There's something really scary stalking the credit-card industry: the specter of the enlightened consumer. That frightening creature, it seems, is behind the troubles at Bank One Corp., which issued a dire profit warning on Aug. 24. Consumers, Bank One disclosed, are giving up cards issued by its First USA unit in droves because of the company's increasingly aggressive policy on late fees. Bank One shares plunged 23% on Aug. 25, shaving $15 billion from its market capitalization. But nearly all credit-card company shares fell, too, even though none has reported the same problem.
Yet. But the forces that are working against First USA, the No. 2 card issuer, may affect competitors, too. In recent years, credit-card companies have fiercely fought for each new customer, sending out billions of solicitations a year and cutting teaser rates to unprofitable levels. Companies sacrifice profits at the front end in hopes of recouping later when the teaser rates expire and they collect significant nuisance fees for such things as late payments. In Bank One's case, that strategy finally hit a wall of consumer resistance.
"It's created a consumer backlash," says Robert B. McKinley, CEO of CardWeb.com in Frederick, Md., which tracks the industry. "No one is really winning here. They are battling over the same customers."
POOR EARNINGS. Bank One blamed the defections in part on a third-party processor that was late in crediting payments. But, bank officials also acknowledge, the aggressive collection of late fees (including charges for checks received on the due date itself) didn't generate enough revenue to make up for customer defections. And the bank's chief executive officer, John B. McCoy, warned that the entire card business is coming under pressure. "The industry isn't growing at 12% anymore," he said. "We have to take share from others now."
The trouble at First USA shocked analysts. "A Bank One earnings disappointment is no surprise," says analyst Diana P. Yates of A.G. Edwards & Sons Inc. "The fact that it came from First USA is." The bank, the nation's fifth-largest, has repeatedly disappointed Wall Street with poor earnings, and its stock has vastly underperformed its peers. But First USA, which Bank One bought in 1997, has been a star performer in the credit-card industry. Under First USA CEO Richard W. Vague, a pioneer in direct marketing, the company's 2.9% return on assets has consistently beaten the 2.3% industry average.
So, if this pillar of the market is shaky, analysts figure, others could be vulnerable to consumer wrath, too. Throw in higher interest rates in general, and the inevitable price competition on the Internet, and chances are card issuers will face even greater challenges. "The problem is bigger than Bank One," says analyst Michael L. Mayo of Credit Suisse First Boston. "Banks need to spend more to keep their market share."
The next move for issuers is unclear. They obviously face potentially conflicting objectives: get more customers and make the business more profitable, too. Charles W. Peabody, analyst at Mitchell Securities Corp., worries that banks will be tempted to go down market, issuing cards to people with spottier credit histories. This strategy could be risky and ultimately not profitable. CardWeb's McKinley suspects issuers could also get tougher--although it certainly wouldn't endear them to customers--by cutting the grace periods before customers have to pay interest, for instance. No doubt, with growth slowing and rivals threatening, card issuers will have to do something.