Vision Credit Education, Inc.

Advanta has thrown in the towel on their small business credit card business. Record charge-offs forced an end to the business. Here is how Advanta is responsible for creating its own demise.

The Announcement

Advanta issued the following statement:

As communicated in our recent letter to customers, we deeply regret that all Advanta Business Credit Card Accounts have been closed effective May 30, 2009.

Why Did Advanta Fail?

Advanta created a name for itself as a small business lender. They specialized in credit cards for small business, giving entrepreneurs a means for providing initial capital while they developed their small businesses. The intent was that these small business owners could buy equipment or supplies to help them ramp up their businesses and earn revenues.

Risky Venture

Small businesses are risky ventures by nature. Most estimates place business closure rates at 50% in the first five years, with 30% closing within the first two. This means that many of these businesses never are able to repay their startup costs.

Advanta’s model depended heavily on this small business revenue. With business failure or closure rates higher than personal bankruptcy rates, it is clear why Advanta may have been theoretically predisposed to higher defaults than other credit card issuers.

Across the Board Interest Rate Hikes

While the floundering economy and the troubles of cardholders put pressure on Advanta’s profits,  it is their response to reduced profits that served as the catalyst for the demise of their credit card program. In the fall of 2008, Advanta chose to raise interest rates on their cardholders, both good and bad.

CardLine recently interviewed Sameer Gokhale, senior vice president of specialty finance and equity research at Keefe, Bruyette & Woods Inc. According to Gokhale, this decision created a problem of adverse selection:

Those cardholders who are a good risk will pay that card down and go to another issuer with a better interest rate, and you’re stuck with cardholders who can’t go elsewhere.

Anecdotal evidence from internet message boards reflected this exodus of well-off Advanta cardholders. They chose to find alternative financing from banks or other credit card issuers. Those that lacked creditworthiness were stuck making minimum payments to Advanta.

With higher interest rates comes higher minimum payment requirements. On a $10,000 credit card with a 2% minimum payment requirement, you are expected to pay $200 for that month’s minimum payment. However, if interest rates are increased to where finance charges go up an additional $100, then the minimum payment just jumped to $300.

By dramatically increasing minimum payments across the board, many cardholders were suddenly unable to meet their minimum payment requirements. Some may have tried to keep up with partial payments while others gave up entirely.

Charge-off Requirements

Credit card companies are required by federal law to charge the debt off as a bad debt once it falls 180 days delinquent. By increasing minimum payment requirements, Advanta pushed more of their cardholders into a chronic late status, where their higher minimum payments were increased even more by late fees, thereby making it nearly impossible to get caught up.

In the first quarter of 2009, Advanta’s default rate skyrocketed to 15.86%. This is a staggering rate of defaulted payments that offset any profits earned by the company. Interest charged does nothing to the bottom line if it is never paid.

By raising interest rates and minimum payments, Advanta accelerated the defaults of its struggling cardholders and scared away its healthy business. In the end, Advanta decided that it no longer made sense to stay in the business. It’s just too bad that they did not understand what they were doing when they hiked their rates in the fall!