Pushing Plastic Is Still One Juicy Game

Almost everybody, it seems, is getting into the credit-card business. General Electric Co., which announced its MasterCard on Sept. 2, and General Motors Corp., which plunged in with a lower-rate, no-fee version of its own on Sept. 9, are only the latest big-league entrants.

Accompanying the flurry of new players is a rash of special deals, discounts, and interest-rate cuts. That's fostering the impression that card companies, which had steadfastly kept rates charged to cardholders above 19% despite falling interest rates in the economy, finally are succumbing to rampant competition.

But while the competition certainly is heating up, it's far less cutthroat than it appears. Thanks in part to the downward spiral in money-market interest rates, the spread between the rates charged to card users and what issuers pay for money is still downright seductive. On Sept. 4, the Federal Reserve lowered the federal funds rate, a good proxy for bank issuers' cost of funds, to 3% from 3.25%. With the average credit card fetching an incredibly steep 18%, the rate spread is huge and will remain so even when many issuers offering floating-rate cards lower finance charges to reflect the recent cut in the prime rate (chart). "The card business is still a bonanza," says analyst Thomas H. Hanley of First Boston Corp. Which is precisely the reason so many folks are so anxious to get into the business.

Given the wide spread, some critics say card issuers could easily lower rates and still make a very attractive return. But major issuers seem in agreement that it doesn't make a great deal of sense to provoke what could easily turn out to be a ruinous price war. "I think it's getting more competitive, but nobody has done anything to kill the golden goose," says Mark Gross, an analyst with IBCA Ltd., a bank credit-rating agency.

SELECTIVE CUTS. Many issuers have recently begun offering lower rates, at least to their most creditworthy customers. That's the result of complaints of excessive rates from consumer advocates and growing consumer demand for lower prices. "The rates are being changed," says Thomas C. Lynch, head of Chase Manhattan Corp.'s card operations, "but they are being changed prudently."

In effect, this has excluded vast numbers of cardholders from low-rate programs. A recent survey of the top 100 issuers by The Nilson Report, a Santa Monica (Calif.) newsletter that tracks the industry, found that 36% of the 139 million card accounts at the top 100 issuers still are being charged more than 19%. Fewer than a third are paying less than 16%, and only 2% are paying under 12%. Robert B. McKinley, publisher of RAM Research Corp.'s newsletter, CardTrak, says only 25% to 30% of applicants qualify for very low-rate cards, vs. 40% to 45% for higher-rate plastic.

The special deals have caught the attention of local government officials. "We understand that low rates are offered to a small subclass of a bank's customers, and that's not what you would typically see in a truly competitive market," says George W. Sampson, chief of the New York Attorney General's antitrust bureau. "It's only really happening around the edges."

COLLUSION? For years, credit-card issuers rebuffed any suggestion that rates should be lower. They argued that the card business is notoriously risky, often producing huge losses. Unlike other forms of consumer credit, such as auto loans or home mortgages, credit-card loans have no collateral. Moreover, cards were made more widely available to consumers, even individuals with less than sterling balance sheets. Issuers dismissed suggestions of collusion from consumer advocates, who found it curious that nearly all of the major issuers charged 19.8%.

Issuers have since mellowed their stand on rates. Most now are adopting tiered rate programs for better customers. But they still insist that costs are high. Write-offs remain steep, they say, especially with personal bankruptcies on the rise. Last year, Visa and MasterCard issuers are estimated to have charged off $8.4 billion in bad card loans. That's almost 25% of the $34.2 billion in revenue they collected, according to The Nilson Report. In 1990, charge-offs totaled $5.9 billion. At the end of March, 4.3% of card loans were 30 days or more past due. That's down from 4.6% in the previous quarter, but the delinquency rate is still above prerecession levels of 3.5%. "You can't just take a product that's priced at 18% to 19% and give it to everyone in the customer base at 12%," says Richard A. Greenawalt, president of Advanta Corp., a Horsham (Pa.) card issuer with 2.2 million Visa and MasterCard customers.

Despite tougher competition and issuers' huge costs, most of them continue to reap handsome profits. Although industrywide profits are declining as more competitors enter the business, many big bank issuers are expected to report a 3% return on assets from their card operations this year, vs. 1% for their bank businesses, according to analysts. That's little changed from last year's results. "I expect another good year" in 1992, says Chase Manhattan's Lynch. "And next year will be another good year."

Even the new entrants in the business, which have been the most aggressive on the pricing front, are expected to make out well this year. American Telephone & Telegraph Co. stirred up the industry in 1990 by introducing its own no-fee MasterCard and Visa, called the Universal Card. Although it has lowered its rate twice since January, AT&T's card division began turning a profit in June. And Paul G. Kahn, head of AT&T's card operations, says he expects an additional half-point rate cut on AT&T's floating-rate card in October, to 14.9% for charter customers and 15.9% for new cardholders.

Even with the pressure to lower rates, many issuers are trying to preserve their existing margins. An increasing number of issuers are adopting variable-rate programs, often pegged to the prime rate, that allow them to raise finance charges automatically if rates rise. Moreover, many issuers of low-rate cards have boosted annual fees to offset the dip in interest income. Wachovia Corp. offers four options, in which it adjusts fees according to rates. For example, the bank charges a $39 fee for its lowest floating-rate Visa and MasterCard, now at 8.9%. Customers who want a lower fee can pay $15 for a standard fixed-rate card, which carries a rate of 17.98%.

CARD TRICKS. Some big issuers have found other ways to offset the impact of lower rates. Often singled out by analysts and competitors is Citicorp. The nation's biggest credit-card issuer won a lot of favorable publicity last April, when it announced it was adopting a floating-rate program that, in effect, lowered rates on its gold and standard bankcards, which have stood at 16.8% and 19.8%, to 13.9% and 15.9%, respectively. Even Senator Alphonse M. D'Amato (R-N.Y.), who ignited the intense debate in Congress late last year over high card rates by introducing legislation to cap interest charges, praised Citi's decision.

On close scrutiny, however, Citi's policy isn't as revolutionary as many industry watchers initially believed. The new rates apply only to purchases after June 1, 1992, while existing balances still are being charged the former rates. Analyst Ronald I. Mandle of Sanford C. Bernstein & Co. reckons that only 20% of Citi's $32 billion in credit-card receivables will be affected.

Even better, from Citi's viewpoint, the new program will have little impact on its credit-card earnings. Its net interest margin is expected to climb above 10% this year, from 9.7% last year, thanks in large part to lower cost of funds. Mandle forecasts that Citi's aftertax card income will climb 31% this year, to $635 million.

Despite the desire of issuers to keep alive and well the goose that laid the golden egg, many observers are convinced that the continuing lush profits could sooner or later set off a far more intense round of price-cutting. Thomas R. Butler, president of Sears, Roebuck & Co.'s Discover Card division, admits that his company, the only major issuer that clings to 19.8% for all its customers, may have to change. Says Butler: "We're not totally deaf and dumb to what our competitors are doing."

Then there's the lingering question about Congress. Although criticism has simmered down as rates have been reduced, consumer advocates, such as Bankcard Holders of America, argue that banks can do better. And the activists may get a sympathetic hearing from legislators before Election Day in November. CardTrak's McKinley says card rates may settle between 15% and 16%. Says McKinley: "Consumers would feel comfortable around that level."

For now, however, credit-card executives are hardly in a panic. Few of them foresee the kind of price war that has shaken other industries, such as airlines. Unless consumers become far more vocal in demanding lower rates, competition in the credit-card business is likely to remain quite prudent. And profits will likely stay exceedingly comfortable.

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