A Look at the Multi-Billion Dollar Business Behind Store Credit Cards

On this special episode of Consumer Goods Industry Focus, special guest Gaby Lapera joins Sean O'Reilly and Vincent Shen to share updates from the financial industry and how they intertwine with the retail sector.

First, learn more about store credit cards from major retailers like Macy's, Target(TGT -0.71%), and Amazon(AMZN 1.49%). While customers are attracted to the shopping discounts and purchase points, companies are reaping billions in profits from these offerings and enjoying access to valuable data. And following Sunday's big game, the cast discusses Quicken Loans' Super Bowl ad and zero-down mortgages as part of a broader update on the housing market.

A full transcript follows the video.

This podcast was recorded on Feb. 2, 2016. 

Sean O'Reilly: Greetings, Fools! Sean O'Reilly here joining you from Fool headquarters in Alexandria, Virginia. It is Tuesday, February 9th, 2016, and joining me to talk about the unholy union between banks and consumer retailer is not only the irreplaceable Vincent Shen, but the articulate, the insightful, and extremely well-read Miss Gaby Lapera. How's it going, Gaby?

Gaby Lapera: I want to be on this show all the time, I get compliments here. (laughs) 

O'Reilly: I try to build up my co-hosts (laughs).

Lapera: Thank you, I appreciate that.

Vincent Shen: I feel pretty good about myself after doing IF for about a year with Sean now.

O'Reilly: I just compliment you every show. And nobody compliments me. Anyways, welcome to the CG show, Gaby! For our listeners who may not be aware, we're kind of doing, what are we calling it, crossover week?

Lapera: Industry Smashup.

Shen: Industry Refocus.

O'Reilly: Oh my gosh.

Lapera: Venn diagram week from our math nerd friend, Kristine Harjes.

O'Reilly: (laughs) Insert eye roll here. So, Vince, do you think we need to buy Gaby lunch for coming on the show today?

Shen: We should. We should do it anyways. She's extremely articulate and well-read.

Lapera: Oh wow.

O'Reilly: And insightful.

Lapera: You guys can have some of my soup. I made soup today.

O'Reilly: Oh yeah, what were we talking about, you made ...

Lapera: Moroccan tomato peanut soup. I don't know, it's delicious.

O'Reilly: (laughs) 

Lapera: If you're ever in Lincoln, Nebraska, go to The Grateful Bread, which may be called Freakbeat Vegetarian now, because people were confused about it being The Grateful Bread being a bakery, and it didn't have anything to do with the band. They have delicious soup and mac and cheese there.

O'Reilly: Did they get sued by the band?

Lapera: I don't think so. It's just a bunch of hippies. They're really cool, though, and their food is amazing, and their cheddar scones ... (sighs) oh my gosh.

O'Reilly: Wow, she's ...

Lapera: Just thinking about them ...

O'Reilly: For anybody who hasn't figured it out, she went to grad school in the great state of Nebraska, and she ... I don't know, you had a good experience, right?

Lapera: Yeah. Nebraska's nice. Vince and I were just talking about Nebraska. Nebraska Nice is actually a thing.

O'Reilly: Oh. Anyways, so, Gaby, as you know, Vince and I usually chat about all things consumer goods, and investing in companies that more or less face the end consumer. You, of course, usually share investing insights for the banking and finance sector. Fortunately for our listeners today, most consumers happen to also have bank accounts. And for our first segments, use credit cards to pay for their Starbucks lattes and trips to the grocery store. You've got some useful insights, as I understand, regarding credit cards. So first, what do consumers need to know about this? What's going on in the credit card industry? And all that good stuff.

Lapera: So, generally, what's going on in the credit card industry, I'm actually going to refer you back to a show that we did earlier in January, I think it was the first show of the year, when we talked about electronic transactions. But, more specifically, for consumers, there are some tricks to credit cards that you should know about.

O'Reilly: I just got pre-approved.

Lapera: (laughs) Oh my God.

O'Reilly: And I feel really good about myself (laughs).

Lapera: Oh my gosh. (laughs) Those things are ... yeah, you get those mailers in the mail, and they're like, "Congratulations! You've been pre-approved for like $25,000!"

O'Reilly: "Me?!"

Lapera: And you're like, "You know, I only make $40,000, but that seems reasonable, I should totally have a $20,000 credit limit!" Of course, that's obviously based on your credit score from before. But credit card debt is nothing to mess around with. I think a lot of people don't realize that the average interest rate on credit cards is 15.18%--

O'Reilly: That low?

Lapera: --for the last quarter. That's the average, so that means there's some people with a lot higher (laughs).

O'Reilly: Got it.

Shen: Yeah, and we'll see, too, talking about some of these retailer-focused store brand cards, the interest rates are--

O'Reilly: Don't tell them that, Vince!

Shen: --even higher than that. Right?

Lapera: Yeah. A lot of the times, those are in the 20-30% range. And that's actually something consumer should watch out for. When you're offered something like a store credit card, a lot of times, they're like, "You get 30% off on your first big shopping thing! And sometimes, we'll send you points!" But a lot of people carry credit card debt, and with the interest rates being as high as they are on those cards, it's not the best idea.

O'Reilly: Even every time I check out on Amazon.com, which is surprisingly frequent nowadays, because ... anyways, they pitch me that Amazon card, like, "You get $30 off this purchase!" It's like, am I going to take out another credit card just for $30 off? Anyways. Backing up a little bit, Gaby, what are the average number of credit cards that the average American has outstanding?

Lapera: So, the average number of active credit cards a consumer has for bank cards, which is the ones that are branded, Visa, Mastercard, those guys, that's 2.24 per person. For store cards, which are like the Target REDcard, or the Amazon card, it's 1.55 per person.

O'Reilly: Unbelievable. Okay. So, Vince, you were doing some research before we came in, on the massive amounts of money that stores make off these credit cards. I get pitched a card every stinking time I leave the house, it seems. Why are they doing this?

Shen: I look at it like this: in the past, you had other ways of between loyalty programs, points and things like that. Now, with Amazon, for example, you have Prime, and they've already espoused the benefits they've seen from that in terms of Prime members spending more money, things along those lines. Well, I think, the ultimate idea behind some of these cards is to build that loyalty, where you get perks, points, or discount per purchase, people who have these store-brand cards will go to whatever retail they have it with and shop more often.

And the thing is, a lot of these big retailers, the ones I want to talk about like Target and Macy's, make quite a bit of money from this. So, even though both of these companies have agreements with actual banks like Citibank, TD Bank, to manage, and they actually own these accounts, the retailers themselves actually have to help with things like promoting and other more administrative stuff. But they get tons of money. So Macy's, in 2014, for example, generated over $750 million in reduction to their SG&A, which is how they record it in their financial statements, from these affiliate fees--

O'Reilly: Oh my gosh.

Shen: --that they receive. And same thing with Target, where they've been able to enjoy really good penetration with their REDcard, so, I think it's like some 20% of their purchases--

O'Reilly: They were almost violent, at one point, promoting that thing, by the way.

Shen: Yeah, every single time you go through the checkout line, if you don't have one--

O'Reilly: It was bad.

Shen: --they will mention it to you. And again, same situation for them. They're making hundreds of millions of dollars in these agreements, and they're not even managing the main accounts under these cards, so it's very profitable for them. It has the side effect of building that brand loyalty, having shoppers coming back because they get those discounts or whatever, and it's very powerful.

O'Reilly: Yep. So, Gaby, I actually knew a guy who was irrationally loyal to General Motors. He was like, "Oh yeah, I got this GM credit card, and they're giving me points toward buying a new truck!" I went to college with him and he ... Anyways. It's literally endless. Macy's only gives you coupons if you use the credit cards, it's just nuts. So, what's going on in the private label credit card industry today? Who issues them, who is actually putting up the money, is this a good business for the financial institutions still? Because obviously, it's great for the retailers.

Lapera: Right. Let's back up a little bit. For our listeners, private label credit cards are credit cards are branded as whatever store they're from, so like the Macy's card or Amazon card, so, it's not associated with a Visa or MasterCard. And typically, with these cards, there's a couple different types, but the one that I think you're talking about is the retail card which is, they can really only use it with that merchant.

O'Reilly: Right.

Lapera: They can't use it anywhere else. They do have some that are called dual cards, which you can use at a merchant, the specific merchant it's been issued for, and then other places, and it works as a regular credit card there. But the main provider of these private label credit cards is a company called Synchrony Financial (SYF 1.40%), which, funny you mentioned GM, because Synchrony Financial got spun off of GE. (laughs) 

O'Reilly: Oh, wow, lots of Generals. So, do they have a monopoly? Do I want to go buy this stock?

Lapera: Um ... I'm not going to tell you to go buy it, because I can't give you the direct financial advice (laughs).

O'Reilly: (laughs) Do you want to go to the water cooler later and tell me?

Lapera: They were very clear about that when I got on-boarded. Erik Stadnik, our lawyer, was like, "Don't. Don't. Just don't." I think that was the whole talk, was just him going, "Don't. Please. Don't." (laughs) But, so, they got spun off of GE. They're doing OK. The retail cards, the dual cards, that's a big part of their business, and they have deals with people like Chevron, Amazon, really big names. I don't know, really, how long it's going to ...

O'Reilly: Be good.

Lapera: Be good.

Shen: I think it's interesting, too, because you have some people changing the model a little bit, like Starbucks, for example. I believe -- I'm not a part of their payment app -- but that's all prepaid, right?

Lapera: Yeah.

Shen: So, I understand it's kind of different, smaller-sized purchases, you're not buying an appliance, for example, through this kind of system. But, for some of these retailers, maybe the kind of convert to the system where too much more interactive and mobile-based.

Lapera: Yeah. And then, one of the benefits of that, of each retailer having their own method, is they get a lot more data on people.

Shen: Yes.

Lapera: I'm sure the bank partners with them and provide some data, but having their own set of data on these people, that's huge. And they've also done studies showing that those loyalty programs that are easy to access on your phone are also a major benefit for those retailers.

Shen: Mm-hmm, probably just in terms of the adoption rate, as well.

Lapera: Exactly. That's actually what Walmart and they're little consortium of friends with their mobile app that's supposed to compete with Apple Pay are trying to do. But, that's not quite rolled out yet. So, we'll see how that ends up for them.

O'Reilly: Cool. Well, before we move on to talk about what's going on in housing, I wanted to point our listeners to focus.fool.com, where you can take advantage of a discount on The Motley Fool's Stock Advisor newsletter. This works out to $129 for a full two-year subscription. Just go to focus.fool.com to take advantage of this offer. Once again, that's focus.fool.com. So, Gaby, Vince and I have been anxious to talk to you about what's going on in housing and mortgage lending. This is obviously a huge part of the economy, and affects an even bigger portion of the economy, because once you buy a house, you need, I don't know, a new TV, furniture, maybe even a dog. So, is housing back since the Great Recession? How hard is it to get a mortgage? I saw that Rocket Mortgage thing during the Super Bowl--

Lapera: I think everyone did (laughs).

O'Reilly: Yeah. Boy, they really struck a populous tone with that. They were like, "We can make America better!" (laughs) 

Lapera: I was talking to someone else in the office the other day, and they were like, "I thought it was a commercial for The Big Short. That's what I thought it was for." (laughs) 

Shen: It was a little bit concerning, how nonchalant they made the idea of, "I'm going to just click this button on my smartphone--"

O'Reilly: Oh my God, yeah.

Shen: "--and get a mortgage." It was a little bit concerning how they make it seem like this trivial matter, when it's not. At all.

O'Reilly: A $400,000 purchase should not be trivial. (laughs) 

Shen: Exactly.

Lapera: Yeah ...

O'Reilly: Gaby, can I still buy a mortgage-backed security if I want? Because I really want to. (laughs) 

Lapera: You just want one mortgage-backed security? (laughs) 

O'Reilly: I'm just kidding.

Lapera: I don't even know how you would go about doing that (laughs). But, yeah, mREITs are always an option. mREITs are mortgage real estate investment trusts. I don't know if you guys ever talked about this, so I figure I'm just going to spell out everything--

O'Reilly: No, go nuts.

Lapera: --what all the acronyms are.

Shen: I think that makes sense, we do not delve into that realm very often.

Lapera: So, the housing market in general, right now, it hasn't reached pre-recession levels. I think, back then, home ownership rate was around 69% in like 2005.

O'Reilly: It's in the low 60s now, isn't it?

Lapera: It's in the low 60s. And I think the lowest it ever got was like in the 50s. But, it has gone down from last quarter. The one thing we are seeing a lot more of, though, is renting. If you--

O'Reilly: Said the three Millennials sitting at a table doing a podcast. (laughs) 

Lapera: (laughs) It's true, it's true, especially among Millennials, that's the group you're seeing doing the most renting, because, I mean, down payments on houses are expensive. I don't know if--

O'Reilly: And, I mean, correct me if I'm wrong, the rule of thumb with home ownership is, you should buy a home unless you're planning on staying in an area for 5-6 years. I don't know about you, but since leaving college, I moved ... 1, 2, 3, 4, 5, 6 times? (laughs) 

Lapera: Yeah, it's a minimum of 5 years. What a lot of people don't think about when buying a home is all the closing costs involved. So, in order for that to average out, you need to stay--

O'Reilly: It's $5,000-10,000, minimum.

Lapera: Yeah, you need to stay for 5 years in order to recoup your losses when you sell your house again, assuming that your house goes up in value (laughs).

O'Reilly: Which is a dubious assumption (laughs).

Shen: So, you guys mentions Millennials, obviously younger people, I can understand, starting their careers, building out their net worth and their savings in order to handle some of these down payments, it's difficult. 20% even on a $200,000 home, I think the median or average in the U.S. is like $150,000, it's still a pretty decent chunk of change. But, you sent me an interesting story that I read from the Bay area, Gaby, about ... I don't remember what they called it ...

Lapera: It's like 0-down home loans.

O'Reilly: Oh, that's right! 

Shen: Then, it was variable interest rate, too! What were you saying? I was like, (laughs) why are we doing this again?! It's been 7 years!

Lapera: Yeah, so, this is the San Francisco Credit Union. The homes in San Francisco are very expensive.

Shen: I think it's an average of $1 million.

Lapera: Yeah. So, to get a down payment for that, 20% down, that's $200,000. And even for people who are working in the tech industry there, that's very, very expensive. So, there's this credit union saying, "We'll let you get a home loan for 0% down." And they're saying, "Don't worry, our standards are super stringent." But you look at it and it's a variable rate, which is not great. You really want a fixed interest rate if you're getting a mortgage. A 30 year fixed interest rate, probably the lowest it's going to get.

O'Reilly: Well, it's even worse, because the Federal Reserve just increased interest rates for the first time in a while, and supposedly, they're going to keep going.

Lapera: Right, yeah. I don't think they're going to super duper accelerate that, though. And interest rates are at a historical low, they're so, so low right now. It's still almost negligible (laughs). But, that doesn't mean that in 30 years, when you're still paying off this house, maybe interest rates are a lot higher and suddenly you're paying off a lot more in interest a lot later. Also, like Vince was saying, it does seem generally on its face like a bad idea. If you can't even come up with a little bit for the down payment, what are you doing buying a house? You know?

O'Reilly: It's bad.

Lapera: And I'm not sure, but I'm pretty sure those must come with PMI, which is private mortgage insurance, which is basically what you have to pay on a mortgage on top of a mortgage.

O'Reilly: Unless you put, what, 20% down?

Lapera: Unless you put 20% down, that's exactly right.

O'Reilly: I remember a couple of primary mortgage insurers. This was back in my first-looking-at-the-stock market days. But, a couple of primary mortgage insurers -- in fact, all of them -- went under. There was actually PMI Group, I think, I'm pretty sure they're gone. What's going on in that industry right now?

Lapera: Honestly, I have no idea. The people in my bureau, the financials bureau, set down yesterday and tried to find a PMI provider, and it is incredibly difficult to find one. It looks like the banks are the ones providing it.

O'Reilly: And they're just charging the money and self-insuring or something.

Lapera: Yes.

O'Reilly: PMI Group is bankrupt, yeah, they're gone.

Lapera: Which is, oh man, and the 2008 recession, just a little road bump for them. (laughs) 

O'Reilly: And I know a new company got formed, and this is reaching in the cobwebs of my mind, but I know George Soros left and helped create one, and they're going to have an IPO, and I just found Radian Group (RDN 0.88%), they are finally starting to make a little bit of money, but they were almost bankrupt in 2011. Anyways. (laughs) I think they just did a reverse stock split, too. I would think that industry would be super profitable now, though, because everybody's like, "Oh, wow. The whole industry just crashed, we can actually charge money for the insurance now."

Lapera: Yeah, and I mean, property values are going up in certain areas of the country. So, eh. And the thing with PMI is, if you can avoid PMI, that is really ideal, because one, you're paying extra money, two, they're super hard to cancel. You go online and look for how to cancel PMI--

O'Reilly: Game over.

Lapera: --and it's just people complaining, "I have no way of cancelling this, I've tried for a couple years now." So, if you can avoid it, I would highly recommend it.

O'Reilly: Putting the money down. So, for all of our Consumer Goods investing listeners, who obviously might own shares in a Home Depot or Lowe's or something, sounds like housing's not Gangbusters, but it's not bad either?

Lapera: Yeah. It's chugging along. Technically, it went down last quarter. But like ...

O'Reilly: It's a quarter, it doesn't matter.

Lapera: Exactly.

O'Reilly: Cool. Alright. Well, that is it for us, folks. If you're a loyal listener and have questions or comments, we would love to hear from you, just email us at [email protected]. Again, that's [email protected]. As always, people on this program may have interests in the stocks they talk about, and the Motley Fool may have formal recommendations for or against those stocks, so don't buy or sell anything based solely on what you hear on this program. For Gaby Lapera and Vincent Shen, I'm Sean O'Reilly, thanks for listening and Fool on!