Issuers: Shed Some Profitability

  Thanks to the lowest funding costs since the early 1960s, credit card issuers in 2002 had their best opportunity in years to widen profit margins. Instead, rising loan losses caused the card industry's earnings to contract.
  Credit Card Management's annual bank card profitability study shows Visa/MasterCard issuers posted a collective 1.99% after-tax return on assets in 2002, down from 2.18% in 2001. Bank card issuers earned an estimated $10.7 billion last year, down 2.5% from 2001's profits of just over $11 billion.
  After 11 interest-rate cuts by the Federal Reserve in 2001 and one more in 2002, issuers' blended funding costs fell to an estimated 3.50% of average receivables last year from 4.05% the year before. But net credit losses rose from 5.91% of receivables in 2001 to 6.55%.
  "When you look at the savings in cost of funds, it didn't offset the deterioration in credit quality," says Katie O'Flanagan, an associate at Westbury, N.Y.-based Auriemma Consulting Group who monitors credit card profitability.
  All things are relative, of course. Even with some earnings contraction, cards remain one of the banking industry's most profitable products. Insured banks posted a record return on assets of 1.31% in 2002, eclipsing the previous high of 1.25% set in 1999, according to the Federal Deposit Insurance Corp. Banks' net income soared to $105.4 billion, up $18.1 billion or 21% from $87.3 billion in 2001, the FDIC says.
  Just like a person looking back on a fading year on Dec. 31, an industry can apply many "what ifs" to its recent performance. For example, if card issuers had kept losses at 6.25% of receivables, they would have posted the same return on assets as they did in 2001 and fattened their bottom line by another billion.
  But a widespread downturn in credit quality against a background of weak job growth clipped even prime issuers such as MBNA Corp., a monoline issuer, as well card programs run by banks big and small. Subprime issuers saw their losses rocket to previously unheard of levels. Metris Companies Inc.'s chargeoffs surpassed 21% in December. And largely because of high credit card chargeoffs in both its Visa/MasterCard program and its store cards (coupled with a good dose of poor retailing strategy), beleaguered Spiegel Inc. is in bankruptcy and its card bonds have gone into early amortization.
  "You've got to have discipline in subprime," says Richard R. House, president of Atlanta-based subprime card marketer CompuCredit Corp. CompuCredit has had some problems of its own, but-unlike cohorts NextCard Inc., which is going out of business, and Providian Financial Corp., which has downsized and moved out of the sector-is looking like a subprime survivor.
  Even community banks' card programs have had an uptick in chargeoffs, though most are still only in the 2.5% to 3% range, according to Paul H. Weston, president and chief executive of TCM Bank N.A., a Tampa, Fla.-based affiliate of the Independent Community Bankers of America trade association's ICBA Bancard processing unit. ICBA Bancard operates agent-bank programs and provides consulting services for local banks.
  "O-two was a challenging year in earnings so the ROA was ... less than '01," Weston says.
  It's Not Over Yet
  The bad-debt wave probably hasn't crested yet. Losses may not start to turn down until at least the second half.
  "From some of the (reports) we've seen, there's going to be potential for additional chargeoffs in the marketplace," according to Paul Grill, a principal at Linthicum, Md.-based First Annapolis Consulting Inc. who tracks the largest issuers' credit quality.
  Here is how CCM arrived at its 2002 profit estimates. Figures were derived from data supplied by and interviews with bankers, consultants, the card associations and others. The ROA of 2.18% for 2001 is revised from 2.20% originally estimated because of updated numbers from the card associations.
  * Average receivables grew 7% to $540.9 billion.
  * Interest income assumes an average annual percentage rate of 14.8% in 2002, down from 15.3% in 2001, and that 83% of balances revolved in both years.
  * Interchange revenue assumes a blended interchange rate of 1.7% of purchase volume, unchanged from 2001, on total credit card purchases of $881 billion.
  * Penalty revenues grew 10% as losses rose and many issuers raised late and overlimit fees to $35. An estimated 20% of total penalty income was overlimit fees compared with 30% in 2001. Federal regulators last year began cracking down on card issuers' overlimit practices, especially in the subprime sector.
  To arrive at a late-fee estimate, CCM assumed that 8% of 225.7 million active accounts were late each month and that 92% of those accounts were assessed a late fee, up from 90% in 2001. The average late fee in 2002 is estimated at $31 compared with $30 in 2001.
  * Cash-advance income is derived from the total of $258.5 billion in credit card cash volume reported by Visa and MasterCard, up 12% from $231 billion in 2001. An estimated 45% of cash volume in both years was balance transfers not subject to fees. The average fee is estimated at 3% for both years.
  * Annual-fee income assumes that 15% of the 410.4 million bank card accounts in 2002 had an annual fee, the same percentage as in 2001. The average annual fee rose slightly to $43.73 from $42.53 a year earlier, according to Tarrytown, N.Y.-based Synovate, formerly BAIGlobal Inc., which tracks card solicitations and pricing.
  * Enhancement revenue grew by an estimated 7%, in line with purchase growth.
  On the expense side:
  * Cost of funds declined to 3.5% of average receivables from 4.05% in 2001.
  * As noted, chargeoffs rose to 6.55% of receivables from 2001's 5.91%.
  * Non-interest expense in the form of operations and marketing is estimated at 4.6% of receivables, down slightly from 2001's 4.7%. Many issuers eased off on marketing, slightly offsetting higher collections costs.
  * Fraud is estimated at seven basis points of charge volume in both years.