Assume credit cards are the next crisis. Also, assume the crisis comes because the charge off rates go so high that no wants to buy credit card bonds. Where is the best place to be short?
But looking at their market situations, there are clear advantages to both.
- Pro: Lower average credit score to AXP customers
- Pro: Lower average income to AXP customers
- Pro: Large auto lending component to the business
- Con: Has substantial commercial lending deposits from its commercial bank
- Pro: Higher customer balances than COF customers
- Pro: Travel Services department (business credit cards) income is largely influenced by business capital spending in general, clearly in decline
- Con: No commercial bank to fund lending activities (used the Fed commercial lending facility early in November)
Capital One has already received 3.55B from the Fed handout program. AXP has recently applied for and will mostly likely receive 3.5B also from the Fed. This is a wash.
If you look at it in terms of product, COF vs. AXP is like Ford (NYSE:F) vs. BMW. AXP has a more affluent, and privileged clientele. This may provide a more orderly deleveraging by the customers who have more income and thus more capital cushion when decreasing their spending. I believe this is currently reflected in the lower charge off rates for AXP customers compared to COF customers.
But if you look at it in terms of capital position, COF vs. AXP is like Citigroup (NYSE:C) vs. Morgan Stanley (NYSE:MS). Citigroup, like COF, has large leveraged position but also a captured deposit base it can use as a cushion when no one wants to buy its short term financing facilities. Whereas AXP, like Morgan Stanley, holds minimal internal capital and lots of leverage that relied on securitization and commercial paper markets for operation.
AXP may now be approved to own a commercial bank and borrow from the Federal Reserve like Morgan Stanley and Goldman Sachs (NYSE:GS), but there are lots of “new commercial banks” pitching the same consumers for deposits, and relying on the Fed for loans is not a sustainable strategy. As history has shown during the S&L crisis of the 80s, initial government charity can turn into leverage to eliminate weak market players. AXP runs this risk.
Both are solid short candidates, but despite its pedigree, AXP is more exposed to credit market freeze and thus appears in a more precarious position.
Capital One said this month it's restricting credit card issuance after charge-off rates spiked to 6.34% in the third quarter from 3.96% in the same period last year.
From the WSJ:
Banks, in turn, are trying to wean themselves from the securitization markets. They're turning to other financing such as certificate of deposit programs, but those can be costly.
The market shutdown is particularly bad news for non-bank finance companies. The ability to sell off car, education and auto loans is critical to companies such Ford Motor Co.'s Ford Motor Credit, American Express Co. and student lender SLM Corp., or Sallie Mae. Without securitization markets, they have less capital to make new loans to consumers.
As reported in the American Express 3Q conference call transcript (American Express CFO, Daniel Henry – EVP & CFO):
… approximately 50% of [American Express] funding was unsecured and 50% was done through securitization.
Moving to slide eight, metric performance for international consumer, we continue to have strong metrics in international consumer although we did see some slowing in billed business in the third quarter. FX adjusted growth in the first and second quarter was 10% compared to the 8% in the third quarter.
In the US while the write-off rate in the quarter was 5.9% the write-off rate in September was 6.1%. We expect the fourth quarter to be higher then the third quarter and we expect the first quarter of 2009 to be higher then the fourth quarter of 2008.” American Express CFO, Daniel Henry – EVP & CFO
Disclosure: The author is long puts on both COF and AXP