Banks with strong credit card portfolios are the .only attractive investments for bond buyers, said a report from Smith Barney, the New York brokerage house.
The report came on the heels of a Standard & Poor's study of the credit card business, which said that fierce price competition hasn't affected the profit levels of the credit cards, so far.
"We like the fundamentals of the credit card business," said David A. Hendler, a bond analyst at Smith Barney and author of the report titled ."Plastic Paradise," which is intended to give institutional investors insights into buying bank bonds.
Although there are pros and cons in any industry, he added, "we like the trends we're seeing -- the plastic business has attractive and sustainable profitability."
He said banks with strong credit card portfolios and the best brand images are most favorable for bond investors. Specifically, the report highlights Citicorp, MBNA Corp., First Chicago Corp., Household Bank, and Bank of New York Co. as banks with strong brand identification and customer loyalty.
The report highlighted major brand strategies making credit cards successful, including affinity marketing, cobranding, price competition, cards linked to a core business, such as the GE Rewards MasterCard, and cross-selling campaigns by regional banks, such as Wells Fargo's California Advantage mortgage rebate card.
Mr. Hendler said banks that rely on commercial lending to corporations may not have as much earnings potential and, in terms of investing in bonds, "you look at earnings potential."
While the Standard & Poor's report identified profits and strong growth, there were indications that intense interest rate competition and lower profit margins could reduce profitability in the future. It neither upgraded nor downgraded its ratings.
Smith Barney recognized banks with strong credit card portfolios as the best bank bond purchases for fixed4ncome investors and saw no profit squeezes in the foreseeable future.
Unlike traditional banking, which some analysts say needs to consolidate to become more competitive, the bank card market is fairly concentrated. with the top 15 issuers controlling more than 58% of the market, up from 40.5% in 1986 but lower than the 60.2% of 1991, the report stated.
Citicorp, MBNA America, and First Chicago top Smith Barney's list of credit card issuers, with AT&T Universal, Chase Manhattan, and Household Bank next in line.
Smith Barney said the bank card market is far from stagnant, with loan expansion running at 10% annually, while outstanding loans grew 17 % and total accounts rose 16% for the first quarter of 1994, according to figures from Visa U.S.A. and MasterCard International cited by the brokerage firm.
At the same time, purchase volume increased 19% and gross dollar volume jumped 26%.
The card market has had seven quarters in a row of accelerating loan growth and the highest rate of growth in more than 10 years. the report said.
The report indicated a profitable future, as card transactions replace cash, checks, and singlepurpose credit cards at gas stations, supermarkets, and in the government sector.
Recently, the Post Office announced that it will begin accepting credit cards, giving banks access to the $25 billion market.
The health sector is also a target of the card business, with Visa and MasterCard pushing increased acceptance at doctors' offices around the country.
By the second quarter of 1994, bank cards accounted for $225 billion in consumer spending. With the introduction of new markets, that figure could increase dramatically, the report said.
To combat a rising loan-rate environment, 70% of card accounts now carry variable-rate pricing, keeping net interest margins in tact.
Net income before taxes has been at about 5% of average outstandings since the 1980s, and Smith Barney said that performance should continue. The report also said that branding of consumer credit has added value to credit cards.
It said that certain credit card issuers that waited to jump on the cobranding bandwagon may have trouble catching up. It listed Chase Manhattan Corp.. Chemical Banking Corp., BankAmerica Corp., Banc One Corp., NationsBank Corp., and Associates Bank as card issuers with strategic pressures.
The report listed First USA Inc., Signet Banking Corp., Advanta Corp., and AT&T Universal as emerging brands with good investment potential.