Visa, MasterCard Can Tough This Out

In the U.S., large banks including Citigroup (C Quote) and Bank of America (BAC Quote), among others, have been saying for several quarters now that rising delinquencies and charge-offs in their credit card portfolios has caused several to pull back on lending limits.

Last week, American Express reported profit fell 25% from the year-earlier period. The New York travel and card services company blamed weaker spending by card members and a large provision to protect against rising losses on wealthy customers and corporate clients who can't pay their bills.

MasterCard and Visa, on the other hand, have remained relatively unscathed amid the credit fallout. As payment networks, they receive a fee from partner banks, who issue the cards, to become a part of their network. They also receive fees for each transaction. They do not hold credit card loans on their books.

Still, Citi's Burton is worried. He notes that "it is only a matter of time" before some consumers "exhaust the available credit on their cards" as unemployment rises and homeowners are no longer able to get cash from the equity in their homes.

"Increasing delinquencies and charge-offs could lead to fewer new cards being issued and a cutback in credit limits creating additional headwinds to card volume growth going forward," Burton writes.

Consolidation in the financial sector also could impact the number of banks issuing cards, Burton says. The impact on card volumes is likely to be small, at least over the near term, but could become a problem, he writes.

For MasterCard, net revenue from its top five customers represented approximately 31% of total revenue as of 2007. For Visa, its five largest customers represent approximately 22% of total revenue, according to the Citi note.

In the past six weeks several large credit card issuers have been forced into acquisitions. Washington Mutual, which was taken over by JPMorgan Chase (JPM Quote) after being seized by regulators last month, was the sixth largest card issuer as of the end of 2007, according to the Nilson Report.

National City (NCC Quote), which agreed to a sale to PNC Financial Services (PNC Quote) on Friday, was the sixteenth largest credit card issuer, Nilson says. Wachovia (WB Quote), which is being acquired by Wells Fargo (WFC Quote) after a bidding war earlier this month with Citi, is the twentieth largest issuer, Nilson says.

The failed WaMu was one of MasterCard's largest issuers, but Macquarie's Williams says that shouldn't be too big a concern.

"As the big banks get bigger you're going to see that they're going to want to deal with both MasterCard and Visa," Williams says. "They're going to want to spread their exposure so that they have the ability to force Visa and MasterCard to compete a little bit for their business."

Of course, Visa and MasterCard are competing in an increasingly competitive landscape. Late Monday, rival Discover Financial Services (DFS Quote) announced it had reached a $2.75 billion settlement with the two companies over the right to issue third-party cards through banks.

The Riverwoods, Ill.-based Discover filed the suit in 2004 following the conclusion of an ongoing antitrust lawsuit initially filed by the Justice Department, accusing MasterCard and Visa of limiting competition in the U.S. credit card market. American Express (AXP Quote) had previously settled with the two larger card network firms in which they agreed to pay a combined more than $4 billion over the antitrust suit.

Visa will pay $1.9 billion, $1.7 billion of which had already been reserved for at the time the firm went public. MasterCard will pay $862.5 million of the settlement and plans to take an after-tax charge of $515.5 million for the third quarter, it said Monday.

Still, Morningstar's Michael Kon says the falling stock prices are possibly creating an opportunity. Visa must fall to $36 a share, while MasterCard needs to fall to $111 before he would consider buying either, he says.

"Even if they have one-two-three bad quarters, that doesn't change the fact that the long-term prospects are very compelling," Kon says.