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To date, Merrick Bank has been primarily funded by “brokered deposits.” Unlike Ally Bank, which has a large business of online checking and savings accounts, marketed directly to consumers, Merrick Bank mostly works with deposit brokers, who organize cash held by other investors, and find competitive interest rates. When a bank wants to lend to a customer, they first need to find the cash that they’ll then lend out.

And unlike many “fintechs,” Merrick Bank has been tested by a recession, breaking even or earning a profit every year since 2003.Īlly can borrow money at a lower cost than Merrick Bank By comparison, banks lost money on their “prime” credit card customers with credit scores between 660 and 719, and earned a more modest profit of 3.1% on the highest-credit-score customers.įor banks that can distinguish between stronger and weaker credit risks, subprime credit card lending can be a lucrative business. These financially stressed customers were the most profitable for banks between 20. In fact, according to research by Souphala Chomsisengphet and her coauthors at the National Bureau of Economic Research, during the peak of the recession, banks on average still earned a 7.9% profit margin on their subprime credit card customers (those with credit scores below 620). You might equate “subprime” and “risky,” but lending to lower-credit-score customers doesn’t always translate to higher odds that the bank will lose money: after all, lower-credit customers are charged higher fees and interest rates. By partnering with Merrick Bank, Ally is signaling that they’ll be pursuing these subprime credit card customers who face greater degrees of financial stress.

In the subprime segment of the market, the risk that banks face is that they’ll lend to customers who are unable to or don’t intend to repay the loan. In the transactor segment of the credit card market, the risk for banks is that they’ll pay $500 or $1,000 to entice a prospect who ends up becoming only a modest spender, never creating enough credit card swipe fees to pay back the cost of the marketing.

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But this route isn’t risk free either - big banks compete fiercely for transactors, throwing down lots of cash in marketing, and offering large “early spend bonuses” to customers who make big purchases within the first few months of opening their account.Ī bank with less data than their competitors is likely to “overbid” for less profitable prospects and “underbid” for more profitable prospects. These transactors typically have higher credit scores.

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Although profit margins are high for incumbent credit card lenders like Chase, Citi, Discover, and Capital One, it can be hard to break into the market for entrants with less data.Īlly could have tried to avoid risk by pursuing a credit card business built around the customers who pay their credit card bills in full every month, commonly known as transactors. Finding those customers can be easier said than done, especially when you’re directly competing against other big banks. With credit card interest rates around 20% or 30%, lenders can only turn a profit if, for every customer that defaults, they find roughly four customers who borrow money but eventually pay it back.

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It’s hard to build a credit card business without dataĪs reported by The Street, Piper Sandler analyst Kevin Barker said in a note to clients that Ally had paid a “steep price to to pay in order to diversify the company’s product offerings,” adding that he would have preferred to see Ally 'organically build a card offering.”īut while Ally probably could have learned how to print plastic credit cards on their own, the acquisition of Merrick brings them something valuable beyond an existing cashflow: data on which current or past customers have defaulted, and which current or past customers paid their bills on time. To be finalized, the acquisitions will need approval by regulators.Īs a veteran of the credit card industry, here are a few of my thoughts on what this acquisition would mean for Ally Bank, CardWorks, and for consumers. Investors haven’t generally treated the proposed acquisition of Merrick as good news: Ally Bank’s stock fell by 13% on Tuesday, although it inched back up in subsequent days.