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This story appears in the August 2009 issue of Cards&Payments.
Many recession-weary small and midsize credit card issuers are weighing whether they have what it takes to continue competing in an industry plagued by economic hardships and an array of tougher card-industry regulations taking effect next year.
The several giants that dominate the credit card industry seem to be getting bigger each year through acquisition, while thousands of smaller issuers, including community and regional banks and credit unions, increasingly are overshadowed. JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., Wells Fargo & Co. and Capital One Financial Inc. control some 80% of the U.S. bankcard industry, according to PaymentsSource.com, SourceMedia's Web site for payments-industry data and editorial coverage. SourceMedia publishes Cards&Payments.
The prevailing theory among industry observers is that size will become a more-pronounced advantage for credit card issuers, and not just from a branding perspective. Indeed, as new industry regulations restrict issuers' ability to raise cardholders' interest rates and charge penalty fees, large issuers' sophisticated systems for determining creditworthiness and more-efficient back-office operations will become crucial in eking out profit in the increasingly constrained card industry, analysts say.
"Scale will be even more essential to competition than it has been because, in order to manage credit risk in the new environment and to stay on top of complex new regulatory demands, issuers will need elaborate risk-management and operations systems that only the big guys can afford," says Srini Venkateswaran, a partner in the financial institutions group at consultancy A.T. Kearney. During the next year, many smaller issuers may exit the industry by selling their portfolios or by setting up portfolio-management arrangements with third-party agents, he predicts.
Getting out will not necessarily be easy in this economy, some experts warn. One credit card portfolio broker says his firm is swamped with calls from smaller issuers looking to sell their card operations, and buyers are few (
But some smaller issuers claim to be defying the odds.
Touting decades of more-disciplined credit-underwriting standards, fewer losses and low turnover among their bases of loyal customers, some smaller issuers believe they are well-positioned to weather the changes ahead. Certain smaller issuers even claim to have gained market share this year at the expense of larger issuers.
Indeed, Jim Foster, senior vice president and group head of national and local accounts at MasterCard Worldwide, disputes the notion that only the largest card issuers can survive into the industry's next chapter.
"A lot of credit cardholders have been displaced recently, and there is a lack of trust out there among consumers," he says. "Customers that are shifting deposits to a new institution might be looking for a new credit card issuer, ... [so] the next 12 to 18 months could be really important for smaller issuers looking to increase the size of their card portfolios."
Does Size Matter?
But smaller issuers will have a tough time sustaining growth if present trends continue, says Ken Paterson, director of credit advisory services at Mercator Advisory Group. The recession has dented profits for all issuers, and its effects will linger for several quarters, he notes.
"It's certainly possible that some smaller and mid-sized issuers could absorb customers during the current marketplace upheaval, but we are not going to see any significant market share shift," Paterson says.
Smaller issuers still have a few other advantages over their larger cousins, including short-term profitability when balancing income against losses, analysts say.
Charge-off rates–the percentage of accounts issuers deem uncollectible–are the single most-important factor in determining a card portfolio's profitability, and the charge-off rates of many smaller issuers were significantly lower than those of larger issuers through the end of last year (
The new card regulations also may have a less-devastating effect in the near term on small issuers' business practices.
The largest issuers in recent years relied heavily on national direct-mail campaigns, dangling low-interest-rate cards and 0% annual percentage rate balance-transfer offers to pursue higher-risk prospects. They also often jabbed customers with sharp interest-rate hikes and steep penalty fees, which proved to be very lucrative.
Outcry from the public and lawmakers eventually led to Congress passing the Credit Card Accountability, Responsibility and Disclosure Act earlier this year, restricting many existing practices of large issuers. Those rules go into effect Feb. 22, 2010.
Besides restrictions on many fees and interest-rate increases, under the new rules card issuers cannot charge over-limit fees unless cardholders approve, and issuers must apply payments first to balances with higher interest rates. Issuers also must provide detailed disclosure of account costs and terms and provide customers with 45 days' advance notice of changes in account terms, including benefits and rewards. Moreover, issuers are barred from marketing cards to anyone younger than 21 without an adult cosigner or proof that the borrower can repay card loans.
To brace for these changes, large issuers have curtailed their direct-marketing programs this year, which has flattened portfolio growth, analysts say. Synovate, the Chicago-based market-research firm owned by London-based Aegis Group PLC, in May reported that issuers mailed 372.4 million card offers to U.S. households during this year's first quarter, a 67% decline compared with 1.13 billion offers mailed during the same quarter last year.
Many large issuers also have raised interest rates for customers across the board in response to the economic downturn. Chase recently raised interest rates on some of its core cards to as high as 23.99% and increased balance-transfer fees from 3% to 5% of the transfer amount.
By contrast, many smaller issuers say they generally have been operating within the new regulations' guidelines for many years, and they never relied as heavily on steep interest-rate increases or penalty pricing as have their larger peers. Many of these smaller issuers claim their card portfolios have continued to grow this year, although not by as much as in past years.
"For smaller issuers, cards are just one of many facets of a bigger relationship, rather than a core product and, consequently, the smaller issuers generally have not engaged in the types of practices that are no longer going to be allowed under the new regulations," says Beth Gorry, a vice president and client business leader at MasterCard Advisors, an independent consultancy owned by MasterCard Worldwide.
The credit card portfolio at First Citizens Bank, a 340-branch subsidiary of First Citizens BancShares Inc., has added many new customers in recent months, possibly because of consumer dissatisfaction with larger issuers, speculates William W. Shaw, the bank's group vice president.
At the end of 2008, First Citizens BancShares ranked 29th in total managed accounts, according to Federal Deposit Insurance Corp. and the Federal Reserve Board reports. The institution's charge-off rate at the end of last year was 2.49%, considerably lower than the largest issuers' average charge-off rate, which hovered around 6% at the end of 2008.
Branch Strategy
"We have a low charge-off rate because most of our credit card customer sign-ups occur inside our branches, where bankers evaluate their creditworthiness face to face," Shaw says. First Citizens charges over-limit and a variety of other card fees, but the bank does not depend heavily on such fees for its profitability, he says.
Like many smaller issuers, First Citizens is turning to its processor–in this case Total System Services Inc.–for regulation-compliance assistance, Shaw says. He declined to say how much extra such services will cost First Citizens.
"There are a lot of details to work out and changes we need to make to make sure our statements and disclosures are in compliance, and it will raise our costs somewhat, but it won't be catastrophic," Shaw says.
First Citizens' small-business credit card portfolio also added customers this summer following the collapse of small-business card lender Advanta Corp. "A bunch of our deposit customers were Advanta cardholders, and we were able to add them to our small-business card portfolio," Shaw says. "We have kept our pricing competitive and reasonable, and as long as we maintain our standards, I see no reason for that to change."
Zions Bancorp, which the Fed ranked 40th based on managed credit card accounts at the end of last year, also is experiencing solid growth this year through use of its more than 500 offices in 10 states. The institution's credit card charge-off rate was 2.73% at the end of the fourth quarter.
"We are not immune from the economic problems other card issuers are experiencing, but our business practices are strong and customers are reacting positively to our brand in the face of negative headlines," says Brian McCaul, vice president of bankcard sales for Zions Bancorp's 114-branch Zions Bank affiliate. "When we read about how the big issuers are cutting customers' lines and raising rates and fees this year, we see it as an opportunity to win over new customers."
Zions primarily relies on in-branch card-marketing efforts, and the bank generally has avoided "teaser-rate" card pricing common among larger issuers, McCaul says. The issuer also has "fairly strict" underwriting guidelines, he says, noting that all Zions deposit customers do not automatically qualify for its credit cards.
"We have great rewards programs, and we're promoting that and letting customers know in our branch-marketing efforts that we never engaged in deceptive practices," McCaul says.
But aside from relying less on high rates and fees, other worrisome factors lurk that could decimate smaller issuers' credit card profits, analysts say.
For one, smaller issuers with a preponderance of customers who pay off their credit card balances each month tend to rely more heavily on interchange than on interest rates and fees to generate card profits. And interchange is coming under scrutiny again this year by lawmakers (
Indeed, while Zions earns some profit from credit card interest and fees, interchange comprises "a good proportion" of the institution's card revenues, says Cindy Smith, senior vice president and director of bankcard products and services. If lawmakers succeed in pushing through proposed legislation that would limit or regulate credit card interchange rates, Zions' card profits would suffer, she concedes.
The recession's effect of lower overall credit card spending also is cutting into smaller issuers' routine interchange revenue, says Venkateswaran. Another ominous problem he sees is the possibility that new customers drifting into smaller issuers' portfolios this year will be higher-risk "credit-seekers" larger issuers are rejecting, he says.
"There is a danger of adverse selection for smaller issuers in this marketplace, in which they could take on more shaky-credit customers," Venkateswaran says. "Portfolio growth during this rocky economic period is not necessarily a positive thing."
All issuers will have to spend more on back-office operations to comply with the new regulations, says Michael Schuchardt, managing director for financial risk strategy at Protiviti Inc., a U.S.-based consultancy.
"The regulations require a lot of attention to detail at every level so that statements and marketing and card offers at the branch level and elsewhere are all in compliance," he says. "Processors will shoulder a lot of the compliance burden, but there could be significantly higher costs for smaller issuers."
Another challenge smaller card issuers face is a lack of detailed information about how much profit or loss each credit card account may generate under the new regulations, says Scott Strumello, an associate at Auriemma Consulting Group. Smaller issuers focusing on an entire household's account may overlook key profitability factors surrounding credit cards, he warns.
"The dust has not yet settled on what the economic downturn and new credit card industry regulations will mean for everyone, but smaller issuers need to move very carefully in the next year," Strumello says.
Smaller issuers that maintain high underwriting standards may find a profitable balance of appropriate interest, fees and interchange revenue. But the largest issuers, whose sheer scale may protect them from certain regulatory and economic shocks, likely will put many smaller issuers at a disadvantage. CP
