Who Will Hold the Cards?
Stand by for the next wave of consolidation in the credit-card business. As American consumers gorge themselves on $675 billion of credit-card debt, the stakes have never been higher for card issuers. Today, the industry's Big Five--Citigroup, MBNA, First USA, American Express, and Discover--control over half the market, up from about a third a decade ago, according to The Nilson Report. But the pressure to get even bigger is intense as the critical mass for a profitable operation soars.
The costs of staying in the game are enormous. Analysts estimate that Citigroup alone plows about $1 billion annually into marketing consumer credit-card services to stay at the top of the pile with its $96 billion of receivables (table). Such massive outlays are unthinkable for even the 10th-largest bank-card issuer, Wells Fargo, with $9.9 billion of receivables, let alone the throngs of small and midsize banks. Besides, says Mark C. Alpert, specialty finance analyst at Deutsche Banc Alex. Brown, credit-card outfits may now need portfolios of at least $50 billion to profitably grow, double what they needed five years ago. "The majority of bank-owned credit-card companies will be sold in the coming years," predicts Kenneth Posner, specialty finance analyst at Morgan Stanley Dean Witter.
LETHAL COMBINATION. Indeed, since late 1997, 17 of the top 35 bank holding companies including Key Corp., SunTrust Banks Inc., and First Union Corp. have sold credit-card units to rivals. Once, they invested heavily to compete with a rising legion of specialty issuers such as Delaware-based MBNA Corp. The lethal combination of thinning margins and a possible rise in bad debts if the U.S. economy slows is prompting even more survivors to rethink their strategies. "The amount of receivables for sale has exploded," says Oliver Sarkozy, a managing director at Credit Suisse First Boston, which advised on sales of $15 billion worth of credit-card portfolios over the past 12 months.
Now Wachovia Corp. is considering throwing in the towel. One of the most successful midsize card operators, the Winston-Salem (N.C.) bank hired CSFB on Feb. 6 to advise it on what to do with its $8 billion credit-card portfolio. Just over a year ago it acquired a $2 billion portfolio from Partners First Holdings LLC, but now it's contemplating a sale--even though the business racked up 16% of Wachovia's earnings in 2000. If Wachovia does sell, it would be the largest deal since Advanta Corp. sold $11.5 billion of receivables to Fleet Boston Financial Corp. in 1998.
Even trophy franchises like American Express and Morgan Stanley's Discover could become takeover targets. As recently as Jan. 24, Wall Street was abuzz with scuttlebutt that Morgan Stanley Chairman and Chief Executive Philip Purcell was mulling selling the Discover unit to MBNA or Citigroup. Purcell denies that he plans to sell Discover, which analysts say could fetch as much as $14 billion. Later, rumors circulated within Morgan Stanley that Purcell wanted to buy American Express. Morgan Stanley neither confirmed nor denied the possible purchase.
SHORT LIST. American Express will not comment on the speculation, either. But analysts believe the company is more likely to be a predator. With a market cap close to $60 billion, it would be an expensive morsel to swallow. Moreover, since Kenneth I. Chenault took over as CEO in January, the company has made it clear that it does not plan to sell its own $50 billion portfolio. Instead, Alfred F. Kelly Jr., president of American Express' U.S. consumer services, sees the economic downturn as an opportunity to gain market share through more portfolio acquisitions. Indeed, American Express recently snapped up a $226 million credit-card portfolio from Bank of Hawaii. And it's on a short list to buy Wachovia's portfolio, investment bankers say.
A wild card that could change American Express' and Discover's fortunes is a Justice Dept. antitrust suit against MasterCard International, Visa USA Inc., and Visa International, expected to be decided this month. If the U.S. District Court of Manhattan eliminates Visa and MasterCard rules that prevent thousands of banks from also offering Amex and Discover cards, then the Discover franchise will become much more valuable--and Amex would likely push hard to grab back market share from archrivals Visa and MasterCard.
As the gulf between large and small credit-card players widens, there's plenty for American Express and others to go for. Analysts say that all midsize banks risk being scarfed up, though most of the larger ones insist they do not plan to axe their credit-card businesses. For example, although Chairman and CEO James Dimon of Chicago's Bank One told financial analysts on Feb. 12 that he expects revenues from the bank's credit-card business to be flat this year, he recently told BusinessWeek: "We love the business. We intend to be a winner in it."
To survive, Bank One and other middle-tier players such as Fleet Boston, Wells Fargo, and Bank of America will need to chase after valuable portfolios to develop a stronghold. Deutsche Banc's Alpert figures there are probably a dozen credit-card portfolios in the $500 million to $2 billion range that could be snapped up by larger players. "The first step is to try and buy," adds an investment banker who asks not to be named. "But if [the middle tier] fail in that, they may be sellers."
The smaller fry may not have much time to decide whether to get out or fight furiously to bulk up their businesses. Just as consolidation heats up, the industry is showing signs of slowing growth. Receivables of credit-card issuers may swell by only 6% in 2001, vs. a solid 10.4% rise the previous year. And new charges--key grist for the future growth of receivables--rose just 5.7% in the fourth quarter of 2000, to $225 billion, vs. 8.8% in the same period of 1999, according to Deutsche Banc Alex. Brown.
Indeed, the credit card industry could experience its worst operating environment in a decade. For the last two years, bad debts declined as consumer confidence rose. But recently, charge-offs have swelled as consumer confidence has fallen. Even large players are worried. Although he did not give specifics, American Express' Chenault warned financial analysts in a meeting on Feb. 7 that credit-card spending slowed in the fourth quarter of 2000. "If spending slows further and credit weakens, we will be impacted--not to the same extent as some of our competitors--but impacted nonetheless," he said. The average delinquency rates for the top 15 credit-card issuers crept up to 4.32% in the fourth quarter of 2000, from 4.11%. Echoes Robert B. Willumstad, head of the global consumer business at Citigroup: "There are concerns that we'll have a hard landing that will ripple through the consumer lending business," though there are no signs of weakness at present.
If there is a slowdown, it will also be tougher to sell expensive credit-card portfolios. "These deals for the most part are in cash," says Michael Hughes, specialty finance analyst at Merrill Lynch & Co. "You have to go out and raise money to do them. And that's tough to do." Analysts estimate that American Express paid as much as a 32% premium for Bank of Hawaii's credit-card portfolio. But "a slowdown in consumer spending could dampen any potential buyer's enthusiasm," says E. Reilly Tierney, a Fox-Pitt, Kelton financial services analyst.
Nevertheless, the credit-card wars won't be over any time soon. After all, when the going gets tough, the tough go shopping.
By Emily Thornton with Heather Timmons in New York and Joseph Weber in Chicago