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Tickers in this Article: AXP, DFS, COF
Independent credit card issuers like American Express (NYSE:AXP), Discovery Financial (NYSE:DFS) and Capital One (NYSE:COF) have seen their share prices slide over the past year. Amex has lost about 14% of its value year to date, and Capital One and Discovery have lost more than 40% of their value.

This is just another example of how the subprime mortgage contagion is affecting other aspects of the lending business. So, what exactly is ailing the sector these days to have caused such a drop in investor confidence?

Cutting The Credit Card Tether
For starters, it's been clear for sometime now that the great American love affair with consumer purchase debt may be slowing down. This may partly be due to the shift in borrowing prompted by the U.S. housing boom over recent years.

According to recent study put out by brokers CIBC World Markets, mortgage debt outstanding has grown at double-digit rates since 2001, yet credit debt has only grown by low single-digit rates over the same period. After peaking at annual rates of growth between 15% and 20% during the mid '90s, credit card debt growth has steadily trended lower, achieving only about 6% year-over-year growth to September. That's well below the long-term average growth rate of about 8%.

It appears that U.S. consumers have been listening to the advice put out by financial self-help gurus like Suze Orman who preach that paying down credit card debt should be the top priority of most people's financial game plans. As of October, payment rates on credit cards have roughly averaged a very healthy 5-times the minimum payment amount, or about 20% of average monthly debit balances at the time of payment. (To learn why you should credit cards from your budget, see Expert Tips For Cutting Credit Card Debt and Understanding Credit Card Interest.)

While these rates have some seasonality, it's clear that the message has clicked with most credit card borrowers: pay down this highly expensive debt as quickly as you can. It's good news for consumers and bad news for card companies as this will make it difficult for card issuers to count on growing card balances going forward, resulting in less robust profit growth in the future.

Charge-Off Rates Still Below Average, But Rising Rapidly
The flip side of this trend toward savvy management on the part of cardholders is that charge-off rates have managed to remain relatively low over the same period, but with a clearly rising trend over the past year. While the average industry charge-off rate of roughly 4% is still about 30 basis points below the long-term average; it has gained about 70 basis points on a year-over-year basis.

Brokers Turn Their Backs on the Sector
This recent upward turn in charge-off rates prompted a flurry of sell recommendations from major brokerage houses recently. All cited a slowdown in consumer spending and further increases in charge-off rates as underpinning their negative take on the sector. The most negative comments were reserved for Capital One and Discovery, whose more "down market" - i.e. poor - clients are seen as being more exposed to the negative consequences of a recession.

In contrast, American Express, with its perceived higher net-worth clientèle and broader international exposure, is seen as being better positioned to weather any sort of downturn in its business resulting from a U.S. consumer led recession. These views appeared to be at least partially confirmed by a subsequent announcement by Capital One's CEO that its actual bad debt charges may now exceed earlier forecasts.

The Bottom Line
While the recent sell recommendations may appear to have come too late to be of any good to investors - funny how that always seems to happen - there may be enough proverbial horses left in the barn to regard this call as worthwhile. The clear takeaway is that one should avoid companies like Capital One and Discovery, who have built their loan books on a weaker credit base than Amex. (For added insight, check out Why There Are So Few Sell Ratings On Wall Street.)

While Amex trades at a premium price-to-earnings multiple of 13-times next year's earnings relative to the 7-times and 10-times multiples for Capital One and Discovery respectively, the prospect of these latter two being hit by sizable unexpected losses next year, makes me prefer quality when making an investment choice at this point.

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