American credit card companies have historically drawn a lot of interest from value investors because they are usually flush with cash. Yet many of the same investors avoid these financial institutions because of the huge liabilities that they carry.
The numbers show us that credit card issuers can be very profitable, but they are definitely not for the faint of heart. The shadow of the 2007–2008 economic meltdown, which generated high rates of default, hangs heavily over this industry.
An Industry with a Lot of Cash
Despite the risks, the U.S. credit industry is capable of generating a lot of cash, which can lead to high levels of float. Float is Warren Buffett’s term for a constant stream of revenue or stockpile of cash that a company can tap or borrow against at any time. Classic examples of float include credit card fees and insurance policy premiums.
These numbers show us just how much cash American credit card issuers are capable of generating:
- Discover Financial Services (NYSE: DFS), which issues the Discover Card, an instrument generally only available in the USA, reported having $10.6 billion (€9.34 billion) in cash and short-term investments on June 30, 2015. It also reported making $3.718 billion (€3.28 billion) in cash from operations and $3.53 billion (€3.11 billion) in cash from financing in the second quarter of 2015. The amount of money Discover had in the bank actually exceeded its second quarter revenue of $8.573 billion (€7.56 billion).
- American Express (NYSE: AXP), or Amex, reported having $21.07 billion (€18.57 billion) in cash and short-term investments on June 30, 2015. It also reported making $10.41 billion (€9.18 billion) in cash from operations and $1.898 billion (€1.67 billion) cash from financing in second quarter 2015. Amex’s revenue of $33.67 billion ($29.68 billion) exceeded the amount of money it held in the bank.
- In contrast, MasterCard (NYSE: MA) held $5.077 billion (€4.47 billion) in cash and short-term investments on June 30, 2015. MasterCard reported losing $2.87 billion (€2.53 billion) in cash from financing but making $3.842 million (€3.39 million) in cash from financing in the second quarter. MasterCard reported a TTM revenue of $9.549 billion (€8.42 billion) on June 30, 2015.
- Visa (NYSE: V) reported having $4.722 billion (€4.16 billion) in cash and short-term investments on June 30, 2015. Visa reported losing $4.77 billion (€4.2 billion) in cash from financing but making $6.643 billion (€5.85 billion) cash from financing in the second quarter. Visa reported a TTM revenue of $13.45 billion (€11.85 billion) on June 30, 2015.
- Capital One Financial (NYSE: COF) a well-known American bank that makes much of its money by issuing Visa and MasterCard products, reported $8.287 billion (€7.82 billion) in cash from financing on June 30, 2015. Capital One reported making $8.73 billion (€7.69 billion) in cash from operations and $8.287 billion in cash from financing during the second quarter. Capital One reported generating a TTM revenue of $22.77 billion (€20.07 billion) in the second quarter.
As you can see, the thesis that U.S. credit card issuers can make a lot of money is absolutely true, but what about the risks?
Why Many Investors are Scared of U.S. Credit Card Companies
The risks the American credit card companies are taking are enough to scare even some brave investors away. The financial numbers indicate that some of these companies are playing a very risky game.
They are essentially betting that their revenues will remain high enough to generate a large amount of float. The float is necessary to cover investment losses and liabilities that they are taking on.
These numbers prove that credit card investments are not for the faint of heart:
- Capital One reported total liabilities of $283.85 billion (€252.13 billion) and assets of $310.5 billion (€273.66 billion) on June 30, 2015. It also reported losing $16.60 billion (-€14.63 billion) in cash from investing on the same day. To make things scarier, it also reported a free cash flow of $2.2279 billion (€1.96 billion) in the second quarter.
- Visa reported total liabilities of $10.8 billion (€9.52 billion) and assets of $39.43 billion (€34.75 billion) on June 30, 2015. It also reported losing $4.77 billion (-€4.2 billion) in cash from investing in the second quarter. Visa reported a free cash flow of $2.037 billion (€1.8 billion) for the third quarter.
- MasterCard reported total liabilities of $8.868 billion (€7.65 billion) and assets of $15.27 billion (€13.46 billion) on June 30, 2015. The payment processor reported losing $100 million (-€88.14 million) in cash from investing and a free cash flow of $735 million (€647.81 million) for the second quarter.
- American Express reported total liabilities of $135.27 billion (€135.27 billion) and assets of $157.15 billion (€138.51 billion) on June 30, 2015. Amex reported losing -$9.321 billion (-€8.22 billion) in cash from investing and a free cash flow of $1.89 billion (€1.67 billion) in the second quarter.
- Discover Financial reported liabilities of $73.65 billion (€64.91 billion) and assets of $84.19 billion (€74.2 billion) on June 30, 2015. It also reported losing -$3.54 billion (-€3.12 billion) in cash from investing and a free cash flow of $553 million (€487.4 million) for the second quarter.
The Danger from Defaults
As you can see, some of the credit card companies have taken on some massive liabilities. Capital One, Discover and Amex all seem to have business models in which the company takes on huge liabilities in anticipation of future revenues.
The danger here is that an increase in the number of credit card defaults could destroy that revenue stream. Such an increase is dangerous because the business model presumes that customers will keep paying their credit card bills and generating float. If the payments stop, the float stops and literally pulls the rug out from under the companies.
The bank card default rate in the United States is currently going down, according to numbers provided by Experian and S&P. The rate for July 2015 was 2.79%, down slightly from June 2015 when it was 2.88% and July 2014 when 2.86% was reported.
That indicates the default rate is stable and fairly low in today’s economic landscape. The danger is if the economy radically shifts as it did in 2007, when the rate rose to 7.1% during the Great Meltdown. The default rate did go up for the first time since 2010, in March, CNBC reported, but it has been falling in recent months.
Are Credit Cards a Good Investment?
The numbers show us that companies that are basically payment processors such as Visa and MasterCard are fairly safe investments because their assets and revenues exceed their liabilities. Visa in particular looks very secure because of its high revenues and assets that exceed liabilities by a ratio of nearly four to one.
Visa and MasterCard are safer because they make their money by processing financial transactions. Many of these transactions, including prepaid cards and debit cards, will continue regardless of how the economy does. They are not relying upon average people to pay their credit card bills on time as Capital One, Amex and Discover are.
If you can tolerate a lot of risk and you like companies with a lot of cash, credit card issuers could be lucrative. Those that dislike risk should only consider adding Visa or MasterCard to their portfolios.