American Express Company (AXP) Q3 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the American Express Third Quarter 2012 Earnings Release. [Operator Instructions] And as a reminder, this conference is being recorded. I'll now turn the conference over to your host, Rick Petrino. Please go ahead, sir.

Thank you, Kathy. Welcome. We appreciate all of you joining us for today's discussion. 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 and Q2 2012 10-Q reports, already on file with the Securities and Exchange Commission. The discussion today also contains certain non-GAAP financial measures. Information relating to comparable GAAP financial measures may be found in the third quarter 2012 earnings release, earnings supplement and presentation slides, as well as the earnings materials for prior periods that may be discussed, all of which are posted on our website at ir.americanexpress.com. 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 including -- 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. And I'll start on Slide 2, the summary of financial performance. So total revenues net of interest expense came in at $7.9 billion. That's an increase of 4% from a year ago. On an FX-adjusted basis, that's 5% growth. If we look back to the second quarter, reported revenue growth was 5%; FX-adjusted, 7%. So there's a slightly lower growth rate in revenues in the third quarter compared to the second quarter. Pretax income was $1.9 billion, 9% growth. Net income came in at $1.3 billion or 1% growth. So net income is growing at a slower pace than pretax income, and that's due to a lower tax rate in the third quarter of 2011. Diluted EPS came in at $1.09. That's an increase of 6%. So EPS is growing at a faster pace than net income due to our share buyback program. Return on equity is 26%, slightly above our target of 25%. And shares outstanding decreased by 4%, and this is also related to the share buyback program. So moving to Slide 3. These are the third quarter metrics. Billed business came in at $220 billion. That's 6% higher than the quarter a year ago, 8% on an FX-adjusted basis. If we compare that to the second quarter, in the second quarter, we had reported billed business growth of 7% and 9% on an FX-adjusted basis. So the third quarter billings growth rates were slightly below the second quarter by approximately 100 basis points, which seems consistent with the broader pattern of decline seen recently by others in the industry. Total cards in force grew 6%. That's a growth of 2% in our proprietary cards, which is consistent with what we've seen over the last several quarters, and a growth in GNS cards of 13%.…

[Operator Instructions] And our first question will come from Ryan Nash with Goldman Sachs.

Just in terms of billed business, can you give us a sense of how it progressed throughout the quarter? I know that it was 7% at the Analyst Day on a days-adjusted basis, and it obviously came in a little bit stronger than that. And then second, just in terms of the European franchise, it was up 3%. In the quarter, can you give us a sense of how that looked by country? Did you see any weakness beyond Spain and Italy?

So as you said, we disclosed that on an FX and days mix adjusted. It was 7% in July. So we're up slightly from there. So obviously, the last 2 months were a little stronger than July. But I would say it was pretty even over those 2 remaining months. So there's not a trend going in either direction. In terms of Europe -- sorry, we had some background noise there. In terms of Europe, I think it's slightly slower growth than we saw last quarter. Notwithstanding that, it is down slightly but still at 3%. So again, we're seeing some slowdown, really, across Europe, so no major change in terms of how the various countries are performing on a relative basis to each other.

Okay. And then just in terms of -- can you just give us a little bit more color on the review of the IRR [ph], what drove it? What are the some of the key changes in your estimates that lead you to believe that there could be a charge taken?

Yes. The -- I think in the normal course, we periodically think it's appropriate to review the estimation process. It's generally driven by behavior changes by customers or as we collect more information. So in the first quarter of 2011, we made a change in the estimation process. Previous to that, we had only used attriter information, people who had left the program, to estimate the ultimate redemption rate for the active participants. At that juncture, we started to incorporate information from active participants. And so after that, we thought we would monitor it, and we thought it was appropriate at this juncture to do an evaluation of the estimation process.

Okay. And if I could just sneak one last question in, in terms of the add-on products, can you give us any sense of what percentage of revenue this is? And have you made any changes to the products that you're offering? Have you shut down any of the selling of any of these products?

So like everybody else in the industry, we know that regulators had a concern about them. So we stopped marketing earlier in the year, and we'll no longer offer Account Protector or ID Protect products as of December 31 of this year. And I'd point out that these products are not a significant source of revenue to us.

Your next question will come from Sanjay Sakhrani with KBW. Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc., Research Division: Back on that URR question, I was just wondering, have you guys considered possibly making changes to your programs, such that to influence the URR lower? I mean, or is it -- is there something that precludes you from doing that, like competition and market share loss? And then, secondarily, I was just wondering on the Walmart partnership and others. I was just wondering what the P&L implications are, just so -- I assume that there's some kind of revenue share agreement. I mean, do those get accounted for in the marketing line? And -- or are they contra-revenue items?

So Membership Rewards, we view as being a competitive advantage to us. As I said, they are an important part of driving billings. It also is a way for us to have a very close relationship to our customers. So it's a key element. It's not the only element. Certainly, cardmember benefits and superior servicing are all part of our value proposition, but Membership Rewards is a program that we think is the best in the industry. We actually think, to the extent we enhance the program and we have higher redemptions, that, that will have a very positive impact on the long-term health of our business. So at this juncture, we're not thinking of any initiatives -- wholesale initiatives to change the value proposition and drive the ultimate redemption rate down. If it continues to increase and drive billings in the future, then we would view that as a positive. In terms of Walmart -- so Walmart, we will, from that product, earn certain discount rate at the prepaid discount rate. We also will earn some float on the balances. There are no rewards costs related to this. There may be some minimal credit-type losses. There are actually no credit losses, but there could be some fraud losses. And really, what we need to do is grow this so that we can scale this and take advantage of what is a relatively low, fixed-base cost related to this product. So that's what I would say in terms of what you should expect in the future in terms of what lines it will hit.

We will go next to Mark DeVries with Barclays.

Dan, as we get closer to the next CCAR process after a year in which you didn't really deploy any significant capital on acquisitions, is there anything you can share with us about what type of payout ratio might be a reasonable request in light of your strong capital position?

I think last year, when we made our request, we wanted to remain [ph] flexibility so that if we were to do acquisitions, that we had built that into the submission that we had made, and also have the ability to distribute a significant portion of earnings if we didn't do acquisitions. And I would think we would structure our submission in a similar manner this year to give us flexibility in terms of what we do into 2013. And I think the fact that we have a strong capital base and the fact that we fared very well in the severe scenario that the Fed selected and had our capital drop to a much lower degree than most others, I think, are all contributing factors that put us in a position to actually make that type of submission.

Okay, got it. And another question. Your loan growth has really been consistently better than the rest of the industry over last year. To what do you kind of attribute that outsized growth relative to peers? And also, kind of what do you think the implications are for credit going forward?

I think we saw in -- throughout 2009 -- the flutter [ph] of 2009, '10 and '11 that we improved sooner on the credit side than most of the industry. And I think loan growth, as we were in 2011, was probably being impacted by the fact that people were deleveraging and we were seeing paydown rates increase over that period. But over the last 4 quarters or so, we've seen our paydown rates stabilize more. And as you know, our paydown rates are significantly higher than the competition. But the fact that those paydown rates are not going up, I think, is a contributing factor to the growth rate in loans gradually increasing over time. And as you know, we are very focused on Charge Card but also premium lending, and so I think all of those things are contributing factors to the growth we see in loans.

Okay. And any implications in there?

In credit? As you know, our credit metrics are at historical lows. As we think about where we go from here, we want to be thoughtful in terms of growing the business -- growing the premium business. Obviously, as you bring on new accounts, they have a somewhat higher risk profile just because they're at an earlier tenure in their life. And quite frankly, I've said this before, if you were to give me a choice of bringing in a group of customers that were going to have a 3% write-off rate, but had better economics compared to a group of customers that had a 2% write-off rate and lower economics, I would pick the group with the 3% write-off rate. Because again, we're not endeavoring just to have a low write-off rate, but good economic decisions when we do our investments.

Your next question is from Craig Maurer with CLSA. Craig J. Maurer - Credit Agricole Securities (USA) Inc., Research Division: I had a couple of questions. So first, back to the URR and just trying to continue to understand the trajectory here versus -- what are you finding when you look at -- you said you started looking at people that are staying in the program versus people that are leaving. How much higher is the redemption rate of those staying in the program versus those you found who have left? And secondly, if I could follow up on Loyalty Partner, we spent a lot of time discussing that when I visited you guys recently, and I know the growth in Germany and India is outstanding and you're coming to Mexico. But when you put that in a broader context of the additional $3 billion in fee income over 5 years that you had suggested, I think it was 3 Financial Community Meetings ago, where are we in that progress?

Okay. So in talking about the ultimate redemption rate, in the first quarter of 2011, we moved from using strictly data from people who had attrited to estimate the ultimate redemption rate to using that data plus information related to current participants, and we thought that would give us a better estimate. So that was kind of the change that we made at that juncture. The work we're doing now in terms of reviewing the estimation process is we're looking at whether we can enhance the segmentation of the information so that we can have a refined estimate that's enhanced. So that's the reason that we are looking at that. I fully recognize that saying that we're going to have a charge isn't particularly helpful to you in terms of understanding the amount. But at this juncture, we haven't evolved the models to a sufficient degree to have a reliable estimate. But I guess, in terms of trying to frame it for yourself, 2 things that you may think about is, first, as we disclosed in the annual report, if there was a 100-basis-point increase in the URR -- this is not a forecast. I'm simply quoting from the annual report. If there was a 100-basis-point increase, then, too, we would have a $330-million increase in the liability and there would be a charge to P&L in that period. I guess the other data point that I would give you, that we haven't disclosed before, is that if we had a 100-basis-point increase in the URR, that would have an impact of increasing annual expense by approximately $40 million. So that's in terms of just dimensionalizing it. Hopefully, it's helpful. Now in terms of your second question related to fee-based revenue progress, so we continue to expand the services we offer to cardmembers, merchants and other customers. There has been no change to the target that we put out there. We're about halfway through our time frame and still think our target is appropriate, although $3 billion is an ambitious target in an economy that remains so uneven. There's still a great deal of work to do, but we are moving forward on a number of fronts. Our emphasis will be on organic growth, but targeted acquisitions, such as Loyalty Partner and Accertify, may also play a role if we see the right opportunities. So hopefully, that answers your question.

Then we'll go next to James Freeman (sic) [James Friedman] with Susquehanna.

Could you share some observations or comments with regard to the fee-based revenue, if you might have an update in that regard?

So fee-based revenues is -- basically, the update is what I just said a moment ago. We continue to expand our services. We're about halfway through the time frame that we laid out to hit the $3-billion target. We recognize that it's a very ambitious target, given the economy. And we have great deal of work to do, but we're moving forward. I think we'll primarily get it through organic initiatives, but we may do targeted acquisitions as well.

So in that regard, Dan, are you still comfortable with the targets that Ken had set forward a year or so ago?

We think that target, which is to be at a $3-billion run rate as we exit 2014, continues to be an appropriate target.

Okay, one last one if I could sneak it in. So could you share some observations about APAC? I know it's not huge, but it was a little clunky. Were there any specific observations in markets like Australia?

Okay. So Asia Pacific, yes, so I think we -- so Australia is a big market for us within the Asian market and we have seen a decline in business there, particularly in the T&E segment. And we think that's probably a reflection of the fact that China is slowing down and Australia's economy has some pretty close linkages to China. So that's the biggest impact that we're seeing that is influencing the slowdown in the growth rate in billings in that region.

Our next question is from Bill Carcache with Nomura.

Dan, given the trajectory of loan growth and spending growth that you're seeing, can you just give some commentary around whether you expect spending growth and loan growth to cross, as you look ahead, such that basically loan growth overtakes spending growth? And then secondly, when does the loan growth that you're seeing lead to reserve building?

So I would not -- I don't want to forecast here, but I think loan growth is driven by 2 things: one, it's the growth rate in spending on lending products; and then the second aspect is customer behavior and whether they are still in a mode that they want to kind of de-lever, in which case, we're going to see higher paydown rates. Or at some juncture, should they move to a space where they're more comfortable and aren't focused on that, in which case, we could move to a spot where the growth in loans is very similar to the growth in spending on lending products. But there's lots of factors that play into that. Certainly, we have never ever had a target for loan growth. So loan growth is simply an outcome of the products we put out there that allow customers to revolve if they choose to and then how that customer utilizes the balance. But it emphasized that we are very focused on premium lending. We are not engaging in balance transfer, and we are looking to acquire customers that are higher spenders. We also have a focus on the fact that there are customers out there who are very good customers for us, are high spenders and carry balances at other institutions. And I think we'd be very interested in acquiring those balances. So certainly, just like Charge Card, premium lending has very good economics, and it will continue to be one of our focuses going forward.

And when does the loan growth that you're seeing lead to some reserve building that -- we've been seeing kind of releases overwhelm everything else, but is that something -- can you give us some color on when you expect that to change?

Yes. So I think, as we grow the business, we have always maintained the same types of credit requirements. Although certainly, as we look to get deeper penetration into premium lending, you bring on new customers. And any time you bring in a cohort of new customers, at least in the first 2 years of their life, they tend to have higher credit losses. So that could be one element of it. And again, we -- as I said before, we don't target loan write-off rates. We target good economics. Obviously, the percentage of people who are in that lower-tenured group could be a factor, then obviously the economy. If the economy continues to be strong as we grow our business, you'll probably see less of a movement. If we see some deterioration in the economy, that'll obviously influence it as we go forward.

Okay. And finally, if I can just do one last one, and going back to the fee-based questions, can you just clarify for us whether you consider bluebird, Serve and just prepaid in general to be part of your fee-based initiatives? And are revenues from prepaid, I guess, included in that fee-based revenue target that you put out there?

I think certain elements would be. So to the extent we get discount revenue on bluebird, you could look at that as it's a fee, because it is a fee. And certainly, other fee elements related to Serve would fit there. To the extent we have interest income on float, I wouldn't consider that to be a fee. So it may -- certain elements in the product will be fees and others will not. But certainly, they would be part of what we're looking to in terms of achieving our target over time.

Okay, and I'm sorry, but just to be clear on that, so the volume that you're going to get on Serve and bluebird, that's going to get thrown into discount revenues and that will drive fees, but the fees on that will count as part of the $3-billion fee-based revenue target.

Yes, it is. And I think it's logical because there's really no credit risk associated with those fees. So I kind of view it a little different than we might discount revenue related to either charge or lending products.

And we now have a question from David Hochstim with Buckingham Research.

Could you just provide a little more color on what you're seeing in the decline in T&E spending? Is it fewer transactions? Is it lower prices on hotels or airline tickets? I noticed there was an increase in airline spending, about 2%, I think, FX adjusted. But I'm wondering if there's economic slowdown occurring in more than just Australia.

Yes. So I would say that we are seeing lower T&E spending compared to other categories pretty broadly. It was a contributor to Australia. It also was a contributing factor to the slowdown in growth rate for Global Corporate Services. And I think we see large corporations, in particular, being a little bit conservative here and seeing a drop in spending among some of our larger corporate clients. So it's pretty -- I think it's pretty broad-based.

And spread geographically as well.

Spread geographically as well, yes, and in some lower levels of transactions. But notwithstanding that, when you consider all those negatives I just said in that sentence, we still are managing to have good business growth on an FX-adjusted basis of 8%.

Right, okay. And then I think you referenced higher cash rebates. Can you just give us an idea of how much those are as an offset to discount revenue line?

Well, it's not an item that we separately disclose. It is one of the items that represents the difference between the growth in billed business and the growth in discount revenues. And I guess it's a reflection of the fact that our cash-back products are being successful in the marketplace, so that pleases us in terms of that product category.

And then finally, could you just clarify what you were saying about the regulatory and litigation reserves? It sounds like you didn't take anything additional in third quarter. Is that to say that you don't -- and I guess, you don't anticipate, or it's not a problem, not estimable [ph], what's related to the protection...

So the majority of the payout we had under the regulatory order had been previously accrued. However, in this quarter, as we continued to do our own ongoing reviews, we did accrue amounts related to those reviews. So they were variable enough to mention but not so large that we would provide the dollar amount.

And I guess, could you give us a sense if they were more or less than a year ago in the third quarter? So was that...

So in the third quarter of last year -- I think in each of the quarters that we've had, I think they've been manageable numbers.

You have a big P&L, but just for the sake of...

That's a good thing.

Yes. But for the sake of kind of making sense of this quarter's expenses versus last quarter, can you just, since you don't want to tell us the amount, give us a sense of the size?

As I said, I think if you went back to the fourth quarter through now, there has been some amount in each quarter but none in any quarter that kind of crosses our threshold for disclosing the amount.

Your next question is from Don Fandetti with Citigroup.

It's been pretty quiet on the DOJ case in 2012. I was just curious, as you look out to '13, do you expect to see any procedural-type moves? Or would you expect it to be quiet again in '13?

I think what we're expecting is for discovery to be completed sometime early in 2013. And then after that, there'll be some time that elapses before we actually get to the next stage in the process.

Then we'll go next to Chris Brendler with Stifel. Christopher Brendler - Stifel, Nicolaus & Co., Inc., Research Division: Could you just give us -- sort of turning back to one of the earlier questions on the $3-billion target for fee-based revenues, I guess I'm not sure. At this point, it's been at least 1 year, almost 2, since you laid out those goals. I'm just wondering, what's going well? What's not? It seems like -- I would have thought we'd get a little more detail on Serve and how that's progressing. The bluebird product seems like a very compelling offer. It could be a big part of that pie should -- as you seek to achieve that $3-billion goal. Can you give us any detail on what the major components of that revenue target were and where you stand today in any way, shape or form?

So I -- there's certainly a broad set of initiatives. Certainly, Serve and prepaid reloadables would be elements where we would expect to contribute to our target. Loyalty Partner is an acquisition that we've discussed with you. We would think that's another notable piece of the pie. I would say, though, that if we were to sit here 3 years ago and think about the progress that would've been made in alternative payments and wallets and the like, you probably would've thought we were further along than we are today. So that's not a comment about American Express, specifically, but really about the industry. We continue to see a fair amount of press releases but not necessarily a fair amount of product that's in the marketplace. And the other thing, as I mentioned, is this is a pretty uneven economy. So it makes the achieving that target all the more challenging, but we do have a number of projects that are under way. And we continue to look at other initiatives as we go forward over the next 2 years, as we head towards the latter part of 2014. Christopher Brendler - Stifel, Nicolaus & Co., Inc., Research Division: Okay, a follow-up question on the credit card business. The lending margin was up this quarter. I didn't exactly -- understand exactly what was driving that. It wasn't like a huge increase but it looked, by my calculations, to be mostly on the top line yields, a nice little bump in the interest charges you're getting on your lending accounts. Anything driving that? I mean, your lending growth has been relatively impressive. I know it's a byproduct of your spending strategy. Just trying to think about what's causing the yield to go up at the same time the loan growth is picking up.

Yes, it's -- so as you say, it's only up slightly. It could be a little bit related to revolve rates but not a huge move in revolve rates. So we continue to watch it and make sure that the mix we have is right. Certainly, just a change in mix among products can also have a slight increase in terms of -- increase or decrease, depending on which way it moves. So we watch it closely. We've said that we want that number to be around 9% and that's what it's been largely over the last several quarters, slightly higher this quarter but not by a huge amount.

Then we'll go next to Ken Bruce with Bank of America Merrill Lynch.

Most of my questions have been answered, but maybe we could get you to dimensionalize some of the asset growth, the lending products growth. You kind of pointed out that spending growth is better than the lending growth and that there's a number of factors that are driving that. But could you, in any way, provide us with some sense as to whether this is an increase in traction for the premium lending strategy or if this is just the willingness of existing card members to increase their borrowing?

So it's hard to tease that out, to be quite frank. We are focused on premium lending. We have developed products to drive in that direction. As I said before, we recognize that there are some of our cardmembers who we know very well and we think have good credit who have balances elsewhere. That's certainly one of the things that we are thinking about. We're staying away from balance transfers and those kinds of initiatives, so we're not going there. And as I said before, we have never had a target for loan growth. It's an outcome of putting products in the marketplace as a design to drive spend and then the consumer deciding to utilize that. And how much they want to utilize that in part will be impacted by lots of things, including how they feel in terms of their confidence and where the economy is going. So there's lots of small moving parts within there. But there's not one overarching driving force that is impacting loan growth. And you could see that it's been a very gradual increase over time. And the fact that is the biggest is that 1 year ago or more, we were really seeing an increase in the paydown rate. And that was holding down loan growth effectively, and that has really -- it's increasing a little bit, but it's really stabilized over the last several quarters. So in terms of a change, I would say that's probably the largest contributing factor.

Okay, that's helpful. And then maybe if you could discuss in any way the decision to essentially rebrand Serve with a much bigger American Express prominence. I've found that to be quite interesting. I don't know if there's a thought that it just wasn't getting enough traction as an independent brand, and it just needs to effectively ride on the coattails of American Express. But if you could provide some sense as to what drove that decision.

So I think all new products evolve over time. And I think as a company, we came to the realization that our brand has a lot of attributes which are important to people who would use the Serve product or a reloadable prepaid. We do stand for trust, security and servicing. All those things are important when you think about a product like those. And so the decision was made to make it more prominent, so people who are purchasing those products recognize the linkage of Serve to the American Express family.

Okay. And is there any -- I mean, is it essentially targeting, from an aspirational brand perspective, a different demographic now? Or is it still the same and it's just a function of gaining more traction?

So I think -- obviously, people who are utilizing the reloadable prepaid, in particular, are a different group of customers than some of our premium products. But I think many of the attributes of our company and our brand are important to that customer group as well. And we think we have a platform in Serve, which is what reloadable prepaid is running on, and so we want to leverage that. And we think we can put products out there that can be very competitive in the marketplace.

That will come from Mike Taiano with Telsey Advisory Group.

So just wanted to follow up on the bluebird question. So it seems like the obvious rationale here is to push more volume onto Amex's network. But I guess, are there some secondary benefits as well? So in other words, from a data standpoint, do you benefit from getting access to a different demographic? And does that help you with some of your other businesses? And would it also potentially help you on the acceptance front as well?

So I'd say yes to all of those things, right? So I think it does push more volume onto our network. We think that is a very good thing. We think we can achieve good economics. We also see it as a large market today, I think over $300 billion. And it's forecasted to grow at, I think, 12% to 13% going forward. So it's a growing market. We have the capabilities and skills to be successful here. And so we viewed it as a good opportunity and also helping to grow to -- contribute to our growth in fee businesses.

Okay, great. And then just one quick follow-up on -- a lot of talk about the fiscal cliff here coming up and just wondering, does that affect your guys -- your planning at American Express in terms of the timing of marketing and your ability to maybe -- if there is a larger impact than expected, to ratchet back on maybe some of your marketing spend early next year?

So in our planning, we always have a base-case plan, and we have been scenarios. If things were to be better, we know exactly what we'd do. And if things were to be worse, we know exactly what we're going to do. So we will monitor this closely. But at the moment, we're focused on our base plan but do have these other scenarios in case we need to react quickly. Okay. So thanks, everybody, for joining the call, and have a good evening.

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