Updated from 11:36 a.m. EST

While signs are emerging in the economy that credit card issuers could be poised to regain some footing, the companies in the group probably still face a rocky path before they can solidly recover.

Not all lenders are created equal however, and some analysts are pointing to MBNA ( KRB) as potentially a good way for investors to participate in the sector.

"A lot of investors feel they want to own stocks with the highest risk and highest return," Morgan Stanley analyst Ken Posner wrote in a research note Wednesday. "But to me MBNA is attractive because it offers high returns for a low amount of risk. Since there's still more pain to be felt on the credit card side, my view is you should jump in early but through a safer play. I don't know if you want to have subprime portfolio in a double-dip recession."

As the economy entered a recession last year, cash-strapped customers defaulted on their payments, hurting profits for the group. But unemployment and bankruptcy data are starting to improve, which could curb default rates. The unemployment rate fell to 5.6% in January from 5.8% in December, while bankruptcies are now expected to rise 16% in 2002, compared with previous forecasts for a 19% increase.

MBNA, analysts say, has the most stable credit quality in the industry, which could protect the company if the recent improvements in the data are just a blip, as some economists believe. Other lenders like Citigroup ( C) and American Express ( AXP) also have strong credit quality, but they don't stand to benefit as much from falling consumer default rates because they also offer a host of other financial services. Most other pure credit card companies are subprime lenders, which lend to consumers with iffy credit histories.

MBNA is also the only pure-play consumer lender that is preparing to move into continental Europe, where growth prospects are high, Posner added.

He raised his rating on MBNA to strong buy from outperform Wednesday and set a price target for the company's shares of $41, about 25% above where they closed Tuesday. Despite his reservations about subprime lenders, the analyst simultaneously lifted his rating on the entire credit card sector to market weight from underweight.

"Credit card/specialty finance stocks have underperformed the market over the last month, and the group now offers upside to our 12-month price targets," he wrote in the note. "Also, it's probably better to be early than late. Because of what we perceive to be a prevailing mood of optimism in the markets, investors may be quick to anticipate a positive turn in the credit cycle."

Top Quality

MBNA said profits grew 24% in the fourth quarter to 60 cents a share, beating analysts' expectations by a penny. While all of the consumer lenders are expected to see continued credit losses in coming quarters, MBNA shouldn't be hit as hard, according to Posner.

MBNA was forced to write off 4.72% of its loans in 2001 because of defaults or expected defaults, and Posner indicated that figure should jump to 5.6% in 2002. By comparison, the industry rate was 5.9% in 2001, and should spike to 6.9% in 2002.

MBNA has been able to build customer loyalty and keep marketing costs down partly by issuing the majority of its cards through institutions like universities and sports teams. Another analyst credited the company's strong management for maintaining good credit quality.

"It's their method of underwriting that gives them more stability in their credit trends," said Robert Napoli of ABN Amro. "All of them had increasing credit losses in 2001, but MBNA is more of a hands-on underwriter. They use less models and more people, and that seems to work for them."

Because the company doesn't extend loans to customers with questionable credit, MBNA also faces fewer regulatory risks than subprime lenders, like Capital One Financial ( COF), Household International ( HI), Metris ( MXT) and Providian ( PVN).

"Regulators are nervous about subprime exposure and fast portfolio growth," Posner wrote. "Subprime loans have been responsible for most bank failures in the most recent years, and they don't want that happening under their noses."

NextBank, the online banking arm of subprime lender NextCard ( NXCD), was shut down last week by the Office of the Comptroller of the Currency, a possibility Posner said he wouldn't rule out for other firms.

The Downside

The danger to MBNA is that a strong economy could result in rising interest rates, which would squeeze the spread between the company's borrowing costs and lending profit. Unlike most other consumer lenders, MBNA doesn't hedge its interest rate risk. As a result, lower interest rates mean it can borrow more cheaply and make more money on its accounts.

MBNA usually makes up in volume what it gives up in margins when interest rates rise, said CIBC World Markets analyst Jennifer Scutti. As the economy grows, more people borrow. Credit quality also improves, averting the need to aggressively set aside reserves to cover defaults on loans.

On the other hand, the company is expected to lose its lead when consumer loans really pick up, possibly in 2003, because its portfolio is growing more slowly than subprime lenders, which can also charge higher rates. "In a good economy the subprime lenders can make more money," Posner wrote in his note. "They charge higher rates because they take more risks."

MBNA was closed up 4% to $34.20. Subprime lenders were also higher. Capital One finished up $1.15 to $48.75. Household International gained $1.35 to $52.15, and Metris, one of the smaller members of the group, was up 86 cents to $16.43.

Providian rose slightly Wednesday, before finishing the session where it started, at $4.40. Hard hit by the slowing economy, Providian is firing workers and is trying to sell off pieces of its credit card portfolio to give profits a lift. The company posted a loss in the fourth quarter of $1.39 a share after additions to loan loss reserves and charges.

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