Dunned If You Do, Dunned If You Don't
After two years of 25% growth, the credit card industry is reeling from a one-two punch that is putting intense pressure on profitability. Not only is the market saturated--there are over 1.2 billion cards in use--but issuers are being squeezed by two very different kinds of cardholders: those who stiff the companies through delinquencies and those who pay their balances before the interest clock starts ticking.
GE Capital Services struck back on Sept. 10 when it announced plans to charge a $25 annual fee to its Rewards MasterCard customers who pay their balances in full each month, while simultaneously lowering the interest rate from 17.1% to 11.9%. The fee is also an attempt to compensate for the cost of its cash rebate program. For example, those who charge a maximum of $10,000 a year on the card receive up to $140 back. Some 20% of GE Capital's 5 million cardholders will be hit with the additional fee, says Robert B. McKinley, president of RAM Research Group in Frederick, Md. "GE doesn't care if it loses this 20% because these are convenience users or cardholders who don't charge a lot and they pay it off," he says.
The number of users who pay promptly has been steadily rising in the industry from 29% in 1990 to 36% today, McKinley adds. And the rise in prompt payers is dragging down performance. Convenience users are costing bank-issuers an estimated $400 million annually in foregone interest, estimates James J. Daly, editor of the Chicago-based newsletter Credit Card Management.
The reimposition of fees comes as no shock to the industry, which has been trying for years to come up with ways to generate additional revenue. Bank card issuers receive 76% of their revenues from finance charges, 11% from the interchange fees paid by merchants, 4% from late fees, 4% from cash-advance charges, and the rest from annual and other fees, according to Daly.
But some of those revenue sources are evaporating. "If it is a no-annual-fee card, that leaves two sources of revenue: interest income and interchange," says Sanford C. Bernstein & Co. analyst Moshe A. Orenbuch. "And if the person doesn't borrow, you're down to just one: interchange." For most issuers, interchange income is 1.3% or 1.4%. "But if you're giving customers back 1% to 2% in value for use of the card, it is virtually impossible to make any money," Orenbuch adds.
While the business is still considered very lucrative--about 3% pretax of total receivables this year--it's far from the gravy train it was in the mid-1980s, when returns hovered around 6%. Indeed, David Hunt resigned last week as president of AT&T Universal Card Services. Performance there had been declining due in part to a high number of convenience users--50%--relative to the industry average of 36%. The Universal card had stunned the industry in 1990 when it offered charter members a lifetime no-fee guarantee.
NO GRACE PERIOD. While no other credit card company has adopted GE's approach, there is reason to expect that other rebate programs such as General Motors' or AT&T's Universal Card will become more restrictive. But because companies need to differentiate their cards in a crowded market, it's unlikely such freebies will be eliminated.
Instead, companies are relying on other more roundabout strategies. Many are shortening the grace period from 25 or 30 days to 20 days to get customers to pay up more quickly. The simplest way is to wipe out the grace period entirely, charging interest from the date of purchase, analysts suggest. "The problem is companies will probably lose the more profitable cardholders," McKinley says.
Some banks are trying to shift convenience users from credit cards to debit cards, which deduct the charges from customers' checking accounts within days of the transaction. Quicker payment reduces costs for issuers.
Meanwhile, fees are being charged for everything from late payment to basic customer services such as requests for additional copies of receipts, statements, or balance information. First Premier Bank in Sioux Falls, S.D., tacks on 50 cents to customers who request their balance more than twice. Another ploy: recalculating interest daily instead of monthly. This can increase the rate by about 20 basis points.
With delinquencies at a 15-year high, banks are keeping an eagle eye on potential credit risks. Even here, they are being blindsided by seemingly credit-worthy, responsible customers who suddenly go bankrupt. To reduce losses, Capital One Financial Corp. monitors cardholder credit files. If payments are falling behind, the company may jack up the rate, essentially requalifying cardholders every three to six months. McKinley predicts other lenders will soon follow suit.
Still, as companies try to shore up profit margins in the face of ever-tightening competition, they are slowly realizing the credit-card business is not the slam-dunk it once was. In fact, McKinley reports that companies are looking for executives with a risk management background in anticipation of further losses. The industry is starting to play defense.