Plastic That Looks Like Gold

Credit-card portfolios are hot -- but the market may be peaking

Would you be willing to pay $1.19 to buy each $1 you owed to a credit-card company? No? Well, outfits such as MBNA (KRB ) and Citigroup (C ) are. In fact, they're fighting one another to to pay top dollar for credit-card operations -- essentially what cardholders owe to the issuers. Despite high delinquency rates, rising unemployment, and escalating bankruptcies that heighten their risks, buyers are forking over premiums that average nearly 19% of debts.

The reason: In the credit-card business, big is beautiful. The industry's giants can weed out bad customers quickly, lure profitable ones into borrowing still more, and spread their risks and overhead among millions of debtors. So paying a premium to plump up their portfolios makes sense, because the income they get from running more and more customers through a back office that's already in place goes right to the bottom line.

Just one problem: There aren't many top-flight portfolios left to buy. In the wake of the consolidation battles of the past few years, more than 80% of U.S. bank credit-card debt outstanding is owed to the top 10 issuers, led by Citigroup. The scarcity has pushed up premiums, even as the deals get smaller. Last year there were 37 major deals involving $24 billion in debt sold at an 18.4% average premium, says industry consultant Robert K. Hammer of RK Hammer Investment Bankers. So far this year, there have been 20 deals -- but they involved assets totaling only $4.1 billion, at an average premium that jumped to 18.99%.

The peak in the market for credit-card debt, however, may be not be too far off. "This year is still a seller's market," Hammer says. "Next year [if interest rates rise] is more of an open question." Indeed, analysts say the giant $31 billion Sears, Roebuck & Co. credit-card business, put on the block in March, could fetch a premium of 8% or less, even though a clutch of bidders is interested. Buyers fret over the hefty charge-off rates on the Sears proprietary card and the retailer's young and untested Gold MasterCard business. They don't consider it top-flight. Sears expects to announce a deal by the end of the year.

The acute shortage of good buying opportunities to boost growth only adds to the pressures faced by credit-card companies. Personal bankruptcy filings were a record 1.57 million in the year through March -- up 7.4% from the previous 12 months, according to the American Bankruptcy Institute. Loan losses are climbing because some 4.2% of bank credit cards are now 30 days or more past due, according to Standard & Poor's (MHP ) And with the jobless rate showing few signs of falling, "U.S. households continue to struggle with the burden of consumer debts incurred in the 1990s," says Samuel J. Gerdano, the bankruptcy institute's executive director.

No wonder card companies are busy pruning their lists to keep only profitable cardholders on the books. Using refined data-mining techniques, they cull nonpayers and delinquents by ratcheting up the rates they're charged or levying fees. Meantime, they inundate top customers with offers to borrow still more -- as long as they remain good risks and keep paying. Making money depends on spotting problems quickly among the millions of cardholders whose accounts the firms handle.

Certainly, more portfolios will change hands as more banks and retailers move out of the increasingly risky business. Says Philip G. Heasley, CEO of Bank One (ONE )'s card-services unit: "In a consolidating industry you try to maintain share." But elephantine deals such as Sears' notwithstanding, most sales will be small. For regional banks or niche retailers thinking about getting out of plastic, times couldn't be better -- but they shouldn't wait forever.

By Joseph Weber in Chicago

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