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Suddenly, This Summer: Bank One's Profit Warning Came Out of the Blue

The bank's claim that problems in its credit card business didn't surface until very recently is being met with some skepticism.
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Two short months.

That, incredibly, is how long

Bank One


says it took for its $70 billion credit card business to go from silk purse to sow's ear.

A combination of competition and in-house mistakes, which, according to Bank One's top execs, only started to cause serious damage since June's end, could cause a shortfall of up to $530 million in second-half 1999 pretax profits at

First USA

, the bank's credit card division.

First USA, acquired by Bank One in 1997 at a hefty premium, accounted for nearly 30% of Bank One's net income in this year's first half, and was, until Wednesday, considered by many to be the only significant source of strong earnings growth at the Chicago-based Bank One.

With the profit warning, which was first made late Tuesday afternoon, Bank One now expects to earn $3.60 to $3.65 per share this year instead of the $3.92 analysts had been expecting, according to

First Call

. Bank One's stock collapsed by 12 5/8, or 23% Wednesday, closing at 43.

During a conference call Wednesday, John McCoy, Bank One's chief executive, was eager to dispel any speculation that the bank failed to give timely notice of problems at First USA. He said the deterioration came rapidly and that management didn't have material evidence of the difficulties until "the last several days."

But this explanation fails to convince some.

"Let's face it, they knew the problems were developing," says Mark Davis, head of research at the


Banc Stock Group fund, which doesn't own Bank One. "But they didn't give the market any sort of heads up."

Joe Duwan, an analyst at

Keefe Bruyette & Woods

, says he attended an analysts' dinner with Bank One management only three weeks ago in Philadelphia, but the executives gave no indications of the problems at First USA.

"The degree of the adjustment is staggering," says Duwan. (Keefe Bruyette has no underwriting relationship with Bank One.)

The bank made no mention of First USA's difficulties in its press release concerning second-quarter results, issued July 20.

Bank One's chief financial officer, Robert Rosholt pointed out during the Wednesday conference call that the bank had mentioned the difficult credit card industry environment in its second-quarter 10-Q filed Aug. 16 with the

Securities and Exchange Commission


But the 10-Q didn't single out First USA, simply saying the industry was facing "moderating demand for unsecured consumer debt products and a continued competitive environment for credit card issuers. This is likely to result in slower growth in receivables and revenue for the credit card industry in the near term."

McCoy clearly anticipated the suspicious reaction of the market. Just before the question and answer session of the Wednesday conference call started, McCoy asked Rosholt with wooden solemnity, "How could this happen as rapidly as it did?"

Rosholt then gave a three-minute, unbroken -- and seemingly prepared -- explanation of what the bank knew and when.

Rosholt said that in the year's first half, First USA met all its targets and only experienced a drop in profit margins that was "not material." The bank, he said, then detected "significantly higher compression in margins at the end of July." By the middle of August, the bank had decided that this compression "was a trend, not a blip," Rosholt said.

One analyst thinks Bank One, which was hit by a number of analyst downgrades Wednesday, did divulge the ugly truth about First USA at the right time. Tom McCandless, an analyst at

CIBC World Markets

, which has no underwriting relationship with Bank One, says it's definitely possible that First USA faced a much-increased competitive threat in such a short period.

And he says that, since the downward adjustment in the earnings projection was going to be so substantial, it wouldn't have been right to let it slip out informally during meetings with analysts or investors.

However, one reason why Rosholt's chronology has been greeted with skepticism in many quarters is that First USA is run by Richard Vague, an experienced and highly respected figure who has headed First USA for over 10 years. But it's possible that Vague and other senior managers have been distracted by the running and promotion of

, Bank One's Internet-only banking subsidiary launched with great fanfare in June.

"I wonder if they're not getting all tied up with and failing to do all the basic blocking and tackling in the credit card business," says Bert Ely, of

Ely & Co.

, an independent financial consulting firm in Alexandria, Va.

Vague, who sold $40.6 million worth of Bank One options last year, had been considered a successor to McCoy as chief executive, although First USA's setback may stall that.

Bank One gave three main reasons for First USA's poor outlook. First, growth has slowed in the credit card industry as a whole. Second, competitors, chiefly through more aggressive marketing, looser credit standards and more lenient payment structures, are stealing customers. And, third, higher interest rates will also hurt the business.

Bank One also said that an unspecified number of First USA credit card customers had left because one of its processing companies had failed to post their payments in a timely fashion.

A Bank One spokesman declined to name the processing firm, but a First USA official said the it was Louisville, Ky.-based

National Processor


. The First USA official said that his company planned to shift all processing in-house during the next several weeks. Officials at National Processor weren't available to comment.