American Express Company (AXP) Q1 2011 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you very much for standing by. Welcome to today's American Express First Quarter 2011 Earnings Release. [Operator Instructions] As a reminder, today's conference is being recorded and information on accessing that replay will be given at the end of today's conference. With that, I'd like to turn today's call over to our host, Mr. Ron Stovall, Senior Vice President of Investor Relations. Please go ahead, sir.

Okay, thank you, Dave, and welcome to everyone. We appreciate all of you joining us for today's discussion. As usual, it's my role to remind you that the discussion today contains certain forward-looking statements about the company's future financial performance and business prospects, which are subject to risks and uncertainties and speak only as of today. The words believe, expect, anticipate, estimate, optimistic, intend, plan, aim, will, should, could, likely and similar expressions are intended to identify forward-looking statements. Factors that could cause actual results to differ materially from these forward-looking statements, including the company's financial and other goals, are set forth within today's earnings press release, which is filed on an 8-K report and in the company's 2010 10-K report already on file with the Securities and Exchange Commission, in the First Quarter 2011 Earnings Release and Earnings Supplement, as well as the presentation Slides, all of which are now posted on our website at ir.americanexpress.com. We have provided information that describes certain non-GAAP financial measures used by the company and the comparable GAAP financial information. We encourage you to review that information in conjunction with today's discussion. Today's discussion will begin with Dan Henry, Executive Vice President and Chief Financial Officer, who will review some key points related to the quarter's earnings with a series of slides included in the earnings documents distributed and provide some brief summary comments. Once Dan completes his remarks, we will turn to the moderator who will announce your opportunity to get into the queue for the Q&A period. Up until then, no one is actually registered to ask questions. While we will attempts to respond to as many of your questions as possible before we end the call, we do have a limited amount of time. Based on this, we ask that you limit yourself to one question at a time during the Q&A. With that, let me turn the discussion over to Dan.

Okay, thanks, Ron. So let's start on Slide 2, Summary of Financial Information. So total revenues net of interest expense was $7 billion, up 7% compared to last year and that's 5% on an FX adjusted basis. Income was $1,177,000,000, up 33% from the prior year. EPS was $0.97 and Return on Equity was 28%. So revenues, while not robust, were an improvement from 4% growth in the fourth quarter and are better than what we see in the industry. Let's go to Slide 3, Metrics. Start off Billed business. The Billed business was up 17% on a reported basis, 15% on an FX-adjusted basis. So this is the fifth straight quarter that we've had Billed business in the 15% range. And the first quarter of 2011 is the strongest first quarter in Billing in American Express' history, both on a reported and an FX basis. Looking at cards-in-force, it's up 5%. We had growth in GNS of 14% and in the U.S. Consumers Small Business Group growth of 2%. Average basic cardmember spending continued to be strong at 13% growth on an FX-adjusted basis, and cardmember loans were flat basically with last year as loans have stabilized which is a positive. Worldwide travel sales is really being driven by air sales, a combination of both higher average price and a higher number of transactions. And we're seeing that both in the Corporate business and the Consumer business. So let's move to Slide 4. So this is Billed Business Growth by Segment, and as you can see by the chart, we continue to have strong growth across all of our segments. The U.S. Consumer Small Business Group grew 13%, the International Consumer business on an FX-adjusted basis was 10%, Global Commercial Services 17% and GNS 24%, for a total of 15%. If we move to Slide 5, this is Billed business Growth by Region, and again, as you can see on the chart, all geographies are having strong growth. In the U.S., growth was 15%; in EMEA on a FX-adjusted basis, 10%; JAPA, which is Asia, on FX-adjusted basis was 18%. Now within there is Japan and the growth rate in Japan has declined. We've seen an impact on Inbound business, but we still have double-digit growth in the Japanese market. And Latin America and Canada grew 16%. So if we move to Slide 6, this is Lending Billed business compared to and as well as managed loan growth. So spending on lending products, as you know, is no longer correlated with the growth in loans. And this is due to the fact that we are focused on premium lending. We have significantly reduced balance transfers, and there's been a change in cardmember behavior since the recession. Now if you look at the lending trust units, you would see that paydown rate continue to increase. So in March of 2011, the paydown rate was 30.4%, and that compares to March of 2010 when it was 27%. As you can also see from the chart as I mentioned before, the loan balances have stabilized. So next, we move to Slide 7, so this is USCS net interest yield. Now historically prior to 2009, the net interest yield was generally in the high 8% to 9% range. In anticipation of the CARD Act, we increased prices and you can see that reflected in the bars related to 2009 as well as the first quarter of 2010. As the Credit Card Act became effective, yields, as we expected, has started to migrate back towards historical levels. But in this quarter, the yield was 9.1 compared to 10% in the first quarter of 2010. So this decrease is resulting in a decrease in net interest income. So moving to Slide 8, which is our revenue performance. We see that discount revenue is at 14%, Card Billed business was at 17% and some of the factors contributing to the 14% growth was the fact that GNS Billed business is growing faster than the average as we've discussed before. Billed business on GNS is lower than on proprietary business. Also, we have a number of Contra-revenue items including corporate incentive payments, partner payments and cash back rewards, which are deductions from discount revenue. Now the discount rate stands at 2.55%, the same level as last year, which is very good. Now as we know going forward, as the mix of our billings changes to more everyday spend, we would expect the discount rate to decline. However, over the past 3 years, it's held up very well. If we look at net card fees, you can see it's up 3%. We actually had an adjustment in the first quarter of $10 million for $11 million. So excluding that, it's relatively flat. If we look at travel commissions and fees of 18%, essentially being driven by air sales as I discussed on a prior page. Now Other Commissions and Fees are up 6%. And here, we have foreign exchange conversion revenue increasing based on higher spend. We also have 1 month of Loyalty Partner revenue, and that's offset by lower delinquency fees. If we look at Other revenues which is up 12%, we have higher GNS partner royalty revenues, higher merchant related fee revenues, higher foreign exchange fees and higher global prepay revenues. And net interest income is down as our loans are flat and the yields that we just discussed are lower. We move to Slide 9. So this is Provision for Losses. So Charge Card, the write-off rate in the first quarter of this year is the same as last year. Receivables are about 11% higher. Now Charge Card provision is a little lower here as we had a modest build in reserves in the first quarter of 2010 and a modest reduction or reserve release in the first quarter of 2011. So Charge Card, as you know, has performed very well during the recession, and now that we're in a recovery period. Now looking at lending, provision is $800 million lower year-over-year. It was $688 million in the first quarter of 2010 and is actually a credit of $120 million in the first quarter of this year. Now there are two factors. 1 is lower write-off rates and the second is the larger reserve release. So the write-off rate in the first quarter of 2010 was 7% and the write-off rate in the first quarter of this year is 3.7%. So write-off dollars in the period are about $600 million lower. In the first quarter of 2010, we had a reserve release of $485 million and in the first quarter this year, we have a reserve release of about $700 million. So $200 million greater. So credit continues to improve, we're improving faster than the industry and write-offs are below historical levels. Next, I'll move to Slide 10. So here in the beginning, I'll basically talk to the first three columns on the left-hand side. The comparison of the first quarter of '11 to the first quarter of 2010. Now we do have total growth and expenses of 19%. And that's a combination of what I'll call business-as-usual expenses. 1 item in rewards, which I'll explain in a minute, plus we're investing to build our business momentum going forward. And that's really being enabled by the strong Billed business volumes, improving credit, as well as the Visa and MasterCard payments we received. So we can see here that marketing and promotion is up 15% year-over-year, and I'll discuss this in a little bit more detail on the next slide. At the moment, I'll skip the rewards line then we'll come back to it. Salaries and Employee Benefits increased 15%. Employees are up about 3,300 from last year or about 6%. We had an increase of about 1,400 employees compared to the fourth quarter, 600 of those relate to Loyalty Partners, then we've had increases in technologies, enterprise growth, as well as world service. It also reflects merit increases, higher benefit-related costs and increased incentive-related compensation accruals. Next, we'll look at Professional Services, which increased 18%. This includes technology consulting on development projects, higher external sales agents in Global Merchant Services, and higher legal fees, some related to the DOJ suit and some related to our acquisitions. Other is up primarily related to some accounting related to some foreign exchange and interest hedges, which I'll talk about on a later slide. The other thing I'd point out at this juncture is the fourth column, which is really showing the change in expenses in the first quarter compared to the fourth quarter. And I draw your attention to marketing and promotion, which is actually down 15% from the fourth quarter, as well as Professional Services, which is 27% lower than the fourth quarter. So here, we see expenses trending down from where we were in the fourth quarter. So let me talk to cardmember rewards expense, which is up 27%. Though a portion of this is simply the 15% growth that we see in spending by cardmembers, the other portion relates to the Membership Rewards program. We continue to improve the Membership Rewards program and its value proposition. We've recently added a number of new redemption options, including Amazon and certain other digital redemption options. We are seeing greater customer engagement by the current program participants, which is reflected in an increase in redemption patterns. Now as I've said in the past, higher redemptions and higher customer engagement is positive from a business perspective. Cardmembers who are active redeemers spend more, attrite less and we have a higher share of their wallet. This program is attractive from both a cardmember and shareholder perspective. We continue to refine our estimation process for the calculation of the ultimate redemption rate. These refinements are captured in the recent increase in redemption patterns by our current program participants. This resulted in our estimate of the ultimate redemption rate for current participants, increasing from 91% at the end of last year to 92% in the first quarter of 2011, which resulted in an increase in the MR reserve of $188 million. Going forward, we will continue to refine the ultimate redemption estimation process as cardmember behaviors in the program evolve. So next, I'll move to Slide 11. Now here, we continue to have high levels of marketing, which again has been enabled by strong cardmember spending, improved credit and the Visa/MasterCard payments. And while the first quarter of 2011 is lower than the fourth quarter of 2010, we are above historic levels and 15% higher than the first quarter of 2010. The areas we're spending on in the U.S. Consumer Small Business area are acquisition of charge and premium lending cardmembers, and loyalty investments including partners payments. The International consumer is focused on acquisition and loyalty spend stimulation, and in Global Merchant Services it's a combination of contractual merchant payments, merchant loyalty spend, perception of coverage and brand advertising. Moving to Slide 12, so here we're going to discuss a number of investments that are recorded in operating expense. Operating expense, which are basically excluding marketing and rewards, increased 16%, 14% on an FX-adjusted basis. And we can see that support functions in global services are growing more slowly than the average. Now above the average are 3 bubbles that are growing as a function of the investments that we're making to drive future business momentum. So we look at the upper left, we see new business initiatives. And here, we're focusing on driving fee revenue. It includes investments in LoyaltyEdge, online and mobile, Accertify, Loyalty Partners and Business Insights. If you look at the next item, it's sales force investments, both in Commercial Card and the Merchant business. If we look all the way to the right, we see variable technology investments, and these are technology investments to develop technology solutions in both our core business as well as our digital advancements. Now there are two other bullets, 1 simply has to do with spending for bank holding company in Basel II regulatory requirements, the other has to do with accounting for our debt and FX hedges. Now here I may give you more information that you actually want, but our FX hedges are functioning as designed. So what we want to do is basically lock in our U.S. dollar net income. So in the first quarter of 2011, the U.S. dollar weakened. As a result, revenues and expenses are higher, therefore, net income in higher. And in this case, we actually pay on the hedge, and so it's an expense. In the first quarter of 2010, the opposite happened. The U.S. dollar strengthened, therefore we reported lower revenues in expenses and therefore net income. In that case we actually received the payment, which is a credit on this expense line. The other item is our hedge on our fixed rate debt where we convert, have a hedge that converts the fixed rate debt to floating. And again, this hedge is functioning exactly as we intend. Accounting requires us to mark this to market. So in some periods, we have an expense, some items we have a credit. So again here in 2011, we have a debit, last year we had a credit. Now these mark to marks at the end, net to 0 and so there's no economics to it. I went through this long explanation because a combination of these things actually had a negative year-over-year effect of $50 million. So now, moving to Slide 13, so this is Expense Flexibility Over Time. So these are expenses excluding provision and they're expenses as a percentage of total revenue, net of interest expense. Now we recognize that we are currently at elevated expense levels, and again, this is being funded by improved credit and Visa/MasterCard payments. Now that it's likely that the benefit in credit provision from credit reserve releases will diminish going forward, and the Visa and MasterCard settlement payments will phase out in the second quarter, those are the MasterCard payments which are $150 million per quarter, and the fourth quarter, which are the Visa payments of $70 million a quarter. As result of that, we are, as a go-forward, we're moving forward with plans to slow the growth in our operating expense toward the end of this year and into 2012. So we would expect this percentage to move down as we go forward. So next is Slide 14, so this is Charge Card Credit Performance, and here we can see that USCS write-off rates are the same in the first quarter of this year as they were last year. In International Consumer and Global Commercial Services, we can see that they've been pretty consistent over the last several quarters. The higher amount in the first quarter of 2010 reflected a refinement in the calculation. So we would expect these metrics to pick up somewhat over time as we continue to grow our business. Moving to Slide 15, Lending, Net Write-off Rate. So here, both the U.S. and the international write-off rate continue to improve. And as you know, our write-off rates started to improve before the industry. And as we said, we moved sooner in terms of credit actions. Our actions have been very effective, and we have a higher quality base. So our write off rate is now at 3.7%, the lowest in the industry. So the write-offs in the first quarter were $541 million, which is about $500 million lower than what they were in 2010. So moving to Slide 16, this is Lending 30-day Past Due, and you can see that we continue to have improvement in both the U.S. and it has stabilized in International. These are at historical lows. So I'd point out that our objective is not to have the lowest possible write-off rate for 30-day past due levels, but to make good economic decisions to drive profitable growth. So Slide 17 is a slide we've looked at in terms of helping us think where we're going, going forward. Here I'd start on the right-hand side. So you can see that the number of bankruptcies are down notably in the first quarter for us. And this is consistent with the trend seen in the industry. Regarding bankruptcies, I'd also point out that the average dollar amount of each bankruptcy has been decreasing and approximately 2/3 of all bankruptcies reported to us, we've already written the account off. So now, looking at the chart on the upper left, and we've used this in the past year or so to be helpful. So here, if you look on the upper left chart and look at the green triangles, so these are the balances that rolled from current to past due in August through September of 2010. And they were write off 5 months later if they remain delinquent, until they wrote off in the first quarter of 2011. Next to that -- next to these, the green triangles, if you look at the next 3 blue triangles, they are lower than the green triangles. So if the 30-day past due write-off to write-off which is on the bottom chart remains constant, an early write-off to recoveries are unchanged, the second quarter 2011 write-offs would be lower than the write-offs we had in the first quarter of 2011. The other item that I'd point out on this chart are the next 2 blue triangles, which are the last 2 blue triangles are flat with the prior triangle. Flowing at the bottom chart, the 30-Day Past Due to Write-off rate, so through March, this past due write-off rate remains pretty consistent with the recent prior periods. Let me go now to Slide 18. So this is a new chart, it's Worldwide Lending Reserve Releases, and if you look across the top, you'll see the amount of reserve releases, the dollar amount of reserve releases, each quarter. And this indicates that in the first quarter of 2011, we released $700 million. Now if we look at the bars, the light blue bars are the dollar amounts of write-offs in their respective quarters. The dark blue bars are provision. So it's write-offs less reserve releases give you provision. So it's important to realize that the improvement in provision has built in the combination of lower write-offs and the reserve releases. So if you use the first quarter of 2010 as an example, you can see that the write-offs were about $1.2 billion, reserve releases were $500 million. And so the provision was about $700 million. And that ties back to Slide #9. If we look at the first quarter of 2011, we actually have a credit in lending provision, and that's because the reserve release of $700 million is larger than the write-offs in the quarter which were approximately $600 million. We would expect the write-off rate to remain below historical levels in the near future. Although I would note that if you went back to the first quarter of 2010, our reserves for loan excluded $5.3 billion. And at the end of the first quarter of 2011, it's $2.9 billion. So going forward, we would expect reserve releases to diminish. If you go to Slide 19, these are lending reserve ratios, coverage ratios. And as credit metrics have improved, our lending reserve coverage has started to come down, and you can see that in U.S. Card as well as Worldwide. Reserves, as a percentage of past due and principal month coverage have also ticked down. And although we had reserve releases of $700 million in the quarter, our reserve coverage remains at appropriate levels. Next is Slide 20, Capital Ratios. You can see our Tier 1 common is 11.8% compared to 11.1% in the fourth quarter. So this increase is primarily driven by lower risk weighted assets. So it reflects the seasonal change in loan balances which have declined, as well as there were certain cash that was considered restricted cash in the fourth quarter but is now free cash. Those are the 2 main drivers. These ratios continue to be strong. Now I would point out that we do not plan to maintain the Tier 1 common ratio above 11%. Our target is to have it between 10% and 11%. I'd now hear that we plan to restart our share repurchase in the second quarter. Now if the Basel III guidelines were implemented in the first quarter of 2011, we would estimate that it would reduce our ratio by about 80 basis points. And that compares to an estimate we had in the fourth quarter of about 50 basis points. And that shows really or finally in the calculation that we made as we continue to gain a broader understanding, and quite frankly, some of the factors quarter to quarter will change. So moving to Slide 21, our liquidity snapshot, we continue to hold excess cash and marketable securities to meet the next 12 months of funding maturities, which is our stated objective, then we're somewhere above that in the first quarter, and that's because Personal Savings, our direct deposit program, actually was somewhat stronger than we expected. Now we can see that on the next slide, Slide 22, so this is a summary of our U.S. Retail Deposit Program. And you can see that the direct deposits increased by $3.4 billion in the first quarter. And you also see that third-party CDs declined by $1.9 billion. And on those CDs, the weighted average remaining maturity is about 19.5 months. Now we don't expect direct deposit growth to continue at this level over the balance of the year. In fact, what happened is we kind of got stuck in the 1 or 2 position on the rate tables, which is not where we want. However, we have sent out marketing materials and when others dropped their rates, we didn't want to drop our rates right on the heels of sending out marketing materials. We have moved our rate down on the highs from 1.3% to 1.5%. And if needed, we will continue to move that rate so that we are not in the first or second position. Deposits now total $31 billion. So with that, let me conclude with a few final comments. Results for the quarter reflect a continuation of the positive business trends, evident during last year. Spending growth remains strong across all business segments and geographic regions despite increasingly difficult prior-year comparisons. We also saw further improvement in lending credit trends, some of it is due to our strategic and risk-related actions and some reflecting the post-recession behavior of customers. But the versions between consumer spending and borrowing levels continues to illustrate this change in behavior, as well as our shift in focus to a more premium lending customer. The net effect of all these factors is an improvement in the risk profile of the overall company. Revenue growth, which continued to improve in the quarter, but still is below our long-term target, continue to outpace our large issuer competitors as strong cardmember spending volumes more than offset the impact of lower loan use. As expected, our strong billings growth and improved credit trends once again provide the opportunity to invest in the business at high levels, while also generating strong earnings. These investments continue to be focused on driving current metrics and building capabilities that will benefit the medium to long-term success of the company. 1 example of a longer-term initiative was the recent launch of Serve, our next-generation digital payment platform. While many investments are reflected in marketing and operating expense, others involve using our strong capital base such as our recent Loyalty Partner acquisition and the Payfone equity investment announced last week. Despite strong momentum across our business, the economic and regulatory environment remains uncertain. In addition, as you know later this year, we will stop receiving the quarterly Visa and MasterCard litigation payments. And year-over-year comparisons will be more difficult in light of the strong 2010 credit and volume trends. In light of these factors, we are moving forward with plans to slow the growth of our operating expenses toward the end of this year and into 2012. The bottom line is our strong competitive position and unique business model are yielding high-quality results. As spending on our network continues to be well above industry average and our credit performance remains the best among the major card issuers. We are confident that our investments and business model are appropriately positioned to manage through the changing environment, capitalize on the opportunities in front of us and continue to win in the marketplace. Thanks for listening, and I'm now ready to take questions.

[Operator Instructions] And the first question will come from the line of Craig Mauer with CLSA. Craig Maurer - Credit Agricole Securities (USA) Inc.: First, let me congratulate Ron on completing his final earnings release.

Thank you, Craig. Craig Maurer - Credit Agricole Securities (USA) Inc.: Moving onto the hot topic which is expenses, a couple of questions there. If we were to add in the $220 million contra expense item regarding the settlement payments to the other expense line, will this quarter represent a good run rate for that line, as it seems this is about where you were running prerecession on average on a quarterly basis? And also if you can just help us with a little flavor in terms of going into next year, you talk about moving the expenses as a percentage of managed revenue ratio back down toward prerecession levels, I mean what type of move can we think about for next year, with the understanding that this is a multiyear effort?

Okay, so I think that some of the elevation in operating expense is going to continue. So to the extent we have investment in sales force, that will continue at that level and we think it will generate revenues that make it a worthwhile investment. Our investments to build teams that enable projects like Business Insights or enterprise growth, again those are expenses that will continue going forward and will be supported by the revenues that they would generate. Now there are some investments that we elevated, particularly in the technologies area, which are projects that have a very finite life to them. And we wouldn't necessarily see those at the levels that we've seen over the last several quarters. So I think we will calibrate our expenses and be mindful that when some of the resources we currently have, such as the release of credit reserves and when the payments of Visa/MasterCard come to an end, that we have expense levels that are appropriate for our revenues and as I said, we would expect expense growth later in the year to scale down and slow. So it's kind of a combination. Some will continue, but others will decrease as we move forward. Craig Maurer - Credit Agricole Securities (USA) Inc.: So specifically, in the Other Revenue line, were we at a good run rate there concerning the settlement payments of contra expense and I guess in a slightly different fashion, if we think about the reserve release slowing that you talked about and the reduction in spending that would be commensurate with that, is that I mean should we look for reduction in HR? I mean, where are we looking for that reduction is what I'm trying to get at.

I guess, I would look at operating expenses, kind of line items together. So I'll look at expenses, exclude provisions, obviously, exclude marketing, exclude rewards. If we exclude those, those are the operating expenses that I'm addressing. And I'm not specifically saying that you're going to see a decrease in that line item. I think there will be a decrease in certain elements of that line item. What I'm saying is you're not going to see the growth rates on that line that you've been seeing over the last several quarters. But not necessarily a decrease. A decrease in certain items, but not necessarily a decrease when you look at operating expenses in total. If that were the case, as we move through the year, the growth rates will decline. Craig Maurer - Credit Agricole Securities (USA) Inc.: Okay, thanks, Dan.

Next, we'll hear from the line of Rick Shane with JPMorgan. Richard Shane - JP Morgan Chase & Co: When we look at the rewards expense, it's basically a function -- the growth rate is a function of 3 things: It's the Billed business growth, whatever you do, whatever incentives you're providing or programs you're running during the quarter, and then in this quarter, getting change in assumption on the long-term redemption rate. Going forward, the way I'm thinking that we should model this and correct me if I'm wrong here is that we should see a really, at least on the margin is a function as the growth in the Billed business, that the change in assumption this quarter, the incremental somewhere between $165 million and $185 million was a one-time event?

Generally, you would expect rewards to grow in line with Billed business unless we are increasing certain programs. Now so I think it's reasonable to expect rewards to grow with business, okay? However, what I would say is that we continue to refine our estimation process around the ultimate redemption rate. And to the extent either cardmember behavior changes or we evolve the program in such a way that we're increasing redemptions, in those cases, we would expect to see increases in expense when we identify those. So I think on an ongoing basis, we're always looking at our estimation process and continue to refine it as appropriate. I would point out that this line is both a combination of Membership Rewards, as well as our co-brand products. The other element that you didn't mention when you think about expense in the quarter is volume related to Membership Rewards. It's volume, it's the ultimate redemption rate and it's the cost per point. And cost per point during some periods will increase depending on the mix of redemption by customers. And in some point, it could decrease, again based on their behaviors or new redemption options that we put into the program. So that's the other factor that you need to keep in mind. Richard Shane - JP Morgan Chase & Co: If I could have just 1 quick follow-up. Is the test for the redemption rate a quarterly test or is that something you review annually?

It's a quarterly test. Richard Shane - JP Morgan Chase & Co: Great. Thank you, Dan.

Next we'll hear from the line of Betsy Graseck with Morgan Stanley.

Just wanted to shift to the capital ratio comment that you had. You indicated a comment Tier 1 10% to 11% was really more in line with where you'd like it to be for your long-term goal. Are you anticipating any type of timeframe to get there? Is that something that you're targeting by year end?

So I would say our target of 10% to 11% is where we are, absent further guidance from the regulators. When they finally come out with their rules, depending on where it is we may modify that. But in the moderate term, I would say it's 10% to 11%. This ratio will obviously move based on the matter of share buybacks we do. We could have periods where a certain amount of cash, we're required to take certain cash prior to the redemption of certain securitization and put it into restricted cash. The extent that happens, those type of things could impact the ratio in the short-term. If you think about share buyback, you should really think about the guidance we've given that we basically want to return about 50% of our earnings to shareholders either through dividends or share buybacks, plus we would have buybacks equal to the amount of capital that's raised through employee plans.

But you indicated too that the ratio could be declined by about 80 basis points or so from your current 11.8%. Did I hear you right?

Someone made the predictions that we're going to drop about 80 basis points next quarter. I'm just saying our moderate term target is between 10% and 11%, right. But that moment we happen to be at 11.8%, next quarter, we're going to have -- moving our balance sheet, we're going to have our share repurchases and we're going to have earnings. Whatever the composite of that is, is where we'll wind up. This could be above 11% or it might be in the 10% to 11% range.

And you indicated your buybacks to start next quarter through this quarter so you're not waiting for anything from the Citi buffer. You also at one point indicated that you didn't think you were systemic risk bank does that assessment still hold?

So we have heard back from the Fed, which had no objection to our plan that we submitted. We are certainly one of the 19 large banks in the U.S. although to the extent there are global significant banks, we don't believe we are 1 of those banks.

Okay, got it. Thanks.

Next, we'll hear from the line of Sanjay Sakhrani with KBW. Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc.: I had a question on the ultimate redemption rate change again. I'm just trying to understand how much of that change was a conscious decision for greater engagement versus some kind of structural change in the competitive environment. Could you just help us think about that, because all if equal, it would seem like you'd have less discretion to spend money elsewhere. And obviously, you're looking to take expenses down. So maybe you could just talk about that and then just how does the current redemption rate assumption track what your assumption is?

So I don't think there is any structural change in the competitive environment. I think we have continued to look to enhance the value proposition of Membership Rewards to the extent we're successful in doing that. We're going to have greater cardmember engagement, to the extent we have greater cardmember engagement, we're going to have higher redemption levels. So I think as you think about how we deploy our resources, we do make conscious decisions about the amount we're going to allocate to rewards versus marketing, how much we're going to have in loyalty programs or acquisition of customers. So all of those things are similar levers and we make conscious decisions about in terms of how we're going allocate our resources at the end of the day. Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc.: And then just on the redemption rate tracking currently tracking to your expectation?

So the ultimate redemption rate is going to be based on cardmember behavior and we do a quarterly calculation where we're endeavoring to estimate what we think the ultimate redemption rate is going to be. If cardmember behavior changes, the estimate will change. And at times we do refinements of the estimation process, and that will result in potential changes as well. So it's a combination of all of those things that impacted the rate in this quarter and will impact the rate of the quarter going forward. Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc.: Okay, thank you.

Next, we'll hear from the line of John Stilmar with SunTrust.

Dan, I hate to go back to cardmember rewards, but was there a step-up function this quarter like one time in nature such that you have like a build of the reserves, such a that it would start correlating a lot more of spending more towards the point made earlier? Or should we start thinking about this at a similar level relative to growth and discount revenue?

Okay, so what the expense is in each quarter is a function of spend, ultimate redemption rate estimate and the weighted average cost per point. Those are the elements that drive expense each quarter, okay. The weighted average cost per point, we actually use the weighted average of the last 12 months as the best estimate for that, okay. Spend is going to be whatever our cardmember spend in a quarter. If the average weighted cost per point and the URR does not change for the quarter, then rewards should grow equal to the growth in Billed business, okay. In this quarter, we refined our methodology, and it resulted in a increase based on the behaviors of our customers in the ultimate redemption rate estimate from 91% up to 92% for our active participants, okay. So each quarter, it will be the same process that I just described.

One other final thing, as you talked about expenses and potentially the growth rate of expenses changing, but you also referenced expenses relative to operating margins. Sort of commensurate with the revenue growth that you're anticipating from the investment spending. And in some of your prior presentations, you alluded to getting back to kind of pre-recession operating margins or certainly things that we've been talking about. Is that still a stated goal and what is kind of the timeframe for us to be thinking about that stated goal that we had in the past?

So I think on average and overtime perspective, I think we want to be at historical margins. It's not a state objective, but I think that's basically where we want to get back to. Now the actual mix of expenses within those margins could change. We could decide to increase the amount that we allocate to or that we target for marketing promotion, or we could target to take that down. We could decide that from an overall perspective, the best thing to do is to increase the value proposition in our rewards programs. And then that would become a larger perspective -- a larger percentage, rather. So I think we're constantly looking at that and calibrating it to achieve the right returns on our investments and the right financial performance on average and over time in line with our stated objective of 8% plus revenue growth, 12% to 15% EPS growth and ROE of 25% plus. So those are all things that we use to calibrate the decisions that we make.

Thank you.

Next, we'll hear from the line of Brian Foran with Nomura.

Do you have a target for when operating leverage will turn positive?

So, just if you can tell me exactly what that calculation is?

So revenue growth exceeding expense growth on a year-over-year basis. I'm just trying to piece together, we've got operating expense slowing, we've got marketing budget which I guess is fairly discretionary, we've got presumably the rewards expense growing in line with discount revenues. But just when will that revenue growth line start exceeding the expense growth line? Is that also something that we could expect to happen at the end of this year and into next, or will that be different because of the trajectory of rewards and marketing?

So I wouldn't do a forecast of revenue growth or expense growth going forward, although I would go back and say that the targets that I just alluded to in terms of EPS growth, which are on average and overtime, I think we've said that 2010 is a good base to think about in terms of achieving those targets on average amount of time going forward. So that would give you an idea of what our expectation is, both for revenues, as well as for EPS growth.

And then just a cleanup question on tax rate, is the tax rate we saw this quarter what we should expect over time or what should we use as a long-term tax rate.

I think our rate was 31%-ish, 32%? Okay, so I think we've said on average over time again, we would expect the tax rate in the 30% to 32% range. In particular quarters, there may be discreet tax items that would cause it to either be lower or higher, but that's about the right range, we should expect, 30% or 32%.

Thanks.

Next, we'll hear from the line of Ken Bruce with Bank of America Merrill Lynch.

I'd like to second the congratulations for Ron. I appreciate your help over the many years.

Thank you very much.

The first question I have is you're obviously seeing the lending side of the equation stabilize much earlier than others. And I'm interested if you could give us any context as to what is supporting the balances stabilizing at these levels. Is it new card acquisitions that are coming in with balances, is it purely just more spending. Could you give us any context for what's driving that superior performance relative to the industry, please?

Okay, so we are focused from a card acquisition perspective on charge cards and premium lending. So I think the nature of the customers we're acquiring is reflective of that strategy. And so they tend to be customers that may be more transactors in nature, may revolve to a lesser degree than customers did historically. I think you're seeing that in the pay down rates that I alluded to before. In March of this year, we're up about 30% compared to paydown rate of 27% in March of 2010. So I think we're having high quality acquisitions. Those customers are spending, you can see that. And the whole, I think, our customer base as well as others are tending to de-lever. And I think all of those things are coming into play. As you said, our customers, when recession was at its height, at the beginning of 2009, pulled back sooner, even though they had the capacity to spend and pay, they were cautious. Now those customers have come back very strongly. We saw our improvements in spending by our customers really move to very strong levels in the first quarter of '09. That's continued. And I think it's really the nature of our customer base, the quality of our customer base that it's causing us to move in advance of the rest of the industry on spending, on credit behavior, as well as from loan balances. Now the other thing you have to remember too is, we've changed strategy, we're not looking to balance transfers as a way of bringing customers on board, we're not using fees or rates. That's another thing that's coming into play. So I think what you're seeing on the loan side is very much a function of our strategy. Now how customer behavior will change over the next 24 months, we will have to wait and see. But I think all those things come into play in terms of what we're seeing in the loan balances.

And as a follow-up, I don't want to beat the expense horse to death, it's pretty obvious that got a lot of flexibility in terms of how you manage expenses over time. What is a little less predictable or a little less manageable is really on the revenue side. And I'm wondering if you could give us any perspective on how you are looking at the investments that you have made, if you're feeling that the returns in terms of the revenue opportunity is coming in either in-line or better or worse than in-budgeted. Or how are you thinking about these investments if you can give us any context around when we would see the revenue side?

So I think you are already seeing the revenue side. I think we're very pleased. We have, over the last 5 quarters, said we want to invest in part to drive near-term metrics. And in part to build capabilities that will enable the success of the company over the moderate to long-term. So when you look at our Billed business growth of 17%, I think that's a very clear reflection that the investments that we're making in cardmember acquisition and in our loyalty and rewards program are paying off. And those growth rates are not only terrific on a absolute basis, they're notably better than the rest of the industry. So I think that's very positive. I think the investments that we're making in terms of fee businesses, businesses that will generate fee revenues, I think we're making good progress there. We're pleased with the results to date. Investments in the digital space, Serve is a very good example. And we bought Revolution Money in January of 2010. We invested in building the capabilities over the next 15 months. We launched Serve in March of this year. We'll continue to build out the capabilities of Serve. So I think there are very tangible indications that our investments are paying off. Now revenue growth is 7% again. It's really the best in the industry. Now it is being impacted by the fact that loans are flat but they stabilize. So that's good. Our yields is at 9.1%. It's down to 10% last year, but we knew that. We expect that as the Card Act came in, that's exactly what would happen. Notwithstanding that, it's putting a drag on revenue growth. So we're cognizant of that, but there are a lot of very positive signs related to both the strategy that we put in place, the investments we've made, the execution on those investments and then the resulting positive output.

Thank you.

Next, we'll hear from the line of James Friedman with Susquehanna.

I wanted to ask two separate questions. As a follow-up to, Dan, you're just prior comment about the fee-based business making good progress. I think you said in the public forum that you were targeting, generating, I can’t remember if it was $3 billion or $4 billion in revenue from those initiatives. Are you still comfortable with those targets? That's the first question. And then separately, I was wondering if you might be able to provide us an update on the DOJ litigation.

Okay. So our target for $3 billion in fee revenues has not changed. And as I said, I think we're making good progress on that front. So there's no change there. As it relates to your second question, the main development on the DOJ front is that there was a hearing on March 2, and we had a schedule of discovery in terms of document discovery, expert discovery, filing of briefs and arguments. And the final pretrial conference is scheduled to be held in February of 2013. Now obviously, any of the parties could ask for an extension if they had good reason for that. But that's the update in terms of the schedule related to DOJ. I guess I'd also point out that despite that DOJ suit being out there, our relationships with merchants continue to operate in a very business-as-usual form. We continue to renew contracts, you can see by the discount rate that it continues to hold at 2.55%. So we view those all as a very positive aspects as we think about really the strength of our network, which is helping to enable the spend of our customers.

Thank you.

Next, we'll hear from the line of Mike Taiano with Sandler O'Neill. Michael Taiano - Sandler O’Neill & Partners: Dan, I just have a question on how we should think about revenue growth. So 7% year-on-year, you're pretty close to I think with your long-term target of 8% is. How should we think of it in terms of relative to Billed business? Because the gap is pretty wide. Should we expect that gap to narrow over time for Billed business to remain slightly higher than your revenue you grow over time? And then also if you could just remind us with respect to the overall economy, if you think that you can achieve sort of your long-term targets under current conditions or if you really need a pickup in GDP.

Yes, I guess what I would say is that if GDP is around 3%, I think in normal conditions that we would be able to achieve our revenue target on average in over time. In this current environment, because we're coming out of a recession and the fact that we have a decrease in yield, that's a drag on the percentage on an aggregate basis. And I would look to fee businesses to help to contribute to the growth in revenues as those investments start to kick in. As you know, anytime we -- as I know, any time we make kind of BAU kind of investments in card acquisition, we have a very good ability to estimate what we're going to achieve. Anytime we do something new, which is some of what we're doing in the fee revenue space, and with Serve, there's a higher degree of execution risk. But we have, as I said before, we're making good progress in this area and I think fee revenues over time will be a contributor that enable us to achieve the revenue growth in excess of 8%. And if you look back over the last 10 years, we've been very successful with our investments. So we have taken share every year since 2002 through 2008. There's a slight dip in 2009, but we have very good share gains in 2010. So that's really another thing that's been contributing to our ability to outperform the marketplace. So again, we achieved 7% revenue growth in the quarter, with 0 growth in loans and a declining yield. So I think our ability to achieve 8 plus percent in revenue growth, assuming a reasonable economy, which I described as GDP of 3%, is very achievable. Michael Taiano - Sandler O’Neill & Partners: One last point of clarification on the capital ratios, when you say 10% to 11% Tier 1 comment, are you talking in terms of Basel III?

So I've been talking really in terms of our current calculation. But even if we went to Basel III, it was 80 basis points lower. Based on our current numbers, we would be within that range. By the time Basel III actually comes into effect, hopefully we'll actually have specific guidance in terms of where the Fed would expect us to be. So we'll refine that more as we get the final rules and we get closer to the Basel III implementation. But certainly, we have terrific earnings power to create free cash flow. This quarter, we had $1,177,000,000 in earnings. Our dividend is only about $200 million. So we'll be showing off almost $1 billion in capital in the quarter. So if we needed to increase that percentage in a given period, we have a lot of wherewithal to do that. Michael Taiano - Sandler O’Neill & Partners: Thanks.

Our next question comes from Bill Carcache with Macquarie.

Dan, you had previously mentioned, apart from the $3 billion target in for fee-based revenues by the end of 2014, you previously indicated that in 2009, you generated about $800 million in fee-based revenues. So that suggests that you're expecting roughly a 30% compound annual growth rate over that period. Can you tell us what the 2010 fee-based revenues were?

It's that number that we've disclosed. We will give I think some disclosures on this as we go forward. I don't think this is a straight line from $800 million to $3 billion, right? I think it requires heavy investment which we're doing right now in the first part of that period and then we'll get escalating results as we move through the period. So I don’t have a specific disclosure on that, but I would say we're making good progress.

Okay, so there's no number that you can share for 2010?

Not at this time.

Okay. And then just for a perspective so we kind of understand as we're moving forward, can we expect at some point to get kind of more granular insight into how each of the various fee businesses are doing as they kind of contribute to that overall target?

So I think it would be fair as we move over the course of 2012 to '14 to figure out what the right disclosures are as an indication that we're actually making progress against our targets of 2014.

And finally, if I could have just 1 last follow-up. There have been some concerns that some investors have expressed about your ability to continue to be able to command premium pricing on Amex spending in light of the relatively lower economics that the Serve product will generate. Can you just talk to that point and just discuss how you intend to handle any potential merchant pushback and different pricing for these different products, particularly at the time of contract, the renegotiation?

Well I think these are two separate products, right? I mean as you think about it, our current products, our charge cards and lending products, and we have a certain set of economics attached to those. I think maybe that the customers that the Serve product will attract are people who today use cash or debit or prepaid. And those transactions will attract the different discount rate. But those are very different products meeting different customer needs. And I think merchants will view them as different in nature. So I think they both will operate, they both will meet the needs of customers in the marketplace but they're different customers. That's not to say that some of our current cardmembers may not decide to open up a Serve account, but I think they'll use them in different ways. So we'll see how the economic model evolves within Serve, but we don't think that it will create any additional pressure with merchants. I think with merchants for our charge and credit products, we negotiate with them all the time when contracts are renewed, and we agree on pricing based on the value that we bring to them over our network.

Thanks.

Our next question comes from Bob Napoli with Piper Jaffray.

Just to clarify I guess on the revenue side, I guess on the loan growth, you're 25% of revenue net interest income. This quarter is down 9% year-over-year. The margin really fell off in the second quarter. So I mean the comparison you established, slight bit of a low growth in 2Q '11 possibly or flat or slight loan growth, but you'll have pretty flat margins. So that by itself, probably gets you over the 8% revenue growth target?

Well I'm not going to forecast what's going to happen in the second quarter, but certainly to the extent the yields, year-over-year start to equalize, which is going to happen in the very near future, that will be a factor that will be less of a drag on revenue growth that was last year or in this quarter. So I think that's a fair observation.

And elected Loyalty Partners, what is the revenue of Loyalty Partner's into the one-month you had and what is the annual run rate, throughout the...

So I think what we said is that last year, it was about $300 million. So you kind of use that as a guidepost in terms of what revenues in this quarter were.

Just 1 big expense item, and I....

1 month with Loyalty Partner in this quarter.

And just 1 expense item, I know this is built into your 12% to 15%, and you have flexibility. But the comp expense is up 15% year-over-year, employees up 6%, and some incentives, I mean were there some unusual -- I mean we shouldn't expect comp expense to grow at a level that would be much above the employee growth rate, should we?

Well I think in the normal course, you would have employee growth and you'd have year increases. I think that's what you think about as normal growth. In this particular quarter, the instance of compensation accruals we're making in this quarter are higher than the ones we made in the first quarter of last year, and there were just some other employee-related benefit items that grew at a slightly higher rate.

Okay, thank you.

And it comes from the line of Don Fandetti with Citigroup.

Dan, I was just wondering if you have a better sense of what the impact of CFDA might be on your business. And also if you hearing anything on the merchant settlement, it might indicate that they're moving towards credit interchange reduction?

Well first, in terms of the CFDA, we have to wait and see. There's been a lot of discussion about exactly what they'll do until they're actually up and operational, which I think happens in the summer and they actually name the person who will leave that organization, we would know that. While we are certainly staying in close contact to the discussions in that area. So that's something that we'll have to just wait and see. Now as it relates to the merchant settlement, I guess not sure exactly which merchant settlement you refer to. So if you're referring to the Visa and MasterCard?

There's been some concern that as part of outside of a monetary settlement, there may be a business practice change with respect to credit interchange. I was wondering if you've gotten any indications that it might be moving in that direction or give any concerns around that.

So I would say we don't really have any insights in terms of the Visa and MasterCard talks that they're having. So I can't shed any light on that.

Sure, thank you.

Okay, so just before we end, as a couple of people have mentioned, Ron Stovall is retiring in 16 days. If you're sitting here, you could see him smile. So Ron has extraordinary knowledge, has been a terrific advocate for the company, but in a very balanced way, I think we're very happy about that. So I want to thank him for his significant contributions that he made. And I think you, the investment community will actually be in good hands going forward as Rick Petrino is taking leadership of the Investor Relations group and Toby Willard who has been a key part of that team and doing a traffic job will continue. So I congratulate Ron, but I have full faith in our team that we'll continue to be able to be responsive to your questions and your needs. So thank you very much.

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation, and for using AT&T Executive Teleconference. You may now disconnect.