The investing thesis behind American Express (AXP) has always been that it has a higher quality of user and thus its defaults will be lower than the typical credit card issuer. Unlike Visa (V) and Mastercard (MA) who issue their cards through banks and collect a "toll" each time the card is used, Amex holds the credit balances and is essentially its own bank. This has enabled Amex in good times to earn a high return on equity as it collects the interest payments that go to the banks from the other card issuers.
All that seems to have changed. It seems, being hit by slowing consumer spending and rising defaults, AmEx is seeking roughly $3.5 billion from the TARP program.
It isn't clear if the application under the Troubled Asset Relief Program [TARP] came before or after AmEx got Federal Reserve approval Monday to become a bank-holding company.
Why? Even the most affluent AmEx customers are cutting back on discretionary purchases, the company has acknowledged. A spending slowdown is particularly problematic for AmEx because its business model revolves around consumers who pull out plastic for their purchases.
That alone would not cause the problem. What would? Delinquencies and defaults on credit cards are rising. Meanwhile, the company is virtually locked out of credit markets because investors who buy consumer loans are sitting on the sidelines.
All this is causing a liquidity problem. Again, like other institutions, not a solvency issue, but a liquidity one. It is also the reason we are hearing stories about AmEx card holders with no credit problems getting credit limits decreased. AmEx is trying to decrease its liabilities.
Not good news for shareholders for two reasons. The decrease in consumer spending reduces the "toll" AmEx gets when a customer uses his card. The credit limit decreases the company is placing on customers now further reduces that effect and reduces interest AmEx wil earn on outstanding balances. When you add this to the increasing defaults, you have a trouble stew.
This is not the "salad oil" fiasco that hit AmEx when Berkshire's (BRK.A) Warren Buffett bought a huge chunk of the company in the late 1970s. This is a fundamental change to the company's structure and the way it does business. The AmEx model back then was to essentially "front" customers money who would then pay it back a month later in full. Now Amex extends payment terms on almost all cards and has branched out into business lending. Now more than ever it is exposed to the consumer and his or her credit condition, not just their current spending patterns.
Previously if you did not pay your AmEx bill each month it was shut off. Now, consumers can continue to rack up debt to their limits while making minimum payments until they are tapped out. In this case, the monetary default risk for AmEx is far higher. This is causing increasing credit losses for AmEx.
The old thought that "AmEx is less sensitive to a recession" has never really been tested. The last real recession we had in the US was the 1990 one (the 2000 "recession" was a pothole). AmEx then was not nearly as exposed to the consumers' credit condition as it is now. Only now are we going to be able to test the thesis. Based on early results, it was wrong.
It also means the old investing thesis needs to be rethought as it has now become less valid.
This is not the same AmEx Buffett bought....