Since the stock market hit its lows in March of 2009, it has been on a steady rise since (depending on when you read this post, things may be different off course). Many pundits are wondering whether this rally is sustainable. Today, I would like to highlight my thoughts on the credit card industry since it is my expertise. I will go through some moves that issuers have made since the financial crisis and offer opinions on where stocks of credit card issuers are heading.
The most important point to note is that prior to the crisis, credit card issuers have been too liberal and granted credit too easily. Due to the competitive nature of the industry, they also offered to many rewards to consumers and they were not compensated for it. For the industry to get back on it’s footing, they would have to resolve these two issues. Here is what they have been doing.
Cost Cutting Measures
Increasing increase rates – Even though the Federal Reserve has essentially kept rates close to zero, credit spreads remain wide. As the securitization market has shut down, credit card issuers have found that borrowing costs have gone up as well. To preserve their margins, they have raised interest rates on existing card holders. Initially, the increases were dished out on folks who were late. A lot of credit card customers who carried a balance were pissed as hell. Then, credit card issuers decided to come clean and just say they were due to “economic conditions” (at least they were being honest about it). Then once the CARD act was passed, they simply decided to raise rate across the board.
Cut credit lines – Credit Card issuers have also been reducing credit card limits for many customers. Credit lines could be cut for so many reasons. Credit card issuers have statistics on consumer behavior that could lead to an increase in default rates. If any ones hits that trigger, they could very well have their credit limit cuts.
Here’s an example of what typically happens. A card holder has a card with a $20,000 credit line that has not been used and suddenly charges $5,000 to the card. A credit card company might slash the limit to $5,200. The reason for this is that people who suddenly use their card when they have not used them for a long time are perceived to be higher risk because they probably are using it as a last resort.
Here’s another example where Amex has cut customers lines because they shopped at Walmart.
In other instances, an unused card will simply be canceled by credit card issuers.
Reduce Rewards – During the bull market easy credit days, credit card issuers had to compete to get new customers. Because the market was already saturated, issuers had to increase their rewards. But very often, this made the cards unprofitable. Here are some examples of how they have cut their rewards.
In the good old days, the best cash back credit cards paid 5% rebates on things like gasoline, supermarket and drugstore spending. Cards like the Citi Dividend Card and the Chase Freedom (old version) had such formulas. Then they cut back to paying 3% rebates, then 2%. Now, there is hardly any card which has such generous formulas. These days, cards may still pay good rebates on certain types of expenditure, but they only pay them during certain periods of the year. The industry jargon for this is the rotating category.
Credit Card issuers has also been cutting back on gas rewards. gas credit cards used to pay 5% rebates for gas purchases. But many gas station cards are now paying rebates based on gallons purchase rather than price. Cards have also cut down their rewards from the lofty 5% levels. For example, the Discover OpenRoad Card is now paying 2% on gas rather than 5%. Amex Business Platinum is also reducing gas rebates from 5% to 3%. They are also putting limits on how much spending you can have on gas before they stop paying any rebates.
Credit Card reward programs have also been cutting on their airline travel rewards too. In the old days, you needed a fixed amount of points to get a free ticket to a particular destination. For example, it normally takes 25,000 points to get a round trip coach ticket around the continental US. But that meant that a ticket that cost $400 would be a better deal if the card holders used his or her 25,000 points than if the ticket cost $150. Such arrangements hardly exists anymore. Instead credit card issuers have arranged with online travel sites and basically, you now need 100 points to redeem for $1 worth in ticket price.
Imposing foreign transaction fees – Credit card issuers tend to slap a 3% fee when you use your card in other countries in foreign currencies. Now most cards impose that fee even if the transaction is US dollars but the company that you purchased from is a foreign company. This is another sneaky way to get more “fees”.
Getting Rid of silly Balance Transfer Offers – In the good old pre 2008 crisis days, credit card issuers were competing furiously with one another by offering ridiculous 0% balance transfer offers with no fees. There was a stage where almost all issuers had identical 0% deals for 12 months with the balance transfer fees waived. The expectation was that folks who transferred their balances would eventually be sticky customers. But instead, they simply switched to another card.
But worse than that, folks started taking on these deals because they were cheaper than a home equity line of credit! Some even took these deals and put them in online high yield savings accounts (which yielded 5% in the good old days).
These days, issuers are now imposing balance transfer fees and cutting down introductory periods to 6 months. They have also essentially removed most balance transfer offers from business credit cards.
Cost Cutting Over – Now what?
As I have illustrated above, credit card issuers have done the necessary measures to weed out “high risk” accounts. They have also for the most parts reduced the rewards that they pay out. But does that mean that they are good investments now? I’m not too sure. Here’s the missing piece of the puzzle.
Consumers have too much debt – The problem with the whole credit card industry is that the market is pretty much saturated in the United States (unlike some emerging markets elsewhere). Most folks already carry a few cards. So it really makes me wonder where will growth come from. I hunch tells me that it will come from innovative offerings to those with very good credit.
Traditionally, issuers like Amex and Discover have tended to target more affluent households. But even some like Amex have been swept up by the “easy money” era. Rather than sticking to their charge cards, they went after the unsecured credit card sector. Their Platinum Card used to be pretty cool until they issued it to thousands of folks and came up with the Centurion Card. But if Amex went back to their core competencies and only did charge cards to high end accounts, their company would be a lot smaller than today!
Impact of CARD Act – The immediate impact of the card act is that credit card issuers have less leeway to make money on things like late fees, over the limit fees etc. They also need a longer time to inform customers of any rate changes.
With the passing of the CARD Act and the fact that consumers are in a debt reduction mode, I think credit card issuers will have a slow growth path ahead. Yes, we might see default rates drop down the road, but my suspicion is that the days of people getting new credit cards all the time are over. My two favorite issuers are American Express and Discover and I think that if they can shrink their business and focus more on high end customers, they will have a very sustainable business model.
Issuers like Chase and Bank of America are in a consolidation phase because of their past credit card acquisitions. Chase took over Bank One’s portfolio and BOA bought out MBNA not too long ago. We are likely to see them consolidating their credit card products and trimming customers. So from that perspective, we might see some positive effects from product consolidation and cost cutting.
Reputation Tarnished – The actions that credit card companies took (like hiking rates and reducing credit lines) may have been necessary to protect themselves against a rise in default rates. But there was a lot of collateral damage in that folks with great credit also got hit. I get lots of angry comments on my blog and I think that many folks are so pissed (coupled with the fact that these companies got taxpayers money in a bailout) that many will not be too thrilled applying for another credit card if they do not need one.
Conclusions – For folks looking to invest in credit card companies, you obviously have to look the financial statements, data and valuations to see if there is any compelling valuations. What I’ve tried to put here is some perspective from someone who see their actions on a micro level. From where I sit, I do not expect this sector to be a great growth story going forward.
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