Prudential Downgrades First Chicago to 'Hold'
First Chicago Corp. shares were downgraded Friday by Prudential Securities Inc. in a sign of Wall Street wariness about the high-growth credit card sector of the banking industry.
George M. Salem, Prudential's banking analyst, cut his investment rating to "hold" from "buy." He is worried that intense competition will erode card-related earnings, which are nearly two-thirds of the company's total earnings.
"The credit card is too big a piece of the First Chicago pie," he said, noting that "this is the highest percentage by far of credit card earnings at any of the 40 largest bank-holding companies."
Cards Remain Strong
The downgrade of First Chicago shares represents a sharp detour from the conventional wisdom, since credit cards remain one of the strongest of banking business lines.
Booming card programs have boosted share prices of such specialists as MBNA Corp. and First USA Inc. to multiples significantly higher than the equities of conventional banks.
Credit card revenues have also boosted returns for the likes of First Chicago and Signet Banking Corp. Signet last week announced a plan to spin off its card business, which now dwarfs its other business lines.
Concern Over Rates
Recently, however, some concern has emerged about the impact of rising interest rates and competition on the profitability of the business. And with the market for consumer credit cards reaching maturity, investors are beginning to wonder how long the boom can last.
Competitive pressures and rising interest rates have undermined the stocks of major credit card issuers, most notably shares of three speciality card issuers regarded on Wall Street as "pure plays" in the business.
First USA, based in Dallas, has slumped 19.1% in price since the end of April while MBNA, in Newark, Del., is off 8%. For Avanta Corp., which is headquartered in Horsham, Pa., class A shares are down 14.6% and its class B shares are off 15.4%.
Ranking Has Been High
A year ago, these stocks ranked among the best performers in the market because of their advanced business strategies and strong growth prospects.
"Their price-to-earnings multiples had gotten elevated. Investors began to worry about the continuation of high growth of card loans and earnings per share," Mr. Salem said.
Mr. Salem noted that First Chicago's average card lending rate of 17% ranks among the highest in the industry, marking its customers as likely targets for sophisticated low-rate competitors, he said.
'Most Profitable Business'
Mr. Salem views this "lending rate risk" as akin to credit risk. Its impact could be felt even more quickly in the hotly competitive card arena, he said.
"In the final analysis, cards are the most profitable business in banking and all banks are scrambling to increase their outstandings," he said. That has pushed down introductory "teaser" card rates as low as 7% for customers willing to switch issuers.
Other analysts don't share Mr. Salem's concerns about the Chicago bank.
"Would you rather invest in a company that earns 30% on equity on 50% of its business or see them take that equity and invest it somewhere else and get back 8%?" asked Lawrence W. Cohn of PaineWebber Inc.
Neutral Rating on Shares
"We're not recommending First Chicago right now because we consider their stock fairly valued, but we think they do a terrific job in the card business," he said. Mr. Cohn has a neutral rating on the shares.
A spokeswoman for First Chicago would not comment on Mr. Salem's rating change. However, she reiterated the bank's position that it has no plans to spin off a portion of its card operations.
Mr. Salem believes First Chicago should be "viewed and valued more as a card company than a banking company" because of the huge part of earnings accounted for by its cards.
Gradual Erosion Seen
But the analyst also emphasized that "few card businesses are run as well" as First Chicago's, and that "the erosion we have seen in card profitability thus far has been gradual."
Mr. Salem sliced his earnings estimate next year for the bank to $6.15 from $7. He said he did not expect much downward pressure on the stock, which should be supported by a 4% yield and a price equal to a low 7.6 times next year's expected earnings.