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Tags: Airlines | Credit | Cards | Consumer

Coffee, Tea, or Plastic? Airlines Offering Credit Cards

Coffee, Tea, or Plastic? Airlines Offering Credit Cards

Dr. Edward Yardeni By Thursday, 04 May 2017 12:08 PM EDT Current | Bio | Archive

When flying, you expect a flight attendant to offer coffee and tea. But Jackie was surprised last month when flight attendants on an American Airlines flight she was on between LaGuardia and Charlotte pitched an American Airlines credit card. How’s that for low-cost advertising to a captive audience?! Jackie was happy to report that there was no violent outbursts on her flight.

The sales pitch did prompt us to have a closer look at the credit card business. Recent earnings out of Synchrony Financial (spun out of GE Capital) and Capital One Financial gave investors the jitters, as both sharply increased their reserves. However, economic data show that monthly payments remain manageable.

Let’s take a look:

(1) Growing quickly. As you’d expect, most consumer loan balances, except for student loans, shrank during the previous recession. Total consumer credit fell $147 billion (or 5.5%) from July 2008 through August 2010 (Fig. 1). Since then, consumer credit has increased rapidly, by $1.27 trillion to a record high of $3.79 trillion, up $1.13 trillion (or 42%) from 2008’s peak. Leading the advance have been auto loans and student loans, which are included in the Fed’s “nonrevolving credit” category (Fig. 2). Lagging has been “revolving credit,” which consists mostly of credit card balances. It’s up 20% through February since bottoming during April 2011, and remains slightly below its 2008 record high. The data suggest that consumers remain more cautious about using their credit cards but have been loading up on auto and student debt.

(2) Back to normal. In Q1 results, Synchrony and Capital One both reported increases in reserves and in charge-offs that caught investors by surprise. Synchrony increased its provision for loan losses by 45% to $1.31 billion, and its net charge-offs in Q1 came in at 5.33%, up from 4.74% a year earlier. For the full year, management expects net charge-offs to be in the low 5%s, edging up to the low-to-mid-5% range in 2018.

The company did not lower its lending standards. Instead, it attributed the need to boost provisions to lower recoveries on defaulted loans, to growth in the overall loan portfolio, and to “normalization trends”—which implies that defaults were abnormally low in the early years of the recovery and now are returning to more normal levels. At Synchrony, loan receivables grew 8.0% in 2015 y/y and 11.3% in 2016. That’s much faster than consumers’ incomes grew, 4.0% in 2015 and 3.6% in 2016.

Capital One’s Q1 charge-off rate in its domestic credit card business was 5.14%, up 0.48ppts from Q4. The company now sees the 2017 charge-off rate on US credit cards in the high-4% to 5% range, up from earlier expectations for the rate to be around mid-4%. “Over the past year and a half, we have seen increasing competitive intensity, a growing supply of credit, and rising consumer indebtedness,” observed CEO Richard Fairbank in the company’s Q1 earnings call transcript. Later on the call, he said, “We continue to be concerned about the supply of credit in the marketplace. Revolving credit grew at about 6.5% year-over-year, the seventh consecutive quarter it has grown much faster than household income. Against this background, we have been tightening our underwriting.”

(3) Not too many deadbeats. There is some good news. Data from the FRB-NY backs up these CEOs’ assertions. The percentage of credit card balances that are delinquent by 90 days or more has fallen to levels well below where it stood in the years leading up to the 2008 recession (Fig. 3). So it’s certainly possible that delinquencies will return to more normal levels and then stop deteriorating.

Another optimistic nugget is that household debt service payments as a percentage of disposable personal income was only 10.0% in Q4 , below the 13.2% peak just before the 2008 recession and lower than the 10.4% level seen back in Q2-1993 (Fig. 4). This is largely thanks to the low interest rates we’ve enjoyed for the past eight years. Credit quality in credit card portfolios may not be improving anymore. But as long as rates stay low and jobs remain plentiful, default-rate “normalization” shouldn’t turn into a spike in the credit card default rate. Just what will happen to the student loan market, where delinquencies now are far higher than during the recession, is a story for another day.

(4) Taking stock. The S&P 500 Consumer Finance stock index is down 11.0% from its cyclical high on May 2, 2016 (Fig. 5). The index has been depressed by the 20.3% decline in Synchrony, the 12.5% drop in Capital One, and the 13.0% drop in Discover Financial since March 1. Analysts still forecast that the Consumer Finance industry will grow revenue by 5.0% over the next 12 months and grow earnings by 7.7% (Fig. 6). The industry’s forward P/E has come down a touch to 11.5, which is high relative to where the multiple has been over the past 16 years but low compared to the highest multiples that the industry has commanded during the best of times over the past 20 years (Fig. 7).

(5) What’s in your wallet? Higher credit card volumes are good news for Mastercard and Visa, which process credit card transactions but don’t hold the outstanding credit card debt. On Tuesday, Mastercard reported that Q1 net revenue rose 12% y/y and adjusted net income increased 13%. Earnings per share rose more than net income, by 16%, due to a reduced share count. Last month, Visa reported that earnings excluding restructuring charges for fiscal Q2 were 86 cents a share, up 27% y/y.

Both companies benefitted as more traffic traveled over their payment systems. At Mastercard, the gross dollar volume on the company’s worldwide network rose 4.7% y/y to $1.2 trillion, including a 2.0% increase in the US. The US volume includes a 5.4% increase in Mastercard’s credit and charge programs and an 0.8% decline in its debit program. The shares of both companies have had a great start to the year.

Visa’s traffic jumped even more dramatically, as it won some large new clients, including Costco Wholesale. The company’s payments volume grew 37.2% y/y to $1.7 trillion, assuming a constant dollar. Visa shares are up 18.6% ytd through Tuesday’s close, and Mastercard’s shares have added 14.4%.

The two companies are members of the S&P 500 Data Processing & Outsourced Services stock index, which has had an amazing run since 2009, climbing 423.0% (Fig. 8). The industry includes Automatic Data Processing, Fiserv, PayPal Holdings, and Paychex along with others. It’s expected to grow revenues by 11.7% over the next 12 months and earnings by 14.2% (Fig. 9). Investors will need to pay up for the above-market earnings growth, as the industry trades at 23.1 times forward earnings (Fig. 10).

(6) The Great Disruptor. Amazon has been around since 1994 and creating headaches for other retailers for many years. But in recent months, it seems that the number of store closures has accelerated as a number of retailers have given up the fight. Even Synchrony CEO Margaret Keane said on the Q1 conference call: “The retailers are going through a transformation. But I would say, as per our reading, it’s definitely accelerated coming out of the holiday season.”

And that presumably means that Synchrony cannot depend on consumers going into a retailer and opening up a credit card to gain customers. So Synchrony is undergoing its own transformation. The company is “making sure we can really attract those customers through the online channels, whether it’s through their iPad or on their mobile phone.” In Q1, 26% of retail-card penetration was online.

The company purchased GPShopper, a mobile app developer, in Q1 for an undisclosed amount. Synchrony made an initial investment in the company in 2015, and subsequently they developed a plugin that allows retailers’ credit cardholders to shop, redeem rewards, and manage and make payments to their accounts with their smartphones, according to a 3/22 article in the Stamford Advocate. More than retailers need to learn how to find customers online.

Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.

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Recent earnings out of Synchrony Financial (spun out of GE Capital) and Capital One Financial gave investors the jitters, as both sharply increased their reserves. However, economic data show that monthly payments remain manageable.
Airlines, Credit, Cards, Consumer
Thursday, 04 May 2017 12:08 PM
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