Sure, Higher Rates Are Bad for Cardholders, but Are They Really Good for AmEx?

It's a universal truth that no credit-card user wants higher interest rates. What's far less certain is how much rate increases help credit-card issuers.

Traditional banks typically benefit because they're able to pass the higher rates on to borrowers more quickly than to depositors who supply their funding. But the playing field for companies such as American Express (AXP) , Discover (DFS) and Capital One (COF) , whose lending has a greater dependence on borrowed money, is more complicated.

Discover, based in Riverwoods, Ill., may benefit the most if the Federal Reserve increases rates this summer, because it primarily has "variable rate assets," like student and credit card loans, while American Express's performance could be pinched by its reliance on short-term debt, Sanjay Sakhrani, a Keefe, Bruyette & Woods analyst, said in a phone interview.

Still, even if the Fed follows through on the two increases it has projected this year, short-term rates would rise only to a range of 0.75% to 1%, presuming the central bank maintains the 25 basis-point increment of December's hike. That increase was the first since rates were cut to nearly zero during the 2008 financial crisis.

"Twenty-five basis points is a fairly negligible amount," Sakhrani noted.

While the Fed originally signaled as many as four hikes this year, it halved that number amid market volatility in January and February, and traders made bets that the central bank would act only once, late in the year.

A June increase, viewed as somewhat likely after recent comments by the Fed's monetary policy committee members, is less probable given a weak employment report last week and the United Kingdom's June 23 vote on whether to leave the European Union, said S&P Capital IQ equity analyst Erik Oja.

A decision to leave is likely to roil global markets, particularly since it would be the first of its kind and the U.K. is the region's second-largest economy, valued at 2.2 trillion euros.

Oja sees July as a more likely time frame for a hike. 

If that proves true, Discover will be ready. Company executives have "been re-positioning their balance sheet" in preparation, Sakhrani explained. "That's kind of what we saw in the first quarter, as we saw the fourth-quarter rate hike flow through the numbers for a full quarter." 

Indeed, the card issuer's net interest income grew 7% in the three months through March, compared with last year. 

Higher rates also pose a risk, however. They "could negatively impact Discover's customers as total debt-service payments would increase, impede Discover's ability to grow its consumer lending businesses, and increase the cost of our funding," the company said in its annual SEC filing. That "would put Discover at a disadvantage as compared to competitors that have less expensive funding sources." 

For American Express, a rate increase would be "somewhat dilutive," Sakhrani said. The New York company's charge-card business -- which charges an annual fee to customers who typically avoid interest charges by paying their total balance each month -- "is funded with short-term debt, and so that works against them in terms of debt costs," he said.

Because 75% to 80% of revenue comes from fees charged to cardholders and merchants who take AmEx cards, "we are far less interest-rate sensitive than our competitors and peers," CFO Jeffrey Campbell said on a first-quarter earnings call. "Because of our charge card franchise, we're the opposite of most of our peers, in that a rising interest rate environment is not positive for us."

McLean, Va-based Capital One, which issues not only credit cards but mortgage and other consumer loans, holds more "fixed rate" assets than some peers, but still has interest-rate sensitivity, Sakhrani said.

Still, what matters more than interest rates for Capital One as well as its rivals is the mixed data coming in about the economy, he said. 

And lending growth, one sign of a healthy economy, is still below average in the U.S.

"We don't see loan growth falling off, we don't see it accelerating dramatically, but it is definitely slowly accelerating towards a 7% annual rate," S&P's Oja said in a phone interview. "Usually loan growth in a healthy U.S. economy should average about 7% a year. Before the financial crisis, loan growth for U.S. banks peaked at 10 to 11%."

At Capital One, average loans increased 14% in the first quarter; global loans at American Express, excluding the Costco and JetBlue portfolios that the company is selling, rose 11%; and loans at Discover grew 4%.

Nationwide, household debt in the U.S. rose 1.1% to $12.25 trillion in the three months through January, with the majority of the increase in mortgage debt. Credit card balances fell $21 billion, according to a Federal Reserve Bank of New York report.

"It all depends on the economy, and to the extent that people are feeling worse about their situations, given the employment numbers, that works against you from a loan-growth perspective," Sankrani said.

Many consumers likely aren't feeling so great.

A recent study by CardHub found that credit card interest rates have increased an average 2.24% since the December rate hike, "but we haven't see the other side of the coin with the deposit rates going back up," John Kiernan, CardHub expert, said in a phone interview. "So it's kind of a net money loser for consumers right now."

See full coverage on the Fed's upcoming interest-rate decisions.

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