Skip Olinger

Pay Back Time for Credit Card Companies

Very good job. You bring up a good question: Who is responsible for allowing credit card debt to pile up to size and mess it is now? Is it the consumer who used credit card debt to indulge in impulse purchases thinking that the appreciation of their house would pay it all off? Or, is the banks that granted easy credit to people who were poor risks and never had a prayer of being able to repay all their debt? Again, we come back to the evils (and there are also a lot of positives) of the securitization market. By securitizing credit card debt, banks substantial transferred risk to the note holders and generated fee income to boost their ROE. Investment banks were screaming for more product so they could maintain their fee income. Investors were screaming for notes that had higher interest rates in a low rate, low risk premium environment. So the banks, in turn, granted more credit to less creditworthy borrowers. Sound familiar? The music has stopped and we are short more than one chair. When you are a lender, you are responsible for maintaining credit standards and denying credit to the unworthy. If you fail to do this, you must suffer the consequences. Going back and raising rates and fees on the group that can still pay to cover your own misjudgment seems very unfair. Bankruptcy law is long established. It is designed to stop a lender from condemning individuals to a life of indentured servitude - from "owing their soul to the company store". So, in my opinion, yes, the government should limit extreme lending practices. And if that reduces banks appetite to lend to the credit unworthy, well maybe that would not be so bad!

Why is the Market Ignoring American Express's Bad Report?

1. very good short summary of 1Q activity. Well written
2. you said $136 billion, you meant million
3. Visa MC as someone above points out is over several more quarters. But I agree, it is non-core income.
4. $25M loss from US ops is not that bad given slow down in spending and write offs. In a past Amex presentation, they showed that write off in, I think '90-91 went to just over 10%. Amex survived. They could very well go to 12-15% this time. Amex will survive. I believe Mr. Market is getting excited about the prospect that the portfolio is getting close to being cleaned up. They aren't putting many new receivables on the books so at some point the losses will stop.
5. You correctly point out that card member spending is way down. Again, at some point it will stabilize and come back.

I don't know if we have reached the bottom of consumer spending or cc write offs, but we are a lot closer. Amex is a great company and it is trading a historical low multiples. It is buy low - sell high. You don't get the lows without a great deal of uncertainty. So don't get mad a Mr. Market, take advantage of his offers. That said, I am not going all in with Amex now. I think we are in for a long haul and there is a good chance Amex and a lot of other companies will retreat.

Credit Card Crunch: Creating a New Generation of Subprime

Interesting detail on FICO but this is old news and not very helpful in stock picking. How bad can the credit card losses get at JPM? What effect on earnings will that have? Will it take the company under? Are they under reserved? At $12 per share, there could be an awful lot of pain baked into that price. Is there a value investment opportunity there even if write offs go to 10-12%? What happens of consumer spending improves in 2-3 years? Or will the company go under?

How this information affects specific stocks would be more helpful.

Is American Express Worth the Risk?

Sorry, but WRONG! Amex's shrinking retained earnings is a result of their repurchasing stock, not high interest rates. Actually, securitizations, until recently, had very low interest rates. And, interest expense does not deplete retained earnings. Net losses, dividends and comprehensive income (loss) deplete retained earnings. In case you had not noticed, Amex generates about 30-35% return on equity in normal times. It does not require high reinvestment of its net income to grow its business. Therefore, they can pay dividends and repurchase stock thereby reducing shareholder equity. This increases returns to shareholders.
Hope this explanation helps


On Nov 13 07:48 PM tshk1221 wrote:

> Well, the interesting point is that the Oracle has been keeping this
> company very long time. Probably, his long-term holding of this company
> is because he knows that this company has proven survival skills
> accumulated for the last 50 years or more. Even if this financial
> crisis is directly hitting this company right now, I don't see this
> company will die soon. Price is very ok. However, fundamentally,
> there is a big issue for this company. Retained earnings are shrinking
> every year from 2005 to 2007. It is depleting retained earnings due
> to hefty interest rate costs it relies on for credit card lending.
> A real bad sign..ExxonMobil and Chevron's retained earnings are growing
> 15% - 20% every year. One thing this company must achieve to attract
> strong attention from real, long-term value investors..Investment
> in this company now could be very risky in consideration of its risky
> business nature, uncertain future as bank holding company and shrinking
> retained earnings, but, as you know, greatest return comes from greatest
> uncertainty.

AmEx Taps the TARP; Not the Same AmEx Buffett Bought

There is nothing new in your analysis and it offers no insight into the current opportunity with Amex. I believe the question are:
- how bad can the write off rate go? It went to 10% (now roughly 6.5%) in '91. That is the big known that can really affect value. I doubt it will go to 100%. There most recent vintages of receivables have the lowest credit scores so that is where the problems are likely to arise.
- yes, rich people spending will go down, likely more than most people project but it won't go to 0.
- securitization gains will go down as well
BUT:
- the company's liquidity problems seem to be addressed with TARP and becoming a bank holding company
- it is still a fantastic franchise head and shoulders better than dealing with MC/V bank people and the rewards are far better.
- times will return to normal and the company will earn and grow at normalized levels
- it is selling at historical lows.
CONCLUSION
Watch the write off situation carefully. Wait for normalacy to return to the credit markets. You may miss the bottom, but there is a lot of upside here.

Corporate Bond Market Grinding to a Halt

How bad is the securitization market? Amex's fall back liquidity plan is to issue more securitization paper if they get shut out of the unsecured long term debt market.

I also assume they are having trouble issuing commercial paper. What is the effect of that.

15 Value Hedge Funds - Portfolio Update

I guess I am dumb like you. I think seeing what some pretty bright people are buying and selling is a pretty good place to get ideas to do my own research. It also provides a good benchmark to compare to my own portfolio.

You should do some further research on whether Buffett sold COP. I saw another post that he, in fact, got an expemption from the SEC to not report is position in that stock. Therefore, it simply droppped from the list and not sold. Given that COP is pretty cheap compared to the rest and that he and Gates were up in Canada looking at oil sands, it seems unlikely that he just punched out of this position in one quarter

The Long Case for American Express

Well Done! How refreshing to find someone on this site that actually reads financial statements!

AXP is the largest card issuer in the world based on total billed business. It billed $181B in 2Q08. The next largest was Citi at $106B (1Q08). That is 71% more than its closest competitor. They have about 24% of total US purchase volume. Discount revenue was up in 2Q08 by 8.7% YOY and their average discount rate was 2.56%. I am pretty sure that is significantly higher than V or MC. (Let me know if you have that stat) You did not mention their superior rewards program that they can afford through their higher rate that locks in customers. Also, Basic cards in force grew 11% (7% US, 17% non US). Their average FICO at acquisition in 1Q08 was 733 charge, 750 credit. This company produces a great ROE of 35% in normal times and they expect to grow EPS 12-15% per year again in normal times. Their earnings declined 36% this quarter. But all in all, this is a great world wide franchise producing great returns with shareholder oriented management and is not going to go away.

The big issue right now is increasing credit losses on their LOAN portfolio. As you point out their CC receivables are showing higher wirte offs but it is not that bad. It is their loan portfolio of $49.7B ($77B including their OBS securitization) that has blown their credit models and incured a 141% increase in 2Q08 YOY. And the company has said they can't predict where it will stop.

So how bad can it get? Looking at a historical chart provieded in their 2/08 presentation, Net Write Offs went as high as 10% in '91 and dropped to around 7% the following year. It reached 7% 2 more times in '98 and '02. It looks like it averages around 4.1%. AXP would make the case that they are better at credit evaluation now. Who knows? Their charge off rate in 2Q08 was 6.7% on a managed basis or $827M on a loan portfolio of $49.7B. This write off rate and the related provisioning caused them to lose money in their US card business for the quarter. So if their write off rate increased to 10% over the next 12 months, that would be an additional $416M in expense per quarter on top of the $827M. I assume the loss provisioning ultimately equals the write offs. While not good at all, the company would still make money. Pretax earnings for this depressed quarter were $766M.

Bottom line - this is a well run company with a very powerful worldwide brand that produces great returns on capital. It is going through a significantly difficult time. Like with all financial companies you never know how bad it will be until its over. But 12-18 months of below target performance does not kill the company. The stock is trading at depressed levels. At $36 per share it is around 15-16x depressed earnings. If you look out 3-5 years and assume the company will be earning what it did in '07 it is trading at 10.6x. Their model is not broken. The stock is cheap.

Winners and Losers from the Mortgage Mess

With all due respect, as the comments above point out, this was not a well thought out article. I have never heard before that it is OK for someone to lose their house so long as they never put up a down payment. I would not look at that as an indicator of personal financial strength.

Ten Reasons to Like American Express

While I am also long AXP and agree that it is very cheap, I think you missed the main issues about the stock. Mastercard and Visa are payment processors only; they do not have loan exposure to their card holders. The issuing banks carry that exposure. With AXP, they not only have their own processing network, they carry the loan exposure on their books. With a mortgage, you at least have a house to collateralize the loan which may, at some point, be worth something. A credit card is unsecured. Therein lies Mr. Market's concern and why the stock is cheap. There is justifiable concern that things are going to get worse for Mr. Consumer and more people will default on their credit card debt.

That said, as you point out AXP has a very high end client with some of the highest credit scores in the industry. They also have an award system that keeps Mr. Consumer locked into using the Amex card and if he becomes late, he loses his points. Amex has been through tough periods before. In 1991 I think their loss rate went up to 9% of their outstandings. (check the recent presentations on their website). Their current reserves are around 6% and they have better quality receivable now. The company should be on top of this issue. And, there are a lot of very smart guys who agree that they do.

I personally think this is an understandable company, unlike AIG or Citi; they have very good management and I doubt you will ever get this company this cheap again. But, it may be awhile before Mr. Market recongnizes it. The risk is that Mr. Consumer falls out of bed and is killed. In that case there may be a lot more write offs than is now predicted. But that's the wager right now.

Why Kass Is Wrong About Berkshire Hathaway

I never considered the idea that this could be a marketing play rather than a financial one. Good insight.

As far as shorting BRK, it does not make a lot of sense to me. The company has little leverage, other than its derivative portfolio, it has an extremely solid balance sheet. Everyone including WEB knows that company will not grow as fast in the future due to its size. And, the company does not sell for a huge valuation. Therefore, I see no catalyst that could occur that would suddenly drive the stock price down. Aren't there more interesting shorts out there? There has to be some highly leveraged companies selling for high valuations with yet to be determined true values of assets on their balance sheet.