Like chameleons, American Express and Discover changed their skins to survive the financial crisis. They may actually be getting used to the camouflage.

The two nonbank institutions, the biggest monoline credit-card issuers, have spent the past year of tumult becoming more like banks, seeking the shelter of more traditional — and stable — funding models as the capital markets short-circuited. They converted to bank holding companies and assiduously built up branchless deposit-taking capabilities.

Today, the two companies stand at a crossroads: continue down that path and turn the funding fixes into bona fide business lines; or go back to their old ways.

If Amex and Discover do end up transforming their deposit platforms into full-fledged direct consumer banking operations, they could deliver on a long-predicted and as-yet unattained credible alternative to brick-and-mortar.

"Probably over the next 12 months to 24 months, there will be some reflection on all of this, and they'll kind of have to decide strategically: what do I want to do with deposits?" said Peter Carroll, a partner at the consultancy Oliver Wyman Group. "Do I want to make it a profitable business that adds value, and also diversifies and solidifies my funding, or do I really want to stick to my knitting?"

To be sure, deposits have their own vagaries. The deposit programs at Amex and Discover predominantly depend on brokered accounts and certificates of deposit — "hot money," as it is often called, that tends to chase high rates and has been relatively easy to collect recently as consumers shy away from risky investments.

Moreover, the securitization markets have thawed; if they continue to improve after the government withdraws its emergency support, part of the rationale for deposit efforts — cheap funding — could wither.

Still, Roger Hochschild, Discover's president and chief operating officer, said the company views its deposit platform as both a funding solution and a business line.

The disruption in the asset-backed securities market "sharpened our focus" on deposits (Discover launched its direct bank in 2007), he said, but the operation is part of a push to "expand from being primarily a card issuer" to a company that includes offerings like student and personal loans.

Carlos Minetti, Discover's executive vice president for cardholder services and consumer banking, said the company has "laid the foundation" to build a full-service direct bank, and cited progressive additions to its product suite, including the recent launch of a high-yield savings account. Discover is exploring a transaction account, he said.

"While adoption in the marketplace hasn't been what many had predicted over the years, given some of the pressures that the bank branching model is going to be feeling in terms of fees" — including overdraft charges — "the time might be now for this to take off," Minetti said.
Amex and Discover have expressed an aversion to the panoply of businesses that typically accompany a traditional branch network.

"Never say never; but the reality [is] that the branch bank assets come with other stuff, other assets that I may not be particularly interested in," said Amex's chief executive, Kenneth Chenault, at a meeting with investors last month.

In a conference call last week on Discover's fiscal third quarter, which ended Aug. 31, its CEO, David Nelms, said its success at enlarging its deposit holdings at attractive rates — without the overhead of a branch operation, or the burden of the other lending businesses that would ordinarily accompany bricks and mortar — inspires "increased confidence that direct banking is the future as opposed to branch banks."

Ron Shevlin, a senior analyst at Aite Group, sees in the deposit platforms at the two card issuers the leading wedge for additional initiatives — like issuing debit cards — needed to offset the dimming growth potential in the credit card business.

"It's getting a lot harder to put additional cards into people's wallets" because of factors such as the increased financial discipline among consumers and the shift to debit transactions, Shevlin said. "Clearly these guys see this coming down the road."

Brian Riley, a research director in the bank-cards practice at TowerGroup, a research firm owned by MasterCard Inc., agreed that direct banks could be a good way to tap the debit market in the face of a contraction in credit cards.

"The debit card has been the transaction card of choice" as consumers have become more frugal, Riley said. "That brings people into more of a banking environment."

At Amex's investor meeting, Chenault said that debit is an "opportunity over time," but that charge cards, a longtime specialty of his company, present "more attractive opportunities."
Carroll said that if Amex and Discover move further to a full-fledged direct banking model "that doesn't compete on price and has got strong brand access to the right subsegments of the market — the affluent and successful small businesses — that might be the beginning of the trend away from the dominance of traditional branch networks."

Any such development is at least a few years away, Carroll said. "I hear people talking about it, but I think everyone's very sensitive, especially in this environment, to start contemplating the building of an entirely new business model."

In the first half of the year, Amex's certificates of deposit placed primarily by third parties almost doubled, to $11.8 billion. The New York company's sweep account balances were about flat over the same period, at $7.1 billion.

Amex had traditionally raised institutional deposits that did not carry Federal Deposit Insurance Corp. backing, but has said that investor appetite for these instruments declined in the fourth quarter as investors pulled back from a wide range of credit markets.

The company announced the launch of its direct-to-consumer deposit program this month.
Discover said last week that deposits originated through its direct platform and affinity relationships (for instance, a sizable arrangement with the American Automobile Association through which it places CDs bearing the motorist group's name) increased by about $2 billion in its fiscal third quarter, to $10 billion, making up about a third of the $43 billion-asset Riverwoods, Ill., company's total deposits.

Regulatory intervention could prompt a retrenchment by banks' new competitors for deposits — or at least drive greater distance between companies that are committed to the deposit business and those for which deposits were more of a funding Band-Aid.

At the height of the crisis, Carroll said, regulators were likely to view access to deposits as a good thing. But over the longer haul, they are "not really in love with brokered CDs," and are likely to apply "some level of differentiation between something that's more like a stable, highly diversified consumer core deposit base at one end of the spectrum, and at the other end of the spectrum, hot money."

Such a distinction, he said, will either force some companies "to back away from [deposits] and go back to relying on wholesale markets, or it may force them … towards making a real business out of it."

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