By AnnaMaria Andriotis
Following some of their strongest years ever, credit-card issuers are grappling with an uneasy future.
Rising loan losses and increased rewards expenses are putting pressure on card lenders' returns. The result is that one of the most profitable consumer-lending categories in recent years may become more of a middling player.
"The easy money has been made in card lending," said Don Fandetti, consumer finance analyst at Wells Fargo & Co.
While cards remain highly lucrative for banks, the benefits of a rising interest-rate environment have been muted lately. The added revenue of cardholders paying more in interest payments each month has also been offset by growing competition from lenders trying to poach card customers by offering lower rates.
Credit cards became an appealing loan category for banks in the wake of the last recession. Card balances grew at an accelerating pace in recent years, reaching a 7% year-over-year growth rate early last year. Total balances exceeded $1.03 trillion in January, the highest on record, according to the Federal Reserve.
But that coincided with an increase in loan losses from historically low levels, as banks set aside more money for future write-offs. They also tightened their underwriting standards, resulting in slowing growth. Card-balance growth in March was up 4.8% from a year earlier, compared with a 6.1% increase in March 2017 from the year-earlier period.
Five of the largest credit-card issuers -- American Express Co., Capital One Financial Corp., Citigroup Inc., Discover Financial Services and Synchrony Financial -- generated a median return of 2.1% on their assets for common shareholders in the first quarter, up from 2% a year earlier but down from 2.6% two years prior, according to analysis by Autonomous Research. The recent peak was 3.7% in the second quarter of 2011, according to an industry analysis by Autonomous at the time.
"The industry was at an unsustainable high...so coming down is expected, " David Nelms, Discover's chief executive, said in an interview.
The pickup in returns for most banks in the first quarter was primarily the result of tighter underwriting, which helped slow the rate of loan loss increases and the amount of money banks are setting aside for future losses. U.S. tax-law changes that lowered corporate tax rates also helped.
Still, returns remain largely unchanged -- and in some cases down -- from about 2 1/2 years ago when the Fed began raising rates. "Rising rates [are] a mixed blessing for the card issuers at this point," said Brian Foran, analyst at Autonomous Research. Companies aren't getting the full benefit of the higher rates because while interest charges on cards are rising, so are the interest rates card issuers are having to pay bank customers for their online deposit accounts.
Some analysts predict that profitability will keep falling, though it remains significantly higher than many other banking products. Credit cards delivered a projected 3.8% return on assets to 14 large banks highly concentrated in the card business last year, compared with an overall 1.35% projected return for all commercial banks, according to payments consulting firm Mercator Advisory Group Inc. Mercator projects that card returns will fall in 2018 to 3.5% due to losses and challenges cutting further costs.
Stocks of card companies have reflected the concern, with Discover shares down 0.8% so far this year, and Synchrony Financial, the largest U.S. store credit-card issuer, down 11.4%, compared with a 4% gain in the KBW Nasdaq Bank index.
Credit-card losses have been mostly rising over the past two years after hovering around near-record lows. The average net charge-off rate -- the share of outstanding debt that issuers wrote off as a loss -- for eight of the largest credit-card issuers reached a nearly five-year high of 3.46% in the first quarter, according to Fitch Ratings. The increases have become worrisome indicators for some shareholders of consumers' inability to pay debts at a time when unemployment is low.
Another pain point for card issuers is the cost they incur from so-called gamers, who search for the highest rewards on their cards. These consumers sign up for credit cards with rich sign-up bonus offerings and then stop using the card once they have tapped out the early rewards.
U.S. credit-card attrition rates, a measure of how many cards consumers and card issuers close, reached 15% in 2017, up from less than 10% a year earlier, according to Mercator.
Meanwhile, banks and fintech lenders that originate personal loans have been increasing solicitations in recent quarters. Many of these offers are targeting consumers with credit-card debt and pitching the opportunity to roll over that debt into a personal loan at a lower interest rate. Their prime targets are the customers who card issuers want to keep most: those with high credit scores who carry a card balance each month.
A record 516 million personal loan solicitations were mailed out in the first quarter, up 46% from a year ago, according to estimates from market research firm Competiscan. This marked the fifth-consecutive record-breaking quarter.