AMERICAN EXPRESS CO quarterly report, Q2 FY2010

American Express Company — Q2 2010 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2010. The interim financial statements are unaudited. American Express provides charge and credit cards, payment-network and merchant services, and travel-related services worldwide.

Financial results and key metrics

Metric	Q2 2010	Q2 2009	Six months 2010	Six months 2009
Revenue, net of interest expense	$6.858B	$6.092B	$13.464B	$12.018B
Provisions for losses	$652M	$1.584B	$1.595B	$3.387B
Expenses	$4.611B	$4.090B	$9.022B	$7.669B
Pretax income	$1.595B	$418M	$2.847B	$962M
Net income	$1.017B	$337M	$1.902B	$774M
Diluted EPS	$0.84	$0.09	$1.57	$0.40

• Q2 billed business rose 16% to $175.3B; discount revenue increased 13% to $3.734B. Average discount rate was 2.56%, versus 2.55% a year earlier.
• Q2 net interest income was $1.188B, up from $741M. Cardmember loan net interest yield was 9.6%, down from 9.7%; management cited higher payment rates, lower revolving balances and CARD Act effects.
• Credit provisions declined 59% year over year in Q2, reflecting improving credit performance and lower reserve requirements. Q2 charge-card and loan provisions were $96M and $540M, respectively.
• Marketing, promotion, rewards and cardmember-services expense rose to $2.122B from $1.512B, as the company increased business-building investment. Q2 effective tax rate was 36%, including a $44M valuation allowance and a higher estimated annual rate.
• Six-month operating cash flow was $4.450B, investing cash flow was $5.485B, and financing cash flow was negative $5.837B. Cash and equivalents ended June at $20.687B.
• At June 30, total assets were $143.763B, total liabilities $129.250B, and shareholders’ equity $14.513B. Long-term debt was $69.345B and short-term borrowings $2.609B; customer deposits were $28.352B.
• Reported cardmember loans were $57.3B, but the year-over-year balance comparison is affected by an accounting change. On a comparable managed basis, loans declined 7.3% from December 31, 2009 to $57.3B.
• Excess cash and readily marketable securities available for funding maturities totaled $25.4B. Long-term debt, securitization and deposit maturities through June 30, 2011 totaled $19.6B.
• Company regulatory capital ratios included 10.7% Tier 1 risk-based capital, 12.9% total risk-based capital and 8.2% Tier 1 leverage. The company’s cash dividend was $0.18 per share for Q2.

Changes versus the prior period

• Net income more than tripled in Q2, while six-month net income more than doubled. The year-ago Q2 EPS comparison is affected by $212M of accelerated preferred-dividend accretion and other preferred-share charges; the 2009 preferred shares were repurchased in June 2009.
• Improved spending and sharply lower loss provisions supported earnings growth. Expenses also increased, notably marketing and rewards spending.
• Effective January 1, 2010, new consolidation rules required American Express to consolidate the Lending Trust. This added securitized loans and related debt to the balance sheet; prior periods were not restated for this accounting change. It also moved related income and expense items out of securitization income and into other revenue, interest income, interest expense and provisions.
• The company corrected immaterial prior-period cash-flow and balance-sheet classification errors involving book overdrafts; it stated the revisions did not materially affect previously issued financial statements.
• Q2 segment income was $522M for U.S. Card Services, $160M for International Card Services, $117M for Global Commercial Services, and $269M for Global Network & Merchant Services. Corporate & Other reported a $51M net expense.

Outlook, commentary and risks

• Management reported double-digit year-over-year spending growth continuing through July, though at a slightly slower rate than June due to a tougher comparison. It expected spending growth to outpace loan-balance growth near term, with higher payment rates and lower revolving levels constraining loan growth and interest yield.
• Management planned to sustain substantial business investment while credit performance remained supportive. Its stated long-term targets included 12%–15% average EPS growth, ROE of 25% or more, and returning at least 50% of capital generated to shareholders on average over time. The company did not expect near-term share repurchases; future repurchases would be subject to regulatory consultation.
• Key uncertainties include unemployment and consumer confidence, credit trends, the CARD Act and required reviews of APR increases, and implementation of the Dodd-Frank Act and Basel III. New rules could affect capital, liquidity, card pricing, merchant practices, compliance costs and funding access.
• American Express cautioned that registered asset-backed securities offerings could be constrained after January 2011 if rating agencies did not consent to ratings disclosure; it said the impact on ABS funding capacity and cost was uncertain.
• Legal and governmental matters include merchant antitrust and anti-steering litigation and investigations. The company said it could not meaningfully estimate losses above accrued liabilities, if any; it did not believe pending matters were then expected to materially affect consolidated financial condition or liquidity, though a particular-period earnings impact remained possible.
• The company disclosed that unrecognized tax benefits could decrease by as much as $681M within 12 months, with the net-income and tax-rate effect of part of that amount not quantifiable. It also acquired Revolution Money for approximately $305M in January; the acquisition did not significantly affect period results.

Important facts for investors to verify

• Separate underlying operating trends from the Lending Trust consolidation when assessing revenue, loans, debt, interest income and provisions.
• Track loan yields, payment rates, loan balances, delinquency and write-off trends, including the effect of changed charge-card receivable write-off timing.
• Assess whether increased marketing and rewards spending produces sustained billed-business and earnings growth, and whether the stated long-term targets remain achievable.
• Monitor the final effects of Dodd-Frank, Basel III, CARD Act implementation and ABS rating/disclosure requirements on capital, pricing, compliance costs and funding.
• Review developments in merchant litigation and tax examinations, as outcomes and timing remain uncertain.