Bank of America’s big buy

Jun 30th 2005
From The Economist Global Agenda

America’s second-biggest bank is spending $35 billion to acquire MBNA, the country’s leading stand-alone credit-card provider. Why are banks keen to buy into a business that has seen growth slow and may soon be hurt by a deteriorating credit cycle?

EVEN in a week with plenty of news to impress Wall Street, Bank of America’s announcement on Thursday June 30th that it plans to buy MBNA was a gob-smacker. Bank of America is the country’s second-biggest bank. MBNA is its largest stand-alone credit-card provider. And $35 billion—the price tag—is the second-biggest deal announced in America so far this year. MBNA’s shares had been drifting up for weeks, but no one expected a deal so big or so soon. The acquisition will more than double Bank of America’s base of active credit-card customers to 40m, with over $140 billion in outstanding balances—placing it firmly in the top tier of American (and therefore global) credit-card companies along with the likes of Citigroup and J.P. Morgan Chase.

The deal makes good sense for Bank of America, which has been looking for something to do with its money (earnings in the first quarter of 2005 were a record $4.7 billion). After spending $48 billion on FleetBoston, the largest bank in New England, in October 2003, it has already hit its limit in retail banking—10% of national deposits—and under the regulators’ rules cannot acquire additional branches. Earlier this month it took a bold step overseas, paying $3 billion for a 9% stake in China Construction Bank—the biggest single foreign investment in China’s banking industry. Bank of America was (and still could be?) a possible buyer for Morgan Stanley, the embattled investment bank which has just ended months of civil war by asking former president John Mack to return to the helm. But even if Bank of America now never bids for Morgan Stanley, credit cards will fill the bill nicely.

Banks like the credit-card business because the juicy interest rates on card balances, combined with their own cheap deposits, produce fat profits. The credit-card business also offers access to a wider customer base. Three weeks ago, Washington Mutual, America’s seventh-biggest bank, bought Providian Financial, a credit-card provider, for $6.5 billion. Citigroup has been a serial acquirer of store-card portfolios. And other banks too are eyeing credit-card targets.

For the credit-card operators as well, merging with a bank makes sense. MBNA grew rapidly in the 1990s, attracting new customers by offering low rates of interest and forming relationships with institutions they were keen to support, such as their old colleges or favourite football teams. Recently, however, growth has slowed in the credit-card sector and MBNA’s business has gone flat, as its pallid first-quarter results made clear. The company has given warning that full-year earnings will be “significantly below” its earnings-growth target of 10%. Earlier this year, MBNA took a $768m restructuring charge to cover the closure of call centres and management-level lay-offs.

The credit-card business in America is highly concentrated already—the top ten issuers control 80-85% of the market—so it is difficult to gain market share. Competition from the big banks is putting pressure on stand-alone operators such as MBNA and Capital One. And the business and credit cycles may be about to turn nasty. Big retail banks’ cheap and stable deposit base will help to cushion the shock of any downturn.

Other banks and card operators are still looking for partners. Capital One bought Hibernia, a big New Orleans bank, in March and is now building up its lending businesses. Will that be enough to keep Capital One from being swallowed up? In May, Wachovia, America’s fifth-biggest bank, said it was interested in expanding in credit cards. And then, of course, there is Morgan Stanley, whose credit-card division, Discover, may yet be for sale. Enter Bank of America yet again?

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