Consistent with Payment Law Advisor’s purpose of demystifying card programs – see, for example, Culture Shock: A Retailer’s Initial Lending Program with a Bank, and PLCC and Cobrand Arrangements – this article briefly reviews various PLCC-program structures that a merchant could adopt, along with key pros and cons of each. Identifying the most suitable structure is one of the fundamental strategic choices for a merchant that’s considering starting up a PLCC program.
In-House, Non-Bank Programs
For many years, “house credit” was just that – a program run from within the merchant’s business and providing credit usable solely in the merchant’s sales channels. One big program run in-house was Sunoco’s, which it sold to Citi in 2004. Sterling Jewelers may be the largest in-house program at present. In-house programs can be run from within the CFO’s or Treasurer’s organization, or the merchant can establish a separate unit (sometimes even a new subsidiary) to run the program.
The biggest advantage of such programs is complete merchant control. For example, if the merchant is only interested in such a program in order to promote sales – rather than, for example, as a source of revenue—it would be free to set the terms of an in-house program accordingly. For example, it might charge below-market APRs or fees or take on more credit risk than a bank (or its safety-and-soundness regulator) would find prudent.
Another advantage of an in-house structure is that the merchant will not be a service provider to a regulated financial institution and thus will escape a service provider’s compliance and examination obligations. At the same, regulatory risk is not eliminated—for example, the Equal Credit Opportunity Act and the FTC Act’s prohibition against unfair or deceptive acts and practices would continue to apply.
The chief disadvantage of an in-house structure is that the merchant, lacking a bank charter, will not be able to export rates and fees. If the merchant’s territory covers many states, this could significantly complicate the operation of its program, as well as reducing its independent profitability. The issue of obtaining and maintaining state consumer-lending licenses can also come into play.
Another disadvantage of in-house programs is the amount of resources and management attention required for a non-core activity, although consultants and outsourcers are available to provide support. A particular concern in this regard may be funding the consumer receivables, as well as maintaining them on the merchant’s balance sheet, since the merchant may not accumulate enough receivables of this type to make securitization practical. The merchant’s operation may also prove slow in recognizing or adopting new technologies and techniques, which banks may identify and implement earlier.
Proprietary Bank Programs
A variation of the in-house model that was popular in the 1980s and 1990s involved the merchant setting up a bank or industrial loan company—for example, Circuit City, Nordstrom’s and others established such institutions. The big advantage of this structure was circumventing the limitations on rate and fee exportation.
For many years, regulators were willing to charter these institutions, but they began disfavoring them even before the financial crisis. (Regulators were concerned, for example, that such institutions’ assets were unduly concentrated, and that, in an effort to boost their affiliated businesses, they were apt to charge rates and fees too low to cover their credit risk.) In the wake of the crisis, the difficulty of securing regulatory approval, plus the prospective costs and risks of compliance, may have largely eliminated this structure as a practical alternative for retailers seeking to set up a PLCC program.
Since the late 1980s, merchants have outsourced most PLCC programs to banks. As originally developed, this model entails the bank administering all key components of the program, including marketing, non-POS customer service and underwriting. (The structural differences between so-called “dealer” programs and others are not addressed in this article.)
The biggest advantage of this structure for the merchant is that its program is being run by an entity whose core mission and expertise is consumer credit. Disadvantages include:
- Less control over the program than in an in-house structure. To the extent the merchant’s rights are not specified in its initial agreement with the bank, the merchant may find itself unable to exercise such rights.
- Loss of control over the customer experience.
- Reduced profitability. Although the bank is able to export rates and fees, the profit-share that goes to the merchant may be quite limited.
- Increased regulatory exposure, as a service provider to a regulated financial institution.
Over the past decade, merchants with powerful brands, big volumes of consumer credit, and capable consultants have been able to mitigate many of the disadvantages they perceived in the outsourcing model. Doing so, and then monitoring the resulting arrangement, entails a substantial resource commitment, however.
Broadly speaking, merchants have implemented two types of mitigants. One type is purely contractual – for example, a provision in the merchant-bank agreement that commits the bank to achieve and maintain certain approval rates and credit lines for applicants and cardholders with certain credit scores. Other examples are provisions that shift revenues from the bank to the merchant.
The second type of mitigant is both contractual and operational – that is, the merchant takes over from the bank certain parts of the program. These are usually parts that the merchant deems key to the customer experience and the maintenance of its brand – for example, marketing and early-stage collections.
In principle, the parts of the program taken over by the merchant could also include owning and operating the receivables. This type of arrangement is not yet typical in the credit card context, although it is sufficiently widespread among non-card based programs that several banks, such as WebBank, have built business models around it. If and when this structure becomes prevalent in PLCC programs, they will truly have moved (to quote the Firesign Theatere) forward into the past.
In any case, these operational mitigants are typically accompanied by increased revenue for the merchant, since the bank is performing fewer activities that warrant compensation. On the other hand, the merchant is accepting greater costs and risks – for example, monitoring costs and compliance risks – than under the traditional outsourcing model.
PLCC programs are widespread and evolution is frequent, including with respect to structural issues such as those discussed above. For example, the impact of Merchant Customer Exchange on PLCC program structures remains to be seen. We will report further on these matters as events warrant.