| Profit
from the Booming Credit Card Business |
Published: September 13, 2005
Imagine owning a business that
pulls in interest rates of more than 13.5% in today's market.
That type of an opportunity
probably sounds too good to be true, especially given the current
environment. After all, interest rates on most corporate bonds, as well
as foreign government debt, remain near multi-decade lows. For example,
10-year U.S. government bonds currently yield just a touch over 4%.
Yet despite this low interest
rate environment, a handful of companies are currently lending money at
double-digit average rates.
Perhaps this just sounds too
risky. After all, basic economic theory tells us that a firm can always
lend money at high rates if it is willing to lend to borrowers with poor
credit histories. Unfortunately though, default rates associated with
these types of risky loans tend to be high, meaning there's a decent
chance that they'll never get repaid.
However, the companies I'm
talking about don't have that problem -- default rates have been
hovering under 5% for the last three years. In other words, the best
firms in this business have a virtual license to print money by
borrowing at ultra-low rates and then turning around and lending out
that same cash at exorbitantly high rates.
As
you've probably already guessed, I'm referring to the credit card
business here. Like most companies in the financial world, credit card
issuers make money from interest rate spreads -- the difference between
their cost of capital and the rates they charge on loans.
The chart to the right shows
the average interest rate charged on a standard (not platinum or gold)
credit card in the U.S. The data is produced by averaging together rates
charged on cards from scores of different issuing banks and card
companies.
My second chart shows 5-year
U.S. government bond yields -- a decent proxy for a bank or card
company's cost of capital. It's clear that the spread between average
credit card rates and bond yields remains very fat. As a result,
business remains excellent for credit card companies.
In
addition, the credit card business is benefiting from fat fees right
now. For example, when consumers travel abroad and make charges on their
cards, the credit card issuers earn an additional fee for handling the
foreign currency exchange. And if you've ever forgotten to mail in your
credit card payment, then you're also well aware that card companies
levy a late fee -- the current national average is about $35 for a late
payment. These additional fees are just icing on the cake for credit
card companies that are already benefiting from strong lending profits.
In the table below, I present a
list of some of the best-positioned publicly traded credit card
companies. And in the text that follows I examine two of my favorite
firms in this industry...
Important:
To view the remainder of this article, in which StreetAuthority.com
founder Paul Tracy and his staff provide a table of key industry
players, as well as in-depth profiles of their two favorite credit card
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-- Paul Tracy
Editor
StreetAuthority
Market Advisor
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Paul Tracy
founded StreetAuthority and became Editor in Chief in 2001. Prior to
that he spent several years as Managing Editor at a multi-million dollar
financial publishing firm with over 150,000 subscribers. In addition to
his role as managing editor and lead financial writer, he was also
responsible for equity research and managing a team of seasoned
professional financial writers, researchers and market commentators.
Paul's previous experience
includes a position at Robert W. Baird & Co.'s full-service
brokerage operations as well as economic research work on a Money and
Banking project funded by the National Bureau of Economic Research. He
has also spent time doing outside consulting and research for the
University of Virginia, has appeared as a guest expert on several
prominent financial radio shows, and has been a featured speaker at
various investment conferences across the U.S.
Paul graduated with a B.S.
in Finance and Management from the McIntire School of Commerce at the
University of Virginia.
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