Riddle me this, gentle reader: With dozens of institutions such as MBNA
The high APR (annual percentage rate) on your card is one of the reasons why the credit card market does defy our Economics 101 assumptions about price competition in a competitive marketplace. If competition isn't driving down revenues, rising interest rates just might.
A key revenue driver for banks is their net interest margin, or how much APR they charge you minus how much they pay investors to borrow money from them. When the Federal Reserve raises interest rates, as it did Tuesday, the cost to borrow money goes up. As the cost of borrowing goes up, net interest margin should fall.
Banks have expected rates to rise for some time, so they've adopted a variety of measures to combat this. Providian, for example, has moved over 66% of its cardholders to a floating interest rate, so that as Providian's borrowing costs rise, so do the consumers', essentially keeping net interest margin flat. MBNA, on the other hand, had only 7% of customers at variable rates as of the end of last year but has been aggressively moving customers to higher APRs. MBNA has been a darling of stock pickers for years, and rightly so. But MBNA and other lenders may find their revenues pinched in coming months as the Fed continues "measured increases."
The Fed's announcement Tuesday was not a shock, but with two more Fed meetings this year, we could end the year with interest rates over 2%, more than double where we started 2004. This potential 1%-plus increase would eat into profits of many issuers, so be vigilant, Fools, when investing in the consumer lending sector. Earnings compression may be just a Fed meeting away.
For more information on these companies and on credit in general, check out these stories:
Fool contributor David FitzMaurice owns no shares in any of the companies mentioned in this article.