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Better Buy: Capital One vs. American Express vs. Discover

By Bram Berkowitz - May 5, 2020 at 7:13AM

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Which of these three major credit card companies is best positioned to weather the storm?

Share prices of Capital One Financial (COF -0.04%), American Express (AXP 0.46%), and Discover Financial Services (DFS 0.20%) have each cratered between 35% and 45% since Feb. 20, when the broader stock market began to fall sharply. Credit card companies are inherently more risky than traditional banks because credit card debt almost always has higher charge-off and default rates than other loan categories, even under normal economic conditions. However, because these are large companies likely to survive a downturn, there is potential long-term value, which is why it is good to take a look now when there is lots of potential upside.

All three of these companies struggled in the first quarter of the year. American Express reported a profit of $367 million, a drop of 76% on an annualized basis . This turned out to be the best performance in the group. Discover reported a net loss of $61 million in the first quarter , while Capital One took a net loss of $1.3 billion .

Despite it taking the biggest loss in the group, I actually like Capital One the best in the long term. Here's why.

Capital One bank building

Image source: Getty Images.

The most conservative loan-loss provisions

The largest of the three companies in terms of total assets, Capital One also set aside more cash in the quarter to deal with potential upcoming loan losses. The bank took a total credit provision of $5.4 billion in the quarter, an almost 200% increase from the linked quarter. Meanwhile, American Express and Discover took provisions of 156% and 116%, respectively . "My personal view is that you guys took a more conservative approach. So we appreciate that. I think some of the card issuers may have a bigger reserve build next quarter," Donald J. Fandetti, an analyst at Wells Fargo Securities, said on Capital One's recent earnings call.

Discover does have a larger coverage ratio than Capital One. Coverage ratio is a measure of total cash stashed away specifically for loan losses against a company's nonperforming loans (loans 90 days past due). At the end of the quarter, Discover's coverage ratio rose to 7.44%, while Capital One's rose to 5.35% . However, Discover also has a much larger credit card portfolio, percentage-wise. Credit card loans make up close to 80% of its total loan book, while that percentage at Capital One is only about 45%, so it would make sense for Discover to be expecting higher losses. 

The best-positioned portfolio

One of the interesting things about American Express is that unlike Capital One and Discover, it makes more money from fees charged to merchants than on interest from credit card loans. That likely helped AmEx perform better in the first quarter, but it could be problematic down the line.

Consumer spending was down 7.5% in March, and one of the industries obviously taking a beating is travel. American Express CFO Jeffrey Campbell said on the company's recent earnings call that proprietary billing volume, which is spending on American Express cards issued by the company, is down 45% in April . That is being driven by spending in the travel and entertainment industry, which makes up 30% of the company's total proprietary billings and is down an astounding 95% in April. Even when normal life resumes, it could take a while for travel and entertainment to bounce back.

Although I didn't see a breakdown by industry in Capital One's earnings materials, CEO Richard Fairbank said on the company's earnings call that weekly purchase volume through April 17 was only down by about 30% on an annualized basis, which could suggest the company relies less on travel spending than American Express . Unlike American Express and Discover, Capital One is also involved in more traditional lines of banking and has more than $145 billion of commercial and consumer loans (other than credit cards). These portfolios are not immune to a downturn, but have traditionally proven safer than credit card debt.

The composition of Capital One's roughly $81 billion commercial portfolio is not terrible either. Real estate, finance, and healthcare industries make up 67% of the portfolio, while the company does have a 5% exposure to oil and gas and a 4% exposure to retail . The company also has more liquidity available, with a common equity tier 1 capital ratio, a measure of a bank's core capital to its total risk-weighted assets, expressed as a percentage, of 12%, which actually increased year over year .

Go with Capital One

When you really look at them, these three major credit card companies all have different business models. American Express derives most of its revenue from fees on card spending; Discover has the largest credit card loan portfolio percentage-wise; and Capital One has a large, more traditional banking unit. Despite the tough quarter, I like Capital One the best because of its seemingly conservative approach and the composition of its portfolio. 


Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

American Express Company Stock Quote
American Express Company
$163.74 (0.46%) $0.75
Capital One Financial Corporation Stock Quote
Capital One Financial Corporation
$115.23 (-0.04%) $0.04
Discover Financial Services Stock Quote
Discover Financial Services
$108.73 (0.20%) $0.22

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