The Associates Raises Credit Card Bet

By Brian Graney (TMF Panic)
December 28, 1999

Despite the well-documented troubles for credit card lenders recently, consumer and commercial finance giant Associates First Capital (NYSE: AFS) went out on a limb today and agreed to form an agent bank partnership with KeyCorp (NYSE: KEY) to jointly manage the Cleveland-based bank's credit card business. Under the deal, The Associates will acquire $1.3 billion in credit card receivables and oversee nearly 600,000 VISA and MasterCard accounts.

Both companies rose slightly on the news as investors tepidly reckoned that the agreement isn't all that bad for the two sides. Certainly, it wasn't shocking considering that getting out of the credit card business was a plank of KeyCorp's restructuring effort last month to improve its earnings.

Like other smaller issuers and even large players such as Bank One's (NYSE: ONE) First USA unit, KeyCorp has had its nose bloodied this year as the prime segment of the credit card business has gone into competition hyperdrive. Overall profits have been hurt as acquisition costs have been sent skyward thanks to lenders poaching accounts from one another with low teaser interest rates and carpet-bomb style ad campaigns.

Getting the heck out of Dodge now is probably a good bet for KeyCorp, especially since credit cards are not a major part of the company's activities and the business hasn't grown at all this year. Likewise, credit cards aren't The Associates' major business area either, but it has been getting larger. Late last year, the company set up a similar agent bank agreement with Washington Mutual (NYSE: WM) to help the West Coast thrift better market credit cards to some 4 million of its customers.

Still, today's deal undoubtedly raises some questions for The Associates' shareholders. The company's large home equity, truck and truck trailer, and equipment financing businesses have been growing at faster rates recently than the credit card business, which only represents about 13.5% of the firm's total receivables.

Given the firm's decision to buy sub-prime auto lender Arcadia Financial last month, there is a sense that The Associates is allocating cash to its areas of weakness rather than its areas of strength. And it's not like the company is getting KeyCorp's receivables at a rock-bottom price. KeyCorp is estimating a net gain of around $330 million on the $1.3 billion portfolio, which is a better deal than the $300 million gain SunTrust Banks (NYSE: STI) is getting from MBNA (NYSE: KRB) for its $1.5 billion in credit card receivables in a sale worked out in October.

So what is the rationale behind today's news? The Associates may believe that it needs to build scale quickly in credit cards in order to stay competitive in the business in the years ahead.

With the changes underway in the financial services industry, focusing on scale businesses has been a popular and by all accounts reasonable strategy. For instance, Mellon Financial (NYSE: MEL) has been shedding all kinds of smaller business units over the past year (including credit cards) and focusing instead on the areas where it is a big player, such as custody services and asset management. But whether The Associates can build the scale needed to become a big player in credit cards and reap more than single-digit growth from this intensely competitive business down the road remains to be seen.

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