Lower consumer spending during the financial crisis affected the credit card service industry. Now that the U.S. economy is recovering and consumer spending is on the rise, a growth in the credit card industry is expected. The success of the industry lies in innovation, allowing credit service companies to increase their customer base. New offers and technological advancements like mobile payment could shape the industry's future, thanks to the wide use of smartphones. Let's take a look at three credit services companies that have opportunities to enhance their earnings with emphasis on mobile payment, growth in loans, and improvement in credit quality.
Loan growth to drive interest income
Discover Financial Services (DFS) reported net interest income of $1.4 billion in the second quarter ended in June 2013, showing year-over-year growth of 3%. This was driven by its loan growth. In the second quarter, credit card loans increased 5% year over year, accounting for around 81% of company's total loan portfolio. The card loan segment is expected to grow further with improvement in the U.S. economy.
In July 2013, the U.S. unemployment rate declined to 7.4% from 7.6% in June 2013. The decline results in higher disposable income and subsequently higher consumer spending.
The company reported net interest margin, or NIM, of 9.44% in the second quarter, up from 9.39% in the first quarter. The mix of better credit yield and low funding cost resulted in the expansion of its NIM. Discover's funding cost declined by 0.01% quarter over quarter to 1.95%. The credit card yield increased 0.03% quarter over quarter to 11.97%. The company expects NIM to further increase in the second half of the year as high-rate funding debt matures. The low funding cost will remain a tailwind in the remainder of the year, which will drive NIM. With a better NIM and credit growth, Discover's EPS is expected to see an upside to around $5 this year compared to $4.50 last year.
Best Buy portfolio sale: In February 2013, Capital One Financial (COF) announced it would sell its portfolio of Best Buy (BBY) private label and co-branded credit cards at the book value of approximately $7 billion to Citigroup (C). Capital One acquired the portfolio as part of its acquisition of HSBC Holdings (HBC) credit card business. The partnership with Best Buy was not a fit for Capital One due to the key differences in strategic goals that resulted in the divestiture decision. The deal is expected to complete in the third quarter of 2013. On completion of this sale, Capital One plans to buy back $1billion worth of shares, which it expects to complete by March 2014. The buyback will reduce share count by approximately 2.5%, and will add $0.20 to the annual EPS.
The company's credit quality is improving with a decline in the delinquency rate. The delinquency rate is the percentage of loans that have delayed payment to total loans that the institution holds. In the second quarter ended June 2013, the 30-plus day delinquencies rate decreased by 0.02% quarter over quarter to 2.35%. As a result of improvement in credit quality, the provision for losses declined 14% quarter over quarter to $762 million. The low delinquency rate increases the earnings of the banks, as it requires fewer provisions for future losses. The delinquency rate for the full year is expected to be around 2.67% compared to 2.70% in 2012, and the provision for losses is expected to decline to $3.9 billion this year compared to $4.4 billion last year. This will result in an increase in income, after provisions, of $500 million.
Agreement with mPOS for emphasis on mobile payment
On June 5, 2013, Visa (V) signed an agreement with three mobile point of sale, or mPOS, providers: iZettle, Sum Up, and Swiff, under the "Visa Ready Program." The agreement allows merchants to accept Visa payments using mobile technology. The Visa ready program enables mobile manufacturers, network operators, and technology partners to access to the Visa network and licenses to make payments through mobile devices. The agreement provides opportunity for Visa in the growing mPOS acceptance solutions. Small business and retailers that were previously doing transactions in cash are now using mPOS solutions to increase their sales and customer. The worldwide mPOS terminals are expected to reach 38 million by 2017 from 9.5 million in 2012, which will help to drive the migration from cash to electronic payment. Mobile payments are increasing with the wide use of smartphones, providing a substantial revenue growth opportunity for the company.
The company launched digital Wallet service V.me in the U.S. in November 2012. The digital wallet is a service customers enroll in through any financial institution and is for online shopping. The customer's V.me account will store their card details and mailing address so it isn't necessary to enter these details at checkout, making online shopping as simple as 'click and ship.' The company is making progress with this service, and it now has 90 U.S. banks, or 49% of company's domestic card accounts, supporting its V.me service. The number of banks supporting this service has doubled since its launch. In the third quarter ended June 2013, 72 merchants signed up for this service, now totaling 235 merchants. This represents more than $25 billion in total e-commerce volume. With success of V.me in the U.S., Visa announced on July 9, it will launch the digital wallet in Australia by the end of this year. The e-commerce sales in Australia are expected to reach $35.4 billion by 2016 from $23.2 billion in 2012. The company is a partner with 40 Australian financial institutions that will offer V.me to their customers.
Thanks to recovery in the U.S. economy and an increase consumer spending, the credit services industry is expected to improve from its decline after the financial downturn. Visa is trying to capitalize on mobile payment technology with mPOS under the 'Visa Ready program.' It will also launch digital wallet V.me in Australia after success in the U.S.
Discover Financial Services' NIM expansion and card loan growth provides good prospects. Capital One's share buyback plan, after the Best Buy portfolio sale, and decline in delinquency rate will drive investors' confidence.
These companies have opportunities to enhance their earnings; therefore, we recommend a buy for them.