Interview Transcript

Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

Walk me through your background in the subprime credit card space before we delve into my questions.

I started at Capital One after working with Associates Financial Services, a company deeply involved in the subprime space. They had one of the largest networks of storefronts and mom-and-pop loan shops, as well as a presence in the consumer card space.

After spending six years with Capital One, I became quite familiar with full-spectrum lending. They lent across the spectrum, but their strategy, referred to as the barbell strategy, aimed to keep the balances equal in the subprime and prime spaces. This helped manage the book of business, especially when public, and provided flexibility to manage loss rates without alarming analysts too much about what they might see in the subprime space.

I then spent several years at GE Retail Consumer Finance, which deals with in-store cards. I joined when we were reintroducing association branded cards into the private label market. At that time, they only offered an in-store card that attracted lower spectrum lending customers due to its pricing and line assignments. They didn't have a higher-end card in the private label space, so we started issuing Visa, MasterCard, American Express, and Discover cards through the retailers. This ended up being more of a near-prime, prime type credit card.

I also spent some time with FLEETCOR, which operates in the business financing space, particularly fuel card transactions. Then, I joined Credit One, which was solely subprime when I joined but has since grown to become more of a full-spectrum lender.

In late 2018, I took on the role of president at Premier Card, a company operating in the deep subprime space for 30 years. I was able to grow the book from two million to 4.5 million accounts. The unique thing about Premier is that the owner was using his own money to fund the receivable book. Now at 87, he dreams of dying broke and has plans to provide for about 89 different philanthropic programs with his net worth. We reached that stage ten years earlier than we thought we would. As a result, they decided to pull back a bit on the business, and I chose to pursue other options. So, all in all, I have over 25 years of experience in the consumer lending space, both full spectrum B to C, B to B, with a focus on subprime for the last ten years.

And where are you currently located?

Currently, I am engaged in consulting work and am in the process of establishing my own business.

Could you provide an overview of the competitive landscape in the subprime space where Capital One competes? It's a bit tricky because Capital One doesn't provide much detail about the composition of their portfolio that we would classify as subprime. Perhaps you could start by giving me your impression of how much of Capital One's portfolio and profits are in this space, and then guide me through the landscape of their competitors in this area.

Certainly. Capital One doesn't delve as deeply as what I would categorize as pure subprime issuers. They definitely operate in the 580 to 640 range. These are individuals who are transitioning into the near-prime category, and they have a significant number of accounts in this space. They are still implementing the barbell strategy, aiming to balance the receivable base in the 580 to 660 range with the base of receivables they have at 720 and above.

My best estimate is that they likely have around 15 million accounts in this space. These accounts revolve at a much higher rate than those in the super prime space, so the accounts will differ, but the receivables will be roughly equivalent. Capital One is somewhat unique in that they frequently move in and out of this space. If they are in an earnings call and losses appear to be increasing, they have an exceptional marketing engine that allows them to shift into credit spectrums that will help them balance the overall loss rate if necessary. Typically, if they report and the market sees losses increasing, you'll see them withdraw from subprime, redirect those marketing dollars to book super prime receivables, which helps them manage the overall appearance of their loss rates.

So, I would consider them a competitor in this space, although I don't believe they participate for the same reasons as other issuers.

And I assume the other issuers are primarily focused on maximizing their profits as consistently as possible.

That's true for a segment of them. There's also a segment of emerging players. I tried to persuade Premier to move in that direction, but they were not interested. This would have slightly reduced the margins. However, there are players in the space like Mission Lane, which has grown to about five million accounts. I believe they are in it for both the customers and themselves. They genuinely want to help customers graduate, learn the right behaviors, and improve their financial situation.

You mentioned that Capital One has approximately 15 million accounts in this space. Firstly, how do you obtain this data? Secondly, I'd like to discuss the rest of the landscape.

We were able to estimate that based on mailings and understanding their book of business. If someone is in the space with a FICO score of 580 or so, you can approximate the blended rate. Some people even publish their blended rate in this space, allowing you to do the reverse math. The net effect is, if you have a 30% charge off in tranches of books of business that they're booking, you know that it matures in about nine months. You can then work out how much they can sustain over time in that space. Growing a book of business in subprime largely depends on the ability to effectively book accounts because the attrition, both voluntary and involuntary, is quite high. It's extremely rateable in the first year on the books.

I believe a third of their ledger is less than 630. That might be the metric they provide. I forget the exact metric they provide. So, would that imply about 50 billion of ledger in this space? Is that the correct way to think about it?

I haven't looked at their PNL in aggregate, because they're also in other lines of business that might be considered subprime. However, if you just look at their card base, it's safe to assume that 50% of those receivables, not transactions, but actual end receivables, are in the subprime space. They report the card side separately, don't they?

Yes, they report the card business separately from the other businesses, like auto. I believe that 30% was relevant to the card business specifically. But I'd have to double-check. So, if I'm doing this math correctly, 50 billion of ledger on 15 million accounts seems like a lot per account.

Typical line assignments on new accounts tend to be more aggressive with Capital One, but they're not as deep as some of the other providers. Most core subprime providers average initial lines, or book of business lines, of around $600 blended average.

Based on that, I thought the number of accounts would have been much higher than 15 million. If it's 50 or 60 billion, it's 160 billion of card loans. So, if it was 50 to 70 billion of loans in the subprime space, then arguably, if it was $1,000 a loan, it would have been around 50 to 70 million accounts.

That seems a bit high to me. In my calculations of the market, there are about 110 to 130 million subprime customers in the US. Of those, I would say 65 to 70 million are marketable in my mindset.

But some of them may have more than one card, I presume.

Yes, multi-card strategies are quite common in the subprime space.

So, walk me through the rest of the competitive landscape. Capital One has 115 million accounts, Mission Lane has five million. Who else and how big are they?

The major players in this field, from a numerical perspective, are Capital One, Credit One, and now Synchrony. If you examine their private label portfolio, it primarily consists of subprime lending. These are the significant players. Then there are several smaller entities such as Mission Lane, PREMIER Bank Card, Total Card, and Merrick Bank, which I believe has merged with CardWorks.

Genesis Finance is another key player in this space, although their operations are slightly different. Many of these companies are privately owned and the owners are primarily interested in annuities. They maintain a book of business but are not necessarily looking to significantly expand their business.

I believe there are emerging entities entering the market. I am aware of three that will be in the subprime market within the next six to 12 months.

Who are these three?

SNAP Financial is launching a card business, which I believe they are naming "Scene". They will probably be in the market in the next four to five months. There's a group in India that is planning to start an e-commerce bank, beginning in the subprime space. I've had a few discussions with them. They are targeting the second quarter of next year. Atlanticus, based out of Atlanta, has been in the subprime space providing point-of-sale financing. They are considering either purchasing or developing a subprime book of their own to a significant size.

I believe OneMain is also launching something in this space.

Yes, they are. However, my understanding is that they are currently focusing more on the near-prime space. They are trying to maintain a FICO score range of 640 to 720.

How should I perceive the size of the ledger at Credit One? I've seen information on Wikipedia that estimates it at one to two billion, but it seems to be much larger than that.

I believe they are larger than that now. When I left, they were over three billion. I estimate that they had about seven to eight million accounts at that time. I believe they have doubled that now and are probably over 10 billion.

They've caught the attention of the CFPB, which regulates any institution with assets over 10 billion.

In terms of the product set, where would Credit One primarily compete? It appears that Capital One is more focused on the higher end of subprime and the lower end of near prime. Where would Credit One and Mission Lane, among others, compete? CardWorks, for example.

Their combined book in that space probably averages around a 580 score, which means they go down to the 550s. It's about setting the right price and line in that space. I believe Credit One has done a good job of creating lifecycle type products. As customers come in and demonstrate good performance, they are migrated to additional cards or other products that better suit their needs, allowing them to retain these accounts over time.

Could you broadly describe who's succeeding and who's falling behind in this sector over time?

What's your definition of success?

Success would mean growing profitably, gaining a relative advantage in key metrics, whether it's growth, profitability, or marketing efficiency. Generally, profitable growth that comes at the expense of competitors would be considered winning.

I would say that this sector is still highly fragmented. The larger, more public players tend to withdraw quickly when times get tough. There's still a high demand. Whether it's profitable demand or not is debatable. The appetite for credit in this sector is substantial. So, I believe that companies like Capital One and Credit One have a desire to grow. However, as they've expanded, maintaining growth of a significant subprime business becomes challenging due to high charge-off rates and the costs of replacing those accounts.

For instance, if you have 10 million and you're going to lose 30% of the accounts you booked last year in the first nine months, the cost to replace those and continue to grow becomes somewhat unmanageable over time. That's why you see many privately owned, highly profitable businesses in this sector. I've worked with issuers that range from 20% to 40% ROE in this space.

What kind of leverage do they have? And what sort of ROA?

That's a good question. Depending on who your regulator is, you may need to manage that down. Now that Credit One has come under the CFPB's radar, it'll be interesting to see how they react to 20% returns on a book of business in this sector.

Are you referring to returns on equity when you mention 20%, or is that an ROE or an ROA?

It's ROA.

Do you think Capital One is earning a similar ROA on their portfolio, specifically the lowest 15 billion?

I believe they're closer to 10 because they're more into the near-prime space. The near-prime space is challenging because it's hard to predict customer migration.

Not many customers stay in the near-prime category over time, and they have the appetites of prime and super-prime customers. Therefore, you have to be much more competitive with product offerings than you would if you're targeting customers with 550 to 580 FICO Scores.

If I recall correctly, some of the Credit One products, like the Caesar cards, offer a 275 line with a $75 annual fee and a 30% interest rate. I assume you can absorb a lot of early defaults on those portfolios and still have them work out really well.

Yes, that's correct.

Capital One seems to have left this space for a variety of enterprise reputation reasons. Why doesn't Capital One compete more aggressively at the lower end of the subprime spectrum?

As I mentioned earlier, this is a challenging area from a regulatory perspective. There's a lot of pressure, which fluctuates based on current perceptions. There are regulators, like Elizabeth Warren, who believe banks shouldn't earn much more than 2%. This results in increased scrutiny. Another reason, from my time at Capital One, is their excellent micro-segmentation. They target the better risks and avoid the worst ones in this space. As I mentioned earlier, once a portfolio reaches 10 to 15 million, it's difficult to grow significantly in this space without resorting to multiple cards and other strategies.

If we were to compare Capital One and Credit One, how would we assess their relative strengths and weaknesses in terms of future competition?

That's a good question. Capital One clearly has scale advantages, which give them an edge in analytics and marketing spend. Credit One, on the other hand, has a deep understanding of the subprime market, as it's their sole focus. Their product sets and strategies resonate with subprime customers. For example, their rewards focus on gas and groceries, which make up 65% of a subprime customer's spending. While this may not be as glamorous to advertise, it's more valuable to a subprime customer.

I'm surprised to learn that a deep subprime card offers rewards. I would have thought that the 2% interchange would be essentially a cost of lending.

The 2% interchange leaves a lot of margin that can be reinvested back into those customer segments. If done correctly, it promotes sustainability, account retention, and encourages customers to prioritize these cards when making payments.

Consider this. When bills come due, these subprime customers have more bills than they have money to provide, and they make choices on who to pay. One component of the reward structure is to put your recurring charges on your Credit One card. We knew that if the customer put their cell phone or electric bill or other aspects on the card, the likelihood of them paying Credit One first went up significantly.

That's smart.

These tactics and strategies not only benefit the customer through rewards but also ensure that payments are made to Credit One first or earlier when a customer faces economic or cash flow challenges. I won't say it's always the first payment, as mortgage and car payments tend to take precedence. But when it comes to deciding which credit card to pay, the strategies that Credit One has deployed are very effective.

It's important to note that when a customer charges a subprime card and starts making minimum payments, there isn't much of a credit line for the customer to continuously spend and churn. As a result, the rewards won't grow exponentially like they would for a prime or super prime customer who might make five or six payments over the course of a month and churn a $10,000 line into a $60,000 or $70,000 spend.

So, you could potentially lose money on the rewards but make up for it through interest, annual fees, and customer retention. That's a clever strategy. I'm curious though, why hasn't Capital One adopted this approach?

Well, it's not their core business. To be honest, it's been a while since I've been there. I believe they leverage the subprime space with the hope that some customers will graduate to other products, but primarily they use it as a revenue lever for their business.

Does brand reputation matter in this context? Capital One, for instance, has a well-known brand and premium cards. On the other hand, Credit One's brand seems to be riding on the coattails of Capital One's reputation.

To be fair, Credit One had their brand first, and Capital One had to pay them for it.

Does the brand reputation matter in terms of getting higher response rates, a better mix of customers, or improved performance? If all other factors are equal, does having a strong brand make a significant difference?

Yes, a strong brand does boost response rates. However, I'm not sure if it provides enough of a lift from a return perspective. In the subprime space, the brand's role is to assure customers that the company is legitimate and stable. The main factors that consumers in this space consider are whether the credit line meets their needs. This is why smaller players can continue to acquire business. Response rates in the subprime sector are significantly better than in the prime and super prime sectors. There's such a demand in this space that customers will respond if they need the credit line.

You're saying that a strong brand does provide some benefits, but they are relatively minor compared to other factors. Does having a full spectrum of products to help customers graduate to better credit options significantly impact the lifetime value? Or do most people not follow through with the graduation process, resulting in minimal changes to lifetime values?

Credit One could do a better job in this area. Companies like Mission Lane and others actively promote, advertise, and work diligently with customers to keep them on track. Credit One's shortcoming is their 100% outsourcing solution to their operations. There's still room in the subprime market to earn loyalty by working with and engaging customers. I saw this strategy pay off at Premier Credit Card. Customers greatly appreciated interacting with the agents, and we worked hard to empower them to establish healthy relationships with customers and help them improve their financial situation. This approach significantly improved customer retention.

Yes, I imagine good servicing makes a significant difference here.

Indeed. Customers prefer digital solutions for simple tasks, but when they encounter difficulties, they appreciate connecting with someone who is willing to assist.

That makes sense. Providing a solution during difficult times is valuable.

Absolutely. Being flexible with payment programs is one aspect of this. One of the challenges I faced at Credit One was the reluctance of leadership to offer various payment programs to customers in need.

Why would that be a contentious issue? Why not just split test it on a subset of customers, observe how it affects behavior, decide if it's beneficial or not, and then proceed?

One of the challenges with some long-standing players in the industry is their adherence to a business model that has worked for 30 years. They are not necessarily open to testing and trying new approaches.

I presume that's not the case at Capital One.

No, Capital One is constantly conducting A/B testing. Currently, their focus is more on the super prime space and other components. Their Information Based Strategy (IBS), hiring process, and other unique aspects create opportunities for continuous innovation and experimentation.

Why is this such a profitable business? One would think that these high returns, which have been consistent for a long time, would have attracted more competition, thus lowering the returns.

We've witnessed one revolution where people tried to do just that. The fintech that entered this space introduced a lot of innovation in technology, customer interaction, and the loan acquisition process. However, I believe they made poor credit decisions during their first revolution.

If you look at the companies that ventured into this space offering loan consolidation and personal loans up to $10,000 and $15,000, you'll see that as soon as growth slows and losses accumulate, customers in this space simply can't manage that much debt. I think in the next iteration of companies like Mission Lane, we'll see if One Financial and others in this space can figure it out. With their aim to democratize credit and reduce its cost, I believe we'll see companies that are willing to do two things. They’ll provide more value back to the customer and accept lower returns than what these legacy companies have. And they'll be smarter, particularly with the advent of alternative credit data, to better recognize the goods and bads in the space.

Continuing along this line of thought, why don't we pool together $100 million? You have a wealth of experience in this area, and I have some knowledge as well. We could start generating 20% ROAs, expand the portfolio, and eventually leverage it to make billions of dollars. What are the pitfalls we might encounter? Assuming we're not reckless, we would test and learn, be cautious about our underwriting, and start small.

The two main concerns are regulators and maintaining funding as you grow. For instance, regulators are currently suing SNAP Financial, a company I mentioned earlier. Navigating regulatory hurdles can be a painful process for those unfamiliar with it. As for funding, when you're dealing with a billion or $500 million, it can be depleted quickly. This is something we're seeing with Mission Lane. They're growing in tranches and have reached a point where they only approve customers they've pre-screened. If you try to open an account via their website, you'll find it's by invitation only. This is their way of ensuring they can maintain the necessary funding to continue growing their business.

But if you're generating 20% ROAs, or even 30% or 40% with modest leverage, you could presumably grow at a rate of 30% or 40% indefinitely without any external funding. What am I missing?

You need to keep significant reserves on file, particularly from a CECL perspective. However, if you have the cash, you can certainly enter this space. But dealing with regulators and the negative perception in the space comes with it.

I'm trying to understand why this isn't a more competitive field. Capital One essentially pioneered this business in the late 80s or early 90s. It's been around for a long time. I would have thought that after 30 or 40 years, the market would be more competitive, the excess rents would have disappeared, and someone would have had the idea we're discussing 20 years ago and been at it for 20 years. Not just one person, but ten. Yet, we don't see 20% ROAs in relatively leverageable financial products persisting indefinitely. I'm confused.

It takes a lot of courage to operate in this space. There are examples of companies that either collapsed or been forced out of business by regulators. The fear of the unknown can be a significant deterrent. If the goal is to eventually go public, there aren't many companies that can achieve the P/E ratios they're aiming for on the market by operating solely in the subprime space.

How large does a company need to be to achieve real scale in this industry? I assume there are significant fixed costs involved in developing and marketing these products, as well as building the platform. What size does a company need to be to not only make money on each account but also avoid losing money overall?

The size depends on the mix of the book. If you're growing at about 5%, you can make good money with a million accounts and gain scale from there.

Who owns Credit One?

Sherman Partners owns it. There are two main reasons why they decided to transition to full spectrum lending. Firstly, Robert De Young, an ex-OCC auditor, knew that if the Federal Reserve saw returns of 20% or more, they would scrutinize them heavily. This is partly why they diversified. Secondly, Ben Navarro, the owner of Sherman Partners, expressed a desire to own an NFL team in 2019. When this became public, he faced criticism for running a loan shark operation, which he didn't appreciate.

You mentioned the regulatory challenges of growth. Could you elaborate on these? And why does one need to be a bank to operate in this industry? Couldn't you operate without being a bank?

The Card Act of 2009 changed the game. You don't necessarily have to be a bank, but you do have to issue your cards through a chartered bank. There are banks, like Celtic Bank, that will license you to issue cards under their umbrella. Several banks in the US allow this. However, regulators will monitor both the bank and you. So, you effectively undergo two full audits every year with regulators ensuring that you are operating soundly.

What are the key areas of focus for regulators?

Regulators focus on all regulations, including AML, BSA, and fair credit reporting. Since the Card Act, they have found a lot of leverage with UDAAP. Unfair and Deceptive Advertising Action Practices.

Which aspect of UDAAP do they take issue with when it comes to highly profitable credit cards? I understand that a $275 line with a $75 annual payment and a 30% interest rate is expensive. But all the information is disclosed. So, is it unfair, deceptive, or abusive? And if so, why?

Generally, there's a perception that making a lot of money is abusive, but let's leave that aside. There aren't necessarily regulations around that. The challenge with UDAAP is that it's written broadly enough from a customer perspective. If you examine CFPB actions, the majority are in the UDAAP arena because it's left up to perception. They monitor complaint blogs and customers often say they didn't see this or that. It then becomes more subjective. Did you present it in such a way that customers were clear on it? Some issuers don't pay enough attention to this. Either it's presented late or in some cases, issuers add on fees and other aspects from a servicing perspective that become confusing. For example, at Credit One, we were somewhat dependent on express payment fees. Customers could only get a payment posted by calling an agent to make a phone payment, which would cost them $9.95.

There are issuers that add on fees post-issuance, which some people refer to as tricks and trap fees. While there are those who do things the right way, there are some who don't. This puts a bad taste in everyone's mouth regarding all issuers in the subprime space.

Are there rate caps on these loans that are relevant? Can you charge anything you want?

It depends on the state you're issued in. Here in Sioux Falls, South Dakota, where many banks are based for credit and issuing purposes, the rate cap is 36.9%.

Is that the total rate or is it spread to prime? If it's a floating rate and interest rates go to 20%, does the rate stay at 36.9%?

Yes, 36.9% is the cap, regardless of what your interest rate is.

Are there other states?

The first year fees are capped at 25% through the Card Act.

The Card Act caps the first year fees at 25% of what?

25% of the line. It doesn't include all fees. There are certain fees like the annual membership fee and others, but there's a rate cap in the first year that the Card Act introduced. That's why you see a lot of subprime issuers not starting the annual membership fee until the second year.

Of all the things for the regulators to go after, it's interesting that they decided to go after late fees.

By the way, they set it every year. The Card Act gave the authority to the Fed to set the safe harbor on what the maximum late fee can be.

What do you think the impact might be on the lower end of the subprime market? Can the products be modified to circumvent this?

If you look at the card act as an example, where over limit fees were eliminated, removing approximately $17 billion in fees from the card industry, products were simply adapted and revised.

Do you think Credit One will make significant inroads that will affect Capital One in its near prime or subprime business? Or do you believe that, as we move forward and look five or ten years ahead, companies will generally stay within their lanes, so to speak, and divide the market without impeding each other's economics?

It's difficult to predict with private companies because I'm not entirely sure what their business objectives are. In the time I spent with Ben, whom I meet with regularly, there wasn't a specific business goal he asked us to achieve. So, I'm not sure what he expects. Premier was a different case, I believe they will continue to try and grow. However, I don't think they will be successful if they venture into full spectrum outside of partnerships. They would need to make a significant investment in that space. I think they'll continue to play in the partnership space like NASCAR, wrestling, the Big Twelve, and to some extent, the NHL.

I noticed that Capital One has a card securitization that has been around for a while. They put a number of accounts into that securitization a long time ago, and I don't think they've added more for quite some time. The account numbers have gradually decreased, while balances fluctuate. What's striking is the remaining balance is quite large and the profitability is quite healthy. It resembles a robust annuity that was established a long time ago. I'm trying to reconcile this with your point about these accounts being short-lived, as I had the impression that a subprime book, despite initial losses and the nine-month peak, would eventually stabilize with better credits who stick around for a long time and are very profitable.

The accounts they put into that securitization were tenured accounts. They had already gone through the initial loss peak. It's a bell curve that normalizes at a certain rate, and then you just have regular attrition. Once you've fully navigated that bell curve and your product is decent, and you're managing lines effectively to meet customer needs, there is a certain stickiness. You'll see attrition below 4% in that population.

Suppose we originate a million accounts with a 580 FICO score, which is at the lower end of what Capital One does and in the middle of what Credit One does. Could you help me understand what that cohort looks like in terms of ledger and profitability over time?

Certainly. In the first year, you're aiming to break even.

What would be the origination dollars for a million accounts? Are these going to be $300 lines, $500 lines, $200 lines? How big are we talking?

If you're in the 580 space, you're probably looking at $500 lines.

Okay, so approximately 500 million would be our stylized example here. In your first-year thinking, break even. What's the revenue yield I should be considering? These cards are going to generate a lot of moving parts.

Indeed. Let me walk you through a bit of a waterfall. In the first year, 30% to 35% are going to charge off. You're going to lose at least 90% of the line you assigned because most of these customers will charge off in the first 45 days. There's another percentage, probably not at Capital One, but some of the smaller issuers where another 3% to 5% will be fraud. The smaller issuers are not as sophisticated at recognizing fraud, particularly in the digital space.

You're referring to third-party fraud?

Yes. Then, once you get past month 16, you're left with a little less than 50% of the book. That's when the second-year annual membership fee kicks in. So the profitability turns pretty significantly in year two.

As losses stabilize and so on. Then you're probably running off 4% of that book. By year two, you're probably closer to 8%. Year three, you're at 4%.

And that runoff is predominantly driven by charge-offs?

A mix of voluntary and involuntary charge-offs.

Presumably, the charge-off rate doesn't fall to 4%?

The charge-off rate will drop to around 8% to 10%, if 30% is your peak.

And then 4% payoff, I guess. So you get around 12% to 13%. So the 4% and 8% are voluntary payoffs, I suppose?

Again, it all depends on how active you are in the account management strategies.

Yes. Initially, how should I think about the revenue yield relative to assets?

In the 580 space? Most are probably charging the fee upfront. Again, it varies wildly by issuer overall depending on how much they're asking for upfront. So someone like Premier on a $500 line would charge a $99 application fee, effectively a program fee. And that is paid before the account is even booked.

So, they would draw down the line, get the $500, and then you would charge them 36% interest on that?

No, that fee is separate from the line. It's a fee charged solely for approval.

And then they would draw down the $500. How do they pay the fee? Do they use the line to pay the fee?


So they pay the fee from another source. I understand. Does this approach create a lot of positive selection among the borrowers? The idea of requiring them to come up with $100 to get the card seems clever. Then the $500 would accrue 36% interest per year. There might also be other miscellaneous fees, such as late fees and rejected payment fees.

Yes, depending on the issuer. At Premier, we didn't charge any post-account fees for servicing or additional cards. We wanted to ensure that everything was clear and upfront for the regulators.

And then there would be an additional annual fee of $100?

The annual fee would be applied in the second year.

Would it be around $100 or $50?

It would be between $75 and $99. We had different product sets.

So that would effectively add another 20% to the revenue yield on performing accounts, which I estimate to be around 60%.


And then the charge-offs in the first year are around 35%. But you have marketing expenses, which is why you're hoping to break even. And then your charge-offs after the first year hopefully fall to 10% to 12%. So that's why you're making a pre-tax, pre-opex ROA of around 50%.


I suppose there would be some servicing costs. How should I consider the servicing costs relative to these card accounts?

As a percentage.

A percent of the ledger.

Yes. If you've migrated to digital solutions, such as e-statements and a good mobile app, the call intensity from the customers is higher, but the servicing costs, excluding the technology you're using, are relatively low. In the first year, the servicing costs, which include phone calls and collections, are high, but the actual customer service costs are low.

Most of your servicing costs will be collections because you're going to have a large book of business and you're going to manage that book of business more intensely and closely than a near prime or a super prime.

How should I consider the collections cost? I presume most of the servicing costs in this book would be collections. So, what would the collections cost be as a percentage of the ledger?

As a percentage of ledger?

If you have 500 million of these loans out, what is your annual expenditure on collections?

It's between 8% to 10%.

I assume there are hardly any additional servicing costs beyond that, such as answering queries and sending out e-statements. Those aren't expensive, are they?

If you have digital solutions, there are none. When I joined Premier, we managed to improve our FTE per account. Over a three-year period, we more than doubled the number of accounts without increasing the FTE headcount.

The cost of collections is interesting. For $500 accounts, which are relatively inefficient to collect because they're small, with a 10% loss rate, which is quite high, the cost of collections is 8% to 10% of the book. I'm thinking that for Capital One's book, where the average account might be $3,000 and the default rate is much lower, the collection costs must be less than 1% of the portfolio.

On the overall mix?

I'm suggesting that if these weren't $500 accounts, but $3,000 accounts, the collection costs wouldn't increase significantly. So as a percentage of the book, if I multiply by six, it goes from 10% to 2%, and if I halve the frequency, it goes from two to one. That's the arithmetic I was considering.

I believe your calculation is accurate.

Can you tell me about growing lines? How do you expand these relationships over time? You originate these $500 loans, but there must be some effort to increase these lines, to make them the primary choice, to expand them. How does that work?

It's not about being the primary choice. The reality is, if you look at all the lines available in the subprime market, consumers are using most of it. So it's not a competition for transactions. You increase the lines through credit line increases and/or multiple cards.

I'm trying to understand how you decide to increase the lines and how you determine the size of these increases over time through the portfolio.

The good customers, or rather the high-performing customers, rise to the surface quite quickly. If you see on-time payments for the first three months, the risk quotient of that customer decreases significantly. At six months, it drops by almost two-thirds.

So it's about engaging with customers sooner rather than later and providing them with small increases that accumulate over time.

Presumably, over time, the credit scores of these customers, if they're performing well with you, have probably improved. How often does this happen? If you started this portfolio with a bunch of people at 580, where would the credit score of the people who are left after two years be?

After two years, if you've built a good relationship with the customers, you'll see some progress. Some companies in this space aren't concerned about positive migration and score improvement.

They're primarily interested in making money. They aim to extract as much as they can from these customers. According to the bureaus, there's a natural migration of about 12% of the population from subprime to near prime. At Premier, I aimed to ensure that 40% of our customers, those who made it past the first year, saw at least a 20% to 30% improvement, or a 20 to 30 point improvement in their FICO Scores.

This is why, in many cases, offering a second card to a customer is more beneficial than simply increasing their credit line. It gives them more opportunities to make on-time payments.

Making two payments improves their credit score more than making just one, according to the bureaus.

Yes, we often heard from federal regulators asking why we didn't just increase their credit lines. We justified it by showing the improvement in their credit score migration when they had two products with us versus just one. It accelerates the process.

The federal regulators were concerned because you were charging two annual fees. It seems like the portfolio migrates upwards, albeit slower than I would have thought. The remaining accounts in the portfolio after two years, how much higher would their score be if they started at 580?

By the third year, I would hope they've increased by at least 60 points.

As their credit lines grow, what prevents them from consolidating their debt or leaving for another option? What keeps the relationship stable?

From the feedback I received directly from customers, there was a sense of loyalty. When I joined Premier, we had about 200,000 customers who had been with us for more than 15 years. We weren't diligent about creating lifecycle products. We were still charging them a $99 annual membership fee. However, they felt a sense of loyalty and gratitude for us being there when no one else would help.

That's interesting.

This is the only area in credit that isn't a commodity. Customers won't leave for a lower price or a better reward.

It's funny you mention that. World Acceptance Corporation charges 60% on its installment loans, but customers still bring them cookies at Christmas.

Exactly, customers in this space often feel a sense of loyalty and gratitude.

Indeed, and for what it's worth, it's well deserved. I've always believed that lending money to those who need it is more noble than lending to those who don't. So, as we've discussed, are there other factors I should consider when thinking about the cohort economics over time? We've talked about customer attrition. If you also have increasing accounts per customer and increasing lines per account, how should I interpret the trend in the overall ledger? In the first year, we discussed a curve where 35% default and then maybe 10% thereafter, with a 4% to 8% prepay. So we can draw a curve for the number of customers. But presumably, the number of accounts per customer and the line size per customer also increase. How should I understand the curve in terms of outstanding?

It largely depends on your credit limit strategies, your lifecycle credit limit strategies. But the net effect is, having been in the business for over 30 years, when you're booking accounts, as long as you remain prudent in line and price. Organizations often get into trouble when they see depressed response rates and start playing with line and price. That will harm you in the long run. However, because there's so much churn on the new accounts, the balances don't build as quickly as you might think on the back end.

What are the key components in terms of underwriting, servicing, and licensing when running one of these operations? Obviously, they've been doing it for a long time and have a lot of resources. But for a smaller competitor, what are the key blocks of the stack they need? The technology, the software?

Clearly, you need relationships with the card associations, such as Visa, Mastercard, American Express, or whoever you're issuing from. You need a processor, typically nowadays it's Fiserv or Total Systems. There are a few new entrants into the market, but the vast majority of the market is with one of those two entities. They handle print production and other aspects. They can provide underwriting systems, or you can build it yourself or get those from Experian or TransUnion. So you have the credit bureaus, and most of the time, you are building your data warehouses and your analytic capability in-house.

And why is this a credit card at all? The way this is being used, it's really an installment loan that people are getting line extensions on. Why is this done as a credit card product?

You raise an excellent point. An installment loan can help you through cash flow issues just as a credit card would. There's been so much branding around acceptance and other aspects that I think consumers don't see the interrelationship between the two.

Could you explain that more? I'm sorry, I don't understand. So when you send someone a credit card, I guess the subtle difference is that they have to go buy groceries with it in order to draw the line down versus they just get some money to go buy groceries.

That's correct. You can't pay for rental cars. To my knowledge, you can't pay cash to get cell phones and other aspects.

Indeed, it can be used to make payments. However, they've already fully drawn it down, so they can't use it for payments. If I understand correctly, they've exhausted their entire line, so they can't use it to make payments unless they pay off the line and then make another payment. Do you follow?

You're still receiving payments from them. So, the payment has to more than cover the fees and charges you're applying to the card. Therefore, they are effectively freeing up between $30 and $45 on the card.

They use that amount for shopping once in a while. The ability to reborrow just that little bit, combined with the perceived utility of being able to use this for shopping, makes it slightly higher in the payment priority stack and slightly more useful in their minds.

That's correct.

Is there also a stigma associated with an installment loan that doesn't exist with the card? Is there any psychological difference in their minds?

There might be. When I mentioned the fintechs that ventured into installment loans, they were offering debt consolidation among other services, and frankly, it cost us some market share. It was a competitor to us. I think the challenge with installment loans is that people typically want more cash in hand, and you don't know at origination if the customer is a good bet for anything much above $500 at that time.

I guess there is a subtle difference, if I understand correctly, in the marketing. An installment loan offers them a certain amount of money, whereas with a credit card, you ask them to apply and then once they've done the work, you inform them that they'll receive a card with a certain credit limit. I think there's a switch in the order of operations, which might matter because the customers who bother applying for the small installment loan have already adversely selected, whereas the customers who apply for the card, and once they've gone through that step of friction, they don't know the line size. So, if the line size turns out to be small, you didn't get adversely selected by those who bothered to go through the process.

To some extent. Although as card issuers, we can, through pre-approvals, offer a card up to $500.

Is there a brand element in applying? I think people are worried that their credit will be impaired by applying for a card.

Yes, there is.

Is there a brand element of guarantees? Could you help me understand how that affects the marketing and the ability of smaller brands to compete?

It's not necessarily about smaller brands. It's the customers' fear of being declined in this space because it inherently hurts their credit score and they don't get anything out of that. Therefore, some sort of pre-approval or guarantee that they are going to be approved for something plays a significant role in this space.

So you achieve this through pre-approvals. At Premier, we were testing the launch of a card, essentially a secured card, which we guaranteed would become unsecured. After six months of good payments, we would transition the secured card to an unsecured one. We wouldn't check your credit bureau or anything at that point because you had demonstrated good payment behavior with us. The only check we were required to do was a debt-to-income ratio. But after six months, we were willing to provide an unsecured line of credit, up to $500.

And was all this promised upfront?

Yes, the only requirement was to make on-time payments for six months.

Could you explain the importance of secured cards as an entry point into this business? We haven't discussed them yet. How crucial are they as a source for these subprime cards?

Secured cards are certainly a positive selector. However, the challenge is that most customers don't have enough cash on hand to provide the initial security deposit. This significantly reduces the market size.

What proportion of new accounts do you think originate from a secured card relationship as opposed to some other relationship?

That's an excellent question. I've tried to delve into that to understand the total marketable universe we're targeting in this space. We had always offered a secured card, but perhaps we weren't marketing it effectively. We would see a trickle of 10,000 to 20,000 accounts a month in this space. The numbers I managed to estimate suggest that only about ten to 12 million customers would have the ability to provide an upfront deposit of $250 to $350.

Why not offer a $50 secured card line as a start?

We could certainly offer partially secured cards.

No, I mean 100% secured, but with a lower deposit. You mentioned $250. Why not start them with a $50 secured card?

It would be interesting to test and see what the response rates would be. I'm not sure if a $50 credit limit would be large enough to engage the customer in that space.

Could you help me understand the marketing channels that are important in this space?

There are various channels for direct mail, including digital, which can be broken down into several components. Organic digital marketing requires a significant branding effort. How often are people visiting your site and considering options? Credit One has done an excellent job of this, integrating their direct mail pre-screen file on their website. If a visitor, say Clifford, were to access the site, the first prompt would ask if they already have an offer from us. They would then enter their name and the last four digits of their social security number to check for pre-screened or pre-approved offers. However, substantial branding is necessary to attract the volume of customers needed. Smaller players often leverage aggregators like Credit Sesame and Bulldog, where people search for potential credit options. These aggregators direct volume to you for a fee. They have the marketing sophistication to drive volume. We have also tested social media spaces and conducted email campaigns that mimic direct mail campaigns. For multi-cards, an email to a customer would result in a new account booking 50% of the time.

You didn't mention Credit Karma. Are they significant in the subprime space? To some extent?

I would categorize them as part of the aggregator pool.

I heard they were bigger than the other aggregators. Perhaps they're not in this space, or maybe I'm mistaken.

They are in this space. However, my experience with them was challenging. They demanded too much, wanting us to integrate our credit models into their systems, which we were unwilling to do. Customers, particularly subprime ones, visit many of these sites while exploring their options. There are about 40 aggregators that I'm aware of. We were leveraging all of them, and it became a competition of price versus volume and other factors. We managed to form partnerships with a smaller set that guaranteed us the volume. These were more like partnerships where we would pay incrementally for higher quality accounts.

We were discussing the major components. You didn't mention partner banks, but I presume you need a partner bank to be a card issuer. They would technically be the issuer.

If you don't have a bank license, you'd have to approach companies like Celtic to form partner bank agreements, also known as agent bank agreements.

You mentioned competitors to Fiserv and TSYS who are more modern. Who might they be? Are they better or the same?

Magenta from San Francisco started in this space, along with another one from India, among others. They are not mature enough at this point where I'd feel completely comfortable putting a book of business on them. However, they do have some advantages as they operate on much more modern technology, which will be beneficial to issuers over time.

You mentioned credit bureaus. What kind of data can you get from them as you're building your mailer lists? Also, what are some of the alternative data sources that are useful?

Indeed, you can acquire all credit attributes from the Bureau if you're willing to pay for it. The approach has evolved over the past decade. In the past, you would specify the attributes you wanted included in the model, and you would receive a model result without necessarily getting the attributes and everything else. However, all the bureaus have moved beyond that model and now provide everything you're paying for. This includes traditional credit bureau information, such as the number of loans a person has, their credit lines, and other aspects. They also provide some employment data and payment verification data. To give credit where it's due, ever since the CFPB agreed two years ago that alternative data is permissible, they've done a commendable job of enhancing their databases by acquiring different ones.

I must admit, I don't have a clear idea of what you receive in the file. Do you get a list of people's names along with all their information?

Generally, you receive a list of names to mail, and then you have access to their system through certain tools. TransUnion, for example, is the Prama database. Essentially, your analytics can access all the attributes associated with what you purchased and the model that you...

Is this all done on a non-anonymized basis?

That's correct.

So theoretically, I could have one of these files and access all the credit data for people I don't like and misuse that data.

You would have to comply with regulations regarding fair lending and other aspects.

There would be some requirements that the regulators would enforce, given that I'm a bank, to prevent misuse of this data.

Yes, to give you a high-level overview, I would approach TransUnion and say, "I'm looking for customers who are likely to respond at X rate in the 530 to 560 FICO range." They would then provide a list of those customers with their bureau scores and other aspects. I could then use this information to target a specific population and offer them a certain product. You could screen them using legal terms, for example, offering a secured card at a certain rate. You could then run a direct mail campaign. For the customers that book with you, you can access their Prama database on a quarterly basis. You have access to the direct mail file and the attributes of those customers for 90 days, but you can't necessarily pull it into your systems. This is how they control the management of the data. Once a customer becomes your customer and you're paying the TransUnion fees, you have ongoing access to many of the bureau attributes so you can continue to monitor and manage those accounts.

If you want to request customers with certain characteristics, how do you communicate the model you want to use to them?

You can provide them with your model if you have built one internally, or they have their own models. You can combine their response rate score with the vantage score on their system.

You can segment with some model. I assume most competent lenders have built their own models.

The larger the organization, the more sophisticated it tends to be, allowing for risk diversification and minor advantages. Personally, I don't believe anyone claiming to outperform the Vantage Score by much more than 5% to 6%, which is significant.

How do you communicate the terms of your model to them? How do you specify the model?

You would either request the attributes needed for the model and pay for them, and they'd send them to you, or you would give them your model and they would run it on their system.

If they provide the attributes, how do you link that back to the individual?

They would provide a name and customer identification.

How do they prevent you from retaining the data?

That's a good question. You would need to provide some initial screening. You would receive the results of that and could conduct further screening on your end. However, once you've pulled a bureau, you are required to provide an offer of credit.

So, if you pull a bureau, you have to provide an offer of credit.

Yes, that's correct.

That's interesting. Why am I not receiving numerous low-value credit offers from people who have pulled my bureau and don't wish to extend credit to me?

Those are invitations to apply. They typically send that information to a mail shop. But those are not extensively screened. They probably only run a check for the highest responders in certain states. They then provide a mailing list.

It seems like you could use the credit bureau's models, an outsourced processor, and even an outsourced call center. This seems to be Credit One's approach. Where does Credit One add its unique value? And where does Capital One add its unique value? Where is Mission Lane trying to add its unique value, and why has it been challenging for them?

Mission Lane is composed of former Capital One employees. They are focusing more on the analytic modeling aspect. The business analytics group at Capital One is quite large and filled with brilliant individuals who spend a significant amount of time identifying micro-segments in each of the markets.

When I was there, they maintained their own proprietary database, which at the time contained 180 attributes on 200 million people in America. They were not in competition, but they had replicated some of what the bureaus did. This provided the analysts with a wealth of information to iterate and find nuances to maximize all decisions.

Clearly, they were large and had a lot of funds to invest in this. When you're smaller, you don't have that luxury. You can build some internal models that will help to the tune of 2%. However, in some cases, the incremental expense doesn't outweigh the benefits from a credit decision perspective until you become much larger.

I imagine this matters more in the mid-prime, near-prime, and high-end subprime space. That's where you want to know which direction people are heading.


Would I be correct in saying that the near-prime space could potentially be the most valuable? Getting a near-prime customer who becomes prime is a major win. But if they become subprime, it's a disaster. The stakes are higher, making it a more challenging game with potentially larger payoffs.

It is a more challenging game and the payoffs depend on what you can offer from a product perspective.

Data seems to be crucial here, not just the data itself, but also access to customers. If you could choose any partner or partners in the world that don't have a subprime card business to build a subprime card business with, who would it be?

It would be the likes of Capital One. I think Credit One is still somewhat immature in that regard.

Because they already know how to do it. But I meant a non-traditional partner. For example, I was thinking maybe Chime.

I'm not certain about their analytical capabilities, but I agree with your point about understanding the dynamics of each segment, particularly the near prime, as you mentioned. In the subprime, if you delve deep enough, say to a 560 FICO score, the net effect is a 50-50 charge off ratio. You could build models until you're blue in the face, but they won't outperform a coin flip most of the time.

The key is to assign the right line up front at the right price, and then actively manage that account throughout its lifecycle. There are many strong data groups, and while I'm not familiar with Chime and their operations, they could potentially assist a start-up company to hit the ground running. TransUnion (TU), for instance, is one of those. Both TU and Experian will customize models.

Experian has their innovation lab, as does TU, which I utilized a few times during my tenure at Premier. They would bring in their top talent, we would send our data analysts, and they would collaborate for a week on model development. Each time we did this, we saw a significant improvement in model performance, partly because it was tailored to the market segment we were targeting.

That's intriguing. So, TransUnion will actually work with you to enhance your model, making it your private model within TransUnion?


That must make you an incredibly loyal customer. I presume TransUnion charges a considerable amount for that.

We negotiated well. We had been with them for 30 years. They didn't have a strong presence in the subprime.

Most issuers work with Experian. So, part of the strategy is how you interact with these vendors. You could act like GE and be the dominant force, focusing on cost, or you could work collaboratively. In my experience, the most value is derived from a collaborative work environment, as it tends to accelerate learning for both parties and provides value to both.

I'm intrigued that you didn't mention Chime. Chime has checking accounts for a large number of low-end consumers and has information about their income and spending. You also didn't mention Bank of America, which has a wealth of checking account information, or OneMain, which has payment behavior and history data from many current and former installment loan borrowers. I'm also surprised you didn't mention Progressive, given their extensive driving data. I'm trying to understand why you didn't consider these entities, which I perceive as having a data advantage. Could you help me understand this?

I believe there is critical data that could be considered as alternative data since it isn't reported to the Bureau. There are numerous options in the alternative data set. I recently spoke with a group in this space who possess a significant amount of payment data. They issue multiple relationship cards in the retail space but have yet to leverage the view of the customer across their entire portfolio. They manage Portfolio A separately from Portfolio B instead of observing how they perform on A to provide additional opportunities on Portfolio B, such as credit line increases and graduation. Any data sets on customer behavior and performance are highly valued, which I suspect is why Experian is entering the debit card space.

Is Experian entering the debit card issuing or data space?

They launched a debit card through Experian about a month ago.

They are essentially opening a neo bank?

Yes, but they've committed to the industry that it will only be a debit card, not a credit card.

A debit card?

Yes, they want to see more off book transactions. They've launched a feature that allows customers to grant Experian access to utility bills and other things that never reach a bureau. However, they require full login credentials, which customers are hesitant to provide.

What do they want full login credentials for?

If you want your utility payments to be added into your Experian score, they ask for all your login credentials for your utility company. They will then periodically check your payments and timeliness.

But that's not common knowledge, hence the friction. I've always wondered why companies like Credit One and Capital One don't venture more into the car insurance business and why companies like Progressive and GEICO don't delve more into the deep subprime credit card business. Both industries are looking for responsible people, and I thought the overlaps would be beneficial. There could be synergies, like offering a better rate if you pay for your car insurance with our credit card. Can you explain why this hasn't been successful?

To my knowledge, none of them have tried, but I agree there is an opportunity. It might be due to their comfort level.

I believe GEICO tried about a decade ago and it didn't go well. Warren Buffett even mentioned in his shareholder letter that he had pushed for this. He said, "I told them that I was older and wiser. They disagreed, but in the end they were right. I was just older."

People often perceive the domains of expertise in this field as distinct. However, you're absolutely right. The customer remains the same, and assessing their worthiness, regardless of the product, should be consistent. At the very least, the assessment should be similar, if not the same in many cases.

I wonder why store-based installment lenders don't issue more cards. Why doesn't OneMain have a thriving credit card program? They have expressed interest in building one, but why isn't it already flourishing? The same question applies to World Acceptance, First Franklin Federal, and Regional Management. What has been preventing these companies from entering this business? They are already in the subprime business, they have branch managers skilled at handling customers struggling with debts, and they have extensive lists of former borrowers with whom they have established relationships. What has been the historical challenge when attempts have been made?

We have seen instances where companies have ventured into this area and made poor decisions. The credit decision differs when you're dealing with a point-of-sale loan as opposed to an unsecured credit card. There are subtle differences, primarily due to the payment hierarchy. However, can a company figure this out? One example is SNAP, which is certainly going to. They have data on customers who are effectively using point-of-sale financing. They understand their payment behavior patterns and other aspects. Their idea is, why not offer cards to these customers? A certain percentage of these customers have successfully made payments on time for at least 12 to 18 months. They know how much they can afford and what the payment was. The idea is to offer them cards. If done intelligently, this can be successful. However, some companies have struggled with this in the past, and SNAP will likely face the same challenges. I had discussions with them as they were considering launching this, and they believed that they could compete online due to their extensive past behavior data.

They don't necessarily have to offer the same size line. They could just offer it to those who have performed well on their point-of-sale payments, and hopefully, they'll do better. This raises an interesting question about competition from companies like Affirm or Afterpay. You would think that all the 'buy here, pay here' guys would have some sort of non-bureau data about payment behavior by certain consumer segments. In theory, they could try to find people who have bad credit but have performed well on their 'buy here, pay here' loans and offer them cards.

If they own that data, there's not much stopping them from doing so if they decide to enter this market, right?

But they don't own that data.

You have companies like PayPal and Amazon that have vast amounts of customer payment behavior data. However, I'm not sure who owns the customer when you make a loan through Affirm at Best Buy or any other retailer. I'm not familiar with their agreements regarding customer ownership.

That's a valid point. You mentioned Amazon and Walmart. Shouldn't Walmart identify customers who are making their Walmart One subscription payments and market cards to them?

They are indirectly involved today, and they ultimately aim to enter the card issuing space. However, I am unsure if the government will ever permit them to do so.

Indeed, all these large companies seem to avoid the less reputable, deep subprime card space. This will limit their ability to compete as they won't be able to establish the economics that make the model work.

I believe that's a common issue for any retailer or non-traditional finance company that has ventured into finance over time. It simply doesn't work out. Take Target, for example. Target had their own card.

It creates too much of a conflict of interest.

Exactly. And analysts fail to understand this. It was the same when I was at GE, which was a large, global bank within GE. The analysts were always puzzled. They would say, "You guys make light bulbs. What's with the financing?"

We've covered a lot. I hope my questions haven't been too simplistic. I'd like to conclude with a question. If you're a shareholder of Capital One and looking at the outlook for the card business over the next five, 10, 15 years, should you be optimistic? Should you be pessimistic? How do you see this company developing over time?

Capital One? They've demonstrated resilience, particularly in the card space. They've made some decisions on the banking side that might be questionable, like the token thing in New York, among other things. What I know about Capital One is that all decisions are thoroughly examined with analytics and tests. That aspect of the company hasn't changed. The only thing that might limit them in the US card space is their size and the fact that the only way they can acquire accounts now is through organic acquisitions. The government won't allow them to buy portfolios due to their size.

That being said, it's a very profitable business. It will continue to be profitable. There will be ups and downs. There will likely be some attack on fees, late fees, and other aspects, but I think no different than what they did in the banking space when they eliminated some of the overdraft. I think they were one of the first banks. Fine, we won't even charge it on the bank side. They figure it out and they adapt and change.

Will the change of late fees alter behavior? One risk is that customer behavior is deterred by late fees. You could have a lot more issues with defaults as a secondary effect of lower late fees.

I don't think it will. My only basis for this is when I was at Capital One and the internet came about. We were concerned about people being able to pay more conveniently on time and we would see late fee revenue decrease. What we found is the customers who logged in behaved well for a month or two and then reverted to their previous behavior patterns.

Why shouldn't I be concerned that Capital One will see Credit One and Mission Lane, which currently operate mostly below their space, creep up into their space and drive the economics in their subprime card business, their crown jewel, down to lower levels over time?

I actually hope that does happen across the board. As I mentioned, there are companies making anywhere from 20% to over 40% in this space. This has to normalize and the only way it normalizes is through competition.

Does it mean that a 20% margin goes down to two? No. You could still, as you pointed out, make some pretty healthy margins in the financing space and do better on behalf of the customers.

Un Is there anything else I should have asked you that's important? Anything else that you think I'd be interested to know based on our conversation and considering the long-term potential future for this company or this industry?

I think you've covered it well. I do believe there will be more competition and that it'll be healthy. But I don't think anyone can take over the market given the way the segment is structured. If you get that big and become public, the scrutiny becomes overwhelmingly negative. I also don't believe anyone's going to be successful in treating subprime customers like super prime customers. They might at the start, but give them 18 months and they'll be out of business.

Out of curiosity, you've watched a lot of people make a lot of money in this business. Why haven't you put together a pool of capital to go do this?

It's not that I haven't tried.

I see.

It's just that it requires a lot of upfront capital to sit on the sidelines. And it takes some courage on behalf of the money holders. The perception of subprime is so negative, which is why, I've made more traction talking to people in other countries who want to do that in the United States than folks who are already here.

I suppose if you go to a big endowment and propose building a deep subprime credit card business that's going to charge 60% rates, they'd suggest investing in tobacco instead?

They see just the press on folks that have been in this space.

Yes, they'd say, though, we'd love to see it. Sounds great, but we're not going to take the reputation risk.

Then the institutional investors, it takes a lot of time and effort to get them over that hurdle as well. So Credit One is largely sponsored by institutional investors. When we tried to diversify, it was hard to get other people to come to the table.

This has been very helpful. Thank you very much. I really appreciate you taking the time.