A look at the US Fed’s most recent card industry
profitability report makes gloomy reading, even without taking into
account recent regulatory interventions hampering issuers’ ability
to raise rates and fees. However, some believe the industry may
emerge fitter and stronger, as Victoria Conroy

There is no doubt that the profitability of the US credit card
industry is in decline, but the issue is whether this decline is
terminal, and whether the industry can regroup in the face of
mounting regulatory pressures and a severe slowdown in consumer

Judging by the latest report from the US Federal Reserve on the
profitability of US credit card operations, it appears that US
issuers have an enormous challenge on their hands. The Fed’s latest
report, based on the consolidated call reports from banks
themselves filed with their federal supervisory agencies, shows
that as of December 2008, 18 banks with assets exceeding $200
million met the definition of a credit card bank, accounting for
approximately 77 percent of outstanding credit card balances on the
books of commercial banks or in pools underlying securities backed
by credit card balances.

These 18 credit card banks reported 2008 net earnings before taxes
of 1.43 percent of outstanding balances adjusted for credit
card-backed securitisation, a massive fall of 132 basis points or
nearly 48 percent from 2007. Although the large credit card banks
as a group experienced positive returns for 2008 taken as a whole,
US issuers experienced losses in the fourth quarter of 2008 as
credit quality problems grew. Despite an increase in outstanding
balances, year-to-date income fell about four percent from the end
of September to the end of December 2008.

Rate of return well below average

The Fed’s report starkly illustrates the scale of the problem now
facing US issuers: “The 2008 rate of return is very low by historic
standards; well below the average rate of return of 3.03 percent
since 1986. Much of the decline in net earnings can be traced to
deterioration in credit quality; credit card delinquencies rose
sharply in 2008 and along with them provisions for loan losses and

The importance of credit card earnings to a bank’s overall balance
sheet is also spelled out clearly. Although profitability for the
large credit card banks has risen and fallen over the years, credit
card earnings have been consistently higher than returns on all
commercial bank activities. For example, for all commercial banks,
the average return on assets, before taxes and extraordinary items,
was 0.04 percent in 2008, down around 137 basis points, or 97
percent, from 2007.

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With recent regulatory measures impacting on the ability of issuers
to re-price and hike interest rates on credit cards, the Fed’s
report notes that while average interest rates paid by consumers
have moved in a relatively narrow band over the past several years,
for the year 2008 credit card interest rates averaged 13.57 percent
for those incurring finance charges, down about 110 basis points
from the 2007 average.

However, the Fed’s report also notes that although on average,
credit card interest rates fell for those paying interest, data for
the first quarter of 2009 shows an increase in rates likely
reflecting re-pricing in response to rising delinquencies and
charge-offs. Only 11 percent of surveyed banks reported interest
rates below 16 percent on their largest credit card plans as of
September 1991, but 85 percent did so as of January 2009. In
addition, the proportion of card issuers reporting that they
utilise variable-rate pricing has also increased substantially
since September 1991, when 23 percent of issuers used variable-rate
pricing; as of January 2009, the proportion was 61 percent.

Issuers take pre-emptive action

Following the passing of the US Credit Card Accountability,
Responsibility and Disclosure (CARD) Act in May, credit card
issuers began scrambling to raise interest rates and fees before
new regulations come into effect in 2010, much to the chagrin of US
consumers and legislators.

For example, JPMorgan Chase announced in June that it would be
raising minimum payment levels for some customers from two percent
to five percent of the statement balance from August 2009, while
Citi raised interest rates on between 13 million to 15 million
credit cards, mainly on co-branded cards with major retailers, such
as its Sears card. Holders of co-branded credit cards who failed to
pay their balance in full at the end of the month saw interest
rates rising by an average of 3 percentage points between January
and April of this year.

Moshe Orenbuch, an analyst at Credit Suisse First Boston, told CI:
“Since January, Citi has experienced the largest increase in
purchase APRs, up 270 basis points from January. This is consistent
with recent management commentary to re-price the portfolio in
order to mitigate credit costs. We expect the current purchase APR
level to remain relatively stable going forward.”

Other fee increases included those applying to balance transfer
fees – both JPMorgan Chase and Discover increased the maximum fee
charged for transferring balances from between 3 and 4 percent to 5

However, re-pricing is not happening across the board. Orenbuch
noted that Capital One has taken a less traditional approach to
pricing modifications in June, having notified customers that
current purchase APRs would remain unchanged until early 2010 or
later, perhaps to coincide with new card regulations coming into
effect, after which a higher APR would take effect. Orenbuch added
that he expected purchase APRs across the industry to continue to
trend higher ahead of card legislation coming into effect in

US Industry Profitability

Delinquencies and charge-offs still rising

When it comes to delinquencies and charge-offs, Fitch Ratings gave
a glimmer of hope in its May 2009 Credit Card Indexes report, in
which it stated that delinquent receivables in US credit card
portfolios had receded from their month-earlier levels, halting a
run of four straight record highs for delinquencies (see CI

However, it looks like that particular upturn was short-lived, with
Fitch’s June 2009 report showing that US consumers continue to fall
behind and default on their credit cards at record rates. At 10.44
percent, June’s charge-offs are 62 percent higher on a
year-over-year basis. Meanwhile, 60-plus day delinquencies reversed
course to set yet another record high at 4.45 percent in June after
dropping seven basis points in May, the first improvement seen in
four months. Given delinquency and bankruptcy trends, Fitch expects
charge-off increases to decelerate in the coming quarter.

The report shows Fitch’s three-month excess spread index falling
below the 5 percent threshold for the first time since November

Excess spread is compressing as a result of soaring charge-offs,
but the overall effect on excess spread would be worse had there
not been strong gains in gross yield. Although prime rate is 175
basis points lower year-over-year, gross yield is actually 17 basis
points higher, indicating that issuers have been successful in
implementing re-pricing measures over the last three

Whether such measures will help issuers gain a reversal of fortunes
remains to be seen but credit cards will continue to be a crucial
element of bank profitability in the years to come. Sanjay
Sakhrani, an analyst at Keefe, Bruyette & Woods, told CI:
“While the industry is likely to be somewhat smaller and less
profitable after new laws are put in place, we still believe credit
cards will continue to provide one of the most lucrative returns of
the asset classes within banks’ portfolios.

“While the CARD Act most certainly is more negative than positive,
we think a positive by-product of its release is that there is now
some visibility for issuers on what’s needed to be done to remain
in the business profitably. Still, we expect returns on assets to
be negatively impacted and the industry to shrink somewhat from
current levels as a result.

“Near term, revenue yields are likely to be flat to higher as a
result of the law given issuers are likely to modify pricing
strategies to offset economic impacts related to the law. From late
February 2010 onward (when the guidelines of the law are
implemented), we think it really comes down where we are in the
cycle as far as the extent of the impact the law will have on
profitability. If conditions remain weak, there is likely to be a
negative impact and vice versa if conditions are better.”

US card industry profitability