Discover, AmEx Maintain Low Delinquency Levels And Charge-Off Rates

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Credit Card companies Discover Financial (NYSE:DFS) and American Express (NYSE:AXP) bear considerable risk – relative to rivals such as Visa (NYSE:V) and MasterCard (NYSE:MA) – as they also lend to their customers on the credit cards they issue. In contrast, Visa and MasterCard’s cards are issued by a third-party. With the risk, however, Discover and American Express also earn significant interest revenues. Income from interest charged on credit accounts for about 20% of American Express’s total income. ((SEC 10-Q Filing, American Express)) The majority of AmEx’s income is generated from the transaction fees it charges merchants and banks.

Earlier this month, both companies released the latest data on delinquency and charge-off rates on credit card loans. In this article we take a look at the latest industry-wide data as well as that released by Discover and AmEx. 

We have a price estimate of $65 for Discover’s stock, which is in line with the current market price. Our price estimate of $102 for AmEx’s stock is about 10% higher than the current market price.

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See our complete analysis of Discover Financial | American Express

Industry Trends Point To Consistent Decline

The delinquency rate represents the percentage of total loans that are past due. The delinquency rate on credit card loans for all commercial banks in the U.S. has been consistently declining. After the recession it hit a high of over 6%, but has since dropped to 2.21% in the third quarter of 2014. [1] The charge off rate, the percentage of loans that are considered unredeemable, on credit card loans for the top 100 banks ranked by assets in the U.S. has declined from a peak of 10.7% in early 2010 to 3.03% in Q3 2014. [2] The table below shows the two metrics for the first three quarters of 2014.

in % Q1 2014 Q2 2014 Q3 2014
Delinquency Rate 2.31 2.25 2.21
Charge – Off Rate 3.27 3.27 3.03

Latest Data For Discover

Discover has consistently maintained these metrics at well below the industry average. The company posted a delinquency rate of 1.8% for the month ending October 2014. Throughout the past twelve months, its delinquency rate has hovered in the range of 1.6-1.8%. The net principal charge-off rate for October was 2.1%. Over the past twelve months, the metric has remained in the range of 2.1-2.5%. [3]

American Express Reported Stable Figures

AmEx had a very low delinquency rate (past 30 days) of only 1% for the month of October 2014. Meanwhile, the company reported a net charge-off rate of 1.3% for the month of October. This is largely in line with what the company has experienced historically. [4]

Provisions For Losses Are Also Rising

Provisions for loan losses are reserves maintained by these companies to absorb estimated losses on bad loans. In Discover’s case, these have gone up by about 35% year-over-year to $1.6 billion during the first nine months of 2014. At present, the loss provisions as a percentage of outstanding credit card loans is about 1.85% for Discover. There is a 10% downside to our estimate for the company’s stock price if the ratio increases to more than 2.6%.

In the case of AmEx, the total provisions for loan losses have increased to $488 million during the first three quarters of 2014 from $419 million in 2013. [2] The ratio of provisions for loan losses to the outstanding credit card loans is at around 2.25%.

Future Outlook Stable

Consumer spending in the U.S. has seen tepid growth over the past few quarters, but still a vast improvement from the recession period. The latest data released by the Bureau of Economic Analysis points towards a slowdown in the growth of consumer spending. Both the personal income and disposable personal income grew by just 0.2% in October, compared to 0.4% in June 2014. Personal consumption expenditures (PCE) also grew by just 0.2% in October compared to 0.5% in June. [5] Generally, an increase in consumer spending can lead to an increase in provisions for losses, such as those seen for Discover, as more liberal consumer spending can lead to greater risk. Going forward we expect the delinquency rates for the two companies to largely remain stable.

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Notes:
  1. Delinquency Rate On Credit Card Loans, All Commercial Banks, Board of Governors of the Federal Reserve System []
  2. Charge-Off Rate On Credit Card Loans, Top 100 Banks Ranked By Assets, Board of Governors of the Federal Reserve System [] []
  3. SEC-8K Filing, November 2014 []
  4. SEC-8K Filing, November 2014 []
  5. Bureau of Economic Analysis, Press Release – November 26 2014 []