It is not quite as dramatic as the dot.com effect that has sent Internet companies' stock into orbit, but a move into subprime credit card lending can do a lot to boost a share price.
Household International Inc. got a taste of subprime fever Thursday, when its shares were pushed 4% higher by news that it was poised to fortify its beachhead in the subprime market by buying the card marketer Renaissance Holdings Inc. (See story on page 1.)
The subprime credit card companies have all been hot this year. Shares of Fall Church, Va.-based Capital One are up 21% this year. Metris Cos. of St. Louis Park, Minn., is up 21%, and Compucredit, an Atlanta-based issuer that went public in April, is up 70%. And despite a series of setbacks because of accusations of predatory lending, Providian Corp. is up 5.3% for the year.
The issuers - and investors - have all been lured by the potential for exponential annual growth in a fledgling market. "There are very few fertile territories and this is certainly the most fertile," said Don Berman, chairman and chief executive officer of CardWorks LP, a privately owned subprime credit card lender and servicer in Plainview, N.Y.
The subprime business is not for the timid. The risk that the borrower, usually with poor or no credit history, will default is much greater than with regular credit card accounts.
"Everything about the subprime business is different from prime and superprime," Mr. Berman said. "How you originate, how you manage the accounts, how you manage the collections. "For card issuers of size, it requires a complete retooling of the factory in order to handle this side of the business."
But subprime lending also brings much bigger interest rate margins and much faster growth rates, which makes it a hot area for lenders, even as competition for borrowers increases in the latter stage of the business cycle.
Household's $300 million deal for Renaissance, a company that it has partnered with since January, "demonstrates Household remains very committed to the credit card business," said Reilly Tierney, an analyst at Fox-Pitt, Kelton in New York. "It is a major sign to the market that this joint venture has been very successful."
Pro forma, Household would have 1.3 million accounts at yearend and a combined $780 million in receivables, Mr. Tierney said. The company said it expects to have 2 million accounts by the end of next year and $1.2 billion in receivables.
Mr. Tierney estimates Household will earn about $40 million in pretax income next year as a result. While the price tag, at six times book value, seems pricey, it is much more modest when expressed in terms of next year's income. Pretax, the price is about 7.5 times next year's earnings.
For Household, "it is late in the credit cycle to be making a big investment in subprime," Mr. Tierney said. "But the positive is it is going to enhance the profitability of Household's credit card business."