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Personal Finances / Credit Cards and Consumer Debt
|Subject: How Credit Card Cos make $$||Date: 6/14/2000 10:51 PM|
|Author: ajhalligan||Number: 36569 of 308946|
This is in response to the Credit Card Bill of Rights thread and the frequent misunderstandings on exactly what a credit card is and how card companies make money.
First off, a credit card is a open agreement to by the Card Co to extend to the Customer an Unsecured Loan. The customer agrees to pay back the loan at the terms the card companies states.
A unsecured loan is signifcantly different from a secured loan like a car loan or a home mortgage. A unsecured loan is not backed by any pledge of assets like a house or a car. In other words the unsecured loan is signifcantly riskier than a house or a car loan because their is no colletrall to collect on. As investors we all know the higher the risk the higher the expected return.
Card companies make money on the interest on revolving balances and from fee income, such as late fees, over the limit fees etc. The majority of open accounts for most credit card companies consist of inactives (people who have never used the card) and convenience users (people who pay in full every month). Since very few accounts have annual fees, and it is impossible to book new accounts with annual fees, the result is that the minority number of card holders revolve, they support the convenience users who are taking advantage of the float, which is an expense to the card companies.
Card company expenses consist of: cost of funds (how much the money they lend you is costing them.) charge offs (loans that the company writes off, this goes directly against the bottom line.) overhead, marketing expenses, royalties and employment costs.
Right now the cost of funds based on the LIBOR is around 6 to 7%, and the other expenses will vary from company to company.
I believe a lot of the anger in the original post was directed at First USA, so I'll use them as an example.
First USA, last year did a lot of things that angered a lot of its customers. I think most of those things have been mentioned. (I am also not a FUSA customer, so I can't speak to them directly.) However, contary to what I see as the popular opinion on this board FUSA did not get away with abusing the trust of its customers. Dick Vauge and the other founders of FUSA who were still there all got fired. McCoy, who built BankOne into a National powerhouse, and whose grand father founded Bank One got canned. Over 4,000 FUSA employees have been let go and the ONE stock has lost over 55% of its value. FUSA is still causing problems and rumor has it that it might be sold off.
Currently FUSA has a charge off rate(write offs over outstandings) of 8% if you add cost of funds at 6.5% your at 14.5% and you haven't even turned on the lights.
First USA's charge off rate is so high because they pissed off a lot customers. The good ones (the ones who pay their bills)had other options, voted with their feet and left. That left a higher percentage of bad ones who don't pay, or declare bankruptcy. They have written off close to $1 Billion dollars in the last 6 months.
The bottom line is that any company, Credit Card or other, who engages in deceptive and unethical behaviour is playing a dangerous game. Retribution from the marketplace is swift and unforgiving. Card companies are competing for your business like everyone else. There are some very good ones and not so good ones.
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