Why Big Banks Would Do Well to Spin Off Credit Cards

The Wells Fargo account opening scandal has intensified scrutiny of cross-selling and has helped resurrect calls for big banks to be broken up. It is premature to say whether this might actually happen, but there is one area where a spinoff could actually be in the banks' interest.

One idea for downsizing several of the large banks is through a sale or spinoff of their credit card business. The first reason why this might be worth considering is purely economic.

The credit card industry has emerged from the great recession once again as the most profitable bank lending business. According to the FDIC, the average ROA for all depository institutions at June 30 was 1.06%, but the average ROA for the credit card line of business was 2.27%. This is not an anomaly — this relatively higher level of profitability has long been a characteristic of the credit card business. From a traditional M&A perspective, virtually any of the large credit card businesses could expect to sell at a considerable premium to book value. Notwithstanding the current tepid IPO market, a sale or spin-off may be one way to unlock shareholder value.

The next consideration is a bit more complicated. A bank would have to ask: Does the greater scale associated with being part of a systemically important bank outweigh the increased regulatory burden? For many banks, a credit card sale or spin-off would generate significant capital at a time when virtually all banks are still feeling regulatory pressure to increase "common equity Tier 1." Not only would the sale premium increase capital, but most card issuers maintain considerably higher levels of equity capital as a percentage of risk-weighted assets than banks as a whole, so the sale of the credit card receivables would also liberate a proportionally larger amount of capital than a similarly sized sale of other bank assets.

To be clear, a sale or spinoff to boost capital and alleviate regulatory burden would not make sense in all circumstances. In some cases, there might be an overriding strategic objective for retaining (or not divesting) the card business. But this should not be assumed to be the case. A sale may make sense particularly if the large multiline bank receives little tangible cross-sell benefits from the credit card business, and if the credit card business can operate nearly as efficiently as a stand-alone entity.

Recent cases where a credit card spinoff or sale occurred demonstrated numerous benefits the company that parted with the unit. For GE, the public offering of its credit card business into Synchrony Financial achieved several complementary objectives. The spinoff eliminated consumer lending risk from the parent, Synchrony was able to achieve significant valuation and the offering helped GE return to more of a manufacturing/technology focus.

Similarly, retailers that owned a card issuer have found that spinning off the card business, either in a strategic sale or theoretically in an IPO, is a good way to quiet shareholder activists who view consumer credit as a distraction from the core business. Witness Cabela's recent announcement to sell its credit card business to Capital One in conjunction with the sale of the retailer to Bass Pro Shops.

But besides the benefits to a large corporation, spinning off a consumer credit business may also be what is best for the consumer.

Have cardholders benefited from card issuers being a subsidiary of a large bank? It is not at all obvious that they have. Perhaps no better case study exists than the Bank of America acquisition of MBNA.

MBNA exemplified the virtues of an independent credit card bank. It invented and owned the "affinity" marketplace, was a leader in innovation and championed customer service before it was fashionable. When B of A acquired it, the virtues of the independent entrepreneurial business quickly vanished. To be fair, the timing of the acquisition (effectively 2006) was a year before the most severe economic downturn since the Great Depression. But given that MBNA's portfolio was predominately made up of prime consumer credit, the presumed stability of becoming part of the largest bank in the country was more than undermined by Bank of America's large subprime consumer exposure.

Spinning off a card business may be one of the best ways for a TBTF bank to slim down, generate a large gain on sale and rebuild regulatory capital. The newly independent card issuer will have every incentive to build its own brand and delight consumers — with no worries about cross-selling.

John A. Costa is a managing director for Auriemma Consulting Group and runs the corporate finance practice.