Credit hangover, big headache for American Express

By Juan Lagorio - Analysis

NEW YORK (Reuters) - American Express Co (AXP.N), which launched its charge card business 50 years ago today, may wish it was back in those good old days.

The fourth-largest U.S. 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 (DFS.N), Capital One Financial Corp (COF.N), JPMorgan Chase & Co (JPM.N) and Citigroup Inc (C.N) 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 U.S. 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 U.S. economy, which could hit consumer spending in 2009.

American Express U.S. 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.

FUNDING COSTS, RESERVES THREAT

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 $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.