The profitability of credit cards fell in 1996 for the second year in a row, but they remain one of banking's most attractive lines of business.

R.K. Hammer Investment Bankers, in its annual card industry survey, pegged the business' 1996 return on average assets at 3.3%. That was down from 3.6% in 1995 and 3.9% in 1994 but equaled the 1993 reading.

"Issuers who bit the bullet by investing in technology or new scorecards and tightening credit criteria are probably going to be safe in 1997," said Robert Hammer, chairman and chief executive officer of the investment banking firm based in Thousand Oaks, Calif.

"But it will be a tough year for issuers who only milk the business for profits and don't reinvest," he added.

Still, the average net-profit ratio of 3.3% well exceeds the 1.19% ROA for all insured U.S. commercial banks through the first nine months of 1996, as reported by the Federal Deposit Insurance Corp.

Credit cards, contributing 5% of total banking assets, bring in 10% of banking profits.

The R.K. Hammer survey put top-line credit card income at 17.9% of relevant assets. This ratio has fallen steadily from 24% in the mid-1980s; it fell by 0.1 percentage point last year. Gross dollar income has risen throughout that period, however, as the industry pie keeps getting larger.

Reversing a three-year decline, the operating expense ratio increased 10 basis points last year, to 4.3% of average assets outstanding. The increase reflects investments in technology and use of more advanced credit scoring, which should bolster profitability down the road.

"Competition has shifted from price warfare to risk warfare," said Edward Furash, chairman of Washington, D.C.-based Furash and Co.

He pointed out that credit losses are now routinely factored in to the cost of doing business, thanks to increasingly sophisticated marketing tools and analytical methods that have allowed more credit to be extended to borrowers who in the past would have been turned away.

Like many industry observers, Mr. Furash said he anticipates a further divergence between ever-more-aggressive companies extending more credit and those that pull in their horns or even pull out of the market.

Some institutions have reported customer delinquency and chargeoff levels as great as 15%. But issuers with smaller portfolios and more conservative credit criteria reported as little as 1%.

"The weighted (chargeoff) average for the industry is 4.2%," said Mr. Hammer, "and despite the fact that some issuers reported higher numbers, chargeoffs are still within manageable levels."

"Bankruptcies will increasingly become a significant problem if issuers don't tighten their credit standards," said Kenneth Keck, executive vice president at Harris Trust and Savings Bank, Chicago.

Even with personal bankruptcy filings at a record pace in 1996, customer repayment rates have increased.

Consumers are paying three to four times more than the minimums required on their card balances, Mr. Hammer said, putting downward pressure on yields to issuers.

Meanwhile, fee income has been squeezed as card issuers try to retain consumer accounts or increase market share.

"Yields are down, but it isn't a cause of concern," said David Ballweg, president of Community State Bank, Union Grove, Wis., and chairman of the Independent Bankers Association of America's credit card affiliate. "Gold cards continue to have annual fees and provide a better profit margin to issuing banks."

Gross cardholder attrition, seen as a leading indicator of profitability, is forecast to reach 17% of accounts and 12% of balances this year, up from the current 10% to 13% range.

"Issuers will purge inactive accounts," said Mr. Hammer, "so the higher figure will reflect systematic management more than an erosion in credit quality."

Issuers are also expected to focus on overall credit quality, reducing customer attrition, and monitoring portfolio size. Also, they will have to be more precise in their targeted marketing and sharper in credit scoring.

According to Mr. Hammer's survey, the cost of funds for credit card operations held steady last year at about 6.15%. He said he expects this figure to rise 25 to 50 basis points in 1997 if the Federal Reserve raises interest rates.

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