could impact mobile payments moving forward.

A small but notable proportion of credit cardholders (‘cardholders’) in both geographies have adopted mobile payments. While UK cardholders are slightly more likely than their US counterparts to have used Apple Pay (12% vs. 9%) and Visa Checkout (9% vs. 6%) within the past month, other options, such as PayPal In-Store Checkout (5% each) and Android Pay (4% each) show similar usage patterns. Although usage metrics are low, satisfaction with each technology is extremely high.

Over 90% of users in both geographies say they are satisfied with their mobile payment app. However, while it may be true that satisfied users are more likely to continue using than dissatisfied ones, user satisfaction alone does nothing to introduce non-users to the technology. UK consumers have a slight advantage in this area, given their introduction to contactless payment technology has familiarized them with tapping at checkout.

“UK consumers were introduced to contactless payments in 2007,” says Jaclyn Holmes, the Director of Auriemma’s Payment Insights. “Their increased comfort with this technology, in the decade since its inception, makes payment behavior at the point of sale less of a barrier for mobile pay adoption. If anything, paying with a tap has become more natural for this population than their US counterparts, who only recently began the move from swipe to dip.”

While exposure to contactless payments may increase comfort with mobile wallets, the shift from brick-and-mortar to online shopping creates an opportunity for mobile payments to grow. Most US and UK cardholders have made an online purchase on their smartphone, but a notable minority (31% and 40%) have not. And there is a link between comfort with making an online purchase via a smartphone and usage of mobile wallets more generally. Notable proportions of US and UK cardholders who have made online smartphone purchases have ever tried mobile wallets (33% and 43%, respectively). This is in stark comparison to their less smartphone-friendly counterparts, who are much less likely to have used a mobile wallet (7% and 5%).

“Cardholders who are more accustomed to shopping on their smartphone are more likely to pay with their smartphone in-store, especially in the UK,” says Holmes. “The US may have had the advantage of earlier exposure to mobile wallets, but the UK’s history with contactless has made the locale ripe for adopting a variety of mobile payment options. Increased familiarity with contactless payment technology and comfort with the smartphone as a payment device will be necessary to encourage the growth of mobile payments.”

Survey Methodology

These studies were conducted online within the US and UK by an independent field service provider on behalf of Auriemma Consulting Group. The UK study (Cardbeat UK) was fielded in August 2017 among 500 adult credit cardholders and the US study (The Payments Report) was fielded June/July 2017 among 800 debit cardholders, of which 567 were also credit cardholders. The number of interviews completed for both is sufficient to allow for statistical significance testing among sub-groups at the 95% confidence level ±5%, unless otherwise noted. The purpose of the research was not disclosed, nor did respondents know the criteria for qualifying. The average interview length was 20 minutes.

About Auriemma Group

Auriemma is a boutique management consulting firm with specialized focus on the Payments and Lending space.  We deliver actionable solutions and insights that add value to our clients’ business activities across a broad set of industry topics and disciplines.  Founded in 1984, Auriemma has grown from a one-man shop to a nearly 50-person firm with offices in New York and London.  For more information, contact Jaclyn Holmes at (212) 323-7000.

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Auriemma’s 2017 Annual Letter

Dec. 1, 2017

Dear Friends,

If you invested in Bitcoin, Jamie Dimon thinks you must be “stupid” and Mark Cuban says you should be prepared to lose your money. Yet, the value of a Bitcoin is now fifteen times greater than it was at the start of the year. The stock market seemed over-heated at 18,000. Even more so at 20,000 and 22,000. Recently, it breached 24,000. So where should investors place their bets?

Retailers are struggling with brick and mortar. But when I took my daughter back-to-school shopping in September, I had to wait in line to get into the outlet mall’s parking lot. I then endured more lines for the dressing rooms and registers.

The US Congress seems ready to pass a tax bill which will help the rich. Or the middle class, depending on whom you ask. There are many other contradictions in politics (which I’ll choose to steer away from in this forum) regardless of whether, like most of our readers, you are in the US or the UK. Even in Zimbabwe… meet the new boss, same as the old boss (as The Who said in 1971).

What’s my point? Simply that the world is complex. It’s full of mixed messages, contradictions, and partisanship. Our own payments and lending industry is no different. This year’s letter looks at how that complexity has manifested itself for our clients over the course of 2017.

For example, US consumer confidence and stock markets are up, credit scores are at a record high, and unemployment is low. Yet, after a prolonged period of stability, US credit losses are on the rise. Of course, the UK market provides a stark contrast. Consumer confidence and the underlying economy are deteriorating, and wage growth is slow. While this escalates concerns about consumers’ ability to pay, the UK’s delinquency rates have been largely unaffected thus far, according to company reports and our proprietary benchmarking data.

So, why are US losses rising despite the positive market conditions? It’s easy to point to the recent uptick in new account growth and the subsequent (and expected) increase in early-stage delinquencies. Or, that non-prime borrowers have recently gained more access to credit. However, the current crop of newer vintages (accounts opened in 2014-2015) are performing worse than expected, according to many of our clients.

These losses don’t signal any existential threat to profitability for issuers in the near term, but our clients are taking the potential threat seriously. While none appear overly concerned about the credit outlook, most are diligently preparing for the possibility of continued deterioration.

The specter of rising losses is perhaps more ominous now that household debt has surpassed its pre-recession peak. For better or worse, the composition of that debt looks very different today than in 2008. Housing debt is down significantly, but auto debt is up dramatically, and student loans have tripled, leading to a raft of implications for the economic outlook.

In the auto lending arena, we are closely watching sub-prime lending. As dealers are pressured to sell more cars, in an era of ride sharing and a amidst a deluge of off-lease vehicles entering the marketplace, auto lenders are under similar pressure to approve more applicants. One result is longer loan terms, with some topping 96 months – a level that few believe is sustainable. The ability to balance sales goals and risk will be a major factor in separating the winners from the losers.Synthetic identity fraud (SIF) was another significant topic on our clients’ radar this year. While EMV has successfully slashed counterfeiting, fraud losses (driven by card-not-present fraud) are higher than ever. With the amount of personal data available on the dark web (particularly in the wake of high-profile breaches, such as Equifax), fraudsters can create synthetic identities by combining real consumer data (such as Social Security numbers) with manufactured data (such as phony birthdates and names). This wreaks havoc on lenders in both fraud control and credit loss management.

As part of a recent study, Auriemma determined that up to 5% of charged-off credit card accounts could be linked to SIF. With the average unpaid debt totaling more than $15,000 per account, that equates to $6 billion, or 20%, in credit losses industry-wide. Issuers are banding together and fighting back, however. This year, Auriemma held its second workshop devoted to the subject. Our newly established working group will coordinate industry efforts to define, measure, and counteract this insidious trend.

As bad as the problem is in the US, I was interested to learn on a recent tour of UK card issuers, that SIF isn’t making headlines in that market yet. While US issuers have been hamstrung by the inability to cross-check applications with Social Security numbers in a timely fashion, the UK has more effective screening processes at account acquisition. But we’ll be closely watching the still-unknown implications of PSD2, which could create an opening for enterprising fraudsters.

In both the US and UK, retail sales are soft, with thousands of store locations closing their doors. But private label and co-brand programs are thriving as the savviest retailers are using these products to drive loyalty. Although 2017 was expected to be a slow year for US co-brand and private label activity, we’ve seen a surge of de novo offerings from the likes of Porsche, IKEA, Uber, Jet.com, Verizon, and others. These new deals, combined with the largest pool of issuers competing for deals in recent memory, made the market frothy indeed.

Issuers, merchants, and networks all worried about the future of co-branding in the UK after interchange rates were slashed to 30 basis points. Certainly, some value props have since been watered down. But other programs became stronger than ever after partners reached new agreements that restructured economics and allowed for more creative and compelling rewards. Ironically, the threat to these programs has forced the survivors (read: winners) to focus on the fundamental reasons why co-branding makes sense in the first place.

During a recent assignment in Japan, we’ve also observed several interesting dichotomies throughout the APAC region. Japan is fascinatingly modern and technologically advanced, though mobile payments have not penetrated the geography. This is true despite their having spread like wildfire in China, thanks to major players like Alipay and WeChat Pay. The average Japanese consumer carries six cards in her wallet (including many co-brand cards), but virtually no consumers revolve, and cash is still widely used. The spend-centric Japanese market is poised for the right combination of players to tap into consumer needs.

Mobile payments continue to struggle in the US, too. Despite consumers being increasingly addicted to mobile devices, mobile payment adoption is declining from an already low base. Between Q2 and Q3 this year, mobile payment usage fell 5% among eligible consumers, according to our proprietary Mobile Pay Tracker research. Earlier, I mentioned mixed messages. Here’s another one: of those who use mobile payments, roughly one-third cite security as a main attraction. A near-equal proportion of non-users say their main barrier to trying mobile payments is – you guessed it – uncertainty around security.

Clearly, it’s imperative that wallet providers and card issuers beef up education and communication around the security of mobile payments. Consumers want assurance that they won’t be responsible for fraudulent transactions, and they want proof that mobile payments are secure.

The regulatory environment remains an uncertain landscape. In the US, look no further than the speculation about the CFPB future leadership and regulatory scope now that Director Cordray is out. Certainly, the interim director will have a very different mindset than his predecessor, likely leading to a new direction for the Bureau. If pressure from the CFPB does subside though, we have no doubt that many state regulators will pick up the slack.

As always, our focus is on advocating for common-sense approaches and drawing attention to unintended consequences arising from regulation. For example, earlier this year, we wrote a comment letter on the continued effects of the CARD Act. While the Act has improved transparency in pricing and marketing, the regulation has also restricted access to credit and eroded the customer experience.

Europe is also gearing up for major regulatory initiatives as GDPR and PSD2 are scheduled to take effect early next year. While both regulatory initiatives share a common theme – putting the customer in control of personal data – the timing and scope of those changes create wrinkles for implementation. For example, PSD2 focuses on making customer data available to third parties, while GDPR is focused on a customer’s rights to keep it private. Moreover, PSD2 is based on current data protection regulations which will be replaced with GDPR. Both regulations present major operational and IT infrastructure changes and will take up significant resources. It might all prove to be worthwhile, however, for innovative lenders that use these initiatives to improve customer value rather than focus exclusively on complying with regulations.

When so many indicators seem to contradict each other, we must prepare for the unexpected. Through our industry roundtables, consumer and market research, partnership support, and corporate finance strategies, the team at Auriemma is prepared to assist clients in achieving growth targets while fortifying defenses against wide ranging threats.

Meanwhile, Auriemma is undergoing its own transformation. You may have noticed that I referred to the company as Auriemma throughout this letter, as opposed to ACG, which was our preferred acronym for many years. This is step one in a complete re-branding exercise we’ve embarked upon to more accurately depict who we are as a firm today and moving forward. Look for a new website, logo, and more in 2018.

We hope you enjoyed our perspective on the mixed signals rampant in 2017. While this annual industry round-up is a long-standing tradition, we continuously issue press releases, research, and articles focused on the topics that matter most to the industry. To follow along, please join us on LinkedIn or Twitter. Or, do it the old-fashioned way – give us a call.

We’d be happy to schedule time with you and your team to explore any of these (or other) topics in greater depth. Contact us at feedback@acg.net to set up a meeting or provide your thoughts on this year’s letter.

Regards,

Michael Auriemma

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The Challenge of CECL for Credit Card Issuers

For many years, the credit card industry calculated the loan loss allowance (the ALLL) as an estimate of losses projected over the next ten to twelve months.  This long-standing practice is now about to be overturned. While card issuers have not disclosed the likely impact of the new approach, a doubling of the loss allowance would not be far-fetched. This change in methodology will only magnify the recent acceleration in credit losses.  It is imperative for card issuers to start communicating with the investment community about this change now, before the financial impact is felt.  Without a proper understanding of the accounting rule change, investors will conclude an increase in the loan loss allowance is a signal that credit quality is deteriorating, which may or may not be the case.

Why did the accounting profession feel compelled to change a long-standing practice? Back in 2008, when the world was trying to come to grips with the global financial crisis, the Financial Accounting Standards Board (FASB) embarked on a project to improve the estimation of a lender’s credit exposure.  The theory was that by moving from an incurred loss model to one which captured the expected credit loss associated with a loan exposure over its complete term, banks and other lenders would be better prepared to endure a future credit crisis.  FASB conducted a long evaluation and comment period which ended in June 2016.  The result, Accounting Standards Update (ASU 2016-13) Financial Instruments – Credit Losses (topic 326), is not yet adopted.  The new standard has far reaching implications and FASB has provided a long lead time for implementation (essentially 2019 or 2020 depending on the classification of the reporting entity).

One of the core concepts of the new ASU was the “Current Expected Credit Loss” standard – or CECL.  CECL requires that the lender estimate the expected credit loss over the life of the loan exposure.  While this is challenging for any lender, it is easier for amortizing term loans than for revolving loans.  In particular, for credit card issuers, determining the “expected life” of a credit card receivable (loan) is inherently complex.  What is the life of a credit card loan? One month, one year, ten years?  Since credit cards give the borrower a payment option (minimum, partial or full), determining the life of a loan exposure is challenging.  Quite obviously, CECL could result in a much higher loss allowance if the life of the average credit card loan were deemed to be longer than one year.

After receiving numerous comment letters from industry participants, the FASB created the Transition Resource Group for Credit Losses (the TRG) so that FASB and the industry could develop practical conventions for implementation of the proposed new standard.

The TRG worked on the knotty problem of the “life of loan” for credit cards.  One of the key areas of focus became the application of principal payments.  Beyond the borrower’s right to vary the payment amount, there was also the question of the allocation of principal payments received by the issuer.  Prior to the Credit Card Accountability Responsibility and Disclosure Act of 2009 (the CARD Act), issuers used various payment allocation methods to prioritize the distribution of principal payments.  CARD Act, among many other changes, required issuers to apply principal payments to the outstanding balance with the highest interest rate first, until the high rate balance was reduced to zero or the principal payment was fully utilized.  Applying principal this way was clearly designed to benefit consumers by having the highest rate balances amortize faster than lower or teaser rate balances.

When card issuers began to consider how to implement CECL for their business, they faced a quandary: allocating principal payments according to the CARD Act could make the estimation of the life of loan even more complicated. Should an issuer assume that the life of a current card loan outstanding can vary with subsequent purchase activity, even if the issuer is not legally obligated to fund future activity?

In June 2017, the FASB reviewed a paper (and examples) prepared by the TRG to propose one of two possible solutions to the credit card payment allocation problem.    The first suggestion, “view A,” was a first in, first out (FIFO) allocation where the oldest balance received the principal payments until it was completely paid (or charged off).  This had the virtue of simplicity and consistency.  The second suggestion, “view B,” was more complicated but attempted to closely follow the CARD Act allocation.  While this may have the theoretical advantage of more accurately reflecting the life of a loan, the complexity of this approach was obvious.

The FASB concluded that while it could see no reason to prohibit either approach, it did see View A as more practical.  The staff also recognized that View A was more consistent with the intent of CECL that the loan loss estimate was for the balance at a point in time.  Moreover, since credit card lines are unilaterally revocable by the issuer, including future purchases would essentially change this from a “life of loan” calculation to a “life of loans” calculation.  At a meeting of the TRG on October 4, 2017, the Board agreed to provide further guidance on the acceptability of both views in a future new guidance Update 2016-13.

The credit card industry has enjoyed years of record profitability and near historic lows in both interest expense and credit loss expense.  Now, as credit losses have begun climbing, the move to CECL will have a compounding effect on the loan loss allowance.  In addition to the advance warning and education that issuers should be starting, perhaps there will be other actions that issuers can take post-adoption.  For example, should issuers calculate the allowance using the old methodology as a “non-GAAP” additional metric to be included in the MD&A section of financial statements?  For some long-time industry analysts, this would have the benefit of allowing easier comparisons to prior reporting periods.  Perhaps after one or two years of reporting under the new standard the old calculation can be dropped but including it for at least a transition period would no doubt be helpful.

There has been much media attention paid to the rising loss rates for card issuers, but there has been little discussion about the coming impact of CECL on card issuer profitability.  The credit card business will remain the most profitable lending area for US banks, but expect the future levels of profitability to “reset” at a lower level. The onus is on the card issuers to help investors understand that, at least in this case, the change in profitability may be more a function of convention than credit.

 

About Auriemma Group

Auriemma is a boutique management consulting firm with specialized focus on the Payments and Lending space.  We deliver actionable solutions and insights that add value to our clients’ business activities across a broad set of industry topics and disciplines.  Founded in 1984, Auriemma has grown from a one-man shop to a nearly 50-person firm with offices in New York and London.  For more information, contact John Costa at (212) 323-7000.

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