July 31, 2008 – 10:48 pm
My team has finished the Amex analysis, and it is interesting. Amex is considered the creme de la creme of credit card lenders, with a premium upscale consumer and business clientele that generally does not carry balances on their cards. Well, don’t believe the hype. A little more on this later.
A quick note… I will change the format in which I distribute my opinions by including highlights in HTML and reserving the bulk of the opinion (including valuation) for download and/or physical distribution at one of my events. Less work formatting and fixing stuff for me. In addition, if you meet me personally, you can get to ask me questions as long as it is not investment advice. Thus far, Amex and HSBC are up next, then the next two phases of my investment thesis are on tap.
SUMMARY OF MY OPINIONS ON AMERICAN EXPRESS
The deteriorating consumer credit environment in the US has seen large credit card companies, including American Express (AXP), witness large write-offs and provisions in the last two quarters. AXP reported 2Q2008 net income from continuing operations of $655 million, or 56 cents a share, down from $1.04 billion or 86 cents a share in 2Q2007, off higher-than-expected provisions on its credit card lending portfolio. Credit metrics for AXP continue to weaken with 30 days past due card loans and 90 days past due card receivables rising to one of their highest levels ever at 3.9% and 3.0%, respectively, in 2Q2008. Amid the continuing US housing price decline, rising unemployment levels and increasing energy, commodity and food prices borne from burgeoning inflationary pressures, we expect AXP’s delinquent credit card payments, credit cards defaults and losses to rise over the current levels. This coupled with rising funding cost off hastily dwindling liquidity in the credit markets, near non-existent securitization activities in the US, and deceleration in AXP’s core credit card income due to slackening consumer spending, should weigh on AXP’s near-to-medium-term earnings. However, we believe that AXP’s liquidity position remains reasonable to weather the current difficult operating environment, particularly as the Company is expected to receive approximately $880 million annually for the next three years consequent to a favorable settlement of antitrust lawsuit against MasterCard and Visa.
II. KEY POINTS
Credit card companies to face macro-economic headwinds. Problems of credit card companies are likely to amplify with rising probability of increased customer defaults. Higher inflation, rising unemployment levels and declining housing prices have intensified concerns about increased credit card losses that could dampen earnings of credit card companies. AXP’s credit metrics continue to weaken with a record rise in delinquent loans and receivables, necessitating increased provision for loan losses over the past few quarters.
AXP’s inadequate reserves and higher expected delinquencies to amplify provisions. AXP’s total reserves for loan losses increased from 3.2% at the end of 2007 to 4.1% at the end of 2Q2008 as the company created additional credit lending reserves of $600 mn in 2Q2008 in expectation of higher credit card losses. However, with rapidly growing credit card loan write-offs and lag in reserves-to-credit losses, AXP will have to create higher lending reserves in the coming periods, exerting downward pressure on its earnings.
Slowdown in consumer spending to impact AXP’s credit card billing business. With US consumer confidence index touching its lowest level since 1992, the effect of slowing consumer spending is expected to hit hard on revenues of credit card companies. AXP has already felt the brunt of decelerating consumer spending in its US credit card business, which witnessed a negative growth of 0.33% in 2Q2008. Consumer spending outside the US has also been impacted by weakening of the global macro-environment.
Lower discount rate to further intensify revenue slowdown. AXP’s discount rate has witnessed a persistent downward slide since 2006 off changes in business mix and pricing discounts led by competitive pressures. AXP’s discount revenues, which currently contribute nearly 47% to the Company’s revenues (gross of interest expense), are likely to remain under pressure, in the near-to-medium term, due to lower discount rates.
Lack of short-term liquidity and lower securitization activities to impact company’s funding strategy and net interest margins. Increased counterparty credit risk in the fast deteriorating credit market has resulted in the rapid dwindling of short-term funding sources. This has caused AXP’s increased reliance on higher cost long-term funds over the past few quarters. We believe that the funding cost is set for higher interest rates amid continuing widening of spreads and perceived higher losses in the financial sector. The problem is likely to be aggravated by AXP’s recently downgraded ratings by S&P and rapidly declining securitization activities in the US, forcing AXP’s net interest margins on a trip down south.
Valuation, Assumptions, and Pro Forma sections are available for download via the full report:
AXP Consolidated final (437.96 kB 2008-07-30 15:11:32) or through one of my BoomBustBlog events only.
Financial Highlights
AXP’s credit metrics continue to weaken
Increased delinquency as customers fall behind scheduled payment dates. A worsening macro-economic environment in the US has led to increased credit card delinquency rates and record charge-offs in the last two years. As per FDIC data, in 1Q2008 credit card charge-offs and delinquency rate in the US increased to 4.7% and 4.9%, respectively, from 3.1% and 3.9% in 1Q2006. The trend is expected to lead to a more difficult situation amid rising unemployment levels, slowing business activities and weakening fundamentals in the US.
Source: FDIC
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