The tough economic climate in the US – and recent card-related
legislation – is placing a myriad of pressures on card issuers.
However, two of the industry’s leading analysts are optimistic that
the worst could nearly be over, and that the merchant acquiring
industry could stand to benefit, as Charles Davis


In a good news/bad news scenario, a pair of leading financial
analysts has announced that while the weak economy would cause
credit card issuers to report weak payment volumes and high
charge-off losses in the second quarter of 2009, the industry may
also be nearing the bottom of the recessionary trough.

According to a pair of reports by Keefe, Bruyette & Woods
analysts Sanjay Sakhrani and Steven Kwok, new card regulations are
putting tremendous pressure on issuers, but “there is now some
visibility for issuers on what’s needed to be done to remain in the
[credit-issuing] business profitably.”

The analysts assume a rather distressing 11 percent unemployment
rate this year, which will generate a corresponding increase in
charge-offs, depressing earnings for the second quarter and through
the remainder of the year. The analysts do not expect issuers to
return to “normal” earnings until around 2011.

Sakhrani and Kwok predict that the Credit Card Accountability,
Responsibility and Disclosure (CARD) Act, which President Obama
signed into law in May, and which places restrictions on card fees
and pricing beginning next year, will hurt overall industry profits
by working in tandem with current economic factors to drive
cardholders away from carrying large revolving balances.

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Regulation could benefit Amex

This could drive cardholders away from revolving cards and toward
American Express (Amex), they note, citing its upscale brand and
the fact that Amex already charges an annual fee on many of its
charge card products, which could appear relatively more appealing
to customers as more bank card issuers tack on annual fees to make
up for lost fee income.

Other issuers, most notably Capital One, could have higher
short-term losses than its peers because of its heavier overall
reliance on fees, including over-limit fees, which the new law will
ban next year.

On the other hand, Capital One traditionally has focused on prime
customers, unlike some large bank competitors that have heavily
marketed card offers with promotional low annual percentage
interest rates to “rate-hoppers,” they say. As a result, Capital
One’s brand and its products could be better suited than some of
its peers to thrive as issuers begin to operate in a more regulated
environment, the analysts say.

In their latest report, Sakhrani and Kwok argue that credit cards
“will continue to provide one of the most lucrative returns of the
asset classes within banks’ portfolios.”

The analysts note at the onset that card companies are “under siege
on many different fronts” and that the industry is likely to be
somewhat smaller and less profitable after new laws are put in
place. But they added that the card companies should be able to
adapt to the new regulations, and in some cases, thrive under

They added that the new rules on fees will least affect credit card
networks Visa and MasterCard and probably will not have as big of
an impact on Amex and Discover as some fear.

Merchant acquiring could thrive

In a recent report on the merchant side of the business, the pair
said that merchant acquirers and processors have attractive
business models given that they do not have exposure to credit risk
and generate fairly strong cash flows that could be used to expand
their business and/or share repurchases.

The industry continues to remain highly fragmented and continued
consolidation/joint ventures will likely occur given that these
business models are highly scalable, they note.

“We believe much of the future growth in the industry could be
driven by expansion into international regions and other channels
such as prepaid and health care,” they wrote. “However, we think
that the continued consolidation in the US banking industry and
potential encroachment by Visa and MasterCard into the space could
pose risks to the merchant acquirers/processors business models.
Thus, we continue to favour both the card networks and card issuers
in our coverage universe over the merchant

The analysts see ample evidence of the US card industry finding the
bottom of the economic free fall, noting slowing chargeback rates,
flattening payment rates and an improving macroeconomic picture.
All of the major card performance indicators are down, they note,
but the rate of erosion is slowing, and none of the bellwether
measures are anywhere near as bad as they were in previous

Still, it may be unwise to dismiss the prospect of unemployment
topping 10 percent, more scrutiny from the government and
consumers’ newfound sense of thrift – especially after the sizable
bounce the credit card stocks have enjoyed as of late. Whether the
equity markets continue to reward US issuers has much to do with
events beyond the control of issuers.