A lot of investors were scared away from U.S. credit card companies by the Great Economic Meltdown of 2007–2008 and rightly so. At the height of that calamity, the industry was experiencing a default rate of 7.1%.
Today, in contrast, the industry is benefiting from very low default rates, around 2.79% in July 2015, according to Experian and S&P. Those default rates are actually down slightly from June 2015, when they hit 2.88%, and 2.86% in July 2014. This would indicate that the industry is actually in a fairly stable position, but is it? Can the industry survive an economic downturn, perhaps one triggered by the economic turmoil in China?
The best answer to that question is yes, the industry itself will probably survive, but some of the companies in it may not. A quick look at the financial numbers indicates that some of the U.S. credit card issuers are on very shaky ground. The number of liabilities some of these companies have taken on puts them at risk for any sort of a falloff in business or an increase in default.
Credit card issuers that could be vulnerable to a recession include:
- Capital One Financial (NYSE: COF), a well-known American bank that makes much of its money by issuing Visa and MasterCard products, reported having liabilities of $263.85 billion (€233.50 billion) and assets of $310.5 billion (€273.66 billion) on June 30, 2015. It also reported losing $16.60 billion (-€14.63 billion) in cash from investing on the same day. To make things scarier, it also reported a free cash flow of $2.279 billion (€2.02 billion) in the second quarter. Nor did Capital One’s revenue appear adequate to cover these potential losses; it reported a TTM revenue of $22.77 billion (€20.07 billion).
- American Express (NYSE: AXP), or Amex, the grand old name in U.S. credit cards, reported having total liabilities of $135.27 billion (€135.27 billion) and assets of $157.15 billion (€138.51 billion) on June 30, 2015. The amount of cash Amex reported losing from financing, -$9.321 billion (-€8.22 billion), also exceeded its free cash flow of $1.89 billion (€1.67 billion) for the second quarter of 2015. Like Capital One, it does have a lot of cash in the bank and impressive revenues. American Express reported generating revenues of $33.67 billion (€29.68 billion) and holding $21.07 billion (€18.65 billion) in cash and short-term investments on June 30, 2015.
- Discover Financial Services (NYSE: DFS), a smaller organization that issues Discover-branded cards, mostly available in the USA, reported liabilities of $73.65 billion (€64.91 billion) and assets of $84.19 billion (€74.2 billion) on June 30, 2015. It also reported losing -$3.54 billion (-€3.12 billion) in cash from investing and a free cash flow of $553 million (€487.4 million) for the second quarter. Interestingly enough, the amount of money Discover held in cash and short-term investments, $10.6 billion (€9.34 billion), exceeded its revenues for the second quarter of 2015, which were $8.573 billion (€7.56 billion).
Judging by these figures, all it would take is a slight drop in revenues created by a sudden surge of defaults to put these companies in a position where they could not meet their liabilities. Discover, Amex and Capital One might be able to survive a short-term correction by turning to the cash they have in the bank, but it is hard to see how they would survive a long-term recession without burning through all their cash.
The problem is that these companies’ business model depends on high levels of what Warren Buffett calls float: a steady stream of cash that they can tap. Any drop off in float and the business collapses. Strangely enough, the business model is similar to that at Amazon.com Inc. (NASDAQ: AMZN), in which the company depends upon constantly growing revenues to generate float just to pay the bills.
The Credit Card Market Is Shrinking
The big danger here is that the American credit card business is not growing; in fact, the market for credit cards in the United States actually appears to be shrinking. Fewer Americans own credit cards, and those that do, are carrying less plastic than before.
The percentage of Americans that hold no credit cards at all rose from 22% in 2008 to 29% in 2014, according to a Gallup survey cited at CreditCards.com. Younger Americans were also less likely to own cards. Americans 19 to 29 years of age owned an average of 1.57 cards; in contrast, those aged 47 to 65 held 2.66 cards, according to CreditCards.com.
The shrinking market may already be having an impact on some of the players in the business. American Express reported a negative revenue growth rate of -4.02% on June 30, 2015. This was the second quarter in a row that it had reported negative revenue growth. It reported a rate of -2.73% in March 2015.
Discover Financial reported a revenue growth rate of .14% on June 30, 2015. Capital One reported a revenue growth rate of 3.72% on the same day. Unfortunately, at least some of that growth could be coming from an exclusive credit card arrangement at Costco Wholesale (NASDAQ: COST) stores in Canada that it took over from American Express. Costco famously allows only credit card in its membership stores. It formerly only took American Express but recently switched to Capital One Visa in Canada and plans to replace Amex with Citigroup (NYSE: C) Visa products in the United States.
American Credit Card Companies Not Recession Proof
It looks as if American credit card issuers are definitely not recession proof. All it would take is a little economic turbulence to cause massive losses at Amex, Capital One or Discover.
That being said, there are some U.S. credit card brands that seem well poised to weather an economic storm. These are Visa (NYSE: V) and MasterCard (NYSE: MA), companies that primarily act as payment processors rather than credit issuers. They make their money by charging transaction fees rather than by charging interest, and their businesses appear to be far more stable because of much lower levels of liabilities.
MasterCard reported total liabilities of $8.868 billion (€7.65 billion) and assets of $15.27 billion (€13.46 billion) on June 30, 2015, for example. Visa was in even better shape; it reported total liabilities of $10.8 billion (€9.52 billion) and assets of $39.43 billion (€34.75 billion) on June 30, 2015.
MasterCard and Visa also reported impressive levels of revenue and cash. MasterCard reported a revenue of $9.549 billion (€8.42 billion) and $5.077 billion (€4.47 billion) in cash and short-term investments on June 30, 2015. Visa reported a TTM revenue of $13.45 billion (€11.85 billion) and $4.722 billion (€4.16 billion) in cash and short-term investments on June 30, 2015. Visa had a free cash flow of $2.037 billion (€1.8 billion) during the second quarter, while MasterCard reported a free cash flow of $735 million (€647.81 million) for that period.
The numbers indicate that Visa and MasterCard seem well positioned to survive a downturn, while American Express, Capital One and Discover Financial are not. It looks as if a major recession would lead to a major shakeup in the U.S. credit card industry, which indicates that credit card companies are not a good investment, while payment processors could be.