Decoding Berkshire Hathaway: Why Does Buffett Love American Express?

American Express is one of only two companies in the United States (the other being Discover) that is both a card issuer (similar to JPMorgan Chase and Bank of America) and a payment network operator (like Visa and Mastercard). This means American Express can earn money from both lines of business. Compared to a pure card issuer, the barrier to entry for payment network operators is very high, with only four qualified companies in the US. Studies have shown that any new operators entering the American market are likely to face losses.

The following chart shows that although JPMorgan Chase's bank card revenue is roughly the same as that of American Express, the latter has significantly higher card business net income.

American Express's focus on high-end customers has resulted in its credit card delinquency rate being significantly lower than that of its peers.

Its premium cards offer substantial signup bonuses and benefits, which not only attract new customers but also enhance customer engagement. Membership Rewards (MR) points system that can be redeemed for high-value travel and beyond increases customer stickiness and payment loyalty. The impact of these strategies is evident in the superior quality of AmEx's assets.

Only 8% of American Express's clients have FICO scores under 660, while its proprietary closed-loop business structure grants the company exceptional insight into consumer data. This enables the company to promptly identify trends and make informed decisions regarding its loan portfolio.

In the first quarter, American Express reported that the rates of accounts 30-plus days past due and net charge-offs (NCO) were 10 to 20 basis points (bps) lower than the levels seen before the pandemic. The company anticipates only a slight rise in the number of accounts past due and in charge-offs throughout 2024.

At the end of the first quarter, AmEx had reserves totaling $5.6 billion, which is equivalent to 2.9% of the total loans and receivables. This reserve ratio is consistent with the levels from the first quarter of 2020.

American Express's source of funds initially relied heavily on corporate liabilities (issuance of ABS and other channels). However, as its membership base expanded, the proportion of funds sourced from customer deposits has risen from only 14% in 2008 to 72% today. The interest on checking accounts for bank cards in the United States is usually very low. Fitch Ratings notes that a shift in the funding structure towards a greater contribution from retail deposits sourced directly from its card members could lead to an upgrade in the company's credit rating.

Unlike traditional banks, American Express does not have direct exposure to the risks associated with mortgage lending or auto financing. Card transactions have proven to be more robust compared to auto and home loans, which are both significant, interest-rate-sensitive expenditures. The unexpected resilience in credit card spending and loan expansion has been mitigating concerns as credit losses begin to increase, though card lenders aren't likely to achieve the double-digit revenue growth of the post-pandemic era soon.

The Credit Card Competition Act of 2023 proposes a mandate for banks with assets exceeding $100 billion to offer their credit card holders a minimum of two networks for processing card transactions. The goal behind this bill is to foster competition within the payment processing industry, which could lead to a reduction in the fees that retailers—such as Walmart and Target—are required to pay for each transaction.

The effects could potentially derive more from changes in transaction volumes rather than from fees alone. Should the bill be enacted, alternative networks like Discover and American Express could potentially increase their market share, as merchants and consumers look for more competitive processing options. It's also worth considering that if the legislation passes, Visa, Mastercard, and others might adapt their fee structures as a way to mitigate any potential revenue declines. This adaptability could include restructuring fees or introducing new pricing strategies to preserve their earnings.