Credit hangover, big headache for Amex

American Express Co, which launched its charge card business 50 years ago today, may wish it was back in those good old days.

The fourth-largest US card issuer expanded aggressively in recent years beyond charge cards paid off once a month into revolving credit cards, a strategy that could be backfiring.

"You're feeling the effects of lending too much in a time when they should have been pulling back, which is 2006 and 2007," said John Williams, an analyst of Macquarie Research.

Higher delinquency rates, bigger loan losses provisions and more expensive funding costs are now widely expected to hit American Express harder than its peers at least until the end of 2009.

Often seen as catering to relatively wealthy customers and companies, the firm has been expanding into credit cards faster than rivals such as Discover Financial Services, Capital One Financial Corp, JPMorgan Chase & Co and Citigroup Inc by reaching a wider range of clients.

Investors are already punishing American Express in the stock market. The credit card company, part of the Dow Jones industrial average, lost a third of its market value in 2008, while Discover's shares fell 10 percent and Capital One stock was up 4 percent.

The company's US card lending portfolio grew 17 percent and 23 percent, respectively, over the last two years, 11 points and 14 points faster than the industry, Credit Suisse analyst Moshe Orenbuch said in a research note.

Furthermore, American Express has grown more in states – such as California and Florida – that have been hardest hit by the housing downturn.

After defaulting on their home loans, some consumers are now expected to do the same with their credit cards, in particular given growing unemployment and a broad deterioration in the US economy, which could hit consumer spending in 2009.

American Express US net charge-offs – a measure of cardholder defaults – jumped to 5.3 percent in the second quarter of 2008 from 4.3 percent in the first quarter and 2.9 percent a year earlier.

Analysts estimate net charge-offs rates could increase to close to 7 percent by the end of next year. The rate of increase would be two or three times higher than its rivals, according to Credit Suisse.

American Express is more dependent on short-term capital markets to fulfill its funding needs than some of its bigger rivals with huge deposits.

Although the firm has already been able to raise 85 percent of its funding needs for 2008 – which total US$27 billion – investors said the current credit squeeze would significantly increase its funding costs.

"They're paying more for money and they're not being able to pass that through to their cardholders, and that's a squeeze for them," said Walter Todd, portfolio manager of Greenwood Capital Associates.

The company has a further US$20 billion in debt expiring in 2009.

"The interest rates on their short-term borrowing have gone up significantly in the last few months and even in the last two weeks, which could present a problem for them," Williams said. "It could drive their interest expense higher and it could be another crimp on their profitability."

Like other credit card companies, American Express is selectively scaling back some US customers' credit lines and reducing efforts to gain new customers domestically. It is also cutting advertising and promotion expenses.

In the second-quarter, American Express set aside US$1.889 billion to cover losses, nearly double the US$977 million it set aside the same quarter last year.

Credit Suisse's Orenbuch said American Express reserved for about 60 percent of prospective loan losses at the end of the second quarter, below the 80 percent rate for Capital One and Discover, a sign it has less margin for error going forward.

Orenbuch, who recently cut his earnings estimates for American Express, expects American Express to boost reserves by a further US$800 million in 2009.

American Express is expected to suffer more as the US housing collapse hits consumer spending.

US consumer confidence has weakened as food and fuel prices have risen and job losses have mounted. US unemployment hit a five-year high of 6.1 percent in August.

The outlook for the US economy has deteriorated even further as the financial crisis forced the US government to craft a US$700 billion financial industry bailout plan.

In July, American Express shocked some investors when it posted a lower-than-expected net income, abandoned its earnings outlook and increased its loan losses provisions.

But investors and analysts said there could be more surprises to come. American Express' earnings per share are expected to rise 8 percent to US$2.93, according to Reuters Estimates, but many believe those figures are too rosy.