American Express Company (AXP) Q2 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the American Express Second Quarter 2012 Earnings Call. [Operator Instructions] As a reminder, this call is being recorded. And I would now like to turn the conference over to your host, Rick Petrino. Please go ahead.

Thank you. Welcome. We appreciate all of you joining us for today's call. 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 and earnings supplement, which were filed in an 8-K report and in the company's 2011 10-K and Q1 2012 10-Q report, already on file with the Securities and Exchange Commission. In the second quarter 2012 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 through the series of slides included with the earnings documents distributed and provide some brief summary comments. Once Dan completes his remarks, we will move to Q&A. With that, let me turn the discussion over to Dan.

Okay. Thanks, Rick. So I'll start on Slide 2. Total revenues net of interest expense came in at $7,965,000,000. That's an increase of 5% compared to last year. On an FX-adjusted basis, it's an increase of 7%. Income from continuing operations was $1,339,000,000. That's an increase of 3%. EPS from continuing operations came in at $1.15. That's 7% increase compared to last year. The difference in growth rate between EPS and income from continuing operations are the share buybacks that we've been doing. If you go 2 lines down, you can see that the diluted shares outstanding are down 4% compared to the second quarter of 2011. And return on equity came in at 27%. So moving to Slide 3, these are our second quarter 2012 metrics. Billed business comes in at $221.6 billion. That's 7% higher on a reported basis and 9% higher on an FX-adjusted basis. And throughout, you'll see that FX is having a larger impact on reported results than normal because of the strength of the U.S. dollar. If we were to look back at billed business growth, just to see a trend, if you went back to the second quarter of 2011, on an FX-adjusted basis, we had growth of 15% in billed business. That moved to 13% in the third quarter of last year, 11% in the fourth quarter. It ticked up to 13% in the first quarter of this year. However, it had the benefit of leap year and came in at 12.6%, so round that up. So I view that more similar to the fourth quarter at 11%. But in this quarter, we're 9%. So we are seeing a slowing in the growth rates over, really, the last 4 quarters. So cards-in-force are up to $100 million, up 6% from last year. GNS cards are growing at 15%, and proprietary cards are growing at 2%. We again see good growth in basic cardmember spending, which illustrates the high level of customer engagement that we have. Cardmember loans are $61 billion, that compares with $60.1 billion in the first quarter of this year and 4% growth compared to the second quarter of 2011. Worldwide travel sales increased 3% on an FX-adjusted basis. So moving to Slide 4, this is billed business growth by segment, FX-adjusted. So each business really had a similar slowing in billed business growth for the quarter. Each decreased about 3% or 4%, so really broad-based slowing in the growth rate. GNS continues to be the highest growth rate at 13%. If we move to Slide 5, this is billed business growth by region, again, FX-adjusted. And here again, you can see that each region has a similar slowing in the billed business growth rate, that ranges from a decline of 2% to 4% and, again, is broad-based. And as you'd expect, EMEA has the lowest growth rate but still had positive growth at 4%. Just a little information for countries within EMEA, Germany had a growth of 5%, U.K. grew at 4%, Italy was flat with last year, and Spain decreased 5%. JAPA continues to be the highest-growth region. So moving to Slide 6. So this is providing some information on billed business in international currencies. So we're providing this because of the impact that foreign exchange was having on the reported numbers. So just to take you through the slide, obviously, these are several of our major countries that we operate in. The first information there, so looking at the euro, for instance, the 5% to 7% is the approximate range of billed business in the euro compared to total billed business. For Australia, it's 5% to 6%. If you go down to the next line, this is really the year-over-year change in the foreign currency compared to the U.S. dollar. So in the second quarter of 2012, the strength of the U.S. dollar drove a 2% reduction in our billed business growth rate. So as you know, in periods of a strengthening U.S. dollar, volume metrics and revenue growth rates are negatively impacted when translated back into U.S. dollars, while inversely, expense [ph] growth rates benefit from the strengthening of the U.S. dollar. As we have estimated in our 2011 annual report, the adverse impact on pretax income of a hypothetical 10% strengthening of the U.S. dollar related to overseas operations for 12 months would be about $175 million. So that's an annual amount if there was a 10% impact. And as you can see for the numbers on this slide that impact is in aggregate less than 10%. So in general, it's our policy to hedge the P&L one quarter out. Slide 7. So this is lending billed business, which is the solid line, the growth rate in lending billed business. And the dotted line is the growth rate in managed loans. So we still have a gap. We have a growth rate of lending billed business being higher at 9% compared to managed loans, which is growing at 4%. But the gap continues to narrow. Now paydown increased quite a bit in 2009 and 2010 but has stabilized in recent quarters. In the second quarter, the trust paydown rate was 31.5%, and that's well above industry average. And as I'll speak to in a few minutes, our credit is behaving very well on loans. So moving to Slide 8, so this is revenue performance. So total revenues grew at 5%. It's not on this slide, but on FX-adjusted basis, it grew at 7%. So starting with discount revenue, it grew at 5%, and this reflects 7% billed business growth, offset by higher contra-revenues including corporate incentive payments and higher cash rebates. Average discount rate on the second quarter of this year was 2.54%, which is flat with the second quarter of 2011, although over time, we still expect the average discount rate to decrease slightly due to pricing incentives and mix change. If we look at the next 3 revenue lines: net card fees, travel commissions and fees and other commissions and fees, on a reported basis, they're basically flat, but on an FX-adjusted basis, they are growing at between 3% and 4%. So if we look at other revenues, that increased 21%, and that includes a $30 million gain on the sale of a portion of our ICBC investment, a favorable revision in the estimate of the liability for uncashed Travelers Cheques in international markets, and higher royalty payments from our GNS partners. Looking at net interest income, it increased 4%, and that's driven by 4% growth in loans. And our net yield is the same this year as it was in the second quarter of 2011, resulting in 4% net interest income growth. So moving to Slide 9, so this is provision for losses. Credit continues to perform very well. However, provision increased 29% as lending reserve releases are well below what we saw in the second quarter of 2011. In charge card, we had higher write-off dollars in the second quarter of this year compared to last year, and that was offset by higher reserve releases in the second quarter of this year than last year, all these -- although these are much smaller amounts than what we see in lending. But the net of that is that the charge card provision is flat, as you can see on this chart. Now in lending, we had lower write-offs in the second quarter of this year. The write-offs this year were $370 million compared to $511 million last year, so write-offs are $140 million lower in this period, so that would drive provision down. However, we had lower reserve releases, as you can see on the chart, and therefore, the benefit of reserve releases were about $230 million less than last year. And as a result, the lending provision is $100 million higher than we had in the second quarter of 2011. So moving to Slide 10, so these are charge card credit metrics. And as you can see on the left, the U.S. consumer and small business group had higher write-off rates in the second quarter of 2011 at 2% compared to 1.5% in the second quarter of last year. And that's why on the prior chart, we had higher write-off dollars in charge card. But I will note that the 2% is lower than the 2.3% in write-offs that we saw in the first quarter this year. International Consumer and Global Corporate products, for the right chart, you can see that credit continues to perform very well, and these are -- all of these metrics are at historically low levels. Next, I'll take you to Slide 11. So these are lending credit metrics. And on the left, you can see that the write-off rate decreased from 3.1% in the second quarter of 2011 to 2.2% in the second quarter of this year, and it's also down 10 basis points from 2.3% in the first quarter. So in the second quarter of this year, if you look at it by month, in April, the write-off rate was 2.4%. In May, it was 2.2%, and in June, it was 2.0%. So we have an improving trend in the quarter. If you look at the right side, this is 30 days past due, and this is also improving. So it improved from 1.6% in the second quarter of last year to 1.4% in the first quarter of this year, and 1.3% this quarter. So I'll just remind you that our objective is not to have the lowest possible write-off rate but achieve the best economic gain when we make investments. But these metrics are at historic low levels and represent best-in-class credit metrics in the industry. Slide 12. So this is lending reserve coverage. You can see that both the U.S. card and worldwide reserves as a percentage of loans continue to come down as the write-off rates and the "30 day past due" rates improve. So the percentage now for the U.S. card is 2.6%, and worldwide is 2.5%. Reserves as a percentage of past due are similar this quarter to the percentages that we had in the first quarter of this year, and that's true for the principal months coverage as well. So for those people who can hear the thunder in the background, if you're not in New York, it's a big lightning and thunder storm here. So the reserves, we think, are appropriate based on the credit models that we use to set reserves. Moving to Slide 13, so this is expense performance. So here you can see that total expenses increased 4 -- 2% and on an FX-adjusted basis, which is not on the slide, would have increased 4%. If you exclude the Visa/MasterCard settlement payments of $220 million that we received in the second quarter of 2011 and which were 0 this quarter, total expenses would have decreased by 2%. So I'll cover each of the individual line items on this slide and subsequent slides, but I would point out that the effective tax rate this quarter of 29% reflects the realization of certain foreign tax credits this year. And the 27% in the second quarter of '11 reflects the impact of favorable resolution of certain prior-year tax items. A normal tax rate for us would be in the low 30s. Looking at Slide 14, so this is marketing and promotion. So on the prior slide, we saw that in the second quarter of this year, marketing and promotion was $773 million. And that's down from 3%, from $795 million in the second quarter of 2011, but it is up from $631 million in the first quarter of this year. So we have said that our target for marketing promotion generally is to be around 9% of revenues so that we can drive growth. In the first quarter, when marketing and promotion was only 8.3% of revenues, we said we had a plan for full year marketing promotion to be approximately 9%. In this quarter, we increased marketing promotion to 9.7% of revenues, and we are continuing to invest in the business at healthy levels to drive growth, and this puts us on track to achieve our plan of approximately 9% -- for marketing to be 9% for the full year of revenues. If we move to Slide 15, so now we're now covering cardmember rewards expense. So cardmember rewards expense for this quarter was $1,463,000,000, and that's down 9% from $1,613,000,000 in the second quarter of 2011. Now the blue section of this bar represents MR points earned in the current period and co-brand expense. I remind you that for co-brand products, the co-brand partner has the obligation to deliver the reward. We pay the co-brand partner each month for the amount we expense and have no balance sheet liability. On the other hand, we are responsible for delivering the rewards earned under the Membership Rewards program and had a balance sheet reserve of approximately $5 billion at the end of 2011. The green section of the bar represents Membership Rewards expense related to points earned in previous periods due to an increase in the estimate of the ultimate redemption rate or a change in the estimate of the weighted average cost per point. The green section in 2002 -- the green section in the second quarter of 2011 represents an increase in the ultimate redemption rate based on customer behavior and an increase in the weighted average cost per point in the second quarter of 2011. Now you can see that there is no green section in the second quarter of 2012 as we had a modest increase in the ultimate redemption rate, much low -- in the second quarter of this year, much lower than the increase in the second quarter of 2011. This quarter is much closer to historical levels of an increase in the ultimate redemption rate in the quarter. But we did have an increase in that we created an expense in the quarter, but it was offset by a reduction in the weighted average cost per point in this quarter, which reduces expense in the quarter, and the 2 items net to approximately 0. Slide 16, operating expense performance, and we have been very focused on this area. On a reported basis, total operating expense increased 10% in the quarter. But if you exclude the Visa/MasterCard litigation settlement proceeds that are included in the second quarter of last year but are 0 this year, it would have been a growth of 2%. Now salaries and benefits decreased 4% compared to last year. And that reflects the fact that in the second quarter of '11, we had a $48 million reengineering charge, and in this quarter of 2012, we had the favorable impact of foreign exchange. Our total employee count was approximately 64,000 and is relatively consistent with the prior year and last quarter. If we look at professional services, it's lower by 5% as last year had higher levels of technology costs. If we look at occupancy and equipment, it's up 14%, and this reflects higher data processing costs related to software licenses and some higher rent. If we look at adjusted other net of $422 million in the second quarter of '12, it increased significantly from $92 million in the second quarter of 2011, primarily reflecting the Visa/MasterCard settlement payment received in 2011. In addition, the increase includes accruals for refunds to customers as well as investment impairments. As to the customer refunds, we are discussing matters with our U.S. banking regulators, including those mentioned in the 10-K. Based on those conversations and our own ongoing internal reviews, we have made some changes to our CARD practices at our 2 banking subsidiaries: Centurion Bank and FSB. The expense for these items is largely reflected in adjusted net other in this quarter. Moving to Slide 17. So this is 8 quarters of information on operating expense levels. And we are at operating expense levels that we believe will enable us to drive business growth. Going forward, we will continue to implement our plans to contain operating expenditures. As you can see, operating expense was similar in the second quarter of this year compared to the first quarter. Now I'm not making a forecast here, but if operating expense stays at the current level, the growth rate for the full year adjusted for the Visa/MasterCard settlement proceeds would be in the low single-digits, and there's no change to our objective of growing operating expense more slowly than revenue growth over the next 2 to 3 years. Slide 18. So this is expense flexibility over time, and this slide shows adjusted expenses as a percentage of revenues, and adjusted expenses excludes credit provision. So on the left side, you can see 5 years of history and on the right side, the past 5 quarters. So both the first quarter and the second quarter of 2011 show improvement compared to the quarters in 2011. And while the second quarter rounds to 71%, it is slightly lower than in the first quarter. Over time, we expect this rate to migrate back towards historical levels in 2 ways: first, through top-line revenue growth and, second, through expense flexibility, which includes our plans to contain operating expense growth. Moving to Slide 19, so these are our capital ratios. Our Tier 1 capital ratio at the end of 2011, that's not on the slide, was 12.3%. It increased to 13.4% in the first quarter of this year as share repurchases did not start until mid-March, after the Fed completed their review of our capital distribution plan. In the second quarter, we built capital with $1.3 billion of net income and $200 million related to employee plans. And as planned, we made capital distributions of $2 billion, $1.8 billion in share repurchases and $200 million in dividends, resulting in Tier 1 common moving to 2.8%. The Tier 1 common ratio of 2.8% puts us in a strong capital position and well above required benchmarks. Moving to Slide 20, so this is total payout ratios. The left side, you can see the ratios for the last 5 years, and on the right, for the past 4 quarters. In the first quarter of 2012, as I just mentioned, we didn't start share repurchases until mid-March. So we only repurchased $200 million in the first quarter of this year. The capital distribution plan allows for $4 billion in share repurchases in 2012, and we repurchased $1.8 billion in the second quarter to bring our year-to-date repurchases to $2 billion, so half of the allowed repurchases at the midpoint of the year. Slide 21 is our liquidity snapshot. We continue to hold excess cash and marketable securities to meet the next 12 months of funding maturities. So we have $16 billion in excess cash and marketable securities, and the next 12 months of maturities is $15 billion. So moving to Slide 22, so this is U.S. retail deposits. As we had limited cash needs in the second quarter and we issued $2.5 billion in unsecured debt and asset-backed securitizations, we allowed deposits to decrease in the quarter by $1.7 billion, but we remain committed to increase direct deposits over time. So with that, let me conclude with a few final comments. Given the uncertain environment, we feel positive about our financial performance in the second quarter, including our ability to continue to grow earnings in the absence of settlement proceeds and with lower reserve releases. Spending growth remained relatively strong, albeit at a slower pace than recent quarters, and we continue to grow faster than most of our large issuing competitors despite a more difficult prior-year comparison. We also saw our average loans continue to grow modestly year-over-year, with net yields comparable to the prior year, leading to 4% growth in net interest income. At the same time, lending loss rates improved to new all-time lows. Despite very strong credit performance, provision expense increased as lending reserve releases were significantly lower this year than last year. Our revenue growth of 5% or 7% on FX-adjusted basis reflects the benefits of our spend-centric mode and stands in contrast to many other issuers who still face year-over-year revenue declines. In the quarter, total expenses were well controlled at only 2% growth or 4% on an FX-adjusted basis. We are still investing in the business, and these investments are driving higher average spending and growth in the card base while continuing to build capabilities for the future. Marketing and promotion, though down slightly year-over-year, represent 9.7% of revenues, up from 8.3% last quarter. In addition, we are continuing to move forward with our plans to grow operating expenses more slowly than revenues over the next 2 to 3 years. We also wanted to remind you that starting in the third quarter, the impact on operating expense growth rates of losing the Visa/MasterCard settlement proceeds will decline significantly. Our capital strength was also on display this quarter as we were able to elevate our year-to-date payout ratio to 83% while maintaining very strong capital ratios. Looking ahead, we recognize that our business is not immune to the economic environment, but we continue to believe that our business model is well positioned for the challenges ahead. So thanks for listening, and we are now going to take questions.

[Operator Instructions] And our first question comes from the line of Craig Maurer with CLSA. Craig J. Maurer - Credit Agricole Securities (USA) Inc., Research Division: I wanted to inquire about performance on billed business so far in July. And also, if you could comment on -- just looking at domestic billed business, seasonality would dictate growth, link quarter around the 10% range, we're a little off from that this quarter. I was wondering if you could discuss any possible specific places where it might have weakened or if it was just general?

Yes. So I think we're not going to comment on July to-date numbers. I would say, though, that in the second quarter, the growth rate that we saw in June was very comparable to the growth rate that we saw in May. In terms of categories, I would say that we probably saw slower growth in T&E categories than we saw in other categories. But really, the changing growth rates that we saw, as I illustrated on the slides, was really across all of our business lines and really across all geographies. So yes, I would say it was pretty broad-based. Craig J. Maurer - Credit Agricole Securities (USA) Inc., Research Division: And if I can ask one follow-up. Regarding the top line, you had mentioned incentive payments as an offset in discount revenue. We've heard that from you guys a couple of times now. Is there any way that we could think about modeling that? And is it worth our time to figure out how to model that as an offset to pure discount revenue?

So modeling always assumes that the future will be the same as the past, if you use historical information. We have had, over the last several quarters, higher levels of incentive payments. Those are based on new agreements with many of our large corporate clients. That is a business that has very high levels of profitability for us. So despite the higher level of incentive payments, sometimes which are triggered by new agreements, sometimes triggered by corporate customers just spending at higher level. And again, we think they are effectively worthwhile investments because it is a business with very good profitability. But the levels that we have from period to period will kind of depend on the growth in their spending and when contracts are removed.

And next we'll go to the line of Ryan Nash with Goldman Sachs.

Dan, just a follow-up on the prior question. Just in terms of the spend volumes, are you seeing any changes in terms of spending patterns, both here and internationally, whether it's moves from discretionary to nondiscretionary, were there any changes throughout the quarter?

Yes. I don't know that there was big shift between discretionary and nondiscretionary. I guess I would just point out that last year in the second quarter, we grew 15%. I don't know that any of our competitors grew at that level. So to the extent you have that kind of growth, when you come to the next year, it's just a higher challenge in terms of growth rates. So given those higher comparables, I think our growth rates remain healthy and are reflective of the fact that the investments that we've made over the past couple of years continue to pay off.

Okay. And then just on the capital, so you've now repurchased $2 billion for the year, and I'm guessing some of this quarter was a catch-up from last quarter, but how do we think about for it over the next 3 quarters, given what your CCAR allotment is? And I know you've talked in the past about having some safer acquisitions, but it seems like we've been pretty quiet on that front. So I just want to think about how we should think about the path over the next 2 or 3 quarters. And second, now that we've gotten the NPR from the regulators, any sense of what the all-in Basel III capital level looks like?

Okay. So as you say, from the balance of the year, we have approvement based on our submission to buy back $2 billion more through the end of the year. We could afford to do modest levels of acquisitions and still buy back $2 billion more. If we had acquisitions at higher levels, then we would moderate the buybacks accordingly, which is, I think, very consistent with what we've said our plan would be as we to go through the course of this year. So no really -- no change there. In terms of new Basel information, what I remind you of is that we have our ratios calculated under Basel I, right? We are still in the process of developing what they would be under Basel II, so we don't have that information yet. But the impact in this quarter of going from Basel I to Basel III is approximately 30 basis points. It varies from quarter-to-quarter, but has generally been in the kind of 20- to 80-basis-points range, depending on quarter. This quarter it was about 30 basis points.

And our next question comes from the line of Don Fandetti with Citigroup.

Dan, I hope you could talk a little bit about, post the MOU merchant settlement, if you can kind of remind us what you allow in terms of surcharging and what the potential impact might be going forward?

Okay. So I think, as most people know, we were not party to that litigation. That lawsuit was filed against Visa and MasterCard, and they control about 70% or 80% of the market. A fundamental legal difference is -- between us and Visa/MasterCard is that they have market power. The courts have recognized this and determined that they used that power improperly. American Express does not have market power. We continue to believe that there's no merit to the separate merchant cases that we are involved in, and we believe that we have strong legal defenses. Now as it relates to surcharging, surcharging is not consumer-friendly. The terms and conditions within the settlement agreement that deal with surcharging are very complicated. So given that complexity, we think it's too early to know what the impact of the rule changes might actually have in the marketplaces, but we obviously will monitor the situation and respond appropriately. Now we've seen different reactions in different international markets where surcharging is allowed by law. In Australia, some merchants have introduced surcharging. It was first allowed there back in 2003, and we've been able to respond effectively and continue to operate successfully. In contrast, in the U.K., we've seen very little evidence of merchants surcharging, and that was first allowed by the Thatcher government many, many years ago. The other thing I'd point out and you should keep in mind is that in the United States, there are 10 states that have laws that prohibit surcharging, and these states represent about 50% of our U.S. billings volume. So the Visa/MasterCard rule change doesn't change the terms of our contracts with merchants. We do not prevent merchants from surcharging, but we do continue to require parity treatment so that our cardmembers are not discriminated against at point of sale. And by parity treatment, I mean that if a American Express cardmember is surcharged 100 basis points, any other credit card that is presented would be charged -- surcharged the same 100 basis points.

And next, we'll go to the line of Ken Bruce with Bank of America Merrill Lynch.

I was -- you pointed out in your earlier remarks that the total cards-in-force have been growing quite a bit more in the network partner area, I believe you stated 15% versus 2% proprietary. Can you dimensionalize maybe the differences in the customer base for network partner card versus the proprietary card? What you expect in terms of spend on a partner card versus a proprietary card, anything that we could -- let us maybe better forecast the overall growth on that line.

Okay. So GNS partners, when we speak to them, their products are targeted to their more affluent customers. That's really the design of the product. It's designed to encourage spending, so they are more affluent customers. Now I would say that the average spend within GNS partner customers is lower than the average spend in proprietary American Express cards. But we see the GNS business as a terrific business for us in that it brings more cardmembers into merchants, so it makes the American Express network more relevant in more markets. And often, these are customers that we would not be able to reach other than through the GNS partner relationships. Today, GNS has grown over the years to be a important contributor to income. Now while the dollar profit that we earn on each dollar of GNS-billed business is lower than what we earn on a dollar of proprietary billed business, it requires very little capital, and so the returns are good. The other thing I'd point out is that some of the -- that many of the GNS partnerships operate in both -- some markets are developed markets and some are developing markets, so you need to take that into consideration as well. But net-net, we think it is a good business overall in terms of the contribution and mix.

Yes. And so, just as a follow-up, I guess we just need to think about how that's going to impact the discount revenues versus overall spend. Also, I -- if I remember correctly, the network cards are mostly on a credit card platform versus a charge card platform. Is that correct?

Yes. I mean, so their products and our products run on our network, right? The cards that the GNS partners issue are often credit cards, so that's a difference. But they run on our -- they don't work -- run on a different network. It's the American Express network.

Okay. And maybe just if I could get one last one. On the refunds that your -- that you took the charge on for in the quarter, can you expand on that at all? We've seen some other peers that have taken similar charges, and I guess I'd just like to better understand what those refunds are.

Yes. So these are -- relate to certain changes that we've made in our CARD practices, and the changes generally relate to items around either pricing, exposure or collections. So that's a -- that gives you a little bit more flavor in terms of the changes we're making that led to the refunds that we're making to customers.

And our next question comes from the line of Scott Valentin with FBR Capital Markets. Scott Valentin - FBR Capital Markets & Co., Research Division: Just as you pointed out, billed business during the quarter slowed across the board and across all platforms. So I'm just wondering, you also reiterated the desire to kind of continue to generate positive operating leverage. Just curious how much flexibility there is if we assume a further slowdown in billed business, given the global economic outlook, how much room there is to still continue to cut costs or accelerate the decline in costs?

Yes. So I think when we talk about our desire to contain operating expense, it's really a long-term view. So it's not just related to this quarter or next quarter or related to a potential slowdown. I think it's really a desire to create operating leverage so that expenses are growing at an appropriate level that enable us to have the investment dollars that we desire so that we can drive business over the long term and achieve our financial targets on an average and over time. So the whole notion of operating leverage is really designed as a long-term objective and not necessarily related to a short-term slowdown. We also could react if there was a severe short-term slowdown the way we have historically when there's been a recession. But I would think of those as really, really 2 different types of focuses on operating expense. Scott Valentin - FBR Capital Markets & Co., Research Division: Okay. So I mean, given -- assuming a modest slowdown in billed business growth, you'd still expect to generate operating leverage?

It's our goal to continue to generate operating leverage from where we are today, yes. Scott Valentin - FBR Capital Markets & Co., Research Division: Okay. And then just as a follow-up, and you mentioned before M&A, if you do anything that's, I guess, not large, you still have limited buyback as well. Where are you seeing -- I mean, you haven't done anything recently, but where are you seeing the opportunities and where are you focused on M&A?

Yes. I think M&A, we would focus on what I'd describe as kind of bolt-on acquisitions, not very large acquisitions. They would be to enable us to achieve our strategic business objectives and/or be in something that's a very close adjacency. Loyalty partners is a good example of that, where they had a coalition loyalty platform in -- primarily in Germany, but in several other countries, we have a significant amount of loyalty experience and we have global reach, and we thought that was a very good combination. And we'd generally be in areas that would generate fee business going forward. So those would be the general parameters of what we're endeavoring to achieve.

And our next question comes from Chris Brendler with Stifel, Nicolaus. Christopher Brendler - Stifel, Nicolaus & Co., Inc., Research Division: Just want to get a little more color, if you can, Dan, on the spending trends. I believe you said that June levels were similar to May levels, and it's a little early to get into July. But just looking at the June and May, I was under the impression that your last public update in June call, I think it was, guided to 9% to10% billed business growth through May. So I'm just trying to reconcile how it slowed all the way down to 7% with just the month of June if June was in line with May. Do I have those numbers right?

So I think you have the numbers right. But the 9% to 10% that we related to April and May were FX-adjusted. Christopher Brendler - Stifel, Nicolaus & Co., Inc., Research Division: Okay. So right in line, then.

The comparable number is 9% for the quarter. Christopher Brendler - Stifel, Nicolaus & Co., Inc., Research Division: Got it. Right in line, okay. And then the second question would be on the expense side, just getting a little more color on the HR costs, salaries and benefits line. The first time you've had a negative growth rate there since '09. I think you did call out the reengineering, but even if I adjust for reengineering, it's still down on a year-over-year basis versus up 7-plus percent in the first quarter. Anything else that helped cut costs this quarter on a personnel side? Is it lower bonus accruals that go along with this lower spending, or anything else that was one-time in nature that helped the OpEx growth slow so much on the PL -- personnel line?

Yes. So I think if you back out the reengineering, you kind of get close to flat. And then really we were helped, as all the expense lines were, by FX. So if you look at total -- I don't know if it's exactly in salaries and benefits, but on the total, it took the growth rate from total expense to the growth rate from 2% up to 4%. So if you had a similar relationship on salaries and benefits, it would be up about 2%, which is in the realm of what you would expect if you have a constant employee base. And what we had in this quarter was similar to what we had in the second quarter of last year in terms of total number of employees. Christopher Brendler - Stifel, Nicolaus & Co., Inc., Research Division: Okay. And then one final one on the spending side again. Some of those growth rates you gave us for some of the countries within the eurozone. Any color you can give us on how much those have changed and how much of a slowdown you're seeing in countries like Spain or Italy or Germany?

Yes. I think we gave last quarter similar numbers, and I would venture to say that the countries in Southern Europe, if I remember correctly -- let's see, I actually have some data here, so let's see. So I would say each of the countries decreased by 2% or 3%, not much different than what we're seeing overall. Spain decreased a little bit more than that compared to last quarter. I think we said Spain was up 2% in the second -- first quarter this year. So not wide variation, other than Spain. Basically the same kind of trends that we're seeing across the world.

And next we'll go to the line of Bill Carcache with Nomura.

Dan, I believe you said that in the past that you think the 12% range is conservatively the Tier 1 common level that you see Amex operating at, given the uncertainties surrounding Basel II. 12% seems kind of high to me, but I wonder if you can just give us some updated thoughts there in terms of what the right Tier 1 common ratio is that we should be thinking about as your target level going forward.

So initially, when we're coming out of the recession, we said we want to be at least 10% or 11%. I think over the course of the past couple of years, we've had good capital generation. And really, in 2011, we kind of increased from that 11% range up to the 12% range, because in our submission to the Fed in January of '11, we only asked for $2.3 billion of buybacks on the assumption that we were going to use half of the capital generated to do acquisitions, which would mean we'd do $2 billion in acquisitions. In fact, that year we only did $1 billion. So we effectively wound up as a result of that of retaining another $1 billion, and that took us from 11 up to 12%. I think we taken artificially high in the first quarter because we couldn't do share buybacks in the first quarter of '12 until our plan was approved. That was in the middle of March. So I'd expect to see us to trend back towards where we were at the beginning of this year, which was 12.3%. We think our submission was appropriate in terms of the levels of buybacks that we requested. And the fact that the Fed approved that level, I think, is a demonstration of our financial strength and flexibility. So this will evolve over time, and each year, we'll probably get better insight in terms of where we want to be. And as we move forward with the work that we're doing on Basel II, which we may not have better insights until we get to 2014, but when we get those better insights, we'll have a better sense of where we want just to settle in. Now the other thing, I think, that's important is not just a raw number that your Tier 1 common ratio is, but if you look at the stress test and see where your ratio is after that stress, may start to become even more important. And certainly, if you look at the data from this year, you can see that based on the stress test that the Fed decided the assumptions on, we had very limited drop in where the Tier 1 common was in that stress, which was different than many others. So I think people start to look at that. And that will be something we'll have to consider when we ultimately set where we decide to hold Tier 1 common ratio.

Okay. And as a follow-up, can you talk about what happened with the bluebird product at Walmart? If you just give a little bit more color there? And I believe you guys have talked about the -- converging all of your prepaid offerings under one platform. I believe that was the Serve platform. Can you update us on where we are on that and whether that's -- bluebird had anything to do with that convergence?

So we do have a plan to move our reloadable prepaid product onto the Serve platform within the next couple of quarters. That doesn't have anything to do with bluebird, but it is a excellent use of the Serve platform for business that we think will be growing, and a business where we think we have a very good product in the marketplace compared to the competitions. So as it relates to bluebird, American Express and Walmart have a great partnership. Our work together on bluebird has moved to a new phase, and we continue to test different points of distribution and marketing messages while also collecting and analyzing feedback for customers who took part in our pilot. And at this time, it wouldn't make sense to speak about any future plans with bluebird, but we appreciate your interest around the bluebird project.

And next, we'll go to the line of Moshe Orenbuch with Crédit Suisse. Moshe Orenbuch - Crédit Suisse AG, Research Division: Have you got any specific plans to reduce the cost per point and how to think about that as we go forward?

So I think the cost per point is something that we're focused on just in terms of -- so the offerings that we put into the program are designed to create value for our customers. We have over 100 different options within the program that are part of what make it an excellent program. And certainly, as we think about adding customers and options, we do think about the overall costs to us. So it's a balance between value to our customers who participate in the Membership Rewards program and the cost of the program in terms of the overall economics of the products that we offer. So for years, we've been focused on the cost per point and endeavored to manage it, and we will continue to do that as we go forward. In this period, it was really not a result of changing the offerings within the program. It was really driven by customer behavior and a change in mix. So in this quarter we just had a shift in mix, really, away from the amount that was being redeemed for airlines compared to what we have had in prior quarters. And that's what really drove the weighted average cost per point down in this given period. Moshe Orenbuch - Crédit Suisse AG, Research Division: And I know you said before that you don't strive for the lowest loss rate, but rather kind of an economic answer. But could you talk a little about why you've got kind 50-, 60-basis-point increase in charge card losses in the first half of this year versus first half of last year?

Yes. So our strategy is to focus on growing spend products, so those would be charge cards, as well as premium lending cards. So as we strove to grow the charge business, to see write-off rates go up a bit is perfectly fine with us as long as we're attracting customer groups that have good long-term economics. And as you know, when you're bringing a lending customer, sometimes it takes 12 to 24 months before the portfolio seasons because people can make minimum payments. In charge card, on the other hand, it's a pay-in-full product, so you see it a lot more quickly. So I think that's part of what drove the increase that we saw through the first quarter. On the other hand, we continue to get focused on what's taking place within our portfolio. And I think that focus is what enabled the write-off rate actually to come down in the second quarter compared to the first. But still, all-in, these are very low write-off rates. And if we can drive the right economics and acquire the right customers, having write-off rates being higher than where they are today are perfectly fine. Moshe Orenbuch - Crédit Suisse AG, Research Division: Great. Just one last very quick thing, and that is the ancillary products that you mentioned in -- are those sold through a third party, or do you sell them directly?

So which ancillary products? Moshe Orenbuch - Crédit Suisse AG, Research Division: The ones that you're talking about having customer rebates before.

I -- so I know -- so I don't know the specific answer to that question. I know we have been focusing on them, and I suspect that at least a portion of them, I think, are sold through our proprietary process. But I don't have a specific split between what's proprietary and what might be with third parties.

And next, we'll go to the line of Mike Taiano with Telsey Advisory Group.

So I just wanted to make sure that I understood your question -- the answer on the surcharging question. So as I understand it, so if Visa and MasterCard were to charge, let's just say, 2% -- or if merchants were to charge 2% on a Visa/MasterCard transaction, your rules would not allow merchants to charge a higher amount than that, even if your cost of acceptance to the merchant is higher?

Our provision does not prohibit surcharging but requires that the surcharging be on a parity basis so that our cardmembers are not discriminated against at the point of sale. So if someone was charging 2% to our customers, then our contracts would require that any other credit card that's presented would be required to have the same surcharge.

Okay. So it's -- they would then have to charge MasterCard or Visa cardholders the same as they're charging you and not vice versa?

No. So our contracts cover our cardmembers, right? The Visa and MasterCard rules cover theirs. So if a merchant has a contract with us, it requires that our cardmembers be charged on parity, as I just described, with what -- and that other credit card companies -- other credit cards that are presented would have to have the same surcharge.

Okay, got it. And then just one follow-up on a -- I saw you guys are adopting the EMV standards. Was just curious what you think that impact will be if there is a additional costs that you'll have to incur later this year or early next year on that?

So we're going to start issuing cards that have EMV enabled, and we will convert cards over, over a multiyear period. So the cost of doing that will not be in 1 or 2 quarters but would be over a several year period.

Next we'll go to the line of Bob Napoli with William Blair. Robert P. Napoli - William Blair & Company L.L.C., Research Division: The -- just a comment on the long-term growth model revenue and earnings growth model, if you can. I mean, obviously, your targets are at least 8% revenue growth and 12% to 15% earnings growth. And I think ken suggested looking at 2010 is kind of a base. As we look forward to 2013 and '14, it doesn't seem like the economic trajectory is going to change all that much from here. It certainly doesn't feel like it today. But are you able to -- do you feel good about being able to hit those targets? I mean, you're blowing out your return on equity target pretty significantly. But can you hit those -- the revenue and EPS? Do you feel confident in those targets?

So on average and over time, I would think about a 10-year cycle, not a 3- or 4-year cycle. And clearly, in times where economic growth is slow, you would expect to have slower billed business growth in those periods than when you had a robust period. So when we say on average and over time, I think we've looked at it an extended cycle. And over that cycle, I think we're confident that we can achieve those levels, we can achieve our financial targets. Robert P. Napoli - William Blair & Company L.L.C., Research Division: And then on spend growth, I mean, your -- you had Continental. How much of an effect has Continental's switch to United had on your billed business?

So we had a fair number of initiatives in place last year when the Continental contract expired. We actually were very pleased in terms of what we are able to achieve in terms of retaining customers through those initiatives at the end of the day. And what I would point out is I don't have any specific data on how many customers we may have lost, but what I would say is over the past year, we have continued to build share in the U.S. So in total, we've continued to be successful in the marketplace when you look at the overall population of people who could -- who are using credit and charge cards. And these days, that's our aim is to be successful in terms of financial results and continuing to be able to compete successfully in the marketplace. Robert P. Napoli - William Blair & Company L.L.C., Research Division: Okay. And then just a last question on Serve, if I could. If you could give some update, I mean, you've invested -- I mean, American Express has invested at least several hundred million dollars to date in Serve, and I know that we haven't seen as many new relationships being announced recently, but when can we get some -- I mean, some information on how successful Serve is being? It seems looking at your numbers and the growth of fee income, it really still seems to be pretty irrelevant, and it's hard to forecast any benefit from that significant investment that you've been making over these last several years.

Yes. So I think -- last year was the year we wanted to sign agreements with other businesses that would put Serve in the path of their customers. This year, it's all about getting customers onto the network, and that's what we're focused on. So that's our focus now. In terms of Serve, we are seeing some successful uses of Serve. Certainly by putting our reloadable products on Serve, if we didn't have that platform, our ability to issue the product would have been hampered. We have also entered into agreements in China with Lianlian, where the basis of that is that Lianlian is going to use the Serve platform as part of their mobile pop-up process. So we are seeing spots we're able to use it. I don't think we're at the point yet where we would release financial information, but we continue to make progress against the objectives that we have set for ourselves. Robert P. Napoli - William Blair & Company L.L.C., Research Division: And then I guess as that relates to your fee income targets, I mean, it seems like you're still quite a ways away from hitting your targets on fee income, and it seems like you need to make acquisitions to grow that. Or are you disappointed with the level of fee income growth that you've been able to generate, given the aggressive target?

Yes. So our target is to exit, I think, 2014 at a $3 billion run rate. Last year, we had $1.3 billion in fee income. So we continue to make progress in the fee area and against that target. So to the operator, I would say I'll take one last question.

And that would be from Brad Ball with Evercore.

Dan, what was the amount of the accrual for refunds in the quarter? And had you accrued any in prior quarters?

So we did have an accrual back in the fourth quarter, which we mentioned at that time. As it relates to the accruals in this quarter, we don't plan to disclose the exact dollar amount. We felt that the cost in this quarter were important enough to mention, but not large enough to quantify.

The adjusted other rose by $110 million year-over-year. Is most of that driven by this accrual?

So I would say that there were 2 items that contributed to it. It was this accrual as well as investment impairments that drove it. So those are the 2 big items that are in the increase.

Okay. And then separately, you continue to show spending on lending products that are growing faster than your overall loan growth, and at the same time, you've got historically strong credit quality. And I'm just wondering when will you start pushing a little harder on loan growth and driving up your net charge-off ratio to a more economically reasonable level? At down at 2.2%, it just seems too low to drive the kind of returns and spending volume growth that you have the potential to get here.

So we have never had a target to grow loans, and I don't anticipate that we will in the future. Our focus is to make investments that have good economic returns over time, and they are currently focused on charge card as well as premium lending. So to the extent customers want have the ability to lend and we have the right credit quality, then we want to put investments up against both charge and premium lending, and to the extent we're successful, we will -- may see loan growth increase, but we don't have any specific targets for loan growth. We really target our investments for the greatest economic return over time.

And what would you say is a normalized net charge-off rate?

A normalized charge-off rate. So that's what we're going to have to wait and see, all right? So over the past 10 years, it was about 4.5%. So I feel pretty confident, not going too much out on a limb, that it will be less than that going forward. But exactly where it will go from here will be very dependent on both our strategy as well as customer behavior at the end of the day. All right. All right. So thanks, everybody, for joining the call, and have a good evening.

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