Last Tuesday, the Senate passed legislation which will impose stricter regulations on the credit card industry. Many consumers have been infuriated with interest rate hikes on existing bills and fees for various services such as paying bills via the mail. These rate increases and fees have been hurting the consumer where it hurts, in their wallets, amid a very harsh recession. Many of the consumers who are feeling the pain are the same lower and middle class Americans who are getting hurt from delinquent mortgage payments and a lost job. The big question is how will this bill affect players in the credit card industry if it is passed by the house and signed by President Obama?

The bill was passed with an overwhelming majority of a 90-5 vote. President Obama has been behind making more stringent regulations on credit card companies even before he was in office. The White House is likely to continue to support the bill, as the bill will increase disclosure and fight interest rate increases for consumers. According to the Wall Street Journal, Senate Banking Committee Chairman Christopher Dodd stated: “Credit cards are a tremendously valuable and useful tool for consumers, providing them with relief during critical moments… This is a very important industry.… We just want it to work better.”

One trade I have been extremely bullish on is a long position on the KBW Bank Index (KBE) while shorting the KBW Regional Bank Index (KRE). This trade has worked out very well ever since I wrote about it on RealMoney’s Columnist Conversation. The play is betting on the relative out-performance of the large cap banks compared to smaller regional banks. The trade is unique in the sense that you are hedging your downside risk by shorting the Regional Bank Index, but profit when the spread widens.

In more detail, the KBE is an ETF of the 20 largest banking institutions in the U.S. Players like Bank of America (BAC), Wells Fargo (WFC), JPMorgan Chase (JPM), US Bancorp (USB), and Bank of New York Mellon (BK) make up the top five holdings of the security. The KRE ETF replicates the KBW Regional Banking Index, which is an equal weighted index of over 50 geographically diverse regional banking institutions. Top players in the KRE include First Niagra Financial Group (FNFG), WestAmerica Bancorp (WABC), TCF Financial (TCB), Hudson City Bancorp (HCBK) and City National (CYN).

Searching for the largest beneficiaries of a potential economic recovery in the financial sector, it is very difficult to determine who will gain first. Many expect large commercial banks to perform well during the recovery; I am against this thought. I would argue that the U.S. banking system will go through a much longer period of re-structuring and re-capitalization which will take at least the next decade to fully sort out. Looking at the current environment, it is best to invest in areas with the least amount of regulation and sustainable fee revenue generation. Keeping this in mind, the best play is Visa, Inc. (V).

Both Visa and MasterCard (MA) have performed relatively well this year (each up over 10% YTD), as investors have rewarded their no-credit exposure business models. Rather than profiting from both the credit card loan portfolios and transaction fees from consumers using their transaction networks like Discover Financial Services (DFS) or American Express (AXP), Visa and MasterCard mainly profit from consumers using their networks and hold no credit exposure.

Ever since the U.S. government forced the top American banking institutions to take TARP money to prevent a total collapse of the banking industry, many have shifted focus to Goldman Sachs (GS) and the company’s next move with this cash. In October, Goldman was forced to take $10 billion of the TARP money. Top executives at Goldman spoke out about taking money, insisting that they did not need any assistance, but graciously accepted the government’s money to appease regulators and the markets.

In February, Goldman was quick to state that it is looking to pay back the $10 billion back to the government as soon as it can. Although Goldman had approximately $122 billion worth of cash and cash equivalents on its balance sheet as of November 28th, it won’t be able to pay the government back immediately. The government set up strict stipulations to make sure that if a bank chooses to pay back the money, it is truly healthy and capable of doing so. So in Goldman’s case, the only way it can pay the injection back is by raising its Tier 1 capital. Goldman is already working on raising its current Tier 1 capital ratio of 15.6% by potentially selling 5-20% of its stake in Industrial & Commercial Bank of China Ltd, a deal which could bring in over $1 billion.

Over the past couple of months, Visa Inc. (V) has performed extremely well relative to the S&P 500. Year-to-date, Visa has squeaked out a 1.85% gain, while the S&P 500 has rapidly declined over 24%. Visa has proven its strength even in this recessionary environment. Last quarter, Visa’s profit increased 35% due to consumers switching to electronic card payments rather than cash. This was consistent with my argument on “Why Visa Will Thrive”, which I wrote a few months back. Given Visa’s recent performance, they are positioned well for a few strategic options, but will most likely be focused on Visa Europe.

Currently Visa Europe is a separate operating entity that is not owned by Visa Inc. When Visa IPO’d in March of 2008, Visa Europe was not included as there were issues with the Single Euro Payments Area, or SEPA. Visa Europe is a great strategic fit geographically for Visa. Visa Europe is a membership organization of 4,600 European banks that have collected over 350 million credit, debit and commercial cards in Europe. In 2007, Visa Europe had technically advanced their card processing platform and was handling more than 6 billion transactions. They provide cross-border transactions in at least 36 European countries. Transaction growth is expected to grow at least 11% each year until 2012.

Over the past week, many of the U.S. banks have been hit hard due to fears that nationalization of our banking system could happen soon. How likely is this option though? The U.S. has prided itself on being one of the strongest free market economies. If banks were to be nationalized, how would that affect the rest of the economy and the morale of investors?

In July 2008, I wrote an article about the future of investment banks and the extreme likelihood that there wouldn’t be a pure play investment bank by the end of the year. I underestimated the speed in which this transformation would occur, especially with the unexpected bankruptcy of Lehman. Now, after looking at the U.S. banking system, it is apparent that without a sharp turnaround in the financial markets, action is necessary to prevent a total collapse on the U.S.’s financial system. The one thing the Fed cannot allow to happen is the freezing of payments and lending not only between banks, but also to consumers and businesses. Without an easy flow of money, the economy will come to a screeching halt.

Although the financials sector plum­meted over 57% during 2008, there are many opportunities to invest in good companies with solid bal­ance sheets at discounted prices. I believe that Goldman Sachs (GS) will be one of the stocks to hit it big in 2009.

Goldman Sachs continued its “best of breed” stance on many of the league tables during the year. Unlike many of their competitors, Goldman’s manage­ment has survived and has been pro­active with the volatility of the equity markets and taming investors' concerns.

On December 17, 2008 Morgan Stanley (MS) posted another loss for their 4th quarter earnings. The firm has been hit hard by losses from assets across the spectrum, and investors have destroyed the stock as it converts to a bank holding company. For the 4th quarter, Morgan Stanley reported a net loss of $2.3 billion, or $2.34 a share, compared with last year’s loss of $3.59 billion, or $3.61 a share. Although this loss is narrower than the previous year, the losses still trump the average analyst expectations of a loss of $0.34 a share, polled by Thomson Reuters. Morgan Stanley reported one day after Goldman Sachs (GS) posted a loss of $4.97 a share, mainly due to the performance of their trading and principal investments group. A more in-depth look into Goldman’s latest earnings can be found here. Both Morgan Stanley and Goldman Sachs’ stock prices have been slaughtered this year, down over 72% and 64%, respectively.

Although Morgan Stanley’s loss was much worse than analysts expected, their reduction of risk showed some signs of hope. Since the start of this year, Morgan Stanley has reduced their leverage from 32.6x to 11.4x. This is truly an accomplishment by Morgan Stanley’s management, as it is extremely important for the firm to reduce their risk. The reduction in their leverage came from a reduction in their total assets this year by 37% to $658 billion. They were also able to raise a significant amount of capital, which also helped to reduce their leverage significantly. Many analysts were happy with the new balance sheet strength and expect this leverage ratio to remain pretty stable. Goldman and Morgan Stanley were forced to reduce their risk in almost a “rat race” pace as investors punished the stocks for their excessive leverage.

Last week, investors anxiously awaited earnings announcements from both banking giants Goldman Sachs (GS) and Morgan Stanley (MS). These reports gave Wall Street a good look at the progress of both companies in their transformation from investment banks to commercial banks. Goldman Sachs and Morgan Stanley gained 19.18% and 11.55% on the week as the financial sector rallied a mere 2.72%. One thing is certain from both of their announcements, it will take a long time for both companies to successfully transform their businesses to deposit taking, de-leveraged and well-capitalized banks.

First, let’s start with Goldman Sachs. Goldman reported their first loss since going public in 1999. They proved themselves to be the most profitable Wall Street firm, and climbed to the top of many of the industry’s league tables… beating out behemoths such as Bank of America (BAC), J.P. Morgan (JPM) and Citigroup (C).

Welcome to Part III of a four part series discussing the current state of the foreign exchange markets and the future problems and issues that will surround it. Part I of this series explained the general relationship between commodities, the Euro, and the Dollar. Part II of this series discussed the reasons why the dollar has rebounded recently. This article will discuss the European and U.S. central bank’s rate cuts, their fiscal stimulus plans, and the LIBOR to fed funds rate and the affects these issues have had on the Dollar and Euro.

Rate Cuts

Welcome to part two of a four part series covering the current conditions of the foreign exchange market. This series of articles is focused on the dollar’s moves in relation to other currencies. The first part of this series is focused on the relationships between the Dollar and the Euro, commodities, and inflation and their role in the forex market. This part of the series will explain some of the reasons regarding why the Dollar has rallied recently in light of the financial crisis.

The moves in the currency market over the past couple of months have been extremely volatile and violent. Many currencies such as the Euro, Pound, and the Australian Dollar have depreciated against the Dollar at historic rates. Since reaching its high of $1.60 EUR/USD in May, the Euro has plunged over 21% to 1.25. The Euro has rapidly declined since August of this year due to many concerns including a flight to safety in U.S. Treasuries, a possible worldwide recession, the European Banking system and the U.S.’s TARP plan.

In an unexpected announcement, Bank of America (BAC) released their 3rd quarter earnings results and announced that they will be cutting their dividend and issuing new common shares to raise capital.  After an interview on CNBC yesterday, CEO Ken Lewis stated that a dividend cut wasn’t completely out of the picture, and that they would do what was best for the company going forward.  Bank of America was obviously in worse condition than he made it seem, as they not only had to cut their dividend, but they also sold $10 billion in new capital as management said that “recessionary conditions” are causing problems in the bank.  For the past couple of weeks, Bank of America looked as if it may be the strongest bank after the acquisition of Merrill Lynch (MER), but obviously more capital was needed than many analysts originally thought.

Bank of America decided to release their 3rd quarter earnings results more than 2 weeks before they were expected to.   They reported net income of $1.18 billion, or 15 cents per share, which was 68% lower than last year’s results of $3.70 billion, or 82 cents per share.  The results were much lower than analyst expectations of 62 cents per share, which were the average pole from Thompson Reuters.  Losses on mortgages and credit cards weighed down the results as its provisions for credit losses were $6.45 billion, up from $5.83 billion in the second quarter.  Net charge offs grew 20% to $4.36 billion compared to the 2nd quarter.  Non performing assets were $13.3 billion, or 1.42% of total loans, leases, and foreclosed properties.  The results were much worse than analyst had expected which sent shares down over 10% in after hours trading on Monday.

Over the past 5 trading days, shares of Lehman Brothers (LEH) [7.25, -0.54 (-6.93%)] have been beaten down over 51% due to capital raising issues. Shares are now down to their lowest point in the past 10 years, and had their biggest drop ever Tuesday in the firm’s 158 year history.

Many investors have become wary of Lehman over the past 3 months and their ability to successfully continue their operations. In order for them to operate smoothly, they will need to raise a lot of capital to offset the sharp decline in some of their commercial and real estate assets.

“Connecting Everything” is a perfect company slogan for a company which has been doing just that. Broadcom (BRCM), a semiconductor company based in Irvine, CA, has had explosive growth recently. Many of its products are regarded as parts of the wireless and multi-face future. Its low-cost, high-speed multi-functioning “system-on-a-chip” semiconductors and the software that combines voice, video, data, and multimedia applications are best-of-breed in the industry.

In addition, Broadcom has contracts with other highly regarded computer companies such as Apple (AAPL), Alcatel (ALU), Cisco (CSCO), Dell (DELL), EchoStar (SATS), HP (HPQ), IBM (IBM), LG, Nintendo (NTDOY.PK), Nokia (NOK), Nortel Networks (NT), Pace, Samsung and many others. Although they have a lot of contracts with these big name companies, they also do a lot of business with smaller companies. In 2007, the leading five customers accounted for about 40% of total revenue.

Federated Investors (FII) [32.44, 0.00 (0.00%)] has underperformed the broader market for some time now. They are down 21% YTD and 23% for the past 6 months. This is relatively better than the Financial Sector SPDR (XLF) [20.35, 0.00 (0.00%)], which is down almost 30% YTD.

This poor performance can be contributed to the broader financial sector, bond/debt markets, and margin contraction. Many asset managers have done poorly this year, but compared to other financial sector companies, you could say they are holding up relatively well.

Many of the losses from loans made from 2000-2005 have now been recognized as rates have now reset on their 2/28 or 3/27 mortgages. Loans which were issued in 2006 and 2007 are seeing higher and higher delinquency rates as an effect of falling home prices and an 18 month excess supply of homes. What is likely to be the new wave of write-downs on mortgage loans will be adjustable rate mortgages, which are set to reset in the next few years. This could destroy the markets once again as they are fighting to get out of this bear market.

What has happened with sub-prime mortgages?

Names like American Express (AXP) and Discover Financial (DFS) will be hurt with these delinquencies as they will be forced to write-down their portfolios. The pure-play card servicers aren’t completely recessionary proof, but history has shown that they perform well during these times, and extremely well during recovery periods. Visa Inc. (V) and MasterCard Inc. (MA)  will continue to outperform their peers and are safe plays for any portfolio.

The Industry

Card Servicers are generally mis-understood by many investors. They operate as pure network use plays. They hold no credit exposure on their books, which is why they have performed so well in this market. They are paid per swipe and by purchase volume. Secular shifts in purchases also provide these companies with solid revenue streams.