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March 28, 2007

How the monolines disappeared

The US card industry underwent a transformation over the past couple of years as the monoline card issuers disappeared from the payment landscape, to be succeeded by more diversified financial services institutions The consolidation craze that has swept the US cards industry since 1997 may have abated for the time being, but there is no doubt that it has irreversibly changed the industry

By Verdict Staff

The US card industry underwent a transformation over the past couple of years as the monoline card issuers disappeared from the payment landscape, to be succeeded by more diversified financial services institutions. Victoria Conroy reports on the major deals to date.

The consolidation craze that has swept the US cards industry since 1997 may have abated for the time being, but there is no doubt that it has irreversibly changed the industry. Major names such as Providian, Metris and MBNA have been subsumed by larger, more diversified retail banking entities, and the few remaining monolines, such as Capital One, have rejected the monoline business model in favour of diversifying and expanding their business lines to ensure sustainable long-term profitability. The table opposite details how monolines have gradually disappeared from view to be replaced by fully featured retail banking institutions.

How diversification became the norm

As was detailed in CI 375, monoline organisations became prime targets for consolidation as they lacked a diversified banking model. In the US’s saturated credit card market, the ability to cross-sell other retail banking products would prove to be the most obvious way of maintaining steady and profitable revenue streams.

Intense competition and tighter margins had combined to place huge pressure on credit card providers. The proliferation of 0 percent interest offers and other consumer enticements initially boosted profits and customer acquisition rates, but also had the effect of eroding consumer loyalty, as cardholders switched providers on a regular basis to chase the best rates. Instead of adding cards to their wallets, consumers were simply replacing them.

US consumers were quickly becoming jaded with credit cards – levels of repayments were increasing rapidly, debts were being paid off more quickly and debit cards were beginning to surge in popularity. The result was that credit card portfolios were losing profitability. Consumers were turning towards lower-cost forms of credit such as mortgage equity withdrawal and auto finance deals, both of which experienced significant uptake in the last three years, due to historically low interest rates and greater competition in the market. Ironically, it appears that those banks that were pushing home equity products to consumers may have inadvertently dented their own credit card profits.

Between 2001 and 2005, the Federal Deposit Insurance Corporation reported that outstanding balances of home equity loans grew from $174 billion to $538 billion, while outstanding credit card loan balances in the same period only grew from $235 billion to $368 billion. Conversely, credit card portfolio profitability fell from a portfolio-wide yield on equity of 2.52 percent in 2002 to 1.86 percent in 2005, according to the Federal Financial Institution Examination Council. It soon became apparent to the monolines that credit cards as a stand-alone business could not remain economically viable, and there was little room to grow the business any further.

Capital One branches out

Capital One was one of the last remaining monolines to realise that it needed to diversify in order to stay profitable. It already had a successful auto lending business, and in 2005 it acquired US regional bank Hibernia for $5 billion. The Hibernia acquisition gave Capital One access to more than 300 bank branches, mainly in the southern US, and a lucrative home equity business. In the first quarter of 2006, Capital One posted a staggering 74 percent increase in earnings.

Capital One followed this move in early 2006 with its acquisition of another regional bank, North Fork, for $14.6 billion. The deal placed Capital One among the top ten banks in the US, and the combined company became the third-largest retail depository institution in New York, the US’s largest deposit market. The combined company was estimated to have deposits of more than $84 billion, a managed loan portfolio of more than $143 billion, more than 50 million customer accounts and 655 branches. The acquisition further expanded Capital One’s product set by introducing North Fork’s lucrative small business franchise.

Other deals were announced, the bulk of which were established retail banks buying more specialised banks in the mortgage or small business sector. However, this didn’t stop 2006 from being a rocky year for banks in terms of overall economic fundamentals and many industry observers are predicting that 2007 could be just as rough. Some investment analysts expect bank earnings to weaken over the year, mainly due to the sudden collapse of confidence in the US housing market, rising interest rates and rising levels of consumer debt. The US Federal Reserve continued raising interest rates through the first half of 2006 in a bid to stem inflation, but held rates during the summer as concerns about an economic slowdown emerged.

Overseas expansion

In this uncertain atmosphere, it seems likely that there will be a temporary halt to the mega-billion takeovers of the previous years. Even though the monolines are now gone, the question of how to ensure profitability appears to be forcing the large diversified US retail banks and card issuers to turn their focus to overseas markets, as has happened at Citi. Suffering from declining card profitability in the US market, the financial services giant recently acquired UK card issuer Egg from parent company Prudential for $1.12 billion. Citigroup said it intends to retain the Egg brand and the unit will be combined with its UK consumer operations.

The purchase includes online products and services including payment and account aggregation services, credit cards, personal loans, savings accounts, mortgages, insurance and investments. Citigroup said the acquisition will more than quadruple its UK credit card base by adding Egg’s approximately 2.9 million credit card customers to Citigroup’s 800,000 cardholders.

It has also made inroads into the increasingly lucrative consumer credit market of South America. In November 2006, Citi reached a definitive agreement to acquire Grupo Financiero Uno (GFU), the largest credit card issuer in Central America, and its affiliates. GFU is privately held and in September 2006 had more than 1 million retail clients representing 1.1 million credit card accounts, $1.2 billion in credit card receivables and $1.3 billion in deposits in Guatemala, El Salvador, Honduras, Nicaragua, Costa Rica and Panama.

Monolines: Mergers and acquisitions

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