Issuers go on a Buying Spree

  Bigger is better. Size matters. Scale above all.
  The card industry spent the spring and summer in a consolidation frenzy, as major issuers gobbled up their brethren at a breathless pace. Full-service banks seeking to expand their payments operations bought most of the large monoline banks that exclusively issue credit cards.
  The question on many industry players' minds is, who will be next?
  Executives and analysts concur that consolidation was a foregone event in an industry with slowing growth, a saturated consumer market, increased expenses and rising interest rates. The next step, too, seems foregone. More mergers and acquisitions.
  "This type of consolidation is not unusual in mature industries. It happened in automotive and computers," says David S. Evans, author of the book "Paying with Plastic" and founder of Market Platform Dynamics in Boston. "Much of it is efficiency driven. The firms that are most efficient will grow."
  The largest deal was the $35 billion purchase of MBNA Corp. by Bank of America in June ("BofA Becomes Top Issuer with MBNA Buy," August). Less than a month earlier, the thrift Washington Mutual Inc. announced it would pay about $6.45 billion in cash and stock for Providian Financial Corp. And August was heated up by HSBC Holdings plc's deal to pay $1.59 billion for subprime issuer Metris Cos. Inc.
  "Retail banks want to get back in (the credit card business) for the product mix and the market power," said Marc Sacher, managing associate at Auriemma Consulting Group.
  The mergers, which may lead to the disappearance of monoline issuers, are proof of an important change in the payments industry, Sacher says. "These companies will focus on the entire payment relationship, going beyond credit card borrowing," he says. "The thinking before was, 'How do we pump up receivables volume?' That has changed to, 'How do we capture greater share of the wallet?'"
  The challenge for the banks will be leveraging the relationship already established with the credit card customer, says Gail Sneed, a card-marketing expert with Maritz Loyalty Marketing. "They need to meld retail products with the card product," she says. "Those have been separate customer bases." Maritz provides reward programs and other marketing services to major issuers.
  Interestingly, one firm long considered the epitome of the monoline has been heading in that direction for several years. Capital One Financial Corp., known for its commercial tag line "What's in your wallet?" is scheduled to buy this September the New Orleans-based retail bank Hibernia Corp. for $5.3 billion. Cap One has diversified into auto loans and global markets, and its domestic credit card receivables accounted for about 56% of its $82 billion in total managed loans at the end of the first quarter.
  Consolidation also continues apace in the private-label card arena. The biggest recent purchase is Citigroup Inc.'s private-label group Citi Commerce Solutions' $6.6 billion purchase in May of the credit card portfolios of the soon to be merged Federated Department Stores and May Department Stores.
  Mergers and acquisitions always have been a part of the payments landscape. Banks were not the only busy buyers, as collection agencies and other vendors bought competitors or firms that could extend their product lines (see sidebar below, "The Year of the Buyout").
  The speed of bank deals this summer, however, seemed to be in hyper-drive, with the largest issuers buying scale as organic growth slowed.
  "This continues the trend we've seen in the last decade," says Joel Gomberg, a consumer finance analyst who covers Cap One, Providian, Metris and others at William Blair & Co. LLC. "The top-10 issuers in the 1990s held about 55% of card outstandings. Today it is roughly 90%."
  Gomberg's numbers are right on target. At year-end 1994, the top-10 issuers held 53.4% of all credit card receivables, while the top 25 held a 74.3% share, according to the SourceMedia's Card Industry Directory, a Cards&Payments sister publication. At the end of 2004, according to the newly released 17th edition of the CID, the top-10 issuers held 90% of credit card receivables, and the top 25 held a 97.3% share.
  Along with the potential efficiencies that come from running a larger bank, an issuer gains sway over its suppliers, says Sacher. "The merged entity will have greater market power over its vendor," he says.
  Meanwhile, the annual double-digit increase in the use of credit cards by consumers has dropped, though the product remains popular. "It's become a more mature market as the use of credit cards has slowed," says Gomberg. "Growth has been in the single digits in recent years." Chicago-based Blair provides investment-banking services along with equity research for high-net worth investors.
  Instead, consumers have turned to debit cards to replace cash and checks. And consumers have turned to home equity lines of credit, with interest rates of 6%, to pay for larger purchases or to pay off credit card balances that can carry interest rates of 12% or higher, says Gomberg.
  The cost of funds is tacking closer to historic levels, with the Federal Reserve increasing its short-term Federal Funds interest rate to 3.5% this August, the 10th rate increase in the previous 14 months.
  Finally, it is getting more expensive for issuers to outdo each other as they compete to put a card in every deserving wallet in the country. "Much of (the consolidation) is due to the cost of running a business-paying for the technology, marketing and risk management," says Gomberg.
  Indeed, marketing has taken a toll on the largest issuers. Citigroup Inc.'s Citi Cards division spent $411.7 million for ads last year, up nearly 230% from the $125.2 million it spent in 2003, according to TNS Media Intelligence. Capital One Financial Corp., parent of issuer Capital One, spent more than $350 million on ads in 2004, up almost 155% from $178.2 million in 2003, TNS found. Cap One executives in July said they would spend $1.4 billion on marketing this year.
  Not all issuers were spending anywhere near these dollars, but it has become clear a top-10 issuer must invest in promotional campaigns to keep its name in the public eye.
  Issuers set a record last year in their mail acquisition campaigns with 5.23 billion letters mailed, up 4.4% from the 5.01 billion mailed in previous record year 2001, according to Synovate's Mail Monitor tracking service. Response was a paltry 0.4%, Synovate reported.
  Most issuers do not break out technology and risk-management costs specific to their card programs, but it is safe to say those line items will increase. Introducing such products as contactless cards and whatever the next techno whizbang may be requires a significant investment. And costs related to risk containment surely will rise as Congress imposes new rules following the embarrassing string of consumer data losses and thefts this year. (On the bright side, Visa reports its fraud rate remains at 6 cents per $100 in card spending.)
  Bank of America made no secret it was seeking scale with its purchase of MBNA. The combined card group, to be led by MBNA's Bruce L. Hammonds, will have a 20% share of the U.S. credit card market, hold $142.3 billion in receivables and have 40 million active accounts.
  BofA plans to quickly convert MBNA cards to the BofA brand but use MBNA's expertise in marketing to affinity groups to expand, said Kenneth D. Lewis, BofA's chairman and chief executive. The Charlotte, N.C.-based bank reported it would save $850 million after tax in 2007 through efficiencies created by combining operations.
  Though BofA already has a large credit card group with an estimated 36.6 million accounts, it has not competed as forcefully as Citi or J.P. Morgan Chase & Co.'s Chase Cards Services division.
  "It will be interesting to see how they leverage MBNA's 5,000 affinity card partnership to bring more BofA services to those customers," says Maritz's Sneed. "Many MBNA cardholders have no relationship with Bank of America. Now they have a reason to."
  Washington Mutual kicked off the buying season with its plan to pay $6.45 billion for Providian. The deal looked to be a combination of two consumer banking leaders with little product overlap.
  Washington Mutual reports assets of $319.7 billion, 2,400 offices nationwide and 9.2 million debit cardholders. But it has a negligible number of credit cards. Providian had $18.1 billion in outstandings at the end of the first quarter and 9.4 million credit cardholders.
  Joseph W. Saunders, Providian's chairman and CEO, will continue to lead the credit card operations from Providian's San Francisco headquarters. Saunders and marketing executive Warren Wilcox were brought in from Fleet Credit Card Services in 2001 to turn Providian around following its near collapse from aggressive marketing to risky subprime consumers.
  Linking with WAMU will have pluses and minuses for Providian, says Auriemma's Sacher. "Synergies can be achieved when you combine a retail bank with a monoline card issuer and get the best of both worlds," Sacher says. After the merger, however, the credit card unit "must compete with other bank departments for resources. You don't have the same independence," he says.
  Putnam Investments LLC, a $195 billion asset money manager that controls about 7.5% of Providian's outstanding shares, came out against the deal. Putnam vowed to vote its shares against the transaction, saying Providian is worth more, especially considering the 30% premium that BofA is paying for MBNA. However, few other shareholders stepped forward to support Putnam.
  Providian's shareholders were scheduled to vote on the deal on Aug. 31.
  The third major deal was the planned $1.59 billion purchase of Metris Companies Inc. by HSBC Finance Corp., the U.S. arm of banking titan HSBC Holdings plc in London. HSBC gained entry to the U.S. market in 2003 with its $14.2 billion purchase of Household International Inc.
  HSBC has two arms in the United States. Prospect Heights, Ill.-based HSBC Finance oversees a $14.4 billion retail card program, while HSBC Credit Card Services operates a $19.7 billion card program, according to the Card Industry Directory.
  Metris has $5.9 billion in receivables and serves a "nonprime" cardholder, according to an HSBC spokesperson. The Metris portfolio should dovetail nicely with HSBC's $30 billion portfolio consisting of prime and subprime cardholders, the spokesperson says.
  HSBC warned Metris the purchase could fall apart if it does not clean up its problems with the U.S. Securities and Exchange Commission. In July, Metris confirmed it had received a "Wells Notice" from the SEC naming Metris, its Chairman and CEO David Wesselink and another executive in a 2003 investigation into the issuer's accounting practices. HSBC has given Metris until March 31, 2006, to resolve the problem.
  Despite the headaches, Metris offers some opportunities. It has long courted the Hispanic market with bilingual advertising and product literature. The cards and the product set of HSBC also could make the unbanked market approachable.
  "Metris could be a way to reach the unbanked. Use a payroll debit card for example. That's a prime market for subprime cardholders," says Maritz's Sneed. "Successful banks have a contiguous product line that serves similar customers."
  The payments industry was left to ponder the next possible acquisition target as summer entered its dog days. The top candidate was Cap One, with its large portfolio, marketing expertise, superior management and well-known brand.
  Cap One's market capitalization is about $20 billion, says Gomberg. In contrast, MBNA's market capitalization was near $30 billion when BofA bid $35 billion.
  Other speculation has been on a possible blockbuster-a purchase of American Express, with a market capitalization near $70 billion, according to Gomberg. That total includes the Financial Advisors division that accounted for less than one-third of AmEx's $29.1 billion in revenues in 2004. AmEx plans to spin off the division before the end of this year. That would leave AmEx primarily with its Travel Related Services group, the card division with 2004 revenues of $21.6 billion.
  AmEx brings a brand name that is known worldwide, along with what is arguably the savviest management team in the business led by Chairman and CEO Kenneth I. Chenault.
  Both AmEx and Cap One declined to comment. Each saw its stock price rise following the MBNA, Metris and Providian deals, as investors bet someone would step forward to make a bid.
  The summer proved exciting for issuers with the string of deals. Down the road, the bigger picture may be the change in the way banks treat their payments business. No longer a stand-alone unit, the goal now is integration of cards with the entire retail product mix.
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