Credit Card Companies: (PS, great pic, KT) -
Heard on the Street
Pervasive Gloom May Mask
Gleams in the Loan Industry
Neither a borrower nor a lender be -- especially during a recession.
The saying helps explain why shares of credit-card issuers and consumer lenders
have tumbled in the past few months, as investors fear that rising unemployment
and an economy likely in a recession will turn millions of Americans into
deadbeats, pulling these companies down with them. High-profile blowups,
particularly that of credit-card issuer Providian Financial, have pushed
already-worried investors into a panic, sending them fleeing from the sector.
Panicked sellers don't tend to be very discriminating about what they dump,
though. Not surprisingly, some of the stocks that investors sold are actually solid
names with conservative operations that are now priced as if they, too, are headed
for the very crowded dustbin of troubled lenders. But some companies are
actually expected to grow as their rivals fall apart, able to benefit from the lower
interest rates that both reduce their funding costs and cut their customers' overall
borrowing costs. Moreover, all the bad news and more is priced into the stocks.
In this camp, according to investors and analysts: Americredit, Metris and Capital
One Financial.
Unquestionably, lenders' woes have grown. In July, federal regulators seized
Chicago-area thrift Superior Bank because of what one regulatory official said
were troubles in its subprime portfolio measuring in the "hundreds of millions" of
dollars. In August, Bank of America said it was taking a $1.25 billion charge to
shut down its subprime lending operations, in effect conceding that the risks of
that area of the consumer market outweighed the benefits.
Then in October, Providian shares sank
58% in a single day after the company
announced similar losses in its subprime
loan portfolio, which focuses on
borrowers with checkered credit
histories. The debacle at Providian, in
particular, sent worries through the rest
of the consumer-finance industry because
it was one of the industry's
fastest-growing competitors.
Now the stronger companies must fight
to regain the industry's credibility.
Sentiment is strongly against them. And
short-sellers -- those investors who bet
the stocks will fall -- are all over them,
adding to their volatility.
"Fear and greed have been driving these
stocks," says Todd Pitsinger, an analyst at
Friedman, Billings Ramsey. "Greed on the
part of the short-sellers and fear on the part of the holders."
Americredit is the largest independent subprime auto lender in the country.
Americredit's earnings have grown 50% a year for the past five years on the
strength of its ability to judge wisely its potential customers. That solid growth
finally attracted the attention of investors this year, and its stock more than
doubled, peaking at $65 in early August. But then the economic slowdown became
more apparent, Bank of America exited from the subprime auto-leasing business,
and short-sellers pounced, more than doubling the number of shares sold short in
Americredit's stock.
The stock plummeted, bottoming out at $14 last week. Since then its shares have
bounced back to $18.96. At the current price, the shares trade at six times the
company's past 12 months' earnings, far below the price-to-earnings ratio of the
Standard & Poor's 500-stock index, which is now about 30, even though the
company's 30% expected earnings growth rate over the next several years is well
ahead of the anticipated growth of the overall index.
"The broader investment community hasn't had the time or the clairvoyance to
differentiate between the companies in the sector," Mr. Pitsinger says.
Clearly there are risks to the stock as more borrowers default on their loans,
analysts say. Indeed, Americredit says the percentage of its loans that are 60 days
behind in payments hit a company record of 3.1% in the past quarter, and no one
knows how high that figure will rise. "The real wild card is where do credit losses
go," Daniel E. Berce, the concern's chief financial officer and vice chairman, said
at an investor conference Wednesday.
The company expects to earn about $3.80 a share in the year ending June 30,
2002, an estimate that is based on loan losses rising 25% in the next year. What
would it take to wipe out profits? "Losses would have to almost double from
where we think they're going today," Mr. Berce says.
All the gloom surrounding the stock masks some bright spots. First is lower
interest rates. A lender like Americredit profits just like a bank does when the
spread rises between the cost of its funding and the interest rate charged to
customers. In Americredit's case, its funding costs are dropping faster than the
rates being charged to its new customers. Second, in a sluggish economy,
used-car sales, which account for 75% of Americredit's loans, rise in tough times,
raising the size of the company's market.
Finally, these strong businesses can take advantage of their weaker rivals' woes.
"Some people believe a recession is the best thing ever to happen to some of these
companies," says Mr. Pitsinger, the analyst.
Metris may be one of them. The seven-year-old company focuses on the so-called
near-prime market, consumers who earn about $40,000 a year but don't have
much credit history. Its shares peaked at $39 in July, but fell with the crowd,
hitting $13.50 last week. They have since bounced back to $16.51 -- giving the
company, which has increased its earnings 40% a year recently, a
price-to-earnings ratio of seven, based on the past 12 months' earnings.
The company expects earnings growth to slow to 15% to 20% next year, an
estimate that assumes unemployment could rise to 6.5% from October's 5.4% and
retail sales could be flat or declining. "You could easily in this environment bet
against consumer-finance companies," says Metris's chairman and chief
executive, Ronald Zebeck. By contrast, he bought shares in his company as the
price fell this fall.
One further risk to this industry, some analysts warn, is the increased regulatory
scrutiny of consumer-credit issues. Mark Alpert, an analyst at Deutsche Banc
Alex. Brown, notes the Federal Deposit Insurance Corp. has tightened capital
requirements for some lenders. Yet, he adds, current stock prices amply reflect
these worries. Metris, for example, "has been beaten up so badly these regulatory
risks have already been discounted," he says.
On the other hand, the drop in interest rates has created two big benefits for
credit-card issuers. Because credit-card payments are linked to the floating prime
rate, customers are enjoying lower monthly interest payments, making it easier for
them to keep up with their payments, while funding costs for the companies have
dropped even faster.
Capital One, the sixth-biggest credit-card issuer, also has seen its stock price fall,
particularly when its close competitor Providian tumbled last month. The shares
now trade at $50, down from a peak of $69.50, yet Capital One has only 20% of
its receivables outstanding considered subprime, compared with 40% for
Providian.
Lehman Brothers analyst Bruce Harting expects Capital One's receivables to grow
between 50% and 60% this year, adding, "Their losses are consistently at the low
end of the industry."
Capital One, indeed, currently has losses equal to about 3.9% of its loan portfolio.
That number is virtually unchanged from the second quarter, and far below the
industry average of about 6.5%, and the 10%-plus recorded by Providian for the
most recent third quarter.
"A lot of companies have built a business model that works great in a good
economy," says Richard Fairbank, Capital One chairman and chief executive. "We
have built a business model that is designed to prosper even in a recession." |
