Despite a faltering economic outlook, US card
issuers and networks are managing to drive growth in some areas.
Changes in consumer payment behaviour are also pushing a greater
number of payments towards debit cards. Victoria Conroy
CI readers could be forgiven for thinking that
US card issuers are mired in misery due to the ongoing credit
crunch and weakening economic conditions for both consumers and
businesses. However, despite the bad economic news emanating from
the US, there are some bright spots for US payment players at a
time when US consumers are demonstrating clear shifts in payment
preferences – a shift which in turn is fuelling a much greater
degree in payment innovation than in previous years.

Driving growth in debit

The most obvious shift in terms of card payment trends over the
past couple of years has been the exponential growth in debit card
payments, which shows few signs of slowing down.

According to US payment research consultancy
TowerGroup, debit card transactions have grown three times faster
than those for credit cards in the period 2005 to 2007, and US
debit volume has continued to grow even as consumer deposits in
their current accounts hit record lows. The growth of debit is a
part of a larger picture of card payments of all forms continuing
healthy volume growth.
According to
, more than 35 percent of consumer transactions were
made on card products in 2006. This increasing shift towards card
payments is also evidenced by the US central bank, the Federal
Reserve, which published in March 2008 its Electronic Payments
Survey covering the years 2006 and 2007, and which stated that
debit payments are the fastest growing payment method in the
Debit’s growth is down to several factors. Over
90 percent of US households have a debit card linked to their
current account, and issuers have made strenuous efforts to boost
activation rates, although low activation remains a problem.
According to TowerGroup, only about half of US debit cards (55
percent) generate consistent use, meaning that debit card issuers
are missing out on significant debit interchange revenue and fee
income. However, debit cards have a much lower attrition rate than
credit cards, given the customer’s link to the current account and
by extension the issuer itself. Debit card attrition is typically
in the single-digit range, whereas credit card attrition typically
operates with a 15-20 percent attrition rate.
Also, a greater proportion of everyday
purchases for things such as fuel and food purchases are being
placed on debit cards, particularly by younger consumers in the
18-25 age bracket. Research published in early 2007 from Experian
Simmons Research found that 70 percent or 23.5 million 20-something
consumers have a debit card, while Visa reported in April 2007 that
40 percent of consumers aged 18-25 use payment cards for purchases
of $25 or less at least 4 times a week.
When it comes to micropayments, or payments of
$5 or less, 25 percent of 18-25-year-olds use their cards for the
majority of these payments, twice as many as those aged at least 45
years old. Separate research from MasterCard reveals that in 2006,
350 billion transactions were made for $5 or less, representing
$1.32 billion in value.
Not surprisingly,
, and by extension their issuing banks, are targeting
small ticket payments as a huge growth opportunity. In April 2006,
Visa dropped the signature requirement for transactions of less
than $25, in order to boost card payment usage in traditionally
cash-heavy sectors such as transport and ticketing, vending
machines and smaller merchants such as convenience stores. In 2007,
MasterCard put a cap on interchange fees on fuel purchases at
petrol retailers, having previously published its interchange rates
in 2006.
Small ticket card payments are also the focus
of the US Federal Reserve, which in June 2007 announced it would be
modifying its Regulation E. Regulation E previously required a
paper receipt be made available for consumers for all debit card
transactions conducted in physical environments, including
unattended areas where consumers would not expect to get a receipt.
Regulation E was modified so that merchants are no longer required
to make a receipt available for debit card purchases of $15 or
According to a 19 March 2008 SEC filing, Visa
USA reported that the 9 percent growth in total payments volume,
excluding PIN-based debit volumes, to $1.3 trillion in 2007 was
partly spurred by its April 2007 introduction of two new acceptance
fees, including a debit acceptance fee on all consumer debut
payments volume and a credit/commercial acceptance fee.
The growth of contactless payment cards and
merchant accepting locations in the US is also driving a greater
proportion of small ticket payments towards card payments. As of
December 2007, there were more than 23 million PayPass-enabled
cards and devices issued globally and more than 95,000 merchant
acceptance locations worldwide. Visa’s contactless proposition
payWave is also gaining traction, and in September 2007 Visa
introduced the Visa Micro Tag in the US, a key fob payment device
incorporating payWave.


The card networks

The past two years saw Visa and MasterCard complete the transition
to publicly traded companies, and also the spin-off of
from its parent Morgan Stanley. Visa and MasterCard
dwarf their smaller network rivals in terms of size and volumes,
but remain focused on doing battle with each other.

In 2007, both networks reported increases in
all forms of payments, particularly debit and commercial payments.
Commercial payments in particular are a hot growth area, with Visa
reporting that US commercial payments volume grew by 16 percent in
the third quarter of 2007, while MasterCard reported a healthy 25.3
percent increase in commercial credit and charge card gross dollar
volume for the full year 2007. It is estimated that in 2006, Visa
had 44 percent of the US market share in credit cards and 48
percent of the US market share in debit cards.
The US remains the largest source of revenue
for both companies, although international markets are increasingly
important. In 2007, the US accounted for 66 percent of pro forma
revenues for Visa, down from 71 percent in 2006, while MasterCard
derived 49.7 percent of its revenues from the US in 2007, down from
52.3 percent in 2006. Even though both networks do not carry
cardholder debt, as does their rival
American Express
(Amex), faltering economic conditions in the
US have the potential to significantly impact their issuing
In its March SEC filing, Visa noted that
increases in interest rates in the US could reduce the number or
average purchase amount of payment card transactions. Certainly,
financial results from the US largest issuers have been impacted by
the weakening economy and credit crunch, most notably in their
credit card operations.
Amex is at more risk than Visa and MasterCard
of a US economic downturn, due to its three-party model as an
issuer, acquirer and processor, as was evidenced by its first
quarter results, announced on 24 April.
Amex reported an 11 percent fall in income from
continuing operations to $974 million, while net income totalled
$991 million, down 6 percent from a year ago. In its US Card
Services unit, which contributes 51 percent of Amex’s revenues,
first quarter net income fell 19 percent to $523 million – however,
revenues net of interest expense increased 11 percent to $3.7
billion, due to higher spending and borrowing by consumers and
small businesses.
Most significantly, provisions for losses
increased 52 percent to $881 million, up from $581 million a year
ago, reflecting higher write-off and delinquency rates as well as
growth in loans outstanding and business volumes. Marketing,
promotion, rewards and cardmember services expenses increased 21
percent from the year-ago period reflecting increased investments
in advertising and promotion, as well as higher rewards costs. CEO
Kenneth Chenault said that marketing spend was being focused on
affluent US consumers and in international markets.
In a conference call with analysts, Dan Henry,
chief financial officer, emphasised that although losses and
past-due levels have trended higher within the US lending
portfolio, US volumes for retail and everyday spend grew 11
percent, representing about 68 percent of US billings. The
remainder of volumes, for travel and entertainment (T&E), rose
by 8 percent.
“Our credit quality indicators compare
favourably to the industry and continue to reflect the benefits
from our focus on the premium market sectors,” Henry said. “We
believe we are managing credit effectively in this difficult
environment, although our actions are suppressing spend volume
growth somewhat and will negatively impact credit metrics in the
near term.”
Discover Financial Services is the sixth
largest issuer in the US, and as of 2007 had $47.5 billion in
receivables, with over 50 million cardholders. It is also the third
largest US merchant network. (see Discover to buy Diners Club).
Discover has made significant inroads in the debit market since the
launch of Discover Debit in early 2006, and in April 2007 it signed
agreements with seven additional financial institutions for the
issuance of Discover Debit cards.
In the first quarter of 2008, US Card managed
loans grew to $47.5 billion, up 2 percent from last year driven
primarily by a 5 percent increase in sales volume. Pretax income
was $375 million, down 6 percent from the first quarter of 2007, as
higher provision for loan losses was largely offset by increased
net interest income and other income. The first quarter US Card
managed credit card net charge-off rate was 4.37 percent and the
managed over 30 days delinquency rate was 3.93 percent, up 51 basis
points and 62 basis points, respectively, from last year.


Increasing levels of debt

One of the knock-on effects of the credit crunch is that US
consumers are finding it harder to access new lines of credit,
which has resulting in them running up existing credit card
balances at a greater rate than before. However, despite pushing up
revolving credit in the short term, it is likely that overall card
debt will slow down as painful economic conditions drag on.

On 7 April, the US Federal Reserve published
its consumer credit statistical release, showing that revolving
credit in February 2008 jumped to $951.7 billion, compared to $947
billion in January 2008 – to put this figure into context,
revolving credit in the first quarter of 2007 was $887.5 billion.
Revolving credit has increased at an annual rate of 6
US credit bureaus such as Experian are also
reporting that borrowers are now more likely to pay their credit
card bills than their mortgages, reflecting increasing financial
distress, and suggesting that many US consumers have resigned
themselves to losing their homes and are using credit cards for
essential purchases such as food and energy.
During the past year, credit card debt has
risen most rapidly in parts of the US where the economy is
particularly weak, including California, Florida, Arizona and
Nevada, areas most mired up in the housing downturn.


Targeting the mass affluent

Given that there are fewer acquisition targets in a consolidated
credit card market, issuers appear to be returning to a focus on
organic growth in their portfolios.

However, what has become clear over the last
year is that US issuers are now making concentrated efforts to
acquire more affluent customers, in recognition that the saturated
middle-income consumer market has little room for expansion.

Bank of America
is the leading credit card issuer in the US
with $161.4 billion in managed loans as of the first quarter of
2008. According to the bank, its card services division contributed
25 percent of the bank’s earnings in 2007. Its card portfolios are
spread across all consumer credit card segments, including rewards,
affluent, co-brand, and affinity segments, and is underpinned by
the bank’s widespread distribution network encompassing over 6,100
banking centres, 18,500 ATMs, and over 5,000 affinity
Despite the difficult consumer credit
environment in the US, Bank of America says its customer base is
strong, citing the demographics of customers booked in 2007.
According to the bank, the average total household income of
customers booked in 2007 was $77,490, with 58 percent of customers
were homeowners with strong employment histories and a track record
of paying bills on time.

JPMorgan Chase
is also touting its high quality and
credit-worthy customer base, and is aiming to gain a bigger
proportion of high net worth and affluent customers by leveraging
the strength of its partner and affinity brands. JPMorgan Chase has
over 300 co-brand partnerships and a large T&E portfolio – one
element of its growth strategy in the affluent cardholder segment
is to improve authorisations and customer service to increase
spend, acknowledging that the high net worth segment are more
likely to undertake international travel.
JPMorgan Chase is also putting an increased
focus on rewards programmes to drive loyalty and engagement, and
higher revenue. According to a recent investor presentation, the
bank stated that rewards had increased from 32 percent of
outstandings in 2003 to 57 percent in 2007. The bank views its
rewards programmes as a key differentiator in a competitive market,
and delivers increased spending, greater levels of retention and
better credit performance.
Its Freedom to Change rewards proposition is
targeted at everyday purchases and enables customers to choose
between cash back and points with losing earned rewards, and offers
3 percent of points for gas, grocery and quick service restaurant
First quarter results for Citi showed that GAAP
revenues in the US cards unit decreased by 2 percent to $3.2
billion compared to the year-ago period, due to higher funding
costs and higher credit losses. However, managed revenues grew 14
percent to $4.8 billion, including a 6 percent increase in managed
Credit costs increased by $447 million, driven
by higher net credit losses, up 23 percent, and a $302 million
pre-tax charge to increase loan loss reserves. The relatively mixed
results for the US cards division lie in stark contrast to Citi’s
international cards division, which saw revenues increase by 76
percent, driven by acquisitions, higher average loans and purchase
sales, up 53 percent and 41 percent respectively.
Citi is taking an approach of improving
performance management by leveraging low cost channels, and
accelerating organic growth, by redirecting marketing funds to
higher growth areas, and expanding and leveraging partnerships.
Citi is also making a more concerted effort to expand cross-selling
programmes with Citi affiliates, for example through instalment
In an investor presentation in mid-2007, Citi
said it was aiming to have over 500 million card accounts leveraged
through its affiliate distribution channels by the end of 2007,
compared to 287 million in 2006.

Capital One
’s US card business reported an 8.8 percent fall in
net income to $491.2 million in the first quarter compared to a
year ago, but total revenues increased by a staggering $474.1
million or 20.3 percent compared to the year-ago period.
Delinquencies improved in the first quarter of 2008 to 4.04 percent
from 4.28 percent in the previous quarter but rose from 3.06
percent in the year ago quarter. Capital One increased its loan
loss allowance by $310 million to $3.3 billion – according to
Capital One, this allowance is consistent with managed charge-offs
of approximately $6.7 billion over the next 12 months.
According to CEO Richard Fairbank, the
company’s US Card pricing and fee changes drove substantial
increases in revenue margin, but also caused credit metrics to
worsen earlier and to a greater degree than in previous quarters.
The company warned that new minimum payment requirements could
accelerate charge-offs for some delinquent customers, and expects
the change to increase overall US card delinquencies and losses
“modestly in late 2008 with further increases in 2009”.


Profitability challenges

In the middle of the current credit crunch, it seems likely that
higher credit card losses and lower consumer spending will see
credit card returns on assets dropping at least 15 percent below
2007 levels, according to research from US research consultancy
TowerGroup. However, this will see issuers focusing their business
strategies on customer retention and expansion, rather than
acquisition or reliance on new account prospects.

TowerGroup says that issuers, in the current
climate, should focus on implementing more customer-centric
business models, and approaches which identify ways to reward
existing customers and encourage continued loyalty and card use.
Issuers will also need to keep a close eye on monitoring
macroeconomic portfolio metrics, such as outstanding balances,
delinquencies, charge-off rates and other metrics which can
negatively impact profitability.