New credit card rules could help banks
The CARD Act might help banks by making their lending businesses less risky over time.
By Lauren Tara LaCapra, TheStreet
New credit-card rules that go into effect today will make the industry less profitable, but also less risky, for the country's largest card lenders and issuers.
Credit cards had become cash cows for big firms like Bank of America (BAC), Citigroup (C), JPMorgan Chase (JPM) and Capital One (COF). Credit cards provided $23 billion in fees alone last year, according to the advisory firm R.K. Hammer, and also have higher interest rates than most other types of consumer debt.
Those penalty fees soared 21% from 2008 while the average interest rate has climbed 2 percentage points during the past six months to 14%, according to CreditCards.com. Customers with the worst credit have been hit the hardest, with their average rate surging to 24.86% from 14.29% over the same period of time.
But just as implied revenue has climbed during the recession, so have losses from delinquencies and defaults. Bank of America, the largest US lender, collected $20.3 billion in interest payments and $9.1 billion in fees from credit-card borrowers last year. Still, it lost $5.6 billion on the business in 2009 because of charge-offs of bad debt and provisions for future losses.
There have been some signs of improvement recently in monthly payment data from big banks, but they aren't out of the woods yet. Consumers are still relying on credit cards as a loan of last resort, and many of them aren't paying it back, due to job losses and other financial stress. When the economy recovers, the Credit Card Accountability, Responsibility and Disclosure (CARD) Act will make it more difficult for lenders to earn quick, easy profits from even the best credit-card borrowers.
The regulation will force banks to be more transparent about terms, offering them in simple language, and will not allow them to quickly change rates or fee structures. If they do plan to raise rates, customers get more time to opt out of the debt agreement and more time to pay outstanding balances.
The CARD Act will also ban lenders from preying on less-sophisticated consumers. For instance, the common practice of offering college students gifts or food in exchange for filling out an application will now be banned, and students will also have to prove their ability to pay before being approved.
Big banks are using different approaches to deal with the impending changes, and the negative effect they will have on revenue and profit.
Bank of America appears to have embraced regulatory changes aimed at helping consumers, as part of its overall push for better customer service. The bank rolled out a "clarity initiative" for its 40 million credit-card customers in November, distributing one-page explainers of terms and fees that were easy to understand. Management has warned investors during conference calls that Bank of America will lose up to $800 million in revenue because of the CARD Act.
Citigroup, on the other hand, has been combating the change by adding annual fees to popular credit cards. The New York Attorney General attacked the firm for attempting to use the same tactic on checking accounts. Citigroup settled the dispute by suspending those plans.
Management indicated during a fourth-quarter conference call that Citigroup will lose anywhere from $400 million to $600 million in net pre-tax revenue as a result of the CARD Act. It's unclear whether the government will crack the whip again for Citigroup's planned credit-card fees, which customers have been informed about via mass mailings.
JPMorgan Chase's Jamie Dimon has been a vocal critic of much of the consumer-protection legislation, saying it will increase costs for banks while reducing revenue without helping consumers. The changes will eventually make all consumers pay more, rather than target the ones who mismanage their money. Dimon’s argument has largely fallen on deaf ears.
"The effects of the CARD Act coupled with the overall attitude in Washington regarding consumer protection will likely continue to reduce industry revenues and profits over the next several years," Credit Suisse (CS) analyst Moshe Orenbuch said in a recent note to clients.
JPMorgan has been aggressive in pursuing new customers and expanding banking relationships with existing ones. The bank estimates it will lose $500 million to $750 million in annual revenue as a result of the CARD Act legislation.
The outlook for the card business is murky. Credit quality of borrowers won't fully recover until the job market does, and stiff regulation will further push down profits. Issuers will therefore face tough competition for the “primest” of prime borrowers, a space typically inhabited by American Express (AXP).
Orenbuch said the current environment is "one of the most challenging in the history of the business," predicting "few winners ... in 2010."
He suggests that investors buy shares of MasterCard (MA) and Visa (V), which, as processors, have little exposure to any of the regulatory or credit headwinds. He remains “neutral” on Capital One and Discover Financial Services (DFS), and thinks American Express will underperform because it lacks exposure to the fast-growing debit card business.
For diversified lenders, the impact of new rules will be felt in the near term. But over the long haul, the CARD Act might benefit the banks it seeks to redress more than the consumers it seeks to assist.
"While the recently instituted CARD Act will reduce near-term profitability, we expect it to lead to a healthier card issuing business with lower credit risk, reducing the sensitivity of the business to economic downturns," William Blair analyst David Long said in a recent report.
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