Credit Card Industry Outlook Growing More Gloomy

The diagnosis isn't complete, but credit card executives are bracing for the pain.

A litany of chronic symptoms-higher delinquencies and expenses, lower profit margins and response rates on marketing campaigns-is growing acute, and analysts are predicting the card industry's weakest performance in many people's memories.

Not with a crash but after a long, slow slide, credit cards may soon even lose their status as banking's most profitable line of business.

Totting up recent numerical indicators, Donaldson, Lufkin & Jenrette analyst Susan L. Roth predicted "a significant slowdown" in card revenue growth over the next two years and saw signs of further deterioration in credit quality.

McKinsey & Co. manager Asheet Mehta said slow growth and lower profits would "drive a major shakeout." Speaking at a Bank Administration Institute conference in Washington, Mr. Mehta said second- and third-tier card issuers would reconsider their commitments as profitability equals or falls below that of core bank businesses. Receivables would then tend to be increasingly concentrated among relatively few big companies.

"The credit cycle isn't turning yet," Ms. Roth said of the widely followed uptrends in bankruptcy filings, card delinquencies, and writeoffs.

While there is cause for cautious optimism on loss rates, she said, the bank card industry faces precariously high chargeoffs. The rate that she estimated for the second quarter-6.5% to 6.7%-could go as much as 2 percentage points higher if a recession hits similar to the one of 1991- 1992.

Mr. Mehta said the major issuers' net interest margin, which averaged 9% in 1992, has fallen by 10% to 8.1%. The average balance in delinquent accounts has risen to $1,400 from $888 in 1994.

Through it all, card issuers are breaking all records in direct mail solicitations, and as competition intensifies, they are spending more and more to sign new customers. Mr. Mehta said the cost of opening a new account, only $40 in the early 1990s, has climbed to almost $100 and may hit $200 by 2000.

"Clearly, the economics are not so compelling any more," the New York- based consultant said.

"Issuers are digging deeper and deeper for new cardholders," said Richard W. Ussery, chairman and chief executive officer of Total System Services Inc., the Columbus, Ga., card processing company. "We call it bottom-fishing."

Mr. Ussery, attending the American Bankers Association Bank Card Conference in Long Beach, Calif., said he looks forward to 1998 as a turnaround year, when banks will have cleansed their portfolios and applied newfound data mining skills to become more precise in seeking and obtaining profitable accounts.

But their marketing zeal appears unabated, even desperate. BAI Global Inc., the Tarrytown, N.Y., company that monitors direct-mail volumes, put the second-quarter 1997 card industry total at a record 881 million pieces.

If the industry sustains its first-half pace, it will surpass three billion mailings for 1997, well above the 2.4 billion in each of the past two years and equal to 30 per household, Mr. Mehta said.

Yet the mailings are increasingly less productive. Since the third quarter of 1992, when BAI Global recorded a 3.3% response, that statistic has been in almost steady decline to 1.2% in the 1997 second quarter.

These and other gloomy trends rated only brief mentions-primarily by Ms. Roth-at the ABA meeting, the card industry's biggest annual gathering. It was a sign that all the consequences have yet to hit home. And with the general economy and overall bank profitability still strong, other observers found reasons for optimism.

Jack Stephenson, a McKinsey principal, said banks are getting better at data base marketing-an essential tool in understanding customer profitability, behavior, and growth potential. One immediate problem, he said, is that 50% to 60% of a typical bank's accounts are unprofitable.

But banks have the advantage of full-service relationships to build on, something that the newer breed of monoline competitors lacks.

"As the industry consolidates," he said, "I think it is unlikely that most of these (monolines) will be out there five to 10 years from now. While many of us fear and tremble at their presence, they are in fact quite a lot smaller than the large banks."

On the other hand, when asked which companies were best at putting their data bases to use, Smith Barney investment banker Robert E. Hyer Jr. named two monolines: Capital One Financial Corp. and First USA Inc., which was acquired by Banc One Corp. this year.

"It is still a spread business in many ways," said Peter C. Aberg, vice president of Goldman, Sachs & Co. He said the industry has reacted pretty well in "scaling back some of the riskiest lending."

Richard K. Weingarten, a Salomon Brothers Inc. director, in a panel discussion with Mr. Aberg, Mr. Hyer, and Ms. Roth, said the consistent growth in card use will lead to bigger and more profitable transaction processing and related fee-generating businesses.

He also suggested debit cards and international opportunities can offset any downturn on the traditional credit side.

The almost unabated growth in bank credit cards since their introduction more than 30 years ago, and the fact that more than 80% of U.S. consumers have cards, led some observers to conclude that the industry is nearing saturation.

"We have seen the number of active accounts drop dramatically," said Mr. Mehta. He said the average cardholder has four general-purpose accounts; 59% are active, down from 74% in 1991.

PSI Global, the Tampa research firm, said there is no reason to give in to the saturation argument. Only 7% of household debt is on credit cards, it said. That compares with 75% in mortgages. PSI said credit cards' share of total borrowing thus has room to grow.

The credit card business also should benefit as more types of merchants, including start-up businesses and emerging Internet enterprises, accept this form of payment.

"New markets have come along logically," said Roger Peirce, group president of electronic funds services, First Data Corp. "It is easy to forget that in 1980 few department stores accepted bank credit cards. In 1990 few supermarkets accepted credit cards."

Ms. Roth said consumers have grown more savvy and will demand benefits from their cards. And banks have been squeezed by their own aggressive pricing. Mr. Mehta pointed out that temporary teaser rates to attract new accounts are too low to sustain profitability, while annual fees have withered away to an average $3 per account from $8.30 in 1991.

"An issuer can no longer compete on price alone," Ms. Roth said. "Differentiation has to come through cobranding or affinity programs. You need cobranding to give you differentiation, but it's too expensive if all you are attracting is convenience-use customers.

"The challenge for 1998 is how to be cost-effective and keep margins up in profitable accounts."

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