High Interest Doesn’t Equal High Returns

Lessons from consumer credit companies that got it right—and wrong

When I was setting up the investment strategy, I thought two categories of investments would be unfit for the free cash flow-focused approach that I was envisioning.

One was biotech companies. Thanks to a pharma company I was on the board of in Eastern Europe, I had the opportunity to attend a discussion between a biotech company seeking capital and a well-regarded specialist biotech investment funds. Representing both sides were people with medical and/or chemical doctorates. The level of specialist knowledge involved about the molecule’s functionality, the competitive positioning, and the regulatory environment was so high that I immediately knew that the patsy at that proverbial poker table was clearly me. That realization, combined with the fact that these companies are often in the development stage and lack cash generation, made it clear that biotech companies are highly unlikely to fit my investment strategy.

The other category of companies was banks. Unlike the biotech companies, this area I felt reasonably comfortable with, given that over my 20 years as a portfolio manager and research analyst I’ve had the opportunity to research and invest in many Eastern European financial institutions. The banks in Eastern Europe are interesting because of their surprisingly simple business models – the best ones benefit from lower borrowing costs due to their perceived quality, can choose among the highest-quality borrowers in a growing economy, and are run efficiently, generating high returns on equity. In fact, we consider them the opposite of many Western institutions that have to contend with low net interest margins due to overly dovish central banks, high costs due to outdated infrastructure, and often generate a significant portion of their overall income from trading and the revaluation of complex assets.

For the above reasons, I felt that traditional banks, even the best-run ones, are unfit for my US equity strategy which is focused on companies generating free cash flows. However, over time, I found that a subset of financial institutions did fit, as they resemble Eastern European banks in the returns on invested capital they generate. The credit card companies.

Credit card loans, in theory, should be highly lucrative. Given the 20-25% annual interest rate, banks should be printing money, since they get money from customers for free or nearly so. The problem is that credit cards are the riskiest types of loans and do not have collateral that could be seized if the borrower is unable or unwilling to repay. It’s normal for even the well-run conservative to carry a cost of risk (losses) of 5%+, which rises much higher in times of economic distress. Given the riskier nature of the loans, underwriting experience, management conservatism, and knowledge of the customer base are often the difference between a high-quality business and a levered disaster.

To illustrate how difficult the credit card business is, it is useful to look at a couple of examples of when otherwise well-run financial institutions went outside of their circle of competence and tried to enter the consumer credit card market.

Goldman Sachs entered the market with the Apple Card – a tech-first, consumer-friendly card distributed via the Apple ecosystem. Given the presence of the premier investment bank and access to what should have been the most lucrative subset of customers (iPhone holders), this product was seemingly destined for success. In fact, the opposite happened: over the next four years, due to a combination of poor underwriting and misspent incentives, the consumer loans generated around $7 billion in losses for Goldman. Moreover, instead of building goodwill with customers, the partnership, due to mismatches between the two companies’ cultures and other operational problems, led to lawsuits and fines.¹

The other cautionary tale is buried in the annual reports from one of the more dynamic fast-growing fintechs – Revolut. While they have been doing an amazing job disrupting some of the bank’s traditional fee sources, such as payments and transfers, they are still struggling with the lending products. Consumer loans were introduced in 2019 and were supposed to go, at first, only to their most creditworthy customers. Despite this, in 2023, the loan book, which primarily consisted of BNPL and credit card loans, generated over 8% of credit losses and only 10% of interest income. By 2025, the metrics have improved slightly to 9.7% interest income and 4% credit losses, but given marketing costs and other expenses such as interchange fees, it is unlikely that Revolut is making money on its credit products.

While new entrants are struggling to figure out how to make money in unsecured consumer credit, I found that most traditional pure-play credit card issuers have done an exceptional job and delivered significant value to shareholders over time.²

Discover Financial was born under the Sears umbrella, changed hands a few times, and eventually became a standalone public company in 2007. The company was a unique blend of proprietary payment networks (Discover and Pulse) and a credit card business aimed at middle-income consumers. Since its listing in 2007 through 2024, Discover has grown its loan book by 4.8x and its net income by 5x. By the time it was acquired by Capital One in 2025, Discover delivered double-digit returns to investors despite going public on what is likely one of the worst possible days on the eve of the financial crisis.

Synchrony Financial, which began as the consumer credit arm of GE Capital, was listed in 2014. Its core business is offering store-branded credit cards, which it does by partnering with dozens of retailers, including Lowe’s and Sam’s Club. The key differentiator for Synchrony is its retailer share arrangement (RSA), which allocates to retailers the income earned above a certain threshold on credit products. The RSA arrangement aligns incentives and creates customer loyalty. Synchrony shares have also delivered double-digit returns to investors since their listing.

Aside from a solid, differentiated business model and good underwriting, both Synchrony and Discover distinguished themselves by allocating most of the excess cash they generated to share buybacks. As I wrote earlier, share buybacks can be a great allocation of capital when done conservatively and deployed when shares are trading at high free cash flow yields. Both Synchrony and Discover used share buybacks to reduce shares outstanding when their shares were trading at attractive valuations amid macroeconomic concerns. Discover bought back half of the company between 2010 and 2024. Synchrony went even further, buying back over 55% of all outstanding shares between 2015 and 2025, including over 25% between 2021 and 2023, when shares traded at high-teens free cash flow yields.

One exception to the solid performance of the pure-play credit card companies is Bread Financial, formerly known as Alliance Data Systems (ADS). While, like Synchrony, it also offers store-branded credit cards, its business practices are quite different and can be described as more predatory. Bread Financial works with retailers such as Victoria’s Secret, Wayfair, and Ulta Beauty while targeting near-prime customers. Their net interest income is significantly higher than Synchrony’s or Discover’s, but so are the loss rates. A significant portion of income comes from late fees, with customers being charged $25 or more even if their credit balance is negligible. I believe predatory practices, such as high interest rates and late fees, combined with mismanagement, are the reason Bread Financial has seen a decline in its loan book since 2022, while Synchrony and Discover showed growth. The share performance tells the same story: since July 2014 (the date of Synchrony’s listing), Bread Financial’s total shareholder return is negative 60%.

Bread Financial is also a subject of one of the more curious conversations I had with a famous value investor with an amazing multi-decade track record of investing in high-quality companies with great managements. I noticed that in 2019, the new CEO who came up from the consumer credit side of the business was way too promotional and was not as forthcoming with information about regulatory changes as its direct competitors. I knew that this famous investor had Alliance Data Systems in his portfolio and asked him what he thought of the management. He responded that while he believes most of the companies in his portfolio have strong management, he can’t say the same about ADS. When I asked about the follow-up on why he owns it, he walked away.

The relative comparison of pure-play credit card companies and some of their wannabe competitors shows how difficult it can be to make money in the business of borrowing at low rates and lending at high ones. The best companies have decades of data on customer behavior that helps them avoid traps and deliver solid returns to their investors. The worst ones are at the mercy of economic cycles and occasionally become the subject of customer and regulator fury. A careful study of business practices and incentives should help find better ones while avoiding the value traps.

Takeaways

- Levered business models can be highly lucrative but require strong, conservative management

- Specialized knowledge is institutional and is hard to replicate even for the best ran companies from adjacent industries

- Capital allocation is often the difference between solid and exceptional performance

Disclaimer³

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1. https://www.marketwatch.com/story/goldman-sachs-apple-card-saga-is-finally-coming-to-an-end-710244e4

2. American Express, which is probably the most iconic credit card company is not included in this analysis because they make most of their money on interchange and membership fees, not interest.

3. The information contained in this post is provided solely for informational and educational purposes and should not be construed as investment advice, a recommendation, or an offer to buy or sell any security. Nothing herein should be interpreted as an offer to sell or a solicitation of an offer to purchase any interest in any fund, vehicle, or strategy. Any such offering may only be made pursuant to formal offering documents and only to persons who are “accredited investors” as defined under Regulation D, Rule 501 of the Securities Act of 1933, in connection with a private offering conducted under Rule 506(b), and who also meet the requirements of Section 3(c)(1) of the Investment Company Act of 1940 or any other applicable exemption.

The views expressed represent the author’s opinions as of the date of publication and are subject to change without notice. The author has no obligation to update, amend, or supplement the information contained herein. Certain statements may constitute forward‑looking statements, which are inherently uncertain and involve risks, assumptions, and factors that could cause actual outcomes to differ materially.

Any references to past performance, investment examples, or specific securities are for illustrative purposes only and do not indicate or guarantee future results. The discussion of any strategy, concept, or thesis is not a recommendation or endorsement and should not be relied upon when making investment decisions. All investments involve risk, including the potential loss of principal.

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