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Further Downside for American Express

Written By Brian Hicks

Posted July 15, 2008

In SC Trading Pit, readers just took a 12% gain on the second half of American Express July 40 puts.  We took 21% on the first half.

But we see further downside for shares of AXP, and would recommend that you buy the American Express (AXP) October 2008 27.50 put (AXPVA).

Here’s why…

American Express (AXP) continues to be a favored short. And that’s because they hold consumer debt, and fall prey to mounting delinquencies. So when I learned that UBS upgraded the stock Tuesday morning from Sell to Neutral, I had to laugh at the absurdity.

The argument remains the same, though.

If you want to own a credit card stock, buy Visa or MasterCard. They do not hold consumer debt. They simply process the cards.

American Express on the other hand deals directly with credit. It has to worry that as of November 2007, credit card debt “soared at an 11.3 percent annual rate in November following an 8.5 percent rate of increase in October” and is still on the rise.”

 They’re the ones where share values are being beaten stilly because of charge-offs, payment delays, and higher delinquencies. Why do you think Discover Financial Services (DFS:NYSE) stock plunged from a $35 IPO price to $13? It’s a card lender, and concerns itself directly with cardholder debt.

Same goes for American Express, who’s CEO said, “Business conditions continue to weaken in the U.S. and so far this month [June 2008] we have seen credit indicators deteriorate beyond our expectations.”

It was January when AXP’s CFO Daniel Henry predicted that the company’s U.S. write off rate would peak between 5.1% and 5.3% in 2008. Unfortunately, a 5.3% write off rate was reached in March. It’s now July and delinquencies and default rates are growing worse.

The United States of Cash-Strapped America

With homeowners struggling to stay above water, American Express has to worry about further delinquency problems, as credit card debt balloons. You’re better off longing MasterCard stock and Visa, than naively risking bets on American Express stock.

Instead of just using credit cards for big ticket items (TVs, furniture), some are now charging gas, food, and even paying other bills with them. And some are only making minimum payments… if they can afford even that.

It’s far more difficult these days for many consumers to dig their way out of debt, since other relied upon options, such as home equity lines of credit, are no longer readily available.

National revolving debt just hit a record $957 billion in April, from $800 billion four years ago. Total credit card debt was up by 0.4% in April, according to the Fed. And Moody’s is reporting that the charge-off rate, which measures credit accounts considered uncollectible, hit 6.27% in April.

Q1 consumer borrowing skyrocketed to $34 billion, the biggest amount since 2001 when the U.S. was diving into a recession. And not all of that may be paid back. Credit card investors are becoming increasingly concerned that a weaker U.S. economy will hurt borrowers’ ability to pay back debt.

But as long as there are naïve investors, and foolish upgrading banks, it’s hard to get that reality to the investing masses. Still, downside risks remain at American Express… even Discover and Capital One. They’ll slide long-term as subprime fiascos are replaced with Option ARM reset fiascos.

High Gas Prices, Housing Slump, and Rising Unemployment… Oh My.

Credit card issuers will face more losses than initially expected.

Hit by cash-strapped consumer reliance on plastic amid rising gas prices, a housing slump, and rising employment, credit issuers could see earnings thwacked by defaults.

“The deterioration in credit cards is accelerating faster than many had expected,” said Christopher Wolfe, an analyst at Fitch, according to CNN Money. “The message we are trying to deliver is that things are going to get worse before they get better. Thus far, credit card businesses have been profitable but that could change.”

Worse, according to the CNN Money article, “Fitch analysts are expecting an increase in prime charge-off rates – or losses from defaults on card payments as a percentage of loans outstanding – to at least 7% by the end of the year from 6.4% in May.”

Vulnerable are credit issuers like American Express, Washington Mutual, Capital One and Discover, not the Visa or MasterCard-like companies.

Ignore or short American Express… and hold long-term.