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Extra credit
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October 12, 2001: 7:06 p.m. ET
After reporting record profits, credit-card issuer MBNA deserves a higher valuation.
Michael Sivy
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NEW YORK (CNNmoney) - Most companies are expected to post lousy earnings for the last two quarters of 2001. But there is a sprinkling of firms that are announcing positive earnings surprises for the third quarter. Pepsico reported strong results on Wednesday, as I mentioned in my previous column (see "Strength through snacks"). And MBNA, the nation's largest independent credit-card lender, followed up on Thursday with an earnings gain of more than 25 percent, compared with year-earlier levels.
Despite those record profits, MBNA's (KRB: down $0.19 to $31.00, Research, Estimates) share price remains well below the all-time high it set last year. That buying opportunity isn't likely to last, however, once consumers' finances begin improving.
The current economy is a mixed blessing for credit-card issuers. Lower short-term interest rates have made credit-card lending more profitable. But lenders could suffer if Americans cut back on their spending or if consumers who have lost their jobs begin defaulting on loans in greater numbers.
The Federal Reserve has been slashing interest rates all year long. And many economists expect the Fed to cut rates one more time before year-end. Currently banks are paying only 2.5 percent for overnight loans and charging an average of 14.2 percent on credit-card balances. Profit margins couldn't get much better.
Those fat spreads are offset to some extent by the difficulties many consumers are facing. The exuberance of the late 1990s left many Americans heavily indebted. The economic slump and fears of further terrorism have eroded consumer confidence. And widespread layoffs have pushed unemployment up to 4.9 percent, the highest level since 1997.
Weaker consumer finances are leading to more delinquencies on credit-card debt. Providian stock plunged by 33 percent on Friday, after the lender announced that third-quarter results would be off sharply because of rising loan defaults. Providian is particularly vulnerable to loan losses because many of its customers have less-than-stellar credit ratings. Nonetheless, other credit-card lenders also fell after Providian's announcement.
MBNA shares lost only 19 cents, however, because the bank's customers have exceptionally good credit ratings. MBNA's typical cardholder has a $70,000 annual household income and a 17-year record of paying bills on time. As a result, the company has been able to post higher earnings for 43 straight quarters.
Although MBNA's most recent earnings report was terrific, the company is showing a small effect from current weakness in consumer finances. MBNA's delinquencies would have ticked up in the third quarter if the bank had not given customers extra time to pay following the Sept. 11 attacks. And over the next two or three quarters, the bank's earnings gains could be less robust than usual.
Any temporary slowdown in growth, however, should abate as soon as the economy picks up. MBNA is continuing to attract new customers at a rapid rate thanks to its affinity cards, which are issued jointly with other organizations. Recent new co-sponsors include the Vermont State Bar Association and the Country Music Hall of Fame.
Once the current slump is over, the bank's profit growth will likely continue at more than 20 percent a year. Since 1997, investors have been willing to award the stock a P/E above 20 for that core growth rate. Currently, MBNA shares are trading at less than 15 times next year's projected earnings, which is unusually cheap for one of the fastest-growing high-quality companies in the financial services sector. 
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