AMERICAN EXPRESS CO quarterly report, Q1 FY2018

American Express Company — Q1 2018 Form 10-Q

Reporting period: Three months ended March 31, 2018; unaudited. American Express is a global payments and financial services company serving consumers, businesses and merchants. Comparisons are with Q1 2017 unless otherwise noted.

Financial performance

Metric	Q1 2018	Prior period / change
Revenue, net of interest expense	$9.718 billion	$8.709 billion; up 12%
Net interest income	$1.841 billion	$1.502 billion; up 23%
Provisions for losses	$775 million	$573 million; up 35%
Total expenses	$6.861 billion	$6.297 billion; up 9%
Pretax income	$2.082 billion	$1.839 billion; up 13%
Net income	$1.634 billion	$1.251 billion; up 31%
Diluted EPS	$1.86	$1.35; up 38%
Effective tax rate	21.5%	32.0%

Discount revenue rose 9% to $5.889 billion; net card fees rose 11% to $830 million. Worldwide billed business increased 12% to $283.8 billion, including 10% growth in the U.S. and 17% outside the U.S. The average discount rate declined to 2.37% from 2.43%. Net interest yield on average Card Member loans was 10.8%, versus 10.3%.

Management attributed earnings growth to higher spending, loans and fee income, as well as the lower tax rate following U.S. tax reform. The effective tax rate comparison also reflects prior-year tax items; the filing says the 2017 Tax Act charge remains provisional.

Cash flow, balance sheet and capital

• Operating cash flow was $2.063 billion, compared with $1.160 billion. Investing activities used $693 million, versus providing $711 million; financing activities used $2.949 billion, versus providing $2.205 billion. Cash, cash equivalents and restricted cash ended at $31.507 billion, down $1.757 billion during the quarter.
• Total assets were $179.956 billion and shareholders’ equity was $19.613 billion at March 31, 2018. Cash and cash equivalents were $31.092 billion.
• Total debt was $54.3 billion, down from $59.1 billion at year-end 2017; customer deposits were $66.7 billion, up from $64.5 billion. Q1 included $2.0 billion of asset-backed securities and $2.0 billion of senior unsecured note issuance.
• American Express Company’s CET1, Tier 1 and total risk-based capital ratios were 9.4%, 10.5% and 12.2%, respectively; its Tier 1 leverage and supplementary leverage ratios were 8.8% and 7.6%. Each exceeded the stated applicable standard.
• The company reported $3.5 billion of undrawn committed bank credit capacity and two undrawn secured facilities totaling $5.0 billion. It stated its liquidity objective is to cover expected obligations and business needs for at least 12 months, including under stressed conditions.

Material changes and operating trends

• Card Member loans reached $72.8 billion, up 14% year over year. Receivables were $54.2 billion, up 14%. The quarter included acquisition of a Hilton cobrand loan portfolio with approximately $1 billion of principal and interest at acquisition.
• Loan loss provisions rose 48% to $499 million. The loan principal-only net write-off rate increased to 2.0% from 1.7%, and loans 30+ days past due rose to 1.4% from 1.2%. Receivables’ principal-only write-off rate improved to 1.6% from 1.7%; 30+ days past due was 1.5% in both periods.
• Rewards expense rose 14% to $2.347 billion and Card Member services expense rose 29% to $409 million, reflecting higher spending, rewards earned and use of travel benefits. Marketing and business development expense rose 5% to $1.345 billion.
• Segment income increased in USCS to $640 million (up 30%), ICNS to $291 million (up 15%), GCS to $552 million (up 35%) and GMS to $472 million (up 32%). Corporate & Other net expense increased to $321 million from $261 million.
• American Express adopted new revenue recognition guidance retrospectively. It reclassified certain card-related costs from contra-revenue to expenses, increasing reported revenue and expenses; management said adoption did not materially affect net income, financial position or cash flows. Segment allocation methods also changed, with prior periods revised for comparison.

Outlook, risks and unusual items

• Management expects the average discount rate to continue declining over time, citing merchant negotiations, competition, OptBlue growth, volume pricing and regulation. The company prioritizes discount revenue growth and overall economics over maximizing the rate.
• Management expects lending delinquencies, write-off rates and provisions to continue reflecting seasoning of recent loan vintages and a mix shift toward non-cobrand lending. It expects net interest yield to stabilize sequentially and marketing and business development expenses to be higher over the rest of 2018 due to increased investment.
• The company suspended share repurchases for the first half of 2018 to rebuild capital, while continuing quarterly dividends at the then-current level. A capital plan covering potential second-half returns was submitted for the 2018 Federal Reserve CCAR review; the Federal Reserve decision was expected by June 30, 2018. No formal full-year earnings or revenue guidance is stated in the provided filing text.
• Legal proceedings and VAT matters remain contingencies. For disclosed material matters where loss was reasonably possible and estimable, the estimated range was zero to $420 million in excess of related reserves; this is not the maximum possible exposure. The company said litigation could materially affect results, although it did not believe proceedings would materially adversely affect consolidated financial condition or liquidity.
• The Supreme Court heard argument in the DOJ and states’ antitrust case concerning merchant anti-steering provisions; the outcome could affect merchant practices, the customer experience and the business. Other key risks include payment regulation, competitive pressure on merchant pricing, rising interest rates and funding costs, cyber and data security, consumer credit performance, and regulatory or litigation outcomes.
• Other unusual items included a loss on a transaction involving prepaid reloadable and gift card operations, partly offset by gains from remeasurement of certain equity investments. The filing also disclosed that American Express Global Business Travel reported approximately 40 Iranian visas and hotel reservations at two potentially Iran-government-affiliated hotels; related gross revenue and net profit were described as negligible.
• Management identified CECL, effective for the company January 1, 2020 absent early adoption, as a significant accounting change that may materially increase credit reserves through earlier recognition of expected lifetime losses.

Important facts for investors to verify

• Whether loan delinquencies, write-offs and provisions continue to rise as recent vintages season, and how reserve levels compare with subsequent credit performance.
• Whether billed-business growth offsets further discount-rate declines, and whether higher rewards, partner payments and service usage support profitable customer growth.
• Progress rebuilding capital, the Federal Reserve’s CCAR decision and the timing and scale of any resumed share repurchases.
• Developments in the antitrust case, VAT matters and other litigation, including any change to the estimated loss range or reserves.
• The eventual CECL transition impact and any revisions to provisional Tax Act estimates or unrecognized tax benefits.