NEW YORK (
) -- The purest credit card lenders are posting very strong earnings results, despite the weak economic recovery, and investors should pay heed.
While this week is a rocky road for bank stock investors, last week's euphoria showed the potential for the beleaguered financial sector to provide some excellent returns.
All six of the nation's largest credit card lenders were profitable during the second quarter, except for
Bank of America
, which is likely to feel a continued drag on its earnings from the mortgage mess for several more quarters.
Bank of America's Global Card Services unit was a bright spot in a second quarter that was dominated by the company's $8.5 billion settlement agreement with institutional investors saddled with mortgage-backed securities originally issued by
, which Bank of America acquired in 2008.
While the mortgage putback settlement and additional mortgage related expenses fed a second-quarter net loss of $8.8 billion, or 90 cents a share, Bank of America's card unit delivered $5.5 billion in revenue and $2 billion in net income during the quarter.
According to SNL Financial, Bank of America's default rate default rate for all serviced credit cards --including securitized loans -- declined sharply during June, to 6.97% from 8.03% in May. A feather in the cap for BofA was a 23.55% portfolio yield on managed card balances, ranking the company second among the "big six" U.S. credit card lenders.
Let's move on to the remaining five members of the "big six" credit card club. As you will see, the "purer" credit card plays are bringing home the bacon for investors.
Strong profits mean strong capital generation, and that means that these three purest credit card plays will have an easier time meeting regulators' increased capital requirements, while still generating excess capital to fund expansion, or return to investors through higher dividends and share buybacks:
closed at $40.26 Friday, down 15% year-to-date, with investors punishing the shares since they underwent a one-for-ten reverse split on May 6.
Citi earned $3.3 billion during the second quarter, or $1.09 a share, increasing from $3 billion, or 99 cents a share, in the first quarter and $2.7 billion, or 90 cents a share, during the second quarter of 2010.
The second-quarter results included a $2 billion release of loan loss reserves.
The operating return on average assets (ROA) for the second quarter of 0.68% was lowest among the five profitable card lenders discussed here.
The company's retail partner cards are in run-off mode, as part of Citi Holdings, and the non-core Local Consumer Lending balances declined to $2.9 billion in June, from $4.7 billion a year earlier.
Within the core Citicorp unit, second-quarter income from Citi-branded cards was $4.1 billion, increasing from $4.0 billion the previous quarter and declining slightly from a year earlier.
According to SNL Financial's analysis of card lenders' master trust filings for June, Citigroup's managed credit card portfolio delinquencies of 35 days or more declined to 3.56% as of June 30, improving from 5.44% a year earlier. The portfolio yield for the managed credit card trusts was 15.71% in June, which was, by far, the lowest among the "big six" card lenders.
Citigroup's shares trade for just under eight times the consensus 2012 earnings estimate of $5.09 a share, among analysts polled by FactSet. Analyst sentiment for the stock is strong, with 16 rating the shares a buy, while four have neutral ratings and two recommend selling the shares.
Of course, Citi's overall earnings picture is still pretty weak. Read on for the stronger earnings performers.
4. JPMorgan Chase
closed at $42.19 Friday, returning 1% year-to-date. Based on a quarterly payout of 25 cents, the shares have a dividend yield of 2.37%.
JPMorgan reported second-quarter net income of $5.4 billion, or $1.27 a share, compared to $5.6 billion, or $1.28 a share, during the first quarter and $4.8 billion, or $1.09 a share, during the second quarter of 2009. The second-quarter operating ROA was 0.99%, according to SNL Financial.
The earnings results were boosted by a $1.2 billion reserve release, including a "$1.0 billion pretax ($0.15 per share after-tax) benefit from reduced loan loss reserves in Card Services."
Net income from Card Services totaled $911 million during the second quarter, declining from $1.3 billion the previous quarter, but increasing from $343 million a year earlier.
Credit card loans on the balance sheet totaled $125.5 billion as of June 30, declining 3% from the previous quarter and 12% from a year earlier.
According to SNL's review of the company's credit card master trust filing for June, JPMorgan Chase's managed card portfolio's had a 30 plus days delinquency rate of 2.59%, which bested all the other members of the "big six" club of card lenders, save
. JPMorgan's credit card master trust portfolio yield during June was 18.59%, for fifth-place among the large card lenders.
The shares trade for 7.4 times the 2012 consensus earnings estimate of $5.68 a share, among analysts polled by FactSet.
Out of 27 analysts covering JPMorgan, 23 rate the shares a buy, while the remaining analysts all have neutral ratings.
JPMorgan Chase has, of course, been a star among the largest U.S. banks throughout the credit crisis and is very cheaply priced to forward earnings. But its overall operating earnings performance can't yet compare to the "purer" credit card companies that follow.
3. Capital One Financial
Capital One Financial
closed at $49.64 Friday, returning 17% year-to-date.
The company on July 13
, following up with a $3 billion senior debt offering on July 15, to partially finance its $9 billion acquisition of
ING Direct USA
, which is expected to be completed close in late 2011 or early in 2012.
The ING Direct acquisition will add roughly $80 billion in deposits for Capital One.
Capital One reported second-quarter net income of $911 million, or $1.97 a share, compared to $1 billion, or $2.21 a share, in the first quarter and $608 million, or $1.33 a share, during the second quarter of 2010.
The earnings decline from the previous quarter reflected "contra-revenue of $52 million," as the Capital One anticipated refunding credit card payment protection fees to customers in the United Kingdom. Second-quarter earnings were also lowered by a $22 million adjustment to Capital One's liability for rewards programs.
Still, the company's second-quarter ROA was 1.90%, which stacks up very well against other large banks with diversified revenue streams.
During the second quarter, Capital One acquired a $3.7 billion credit card portfolio from
Total credit card balances on Capital One's balance sheet were $62.7 billion as of June 30, increasing from $61.9 billion a year earlier. Cards represented 49% of total loans.
According to SNL Financial's review of the company's credit card master trust filing for June, Capital One's managed card 30 plus days delinquency rate was 3.31%, improving from 5.16% a year earlier, and ranking the company fourth among the "big six" card lenders. Capital One's managed card portfolio yield was 19.39%, also ranking fourth.
The shares trade for 8.2 times the 2012 consensus earnings estimate of $6.06 a share.
Out of 20 analysts covering Capital One, nine rate the shares a buy, nine have neutral ratings, and two analysts recommend selling the shares.
Although investors weren't please following Capital One's common offering, with the stock "breaking price," the company's earnings performance speaks for itself. Next, investors will be wondering if it's worth paying $9 billion for $80 billion in deposits.
2. American Express
Shares of American Express closed at $5.24 Friday, returning 23% year-to-date, as the "gold standard" among card lenders has continued to post strong earnings quarter after quarter.
The company reported second-quarter net income attributable to common shareholders of $1.3 billion, or $1.11 a share, increasing from $1.2 billion, or 98 cents a share, in the first quarter, and $3.0 billion, or 84 cents a share, during the second quarter of 2010.
The second-quarter operating ROA was 3.55%, according to SNL Financial.
Non-interest revenues grew 15% year-over-year, to $6.5 billion during the second quarter, with strong growth in travel and other commissions, and even a small increase in card fee revenue. Net interest income was down slightly year-over-year, to $1.15 billion.
Credit expenses declined, with second-quarter provisions for credit losses totaling $357 million, compared to $652 million a year earlier.
On the expense side, the largest cost increase was cardmember rewards, which totaled $1.6 billion in the second quarter, rising 35% year-over-year. While dodging analysts' questions on the growing rewards payouts during the company's earnings conference call, CFO Daniel Henry did say that "We have a plan to slow the growth in our operating expenses as we exit this year."
According to SNL's analysis of the company's credit card master trust filings for June, American Express led the large card lenders with a 30+ days delinquency rate of 1.65%, although its managed card portfolio yield of 21.20% ranked third.
Shares of American Express are trading for over 12 times the consensus 2012 earnings estimate of $4.25 among analysts polled by FactSet. While that may seem expensive when so many banks are trading around eight times forward earnings, you have to pay more for such a steady earnings performer, and the shares were trading around 20 times trailing earnings through 2008, indicating tremendous upside in a better economy.
Out of 21 analysts covering American Express, 16 rate the shares a buy, three have neutral ratings and two analysts recommend selling the shares.
1. Discover Financial Services
Discover Financial Services
closed at $25.97 Friday, returning 41% year-to-date.
On June 15, the company announced that its board of directors had authorized a $1 billion share repurchase program, expiring in June 2013.
Discover's fiscal year ends on November 30. For the fiscal second quarter ended May 31, net income allocated to common stockholders was $593 million, or $1.09 a share, increasing from $459 million, or 84 cents a share, the previous quarter and $185 million, or 34 cents a share, a year earlier.
The fiscal second-quarter operating ROA was a very strong 3.76% according to SNL Financial, and the strong performance reflected a $401 million release of loan loss reserves.
Net interest income for the fiscal second-quarter was $1.2 billion, increasing 4% year-over-year, while other income increased 6% to $544 million. Expenses increased 24% year-over-year, to $635 million.
Total loans increased 5% year-over-year, to $52.5 billion, as of May 31.
According to SNL's analysis of Discover's credit card master trust filings for June, the company ranked third-best among the large card lenders with a 30+days delinquency rate of 2.71%, and had the highest portfolio among the group, of 23.67%.
Like many large card lenders, Discover is facing inquiries by regulators into the sales and marketing of its credit protection products. In a July 1 note, Henry Coffey of Sterne Agee pointed out that the credit protection fees are included in "fee product revenue in Discover's financial reports, and that "in 2Q11, fee product revenue represented 5% of gross revenue and 6% of net revenue or $105 million," and estimated that the products contributed only 5 cents per share in quarterly earnings. Coffee predicted the regulatory review of Discover's credit protection products "will pass without consequences," and reiterated his "buy" rating on the shares, with a $30 price target.
The shares trade for less than nine times the consensus 2012 earnings estimate of $2.97, among analysts polled by FactSet.
Out of 17 analysts covering Discover Financial Services, 10 rate the shares a buy, while seven have neutral ratings.
As we have seen with the company's recent $1 billion buyback program announcement, strong earnings lead to rewards for investors, and even with the stock's fantastic performance during the first half, Discover Financial still looks like a bargain for long-term investors.
Written by Philip van Doorn in Jupiter, Fla.
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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.