By Sam Stovall
Charging its way onto the Standard & Poor's this week is the S&P Consumer Finance subindustry index. This group includes well known names like American Express (AXP ), CapitalOne Financial (COF ), and MBNA Corp. (KRB ). It also features some lesser-known entities: AmeriCredit (ACF ), Rewards Network (IRN ), and Providian Financial (PVN ).
Providian, by the way, was recently in talks to be acquired by Barclays (BCS ) -- since broken off -- which could be a cause for the subindustry's recent price strength. Regardless of whether Providian is eventually acquired, S&P's investment outlook for the consumer-finance subindustry is positive. S&P analysts see improving credit trends, continued strong consumer spending, and benign interest rates aiding results.
S&P views recent quarterly results as indicating that credit quality is improving, and we believe this will lead to better earnings growth for 2004. In the credit-card segment, declining interest rates and aggressive marketing of cards with low introductory rates earlier in 2003 helped depress net interest margins throughout 2003. However, S&P expects margins to stabilize in 2004, as introductory rates readjust upward, partly offset by higher funding costs if interest rates increase.
OVER THE PEAK.
Slightly higher interest rates should help drive greater loan growth in 2004, in S&P's view, as cash-out refinance mortgages become less attractive, offering consumers fewer opportunities to pay down credit-card loan balances. That could translate into higher average balances for cardholders.
In terms of credit quality, S&P thinks the peak in credit costs among consumer lenders has passed because economic growth has improved. Many consumer lenders have recently reported lower delinquency rates, and S&P sees this leading to lower loss rates and greater profitability over the next several quarters.
For the longer term, S&P thinks pricing pressures will remain intense, challenging the profitability of marginal competitors and leading to continued consolidation of credit-card portfolios. S&P expects the larger consumer-finance competitors to benefit from consolidation in terms of better pricing power and economies of scale, and to supplement domestic growth with growing origination efforts in international markets, which are viewed as offering greater growth potential.
S&P believes increased regulatory pressures on originators of subprime loans may lead to slower loan growth for that segment in this economic cycle than in earlier years. We think this could add to pressures on these concerns to consolidate with financial companies with larger and more diversified consumer-loan portfolios.
S&P's top choices in the group include Capital One and MBNA, each ranked 5 STARS (buy). Providian and Advanta Corp. (ADVNA ) carry a 4-STARS (accumulate) recommendation. Of the other companies mentioned in this report, American Express and AmeriCredit are each ranked 3 STARS (hold), while Rewards Network isn't followed analytically by S&P.
Industry Momentum List Update
For regular readers of the Sector Watch column, here's this week's list of the 11 industries in the S&P Super 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500) as of February 20, 2004.
* S&P's stock appreciation ranking system for the coming 6- to 12-month period: 5 STARS (buy), 4 STARS (accumulate), 3 STARS (hold), 2 STARS (avoid), 1 STAR (sell).
Stovall is chief investment strategist for Standard & Poor's