Credit Card Rates: How Low Will They Go?

Price competition in the credit card industry is heating up like never before.

Until very recently, competitors in the credit card wars waged their battles mainly by reducing annual fees and offering a variety of flashy promotions to customers - from merchandise insurance to low-price guarantees to roadside help for stranded motorists.

But the rate charged on outstanding balances, currently holding at 19.8% for major card issuers, is under attack.

So just how low will the rates go?

"I think rates will settle in the 15% to 16% range," said Robert B. McKinley, a publisher and editor at RAM Research and Publishing Co., Frederick, Md. "The minute one major issuer cuts rates, it will open the flood gates. This business moves in tandem. Already you're seeing some fairly significant players slicing rates."

"These are clearly the rumblings of a rate war," he continued. "Do not be surprised if major issuers, now charging 19.8% slash their interest rates before year end. In fact, don't be surprised if they do so tomorrow."

In May, American Express Co. shot an opening salvo in the rate war with full-page ads posing the question: "Why pay Visa or MasterCard over 19% a year?"

American Express charges a 16.25% rate on Optima, a variable-rate, general-purpose credit card.

Rate Tied to Prime

Wachovia Corp. entered the fray later that month. The Winston-Salem, N.C., company's card subsidiary began hawking a new variable rate card, with interest at 2.9 points above the prime rate.

Lesser-ranked issuers followed suit. For example, National Westminster Bank USA began running comparison ads touting 15% interest.

And Ford Motor Co. looked as if it might be prodding other players into an interest rate war when it announced plans in June for a new no-annual-fee Visa or MasterCard at an introductory rate of 15.9%. After the first six months, however, Ford will hike the interest to 19.8%, in line with the top bank issuers.

Nevertheless, Mr. McKinley believes that rates - at even the biggest issuers - are poised to fall because of stepped-up competition.

But for Chase Manhattan Corp., the nation's second largest card lender, lower rates are not in the offing.

"Chase doesn't have plans to lower rates," said Amy Sudol, a company spokeswoman. "We're constantly testing different fee and pricing schedules and always enhancing the value of our cards with add-ons like extended merchandise warranties and air travel discounts. But we're staying away from knocking our rates down."

Other industry analysts agreed with the Chase strategy.

"When Wachovia rolled out its low-rate product, a lot of eyebrows were raised," said Stephen Szekely, a vice president specializing in credit cards at PSI, a Tampa, Fla.-based consulting and research firm. "Most of the major credit card issuers won't try to mimic Wachovia. It's not consistent with their business."

The overriding reason major lenders will shun a rate war, said analysts, is the huge stake they have in maintaining profitability.

"The fact of the matter is simple: credit cards remain a very, very lucrative business and as a result there is little incentive to cut rates," said Campbell Chaney, a banking industry analyst at Sutro & Co., San Francisco.

On credit cards alone, banks with large portfolios earn returns of 2% or more on assets - more than three times the profitability of business loans, estimated Mr. Chaney.

Raphael Soifer, a banking analyst with the Wall Street firm Brown Brothers Harriman, agreed. He believes the inevitable rate cuts bode poorly for bank card issuers: "The absolute profitability of credit cards in the U.S. has probably seen its best days."

What's more, said Mr. Szekely, the issue of lowering rates is overblown. While consumers, in opinion polls, will always express a preference for a lower rate, few will change their ingrained habits.

"A large chunk of cardholders have already traded a high interest rate card for one with a lower rate," he said. "Therefore, what you're really looking at is only 12% to 15% of the people out there who really care what their interest rate is."

Wachovia, for example, is targeting a very narrow niche with its card - no more than 5% of the marketplace, estimated Mr. Szekely. With processing and and other costs eating up 3% to 4% of profits, Mr. Szekely said, "Wachovia has little breathing room, or tolerance for any type of loss."

Those losses could actually increase as banks use lower rates to attract customers. Critics of low-rate cards warn that issuers could be attracting higher credit risks.

"Although I don't have any credit quality information on consumers to back this up, my discussions with bankers lead me to believe that people who are attracted by a low rate card are those who plan to carry a balance," said Bruce Brittain, president of Brittain Associates, an Atlanta consulting company. "Intuitively, it makes sense that they are the higher risk consumers."

But the issuers of low-rate cards say that simply isn't so.

"Based on our experience [with a 14.98% card], we expect to attract consumers who handle their credit without frequent problems," said Wachovia's Mr. Costner.

PHOTO : Lowest Credit Card Rates Source: RAM Research USA

Mr. Levy is the banking reporter for The Tampa Tribune.

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