Exclusive Bank Card Profitability Study and Annual Report 2005

  It was a good year for bank card issuers in 2004. Losses were down, consumers continued their shift to using plastic instead of cash and checks, and cardholders were better at paying their bills.
  Credit Card Management found that Visa/MasterCard issuers posted a collective after-tax return on assets of 3.7%, up from 2.53% in 2003. The issuers earned $21.44 billion last year, up 51% from $14.24 billion in 2003.
  The positive results occurred with interest rates quite low, consumers using their cards to purchase nearly every good and service, and issuers deploying sophisticated risk-management systems that weed out money-losing consumers. "The economic recovery continued, and issuers pulled back from subprime and nonprime consumers," says Katie O'Flanagan, an Auriemma Consulting Group associate who tracks card profitability.
  Visa and MasterCard credit card purchase volume totaled $950.4 billion last year, up only slightly from the $945.7 billion in 2003. The 2004 volume does not take into account the $438.6 billion in purchases conducted with signature-based, or offline, debit cards. Incorporating that change in consumer behavior raises last year's total purchase volume on association-branded cards to $1.4 trillion.
  The cost of funds remained quite low despite increases by the Federal Reserve. The average rate was near 2% for the year, as a series of increases by the Fed kicked in by December.
  Last year, the Fed raised its federal-funds rate five times in 0.25% increments, from 1% in January to 2.25% by the end of December. The Fed had raised the rate to 2.75% by April of this year, with indications it will keep moving it higher.
  Securitized card-funding sources generally are based on the London Interbank Offered Rate indexes, which parallel the federal funds rate. Issuers typically pass on these funding cost increases to consumers in the form of higher annual percentage rates.
  The downside is the shift by many consumers to alternative funding sources of their own, commonly their home-equity lines of credit. Nonrevolving credit loans grew nearly 28% from 2000 through 2004, compared with 17.5% for revolving credit during that time period, according to the Fed.
  There was a steady decline in losses caused by chargeoffs, dropping to 5.5% of average receivables last year from 5.9% in 2003.
  Issuers did step up their marketing programs, ending a two-year decline. They sent consumers a record 5.2 billion-plus card offers, according to Synovate, the Chicago-based compiler of solicitation efforts ("Opt Out? Mail Offers Reach Record Highs," April). Analysts say competition and a steadily growing economy caused the rise.
  2004 proved to be a good year for banks. Federally insured financial institutions set a record with reported net income of $123 billion, up 2% from $120.5 billion in 2003, according to the Federal Deposit Insurance Corp. Loan growth and lower losses led to the increase, the FDIC reported.
  More cardholders are paying their bills on time. Moody's Investor Services reported that the payment rate on a basket of asset-backed credit card securities was 17.44% in last year's fourth quarter, up from 15.63% during the same period in 2003.
  There is no secret to the bolstered payment rate given the improved unemployment rates, says David Wyss, chief economist at Standard & Poor's. "People that have jobs can afford to pay off their credit cards," he says. "The biggest key is employment."
  Issuers also continue to clean out subprime consumers. "Credit quality has been slowly improving for several years," says Paul Grill, a partner with First Annapolis Consulting, a Linthicum, Md.-based consultant to the payments industry. "We've seen a 50 basis point improvement in the loss rate across major issuers in the last two years."
  Issuers and the card associations also can pat themselves on the back for the expansion of card acceptance. Last year, the major breakthrough occurred in the $125 billion fast-food industry, with card-accepting terminals sprouting at the point of sale.
  "A consumer's card is becoming more of a spend vehicle than a lend vehicle," says Grill.
  That change in behavior indicates why issuers are turning to interchange fees as a more important source of revenue along with interest on unpaid balances. Interchange is a fee issuers receive for card payments from acquirers, who pass the expense on to their merchant customers.
  Interchange as a net share of issuers' revenues has risen about 25% in the last three years, to 23% last year from 18% in 2002, says Grill.
  Another positive trend is the decrease in fraud, dropping to 0.06% of sales, according to Visa.
  Recent reports of the theft of consumer card information from retailers and data warehouses suggest that the entire cards industry will be spending more to secure cardholder information. A recent study from Financial Insights found that nearly 6% of consumers switched banks because of fears of identity theft.
  The remainder of 2005 seems to be shaping up as the year focused on bankruptcy. Issuers tend to hide behind the curtain when the subject arises, preferring to let the American Bankers Association do their talking.
  But the recently passed bankruptcy-reform legislation will raise bankruptcy filings, at least until the end of this year, according to most pundits. The bankruptcy-reform bill, which President Bush signed into law on April 20, also may further the rise in the payment rate as consumers ensure their debts are paid, Auriemma's O'Flanagan says.
  CCM developed its profitability report from annual reports, government agencies, Visa and MasterCard figures, and interviews with financial analysts and industry consultants. As for revenues:
  * Receivables grew 3% based on earnings reports filed by major bank card issuers, and data from Visa and MasterCard.
  * Interest income assumes an average APR on revolving balances of 15%, up from 14% in 2003, and that 83% of balances revolved.
  * Interchange income applies a 1.75% blended interchange rate, up from 1.7% in 2003.
  * Penalty fee income was up 5% in 2004, as late, over-limit and other penalty fees rose. The average fee for 2004 is estimated at $35, up from $32 in 2003.
  * Annual fee revenues assume that 12% of bank card accounts paid a fee, down from 13% in 2003. The average annual fee on an open account was $46.73 in 2004, up from $44.30 in 2003, according to Synovate's Inside Track.
  * Revenues from enhancements such as credit insurance and other marketing programs are estimated to have increased proportionately with charge volume.
  On the expense side:
  * Cost of funds dropped to 1.99% of average receivables, compared with 2.7% in 2003.
  * Operations and marketing costs rose nearly 10%, as issuers increased direct-mail solicitations and built campaigns targeting select consumers.
  * Fraud is estimated at 6 basis points of charge volume for 2004, down from 7 basis points in 2003.