Correction Appended
Independent credit card issuers have become an endangered species in the financial service sector this summer as the big banks, in search of higher profits, try to acquire them.
Yesterday, HSBC Holdings of Britain said it planned to buy Metris Companies, the 11th-biggest credit card issuer in the United States, for $1.59 billion in cash. In June, Bank of America said it would buy MBNA for about $35 billion. And a few weeks earlier, Washington Mutual said it had agreed to pay $6.45 billion for Providian Financial.
Banks see expanding into credit cards as an extremely profitable way to take advantage of the interest rate spread between the money they lend to customers and the money they take in from deposits. Credit cards can also be wallet-sized billboards for the banks' brands and an important way to cross-sell products like home mortgages and mutual funds.
Stand-alone issuers have higher capital costs because they lack a deposit base, and they have struggled to reach new customers in a saturated marketplace. Because they offer only credit cards, finding a more diversified financial firm to merge with has become a necessity for many.
"Our thinking was heavily influenced by our credit ratings," said Bill Houlihan, the chief financial officer of Metris. "We are single B- where all of our competitors are investment grade companies. That gives us a much higher cost of capital in that environment."
Metris, which is based in Minnetonka, Minn., will expand HSBC's base of lower-end customers, who typically pay higher interest fees but also have a greater risk of default. Of course, it is also a segment that it understands well. Not only did HSBC inherit a similar clientele when it merged with Household International in 2003, but David Wesselink, Metris's chief executive, was a longtime Household executive.
HSBC said it would pay $15 a share for Metris, a tiny premium over its Wednesday closing price of $14.84. But the deal could results in an enormous payday for Thomas H. Lee Partners, a private equity firm that is Metris's largest shareholder. Thomas H. Lee stands to receive at least $682.6 million if the deal is completed by Dec. 9. If the acquisition is delayed, it could pocket even more.
Metris has faced a series of regulatory problems over accounting irregularities, and disclosed that the Securities and Exchange Commission may pursue an enforcement action against two executives, including Mr. Wesselink. The deal, expected to be completed by the end of 2005, is subject to the resolution of the case.
With the latest deal, the focus now turns to whether Capital One, the largest independent issuer left, will become a target. Some Wall Street analysts are already counting down the months.
"You can see them trying to hold off for another six months to a year," said David Hendler, a financial services analyst at CreditSights, an independent research firm in New York. "There are a lot of willing buyers for Capital One, but they are still of a mind they can do it. MBNA was in that frame of mind for a long time until the fundamentals like payment rates began to slip."
To be sure, there are some important differences between Capital One and the other stand-alone issuers that have recently been sold. While MBNA and Providian pioneered marketing concepts like affinity partners and customer data analysis in the early 1990's, each had struggled to come up with breakthrough ideas recently. Capital One, however, has produced a steady stream of innovations, including low-interest teaser rates and flexible frequent flier mile programs.
Neither Providian nor MBNA made significant attempts to diversify their funding sources. Capital One, however, did. It now has a $13 billion automobile loan portfolio, and by September it should complete its $5.35 billion acquisition of Hibernia, a retail bank with branches in fast-growing areas like Texas and Louisiana.
"Capital One does have access to lower cost of funds through deposits with Hibernia," said Ed Groshan, an analyst at Fox-Pitt, Houghton in New York. "The issue is: will that be enough?"
Just a decade ago, the nation's stand-alone credit card issuers were Wall Street darlings, buoyed by double-digit industry growth rates and access to cheap capital. Today, however, growth rates have slowed and easy capital has dried up. Moreover, a rising interest rate environment, which will make funding more expensive without a large deposit base, and a more stringent national bankruptcy law, which could cause charge-offs to surge, have further dimmed their prospects.
Correction: August 6, 2005, Saturday An article in Business Day yesterday about HSBC's acquisition of Metris, the credit card issuer, misspelled the surname of an analyst who commented on changes in the industry and misstated the name of his firm. He is Ed Groshans, not Groshan; the firm is Fox-Pitt, Kelton, not Fox-Pitt, Houghton.