Some speculate that the next leg to fall in a massive global de-leveraging will be the credit card business. Given that the crisis started with bad debts in the mortgage market, it makes sense for many to believe that our obsession with plastic will end and end badly.
While it is true that extension of credit may have gotten out of hand, it is important to remember that credit used appropriately is a great booster to productivity. Plastic makes it easier to transact business thus more business gets transacted. (See also: "American Express (AXP): Consumers Leaving Home Without It.")
Indeed the amount of consumer debt used in this country has ballooned to extraordinary levels. To the extent that such debt cannot be paid back, enormous strain is put on the system not too dissimilar to the mortgage mess.
The big difference is that credit card companies do not generally package pools of credit debt that then are sold to other investors as securities of the highest grade. In fact, most credit debt stays on the balance sheet of the company issuing the debt.
Reserves are set aside for defaulted payments and complex formulas are used to determine interest rates. Credit card debt is appropriately priced given the risk for default as far as I can tell.
Those with lower credit scores pay higher rates. Those with bad payment histories are charged fees for late payments. Miss a payment and your rate may increase. That sounds like reasonable lending to me.
Putting aside social implications of certain practices, these terms ensure that credit card companies generate big profits. Some of the biggest profits come from the branded cards like…
>
…MasterCard, Inc. (MA) and Visa (V).
The branded names make their money servicing the plastic and processing the cards. They get paid each time a transaction takes place. It is a beautiful model and one that is growing substantially.
One could even argue that the MA and V will do well no matter what happens in the economy. Yes, business declines if a recession hits, but any reductions in transactions are likely to be made up by more cards issued and greater used of existing cards.
The market though is not convinced of that argument. Both MA and V have been losing value steadily this year as the market veered from economic slowdown to complete financial Armageddon.
Actually, the branded credit space was doing quite well until the market imploded during the summer. MA was up over $100 from the start of the year in early June. The next thing you know is that MA is trading down more than 50%.
In four short months the world changed. Some would say the world nearly ended, but was it really that bad? Maybe not.
This week MA announced that revenues had increased by 24% in the third quarter. Processed transactions were up 13% in the period to 5.4 billion transactions. So much for the slowing economy negatively impacting results at MA.
The market seems to have missed the boat here with valuing MA. Yes, there are challenges, but current pricing is expecting a meltdown of epic proportion. Even then, MA may still do well for reasons mentioned above.
The stock moved big today, but it is not too late to buy this former high flyer. If the economy does better, expect MA to recover its lost value in a very short time.
This article was written by Jamie Dlugosch, contributor to InvestorPlace.com. For more actionable insight like this, go to: www.InvestorPlace.com.
