Assume credit cards are the next crisis. Also, assume the crisis comes because the charge off rates go to historical levels that no wants to buy credit card bonds. Not a stretch of the imagination in any regard, considering the state of the US consumer. Where is the best place to be short?
Looking at options, both Capital One (COF) and American Express (AXP) charge close to the same amount on their JAN 10 $20 puts ($5.2 and $4.8 respectively).
But looking at their market situations, there is a clear advantages to both.
Capital One
• Pro: Lower average credit score to AXP customers
• Pro: Lower average income to AXP customers
• Pro: Large auto lending component to the business
• Con: Has substantial commercial lending deposits from it’s commercial bank
American Express
• Pro: Higher customer balances than COF customers
• Pro: Travel Services department (business credit cards) income is largely influenced by business capital spending in general, clearly in decline
• Con: No commercial bank to fund lending activities (used the Fed commercial lending facility early in November)
Summary:
If you look at in terms of product, COF vs. AXP is like Ford vs. BMW, AXP has a more affluent, and privileged clientele. This may provide a more orderly deleveraging and is currently reflected in the lower charge off rates for AXP customers compared to COF customers.
But if you look at it in terms of capital position, COF vs. AXP is like C vs. LEH, COF has internal capital it can use as a cushion when no one wants to buy it’s short term financing facilities. Whereas AXP, like the now defaulted Lehman Brothers, had minimal internal capital and lots of leverage that relied on securitization and commercial paper markets for operation.
Both are solid short candidates, but despite it’s pedigree, AXP is more exposed to credit market freeze and thus appears in a more precarious position.
Supporting Research:
“Capital One said this month it's restricting credit card issuance after charge-off rates spiked to 6.34% in the third quarter from 3.96% in the same period last year.”
“Banks, in turn, are trying to wean themselves from the securitization markets. They're turning to other financing such as certificate of deposit programs, but those can be costly.The market shutdown is particularly bad news for non-bank finance companies. The ability to sell off car, education and auto loans is critical to companies such Ford Motor Co.'s Ford Motor Credit, American Express Co. and student lender SLM Corp., or Sallie Mae. Without securitization markets, they have less capital to make new loans to consumers.”
“… approximately 50% of [American Express] funding was unsecured and 50% was done through securitization.
Moving to slide eight, metric performance for international consumer, we continue to have strong metrics in international consumer although we did see some slowing in billed business in the third quarter. FX adjusted growth in the first and second quarter was 10% compared to the 8% in the third quarter.” American Express CFO, Daniel Henry – EVP & CFO
“In the US while the write-off rate in the quarter was 5.9% the write-off rate in September was 6.1%. We expect the fourth quarter to be higher then the third quarter and we expect the first quarter of 2009 to be higher then the fourth quarter of 2008.” American Express CFO, Daniel Henry – EVP & CFO as reported in the American Express 3Q conf call...
Transparency: The author owns both AXP Apr 09 puts at $3/contract and COF JUN 09 $25puts at $5.58/contract.
Showing posts with label COF short. Show all posts
Showing posts with label COF short. Show all posts
Monday, November 10, 2008
Wednesday, May 7, 2008
No credit for Capital One
The Quote of the Month
““It takes a man a long time to learn all the lessons of all his mistakes. They say there are two sides to everything. But there is only one side to the stock market; and it is not the bull side or the bear side, but the right side. It took me longer to get that general principle fixed firmly in my mind than it did most of the more technical phases of the game of stock speculation.” Jesse Livermore, “Reminiscences of a Stock Operator”.
The Position of the Month
Stock: COF
Position: Short
Basic Position Opening Price:
Above $55
Basic Position Expected closing price:
Below $40
Advanced Investor Position Opening Price:
Buy COF $50 Jan 10 puts at $10
Advanced Investor Position Closing Price:
Sell to Close at $14 / contract
The Summary
Capital One is a leveraged lender with high percentage of low quality cardholders.
The Story
Any investment related to credit cards is a bet on the American consumer. When the American consumer can hold a job, they can maintain their credit card balance. In this case, credit card companies profit on carrying fees. If Americans lose their job, then credit card costs spiral out of control. In this case, credit card companies lose money from charge offs, lost income streams, and decreased portfolio quality.
Off balance sheet securities performing poorly(1) 4/13/08 “Off-balance sheet item ($49B) has a default rate of 5.8% where the base portfolio is 3.26%.”
Credit card charge offs still at low levels considering economic outlook(2) 4/10/08 “Now, as the "almost-affirmed" recession is upon us, delinquencies will rise along with foreclosures and bankruptcies. This will surely trickle down to the lenders as the inflows they receive dwindle, outflows grow and non-recoverable debt increases. While a 6% rate may seem historically high, back in 2003, Capital One posted rates closer to 8% as the U.S. was starting on the road to recovery from a difficult 2 years of recession and the fall off from the domestic stock markets averaging near -50%.”
COF insiders are selling
(3) 3/24/08 “COF insiders are dumping shares. Whether planned or not, insiders reduced their positions by 10% during the past few months. Keep in mind that this company announced, back in February, a massive buyback program planning to redeem 10% of the total market cap. This points to the obvious strategy of the company’s management to help keep shares artificially high as they are selling. Institutions have also had the same idea and have sold off over 23 million shares during the past 6 months, effectively reducing their positions by 7%”
Americans revolving credit increasing as economy suffers
(4) 4/25/08 “Revolving debt, which typically comes from credit cards, has increased at a faster rate than overall debt since the summer of 2006 -- right about when the housing market began to implode.
The trend seems to suggest consumers are using credit cards to patch up holes in revenue that once could be filled by refinancing or selling a home. Now that home values have dropped sharply and are predicted to fall further, at least over the short term, consumers are left without the housing crutch they once relied upon.”
The story is very simple. If you think the unemployment rate is going up, then credit card companies will suffer in direct proportion to the increase in unemployment.
To underscore the link, look at the graph below and think about how it corresponds to home equity cash out phenomenon. As equity transferred from homes to consumer spending, credit cards benefited from increased revenue and lower defaults.
Moreover, projections are that credit card charge offs will continue return toward the mean in terms of historical charge off rates.
(5) "Despite these negative macroeconomic trends, credit card delinquencies and charge-offs have just recently returned to their long-term averages following a two-year period of exceptionally strong performance in the wake of the implementation of new bankruptcy legislation in 2005," Cynthia Ullrich, a senior director at Fitch, said in a statement.
The Conclusion
This investment hinges on the pretext that the credit unwind will directly effect the American consumer in terms of economic contraction and reduced leverage in household spending. Considering the current situation, this looks like a low risk investment with many different scenarios leading to the predicted outcome.
Sources
(1) Andrew Horowitz, http://seekingalpha.com/article/72030-capital-one-outlook-not-as-rosy-as-analyst-describes
(2) Andrew Horowitz, http://www.bloggingstocks.com/2008/04/10/capital-one-financial/
(3) Andrew Horowitz
(4) TheStreet.com, 4/25/08, http://www.thestreet.com/_yahoo/funds/saving-money/10413643.html?cm_ven=YAHOO&cm_cat=FREE&cm_ite=NA
(5) “Fitch study shows credit-card delinquencies and charge-offs rising, will pressure securities”
Wednesday, April 30th, Reuters, http://biz.yahoo.com/ap/080430/fitch_credit_cards.html?.v=1
““It takes a man a long time to learn all the lessons of all his mistakes. They say there are two sides to everything. But there is only one side to the stock market; and it is not the bull side or the bear side, but the right side. It took me longer to get that general principle fixed firmly in my mind than it did most of the more technical phases of the game of stock speculation.” Jesse Livermore, “Reminiscences of a Stock Operator”.
The Position of the Month
Stock: COF
Position: Short
Basic Position Opening Price:
Above $55
Basic Position Expected closing price:
Below $40
Advanced Investor Position Opening Price:
Buy COF $50 Jan 10 puts at $10
Advanced Investor Position Closing Price:
Sell to Close at $14 / contract
The Summary
Capital One is a leveraged lender with high percentage of low quality cardholders.
The Story
Any investment related to credit cards is a bet on the American consumer. When the American consumer can hold a job, they can maintain their credit card balance. In this case, credit card companies profit on carrying fees. If Americans lose their job, then credit card costs spiral out of control. In this case, credit card companies lose money from charge offs, lost income streams, and decreased portfolio quality.
Off balance sheet securities performing poorly(1) 4/13/08 “Off-balance sheet item ($49B) has a default rate of 5.8% where the base portfolio is 3.26%.”
Credit card charge offs still at low levels considering economic outlook(2) 4/10/08 “Now, as the "almost-affirmed" recession is upon us, delinquencies will rise along with foreclosures and bankruptcies. This will surely trickle down to the lenders as the inflows they receive dwindle, outflows grow and non-recoverable debt increases. While a 6% rate may seem historically high, back in 2003, Capital One posted rates closer to 8% as the U.S. was starting on the road to recovery from a difficult 2 years of recession and the fall off from the domestic stock markets averaging near -50%.”
COF insiders are selling
(3) 3/24/08 “COF insiders are dumping shares. Whether planned or not, insiders reduced their positions by 10% during the past few months. Keep in mind that this company announced, back in February, a massive buyback program planning to redeem 10% of the total market cap. This points to the obvious strategy of the company’s management to help keep shares artificially high as they are selling. Institutions have also had the same idea and have sold off over 23 million shares during the past 6 months, effectively reducing their positions by 7%”
Americans revolving credit increasing as economy suffers
(4) 4/25/08 “Revolving debt, which typically comes from credit cards, has increased at a faster rate than overall debt since the summer of 2006 -- right about when the housing market began to implode.
The trend seems to suggest consumers are using credit cards to patch up holes in revenue that once could be filled by refinancing or selling a home. Now that home values have dropped sharply and are predicted to fall further, at least over the short term, consumers are left without the housing crutch they once relied upon.”
The story is very simple. If you think the unemployment rate is going up, then credit card companies will suffer in direct proportion to the increase in unemployment.
To underscore the link, look at the graph below and think about how it corresponds to home equity cash out phenomenon. As equity transferred from homes to consumer spending, credit cards benefited from increased revenue and lower defaults.
Moreover, projections are that credit card charge offs will continue return toward the mean in terms of historical charge off rates.
(5) "Despite these negative macroeconomic trends, credit card delinquencies and charge-offs have just recently returned to their long-term averages following a two-year period of exceptionally strong performance in the wake of the implementation of new bankruptcy legislation in 2005," Cynthia Ullrich, a senior director at Fitch, said in a statement.
The Conclusion
This investment hinges on the pretext that the credit unwind will directly effect the American consumer in terms of economic contraction and reduced leverage in household spending. Considering the current situation, this looks like a low risk investment with many different scenarios leading to the predicted outcome.
Sources
(1) Andrew Horowitz, http://seekingalpha.com/article/72030-capital-one-outlook-not-as-rosy-as-analyst-describes
(2) Andrew Horowitz, http://www.bloggingstocks.com/2008/04/10/capital-one-financial/
(3) Andrew Horowitz
(4) TheStreet.com, 4/25/08, http://www.thestreet.com/_yahoo/funds/saving-money/10413643.html?cm_ven=YAHOO&cm_cat=FREE&cm_ite=NA
(5) “Fitch study shows credit-card delinquencies and charge-offs rising, will pressure securities”
Wednesday, April 30th, Reuters, http://biz.yahoo.com/ap/080430/fitch_credit_cards.html?.v=1
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