Credit Cards a Plastic Profit Machine

NEW YORK ( TheStreet) -- One might think that credit card processors would be suffering the most from a wave of negative attention cast upon their plastic profit machine, but that doesn't seem to be the case.

Banks are facing tens of billions of dollars worth of writedowns on bad credit card loans, while consumers contend with heady fees and unexpected rate hikes. Politicians have concocted an assortment of legislation and a new consumer protection agency to crack down on credit card lenders.

But for the big negative spotlight that has been shining on credit cards recently, the companies most associated with them seem to be suffering the least.

MasterCard ( MA) and Visa ( V), which profit from transaction fees rather than interest payments, as well as competitors like American Express ( AXP) and Discover ( DFS), which have a similar but more diverse business model, have performed relatively well through the financial crisis. They are expected to build strongly on that soft landing once economic conditions begin to improve.
Who Makes Money From Credit Cards

Neither Visa nor MasterCard were totally immune to the recession, as both posted drops in volume last quarter. Still, they both matched or exceeded revenue estimates and topped Wall Street's profit targets through some combination of cost-cutting, increased debit card usage and expansion in untapped markets. Shares of Visa closed fractionally higher on Thursday at $67.21, while MasterCard rose 3% to $194.11.

Visa CEO Joseph Saunders said the results "exemplify the resiliency and stability of our business model," while MasterCard CEO Robert Selander called card processing a "global, flexible and resilient business." Both focused on opportunities to expand further once the economic tide turns.

At present, an increasing number of consumers have stopped paying credit card bills altogether, amid widespread unemployment and economic duress. While processors' fee revenue is unaffected by that, banks that extended credit could face more than $80 billion in writedowns on receivables and credit-card securities through 2010, according to the Federal Reserve's stress test assumptions. Those companies include big players like Bank of America ( BAC), JPMorgan Chase ( JPM), Citigroup ( C), Wells Fargo ( WFC) and Capital One ( COF), as well as credit card lenders like AmEx and Discover.

Processors are undoubtedly facing headwinds from a consumer spending slump and broad deleveraging. When times are good, consumers are ready, willing and able to swipe. When times are bad, they tighten up the purse strings and rely on cash, while paying down debt balances.

"Credit card companies make their money in two ways -- in volume and on fees," says Bernard Weinstein, director of the Center for Economic Development and Research and an economics professor at the University of North Texas. "Volume is down because we're in a recession, and as a result of higher fees and charges some people are abandoning credit card use and going back to cash."

Personal spending has been sporadically improving, but is still far from year-ago levels. It also appears driven by bargain-hunting, rather than true underlying demand. A report on Tuesday showing that consumer confidence has plunged to the lowest level this year and far below expectations indicated worse times ahead.

As unemployment sails higher toward double-digit territory, reaching 9.5% in June, delinquencies on credit card payments are rising as well. As one example, Bank of America has reserved over $3 billion against future credit card losses, more than any other type of consumer debt. Net losses on its credit card book scaled up to 11.7% of the loan portfolio last quarter, up from 8.6% the previous period.

Unsurprisingly, while consumers are working to pay down debt, stay current or simply not go bankrupt, they have also scaled back on credit card usage. According to the Fed, consumers brought down revolving debt levels by $32.9 billion, or 3.4%, during the first five months of the year.

Cross-border travel, another area where card processors collect fees, is also very weak. Far fewer people are planning business trips or vacations, with the Air Transport Association of America predicting that airlines will transport 14 million fewer plane passengers this summer, a decline of 7%.

None of these trends bode well for card processors.

However, while no one expects a sudden resurgence in volume and fees, the companies have been remarkably adaptive in navigating the recession, working hard to slash expenses and adjust business models for rough times. For instance, AmEx boosted reserves, cut costs fairly dramatically and has worked to modify debt agreements to keep borrowers current. MasterCard will benefit from a higher fee structure, while Visa and MasterCard have both worked to build their presence in expanding markets overseas.

A recent report by Deutsche Bank analyst Christopher Mammone evokes the sentiment of many analysts and investors. Although economic realities "pose a challenge to the top-line outlook" for MasterCard and Visa, "we continue to see potential for earnings upside," Mammone writes.

Looking at bottom-line results, or share performance, since July 2008 gives a stark contrast to other types of financial institutions that suffered from massive writedowns.

Plastic Performance

Over the past year, including the height of the financial crisis in 2008, MasterCard has earned $762 million, more than double its $319 million in profit during the same period a year earlier. Visa has swung to a profit of nearly $1.5 billion, vs. a loss of $495 million.

AmEx, which has exposure to bad loans, unlike its straight-processing peers, has earned $1.6 billion, down 55% from the comparable period a year earlier. But unlike big banks that were fellow TARP recipients, AmEx has remained profitable in every quarter of the downturn.

Discover, whose fiscal year ends in November, has earned $958 million in the 12 months ending in May, more than double the $461 million in the previous comparable period.

Instead of driving the downturn, processors have simply become a reflection of the economy, and their outlook appears brighter in the near term than banking peers.

Analysts have remained bullish on the credit card companies, believing that card spending is bottoming out, and that delinquencies and credit losses for AmEx and Discover will soon peak. Despite indications that consumer protection laws are on the way, it's unclear how much effect it will have on card processors, if any at all.

Those factors, combined with easy comparisons to this year's slump, there is overwhelming sentiment that the companies will continue to grow in 2010.

"Recent share strength suggest to us that the market may be gaining comfort that the various spending proxies we track indicate that a bottom may be forming for the consumer," Mammone says, "and that there is nothing imminently negative looming on the regulatory front."

-- Written by Lauren Tara LaCapra in New York.

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