A New Headache For The Credit-Card Biz

First refinancing let people pay off their cards. Now they're tapping home equity

Robert E. Stone II is the kind of guy credit-card companies hate. When those seductive low-rate card offers come pouring in by mail, he says, "they go right into the recycling bin." The only thing Stone, a university press marketing manager in Ann Arbor, Mich., wants to do is pay off his debt. Adding more plastic to his wallet, he says, would be "taking two steps forward and three steps back."

Unfortunately for credit-card issuers, more and more folks are finding ways to move away from plastic. For several years they've piled their debt onto their home mortgages through refinancing. And with the refi boom winding down, they're moving it to low-rate home-equity loans. The shift, along with the higher costs of funds, is dimming industry prospects. Growth in credit-card receivables -- what card holders owe -- has slipped to low single digits for issuers in the last couple of years, and some industry watchers think the trend is here to stay. "The logic of borrowing at 3% to 7% on a home-equity loan compared to 13% on a credit card is too powerful to ignore," says Morgan Stanley (MWD ) analyst Kenneth A. Posner.

That dynamic has transformed the credit industry into an ever more cutthroat arena in which maintaining profitability is increasingly tough. Fierce competition in the battle for market share has driven plastic issuers to keep churning out the zero-rate or low-rate balance-transfer offers they've come to rely on. And despite rising rates, there's little sign that the avalanche of offers will slow. "You can count on that lasting," says Robert K. Hammer, who heads his own bank-advisory firm in Thousand Oaks, Calif. "It continues unabated."

The double whammy -- first from the refi boom and now from the home-equity loan craze -- is clearly taking a toll. Pumped up by consolidation, pretax profits for the industry's seven biggest card issuers are growing at a heady 29.2% clip this year, but that rate will likely slow sharply to 18.8% next year, forecasts Credit Suisse First Boston analyst Moshe Orenbuch. Morgan Stanley expects credit-card companies this year to lose some $17 billion in receivables to mortgage refinancing and $89 billion to home-equity loans. "People have been consolidating a lot of debt, and they've been using their home equity to do that," says Greg McBride, a senior financial analyst at Bankrate.com, a firm that tracks the card industry.


To fight off the profit squeeze, plastic merchants are trying to impose higher rates. Their preferred strategy: shifting customers to variable-rate cards, whose rates can change without notice, instead of fixed-rate cards whose customers must be warned in advance of a change. For instance, Capital One Financial Corp. (COF ), which had long stressed its low rates, on Nov. 18 began promoting a "PrimeLock" card, whose rate matches the monthly prime lending rate and rises along with it. Perhaps 60% of new card offers are for variable-rate cards, up from half in 2002, says McBride of Bankrate.com.

That has helped. On average, variable-rate cards carry an annual interest rate of about 14.34%, up from 13.9% a year ago, according to Bankrate.com. For most consumers who carry balances, such small hikes add only a few dollars to the typical monthly balance -- not enough to make them switch cards but enough to help bolster margins. Still, card issuers must walk a fine line, wooing some consumers with low teaser rates even as they hike rates for others.


Indeed, credit-card companies are quietly putting the squeeze on customers in other ways. They're shortening the periods when low teaser rates stay in force, for instance, sometimes to as little as three months.

At the same time, they're increasingly resorting to marketing gimmicks to keep cardholders from looking for better deals. Elaborate rewards programs that offer airline miles, electronic gear, gift certificates, and even seats on the bench at NFL games are among the come-ons credit-sellers are using. MBNA Corp. (KRB ) offers American Express (AXP ) credit cards that carry the names of alumni associations or other so-called affinity groups as well as a card that lets consumers amass points used to reduce their mortgages. MBNA Senior Executive Vice-President Jim Donahue insists that his company can outgrow the industry. But he concedes the growth rate "is going to be a little bit lower" than the sharp gains of a few years ago.

The credit-card industry may get help from an unexpected quarter: Bank regulators are hinting that they won't allow the home equity binge to continue unfettered. Given the roughly $460 billion in such loans outstanding, the Comptroller of the Currency is drawing up new guidance for national banks on managing risks in their home-equity portfolios. "We have lots of risk guidance for credit cards, but now home-equity loans are getting to the same scale," says a spokesman for the Comptroller. "We just want to make sure that banks are managing those risks as well."

Still, credit-card outfits can't just fight among themselves anymore. Now they can add home-equity lenders to the list of rivals that are finding gold in America's growing mountain of consumer debt.

By Joseph Weber in Chicago, with Mike McNamee in Washington

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