This story is an updated version of one that appears in the May 2009 issue of Cards&Payments.
U.S. bankcard issuers managed to sidestep the worst effects of the mortgage meltdown through the first half of last year, but in the latter half a full-blown economic crisis swept the banking industry. Credit card spending suddenly flattened, and charge-offs soared.
In two dramatic fourth-quarter developments, JPMorgan Chase & Co. acquired teetering Washington Mutual Inc., and Wells Fargo & Co. absorbed Wachovia Corp., instantly reshaping the competitive landscape for card issuers.
Though analysts say 2008 likely marked the beginning of an economic downturn that will endure for at least two years, U.S. issuers of Visa- and MasterCard-branded consumer cards still managed to turn a solid profit, Cards&Payments data show. Issuers posted a collective after-tax profit/return on assets of $17.71 billion, or 2.48% of average outstandings. That represents a 2.9% drop from the previous year's collective profit of $18.25 billion, or 2.71% of average receivables (see chart). (Also see U.S. and Global Charge Volume and Market Share of the Leading Brands.)
Cards&Payments calculated total bankcard receivables on managed credit card outstanding balances for the nation's top 12 U.S. Visa and MasterCard issuers at the end of 2008 compared with 2007, using data gathered from the Federal Reserve Board and the Federal Deposit Insurance Corp. This methodology marks a shift from previous years, when C&P based the industry's total receivables on data the card brands previously supplied or required estimating.
The most significant development affecting issuer profitability last year was the sharp increase in credit card delinquencies and charge-offs. Although issuers began tightening card-underwriting standards in 2007 in response to a softening economy and rising charge-offs, credit card delinquency and charge-off rates soared during the second half of 2008.
"What was different about 2008 was the velocity of accounts going into default during the final months of the year," says Scott Strumello, an associate at Auriemma Consulting Group, a U.S.-based consultancy. "Accounts flowed through the delinquency buckets and to charge-off status faster than we have previously seen, disrupting old business models. Instead of signaling a warning of potential charge-offs, delinquencies last year tended to point directly to charge-offs."
Issuers had combined average outstandings of $713 billion last year, up 5.8% from $674 billion in 2007, C&P estimates show.
Purchase volume on consumer cards reached $1.37 trillion, up 0.74% from $1.36 trillion in 2007, C&P research shows. Purchase volume had increased by 3.1% in 2007 from the previous year.
Total charge volume, including cash advances, was nearly flat at $1.58 trillion compared with 2007.
Issuers' cost of funds reached $22.82 billion last year, down 12% from $25.92 billion in 2007, caused primarily by a lower federal funds rate. Robert K. Hammer, chairman and CEO of U.S.-based R.K. Hammer Investment Bankers, estimates that the lower cost of funds probably boosted issuer profitability by about 40 basis points.
But the slight advantage issuers gained through eased funding costs was more than offset by the sharp spike in charge-offs, especially toward the latter half of 2008. "The surge in charge-offs last year far overshadowed all other profitability variables in 2008," Hammer says.
The average charge-off rate for prime credit cards in 2008 was 6%, compared with 4.35% in 2007, according to C&P research. In fact, last year's charge-off rate marks a return to historic charge-off rates, says Cynthia Ullrich, senior director of asset-backed securities for Fitch Ratings Inc. Prime credit card charge-offs typically hover around 6%, but rates were uncharacteristically low in 2006 and 2007 following a change in bankruptcy law, she notes.
"Charge-offs rebounded last year, as unemployment grew and home values weakened," Ullrich says. "Consumers who fell behind on their credit cards became unable to catch up as alternative funding sources, such as home equity-funded lines of credit, dried up."
Charge-off rates varied significantly among issuers, and individual issuers' profitability rates correspondingly fell within a wide range last year, Hammer notes. Some issuers' income yield in 2008 was as low as 11%, while others' were as high as 22%, according to Hammer's research.
Bankcard issuers last year generated total revenues of $129.60 billion, up 9.8% from $118.03 billion in 2007. Expenses rose 13.8%, to $102.36 billion from $89.96 billion, driven by a 52% increase in charge-off costs. Spending on marketing and promotions rose 2%, to $35.65 billion from $34.80 billion in 2007 (see chart).
Cards&Payments' research reflects an average blended interchange rate of 1.75%, slightly lower than 1.77% in 2007, as card networks responded to industry pressure to reduce interchange rates on some merchant categories including gasoline. Those rate-reductions were somewhat offset by card issuers continuing to aggressively market credit cards with premium rewards programs, which tend to carry higher interchange rates, Strumello suggests. Merchant acquirers pay interchange to card issuers.
C&P developed its profitability report from issuers' earnings reports, government agencies, Visa and MasterCard revenue and operational data, and interviews with industry consultants and analysts.
As for revenues:
• Total year-end receivables grew 2.7% in 2008.
• Interest income assumes an average annual percentage on revolving balances of 15%, up from 14.2% in 2007, and that 81% of accounts revolved, down slightly from 82% in 2007.
• Penalty-fee income was up 14%, and the percentage of accounts delinquent rose slightly to 5% from 4.8% in 2007. The average late fee for 2008 was $39, up from $37 in 2007.
• Annual-fee revenues assume that 16% of bankcard accounts paid a fee, down from 19.2% in 2007. The average annual fee on an open account was $45.25, compared with $48 in 2007.
• Revenues from enhancements such as credit insurance and other marketing programs increased by an estimated 10%.
On the expense side:
Cost of funds fell slightly, to 3.02% of average receivables from 4% in 2007.
The fraud rate rose slightly, to 7% of total charge volume from 6.6% in 2007.