VOL. 81 NO. I AUSUBEL: CREDIT CARD MARKET competitive spot markets, if unobservable Bank credit card increases in quality exactly offset reductions low-up survey n factor costs. The profitability data enable performed direct one to dismiss this possibility: profits, in of the 50 larges fact, dramatically rose at the time that the cards cost of funds dropped Call reports: Profitability data for another It is possible to object to the following nine of the extracted reported, by their very nature, represent FDIC call reports filed by the banks with the ex post profits. Perhaps(especially since the Prospectuses: Partial data on profitability for sample period is during a cyclical boom)the an additional eight large banks were ob- observed profits are merely a very favorable tained from filings with the SeC in con- realization of a random variable whose nection with the sale of credit-card ex ante returns were quite ordinary Second backed securities it might be thought that, while the credit card market was extremely profitable in Respondents to the author's survey were the years 1983-1988, the market has now promised anonymity (but details of the con quilibrated and henceforth normal returns struction are provided in Appendix A). The will be observed. Third, the profitability call reports and prospectuses are part of the figures might be derived from accounting public record. Table 2 reports the size dis- data that either are being misinterpreted or tribution of banks included in each of the are systematically misstating true economic survey, call report, and prospectus samples I consider each of these concerns else A. An Illustrative Profit Calculation where in the paper. In Section IV, I briefly discuss an additional source of evidence(the As will be detailed in the next two sub Federal Reserve Systems functional cost sections, earnings in the banking industry analysis), which, while significantly less reli- are usefully expressed as a percentage of able than the other data (in this author's assets: returns on assets are linked with opinion), gives profits over a longer period returns on equity by the banking system's that includes the previous cyclical down- capital requirements. Before reporting turn. In Section V, I introduce another in- mary profit figures for 15 and estimates for dependent set of data which examines eight of the 50 largest issuers, I will examine sale prices of credit card portfolios between in detail the components of revenues and banks and finds that they trade at large costs for one individual credit card issuer, I premia. The latter data indicate that ex ante consider here Maryland Bank, Na returns from credit cards are quite large (MBNA), the Delaware-based credit card and, since they are based on market valua- arm of MNC Financial. which is ranked tions, should help allay any fears that the seventh in Table 1. 18 This institution was accounting data are being misinterpreted. selected because more public information Finally, it should be recalled from Table 4 exists on its credit card operations than on that the interest rate spread was quite any other banks: MBNA, which is required healthy except for a brief period around to file its own call report, has credit card 1981 and that this brief spell of unprof- loans exceeding 92 percent of its assets, and ability can be attributed to banks not hav- it has also made several credit-card-backed ng yet established credit card subsidiaries securities offerings exploiting the Supreme Court's marquette ecision. This episode does not seem likely I MNC Financial is the 39th largest U.S ussed in this section originate from three National Bank. nthe the csr orate parent of Maryland The ex post profit data re and. MBna was founded in Newark. Di independent sources and were assembled by 1982, apparently to avoid Marylands usury the author also the text near footnote 9 This content downloaded from 202. 120. 224.93 on Sun. 17 Dec 201707: 42: 57 UTC Allusesubjecttohttp:/about.jstor.org/termsVOL. 81 NO. 1 AUSUBEL: CREDIT CARD MARKET 57 competitive spot markets, if unobservable increases in quality exactly offset reductions in factor costs. The profitability data enable one to dismiss this possibility: profits, in fact, dramatically rose at the time that the cost of funds dropped. It is possible to object to the following analysis on several grounds. First, the data reported, by their very nature, represent ex post profits. Perhaps (especially since the sample period is during a cyclical boom) the observed profits are merely a very favorable realization of a random variable whose ex ante returns were quite ordinary. Second, it might be thought that, while the credit card market was extremely profitable in the years 1983-1988, the market has now equilibrated and henceforth normal returns will be observed. Third, the profitability figures might be derived from accounting data that either are being misinterpreted or are systematically misstating true economic profits. I consider each of these concerns else- where in the paper. In Section IV, I briefly discuss an additional source of evidence (the Federal Reserve System's functional cost analysis), which, while significantly less reli- able than the other data (in this author's opinion), gives profits over a longer period that includes the previous cyclical down- turn. In Section V, I introduce another in- dependent set of data which examines re- sale prices of credit card portfolios between banks and finds that they trade at large premia. The latter data indicate that ex ante returns from credit cards are quite large and, since they are based on market valua- tions, should help allay any fears that the accounting data are being misinterpreted. Finally, it should be recalled from Table 4 that the interest rate spread was quite healthy except for a brief period around 1981 and that this brief spell of unprof- itability can be attributed to banks not hav- ing yet established credit card subsidiaries exploiting the Supreme Court's Marquette decision. This episode does not seem likely to be repeated. The ex post profit data reported and dis- cussed in this section originate from three independent sources and were assembled by the author. Bank credit card survey: The author's fol- low-up survey yielded profit calculations performed directly by executives of seven of the 50 largest bank issuers of credit cards. Call reports: Profitability data for another nine of these issuers were extracted from call reports filed by the banks with the FDIC. Prospectuses: Partial data on profitability for an additional eight large banks were ob- tained from filings with the SEC in con- nection with the sale of credit-card- backed securities. Respondents to the author's survey were promised anonymity (but details of the con- struction are provided in Appendix A). The call reports and prospectuses are part of the public record. Table 2 reports the size dis- tribution of banks included in each of the survey, call report, and prospectus samples. A. An Illustrative Profit Calculation As will be detailed in the next two sub- sections, earnings in the banking industry are usefully expressed as a percentage of assets: returns on assets are linked with returns on equity by the banking system's capital requirements. Before reporting sum- mary profit figures for 15 and estimates for eight of the 50 largest issuers, I will examine in detail the components of revenues and costs for one individual credit card issuer. I consider here Maryland Bank, N.A. (MBNA), the Delaware-based credit card arm of MNC Financial, which is ranked seventh in Table 1.18 This institution was selected because more public information exists on its credit card operations than on any other bank's: MBNA, which is required to file its own call report, has credit card loans exceeding 92 percent of its assets, and it has also made several credit-card-backed securities offerings. 18MNC Financial is the 39th largest U.S. bank hold- ing company and the corporate parent of Maryland National Bank, the largest commercial bank in Mary- land. MBNA was founded in Newark, Delaware, in 1982, apparently to avoid Maryland's usury law. See also the text near footnote 9. This content downloaded from 202.120.224.93 on Sun, 17 Dec 2017 07:42:57 UTC All use subject to http://about.jstor.org/terms