Bank card issuers earned an estimated 3.9% return on assets in 1994, according to an informal industry survey by investment banker Robert K. Hammer.
The healthy pretax return, up 60 basis points from 1993, is the result of continued improvements in operating expenses, a decrease in chargeoffs, and a favorable blended cost of funds, said Mr. Hammer, chairman and chief executive of R.K. Hammer Investment Bankers, Newbury Park, Calif.
"It doesn't change much in the aggregate from year to year, although with any one issuer you can have dramatic changes," said Mr. Hammer, noting that credit card ROAs ranged from 1% to 6%.
Accounting for 6% to 7% of banking assets and 8% to 10% of bank earnings, MasterCard and Visa operations still outperform other banking activities. All FDIC-insured commercial banks had an annualized 1.18% ROA through the first nine months of last year.
"Credit cards were, are, and in the near future will be one of the better assets on the balance sheet and one of the best streams on income statements," said Philip G. Heasley, vice chairman of First Bank System Inc., Minneapolis.
Mr. Hammer has been estimating aggregate card profitability since 1983, when the pretax net income as a percentage of assets was at its peak of 5.4%. Each year, Mr. Hammer conducts interviews with credit card executives, rating agencies, and investment bankers to calculate the yields.
"The longer-term trend - I don't whether it will show up in 1995 or '97 - is that returns on the business are going to be under continuing pressure," said Cynthia Graham, president and chairman of Barnett Card Services Corp., Jacksonville, Fla.
The 4% ROA might be cut in half at some point, she said. But 2% could still be twice what the general banking business has to offer.
"I think over time, because this is such an attractive business, it's going to continue to attract competition, and that is going to have an impact in terms of compressing yields and also requiring more investment in marketing dollars to net the same number of new accounts," Ms. Graham said.
Mr. Hammer's survey examines total income, operating expense, chargeoffs, cost of funds, and pretax net income. Mr. Hammer measures return on average outstandings for national brands, private-label cards, regular credit cards, and gold cards.
Total income for national brands dipped 10 basis points in 1994, from 18.6% to 18.5% of outstandings, reflecting increased competition of low- rate products, Mr. Hammer said.
"For those who then lose customers, that attrition cuts into their profit as well," he said. "Either way you have some softening of income.
"But in a rising-rate environment, that's not going to last forever. That's starting to flatten out. I don't think we'll see a whole lot of drop below that."
Ms. Graham questioned the survey's income yield, noting the interest rate pressures of 1994. "Some of the most recent rate increases have not percolated through, so that might account for how he's come up with that estimate," she said. She guessed it might be closer to 17% or 18%.
"If you look at it, (the yield) has been relatively flat over the past couple of years," Ms. Graham added. "I think that's because there's been more of a migration to variable pricing and more teasers. That's why I think this looks sort of high."
At the same time, Mr. Hammer found the operating expense ratio fell 20 basis points to 4.5%, principally because previous technology investments continued to pay off, he said, such as behavior scoring, adaptive controls, and other forms of productivity improvement.
Beverly B. Wells, president of Wachovia Bank Card Services in Atlanta, said she was concerned about pumped-up earnings, citing the ever-growing cobranding craze. She wonders if the industry will be willing to sustain higher credit losses, and if cobranding partners will keep up their high rates of marketing spending.
"As long as we're continuing to add borrowers at the rates that we have, which I don't think we will, a lot of the true numbers for the industry are masked by the growth," Ms. Wells said.
Wachovia, which does not offer cobranded cards, isolates accounts that were added in a certain period and tracks their performance instead of looking at the aggregate, she said.
"I think you can be lulled into saying, wow, this is such a great business I can cut my margins. You can really get caught up in it."
Net chargeoffs continued a slow, steady decline - by 20 basis points last year, to 4.4% - reflecting fewer bankruptcies and the fact that credit card companies invested in systems and behavior scoring, Mr. Hammer said.
The dip in chargeoffs is accentuated by the fact that the amount cardholders pay each month is rising to around 15% of receivables from 13.5%, he added - plus an improved economy.
Cost of funds in 1994 stood at 5.7%, down 30 basis points as a blended average from 1993. But Mr. Hammer said it will climb closer to 6% by the end of this year.
Rising interest rates will put pressure on profits for 1995, he predicted. Operating expenses will improve, chargeoffs will improve, while income will be about the same.
"It's the interest margin where people are going to get hurt this year," Mr. Hammer said.
"The industry overall is taking more risks than it used to in earlier days," said Kenneth R. Keck, executive vice president of Harris Bankcorp's Harris Bank Card in Buffalo Grove, Ill.
"The cost of funds in the '90s has been less than it was in the '80s. Total income is falling, the consumer is benefiting from increased competition as the yields from these portfolios are decreasing.
"I think everybody is interested in what's going to happen to interest rates this year, because I do see very competitive yields out there," Mr. Keck added. "We've been blessed with low interest rates the last few years. If the competitive yields keep coming down and if the competition keeps putting these low rates out there, it could provide some squeeze on the industry."
Mr. Hammer found that private-label programs have a pretax net income yield of 0.5%, unchanged from 1993 and well below the 3.9% of national Visa and MasterCard programs.
Retail store cards generally have a higher interest rate than national brands, but higher delinquency rates, chargeoffs, and operating expenses. Total income for private-label programs generated an 18% yield, operating expenses 5.5%, net chargeoffs 6.5%, and blended cost of funds at 6%.
The net yield for regular cards was 3.8% and for gold cards 4.1%.
Mr. Hammer said the earnings estimates reflect an overall industry perspective and are not meant to be indicative of any one issuer or region.