American Express Calls Investment Banks' Bluff 19 comments
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I guess it all depends on what you look for.
Analysts and the talking heads have largely chosen to ignore several key developments in their assessment that it’s time to buy financials stocks. As I mentioned in Monday’s essay, this current market rally, led by financials, was largely the work of the SEC crushing shorts. The icing on the cake for the “worst is over” crowd were better than expected results from Citigroup (C) and Bank of America (BAC).
Setting aside the fact that most of these “better than expected” results came from smaller write-downs—a bogus reason given that most of the assets on these firms’ balance sheets are valued in-house (subjective), not by the market (more objective)—consider that all of these firms are still losing money. For instance, Citigroup announced a 29% decrease in revenue from 2Q07, write-downs of $7.2 billion, and a total loss of $0.49 per share (analysts expected losses of $0.66 per share).
These results aren’t “better than expected,” they’re “less horrendous than expected.”
Beyond this, I have difficulty understanding how Citigroup and others are beating estimates while American Express (AXP), the ultra-prime of the credit card companies, just announced that both results and credit conditions are worsening.
On Monday, American Express announced profits of $0.56 per share, compared to analyst expectations of $0.83 per share. All told, second quarter earnings fell 38%. That’s bad enough, but listening to AXP CEO Kenneth Chenault on the post-earnings conference call, it’s clear things are getting worse, not better.
Accord to Chenault, “Over the past month or so we have seen clear signs that the U.S. economy is weakening. Unemployment rates, as we know, took the largest jump in over 20 years. Home prices declined at the fastest rate in decades and consumer confidence is at one of the all time low points… This fallout was evident across all of our consumer segments, even our longer-term super prime card members… In other words, more and more consumers who are falling behind in their payments are remaining delinquent.”
AXP is the cream of the crop for credit card companies. AXP cardholders charge an average of $12K a year, roughly five times that of Visa or MasterCard holders. They spend more and default less. So to hear that AXP is experiencing a higher rate of defaults than expected, as well as a greater number of AXP cardholders remaining delinquent, is truly worrisome.
Chenault continued, “In light of the magnitude of the negative economic trends and our experience, we now believe the economic weakness in the US will likely worsen throughout the remainder of the year and negatively impact credit and business trends ... we now expect that our lending write-off rate in the third and fourth quarter will be higher than June levels.”
So we’ve got the top of the line, ultra-prime credit company missing analyst estimates and worrying that things are getting worse, while investment banks beat estimates and proclaim that conditions have improved dramatically.
Somehow I don’t think the banks are being totally candid.
Over the last three quarters, banks and other major financial firms have employed countless tactics to bolster their results. Whether it was public announcements—the CEOs proclaiming “the worst is over”—or fuzzy accounting—recording write-downs in debt as profits or moving more assets to Level 3, thus removing any mark-to-market valuation—these guys have done everything they can to make their results look “better,” I mean, “less horrendous,” than expected.
They’re still doing it now. And things are going to get a lot worse before they get better.
I’m looking around for more shorts in the financial sector. This latest rally has all the hallmarks of the last one—change in sentiment, better than expected results, worsening fundamentals. When the party’s over and the shorts have covered, financials will begin their next step downward. I want to profit when they do.
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This article has 19 comments:
It is not impossible to have the following two things occuring at the same time:
1. Individual consumers are stretched and are having issues with their credit, including the super credit worthy ones. This is what is affecting Amex and,
2. Asset valuations at the banks for the mortgage assets (created in the past) have been marked down significantly and there is not much markdown left to take. Additionally, the investment banking activitiy may have picked up in pockets. The banks are also restructuring and disposing off assets, etc. Additionally, some consumers may be pulling their deposits out of Indymacs of the world and putting them at Bank of Americas of the world. Therefore it is quite plausible that some of the banks had a better quarter than what the street thought and the things may indeed be improving for some of the banks. In fact, as liquidity continues to come back in the market, you may find a lot of previously marked down assets written up as the market begins to be able to price them
You are comparing apples and oranges and jumping to conclusions
Otherwise your article is emotionally-driven and short on facts. You don't tell us anything insightful about credit quality or earnings drivers for these companies. AmEx is a bit different from companies in the mortgage business, since AmEx loans are collateralized by people's desire not to have a low credit score (almost irrelevant, in today's environment of scare credit and more pressing financial concerns) whereas mortgage loans are collateralized by the roofs over people's heads (fairly valuable for most people, and a forecloseable asset in the event of default). When someone defaults on an AmEx loan, the whole thing the company can collect is one more name and address to sell to the collection agency for pennies on the dollar. When someone defaults on their mortgage, their bank gets a house, which should eventually be worth significantly more.
Also your comparison of AmEx cardholders to V and MC cardholders is spurious because most people have no more than 1 AmEx card (since they're issued by only one company) and many V/MC cards (since they're issued by every bank, stores, lenders, etc.). Also, even if your data point were comparable, I'm not quite clear on how people who charge a lot present less credit risk than people who charge a little, absent any information on net worth or income.
I understand that banks have exposure to second liens and uncollateralized consumer debt, but they have much less of it and much more stable business than a pure credit card company.
In the meantime, the banks have claimed the $12,000 of interest as profits (seen in accounts receivable). But I'm not going to pay that back. AND I'm not going to pay back the $10,000 for the TV. That means the $12,000 of profit must now be converted to a $22,000 loss.
The banks keep delaying doomsday by allowing $10 minimum payments and increasing credit lines to prevent default. Once CC holders start defaulting, watch out.
It's hard to tell the truth in the banks' financial statements. Ideally, you'd want to compare the accounts receivable and cash flows to historic levels in the mid/late 1990s. With all of the off-the-books special entities, we really have no idea how bad their situation is.
This is a classic case of the emperor's new clothes and cheers to Chenault for not sugar-coating what he sees.
"Citigroup Looks Better After $2.5 Billion Loss"
"Citi posts $2.5 Billion Loss, Shares Surge"
What the heck? This goes against every bit of logic and reasoning I know of.
For me, the pertinent statement is from AXP: Chenault continued, “In light of the magnitude of the negative economic trends and our experience, we now believe the economic weakness in the US will likely worsen throughout the remainder of the year and negatively impact credit and business trends ... we now expect that our lending write-off rate in the third and fourth quarter will be higher than June levels.”
Add this to what Jamie Dimon has been telling us, again without deceit, and we basically saw 2 straight dudes calling the credit situation as it is (and it ain't looking too good), versus a crowd of shysters and bottom-feeding pumpers selling snake oil.
Saying this though, I really don't want to see those criminal naked shorts back again. Let the markets find their own true levels without any more hysterical bashing or pumping.
Right there you lost all credibility as MA and V are not banks. They do not have the exposure to debt. They are the transaction processors. I thought this was common knowledge by now.
I knew they must be hurting because I am recently getting at least five emails and three post mailings a day for some new schemes I don't want or need.
Some friends tell me Amexco are cutting monthly charge limits on some of their BIG business clients who have always paid on time. It looks like we'll all have to start getting cash at the bank like in the olde dayz and carry a Glock! jeeeeeziz...
and to all the V and MA-lovers who immediately react if their darlings are mentioned with axp: the author didn't state that V or MA were in trouble. he simply wanted to illustrate the point that axp has a higher net-worth and higher turnover-clientele than the two. and that therefore, a deterioration here is extremelx significant for the financial sector. so sit back and relax. nobody slapped your two darlings.
funny. really.
FXTrader, how can Visa and MA have lower net-worth clients than AXP when V's and MA's clients are banks?? Please explain.
I am a AXP charge card holder and have a annual fee of $400. This still have not swayed me to give it up. The card is a more prestigious card and carries extra benefits.
The big concern to me is when the Option ARM mortgage loans recalculate. The first problem is that these loans offer a low payment based on a 1%-2% interest rate. Howeverr the payment on this rate does not even cover the interest accruing on the loan at an actual rate of about 7.5% which can adjust each month. This loan is better known as a negative amortization loan.
BUT the largest problem is the way banks recognize the income. Banks are allowed to recognize the full P&I payment based on the 7.5% rate even though they are getting paid on the 1%-2% rate. It is deferred income but still recognized. This is a bigger issue than any credit card issue out there.