JULY 2004

Trends in Credit Card Lending Activity

Issued in June, the Federal Reserve Board's fourteenth annual report about the profitability of credit card operations of depository institutions reveals that banks dedicated to the issuance and servicing of credit card accounts consistently enjoy higher returns than those involved in all commercial bank activities. For the purpose of this survey, the Fed defines these monoline institutions as: 1) having more than $200 million in assets; 2) holding the greater part of these assets in consumer lending (i.e., loans to individuals); and 3) designating credit cards as 90 percent of their consumer lending. Note that some of these card banks are units of larger bank holding companies.

Twenty-one banks accounting for approximately 67.5 percent of outstanding credit card balances at the end of 2003 met the criteria outlined above to be deemed large credit card banks. In 2003, large credit card banks reported an 11.6 percent increase versus 2002 in net earnings before taxes adjusted for credit-card backed securitization. As shown in the figure below, the return on credit card operations of 3.66 percent of outstanding balances in 2003 represents the fourth consecutive year of improvement in earnings. The higher returns earned by large credit card banks reflect and compensate for the risk associated with this form of undiversified lending. The increased returns in 2003 are attributed to a number of factors including improvements in credit quality and decreases in both interest and noninterest expenses per dollar of assets.

Credit card holding increased almost 2 percent from 2002 to 2003 to approximately 4.8 credit cards per person. The number of VISA and MasterCards alone reached 556.3 million in 2003. Facing a moderation in the rate of growth in cardholding reflecting saturation in the card market, card issuers have engaged in aggressive competition for new customer accounts. The nature of the competition has changed over time and the feature driving it now involves interest rates. Improvement in credit scoring technology allows more and more issuers to engage in risk-based pricing while over half offer variable-rate pricing that adjusts automatically to market conditions.

Competition also led to the continuation of the consolidation trend in 2003. Sears Roebuck Acceptance Corp securitized $3.9 billion in 2002 making it the largest ABS retail issuer and sold its MasterCard portfolio to Citibank. Next, FleetBoston Financial bought Circuit City's $1.5 billion credit card portfolio and was then acquired by Bank of America resulting in "...a combined entity valued at more than $48 billion in general-purpose credit card receivables" according to Standard and Poor's. The domination of larger issuers is reflected in the composition and weighting within S&P's Credit Card Quality Index. In May 2004, the top ten issuers represented 87 percent of the $400 billion in receivables held in rated credit card-backed securities trusts, representing two-thirds of the U.S. bankcard market.

Pricing practices reflected in credit card interest rates have also changed in recent years. As noted above, many issuers employ risk-based as well as variable-rate pricing (54 percent of issuers as of January 2004). After a period of relative stability since the early 1970s, rates experienced a sharp decline from mid-1991 through early 1994, remained flat until 1998, and since then underwent another period of rapid decline (see figure below). The average interest rate for those credit card holders incurring interest charges in 2003 was 12.92 percent.

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