What is ROA?
ROA (Return on Assets) is a metric that determines profitability by evaluating the ratio of net income to assets. The mathematical equation for ROA is Return on Assets = (Net Income / Total Assets).
Net income is expressed as a dollar value, and is determined by the difference between sales and the cost of goods, expenses, taxes and other deductions. ROA is expressed as a percentage and weighs net income against the sum of every asset's total dollar value. These assets can include inventories, physical infrastructure, accounts receivable, investment holdings, as well as any profit that remains after subtracting costs - essentially, anything that the company could theoretically liquidate for cash.
In the context of credit cards, the Mercator Viewpoint defines ROA as: "It expresses the effectiveness of operating income, expenses, and loan loss provisions as a percentage of portfolio value." In essence, credit card ROA evaluates how efficiently a company utilizes its resources.
Credit card ROA
All businesses, including credit card issuing banks, can use ROA as one metric for evaluating profitability. Credit card ROA is defined solely by the income and assets directly related to lending and loan repayment, and the ROA for credit card issuing banks tends to be higher than that of commercial banks. The top issuing banks include American Express, Bank of America, Capital One, Citi, Discover, TD Bank, and Wells Fargo.
Credit card issuers bring in money from their credit business in two ways: via interest income and non-interest income. Both types of income are associated with various expenses and operational costs, deducted from gross income to produce net income. An additional primary credit card expense is the loan loss provision, a preemptive cushion set aside for expected losses. The only relevant credit card assets in this context are the total closing receivables (the outstanding balances of all cardholders at the end of the month or year). Credit card ROA is calculated by adding net interest income and net non-interest income, subtracting the provision for loan losses, and dividing by closing receivables total.
Credit card ROA is strongly affected by interest income, the interest collected from consumers who use credit cards to borrow money. Credit card interest is only applied if the cardholder does not pay off their balance in full at the end of each month.
The interest is an annual percentage rate (APR), calculated by adding the prime rate to an additional percentage set during the financial institution's underwriting function. In industry parlance, this is "Prime + X." As a result of the economic effects of the COVID-19 pandemic, the prime rate is 3.25%, the lowest rate in history.
Non-interest income also influences credit card ROA, which comes from the fees and expenses banks charge cardholders and merchants. This includes additional fees on cardholders for delinquent payments, fees for international payments, and service charges. Net non-interest income also consists of all expenses charged to businesses that accept the credit card from their customers, including operational costs, rewards, technology and marketing.
Banks primarily drive credit card profits through interest income and rely more heavily on non-interest income when interest rates are low. Additionally, if there are losses from unpaid loans - and there always are - this reduces non-interest income.
Provision for loan losses
The risk when lending money is that not all cardholders will repay their bills. Credit card issuers know this and account for a certain probability of losses in the form of a loan loss provision. This is an income statement expense set aside to allow for uncollected loan payments. Loan loss provisions are standard practice for credit card issuing banks, as they are required to account for estimated losses to present an accurate financial assessment. Credit losses impact the ROA, and there are several stages of unpaid loans before companies deem the money lost.
The future of credit card ROA
As the world moves towards a post-pandemic reality - or at least towards endemic COVID-19 - credit card issuing banks are continuing normal operations and looking towards the future. While this article gives an overview of credit card ROA, it does not provide a deep dive into the relevant data or nuanced insight into what the coming years have in store. Mercator Advisory Group's recent Viewpoint, In Search of a Profit: 2020 Credit Card Return on Assets Slipped During COVID but Remains Strong, offers a broader look into this topic.