MBNA's Earnings Machine Has Engine Trouble

The credit-card giant's market isn't boundless after all

For eight years, MBNA Corp. (KRB ) has defied the laws of gravity. Confounding naysayers, the Wilmington (Del.) credit-card giant has delivered annual earnings gains of 25% or better. Its secret: affinity programs, where MBNA teams up with such organizations as the National Education Assn. or the Cincinnati Reds to issue cards bearing their logos.

Through such partnerships, MBNA has created an earnings juggernaut with $98 billion in loans, 15% of the U.S. credit-card market, and the second-lowest rate of bad loans in the industry.

But it looks like 2002 could be the year MBNA falls to earth. Its portfolio is now so large that it's hard for the company to add accounts at the same pace. Growth in the market is cooling off, and fewer regional bank-card portfolios are for sale--a significant factor in MBNA's recent growth. Analysts also warn that MBNA's big bet on international markets, begun in 1994, may be slow going. "The rate of growth will have to come down," says John P. Waterman, chief investment officer at Rittenhouse Financial Services Inc., whose funds hold MBNA shares.

That reality, along with worries about slowing consumer spending, seems to be weighing on MBNA's stock, which trades at around $36. It has been more or less flat for the past couple of years despite the company's strong earnings gains. Moshe Orenbuch, an analyst at Credit Suisse First Boston, notes that MBNA's price-earnings ratio based on projected 2003 earnings is about 13.5: That's roughly 70% of the overall market multiple and somewhat less than the 85% the company has seen historically.

MBNA President Charles M. Cawley acknowledges the growth challenge: "It gets tougher for us every year," he says. Friedman, Billings, Ramsey & Co. financial-services analyst Todd A. Pitsinger figures net income will be up 16.3% this year, to nearly $2 billion. While that's certainly respectable--and in line with the 15%-plus growth that Cawley and Chairman and CEO Alfred Lerner, owner of the Cleveland Browns, have targeted since taking the company public in 1991--it's well below what Wall Street has come to expect.

For years, analysts have warned that MBNA's growth could stall. The company defied such predictions by attracting large numbers of low-risk, free-spending borrowers. But the credit-card market is expected to slow to 6%-to-7% growth from double digits in the '90s. Plus, most customers have cards with fixed rates, which the company can raise or lower with 30 days' notice. However, those fluctuations tend to lag changes in the rates that MBNA must pay to finance its receivables. Last year, its cost of funds fell faster than the rates it charged customers, giving earnings a boost. But the same phenomenon will work against MBNA if rates rise later this year.

Cawley isn't giving up on U.S. expansion. He figures that, despite critics' pessimism, there are still plenty of new affinity groups to sign up. All the same, slowing domestic growth is encouraging MBNA to push harder into foreign markets. It has beachheads in Britain, Ireland, and Canada. On May 14, MBNA got approval to open an operation in Spain, its first in Continental Europe. Right now, just 11% of the company's portfolio is outside the U.S. MBNA Senior Executive Vice-President Bruce L. Hammonds figures that can grow to 20% over the next five years.

But while MBNA has seen major success in Britain, expansion in Continental Europe may be slower. That's because British consumers use credit cards much the same way Americans do, carrying outstanding balances, but many Continentals still pay off balances automatically each month. "The challenge will be to change consumer behavior," says Gary M. Stibel, principal at New England Consulting Group.

Cawley admits that MBNA has a marketing job ahead of it in Europe. But he notes that the card giant has done it before. Half of British cardholders paid their balances in full each month when MBNA started there eight years ago. Now, just 10% of MBNA's customers do.

The one thing MBNA won't do, he says, is become overly aggressive to juice its earnings growth rate. "We grow at our own pace," he says. The question now is how much that pace might slow in the years ahead.

By Amy Barrett in Philadelphia

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