American Express Company — Q2 2018 Form 10-Q
Business context and reporting period. American Express is a global payments company offering charge and credit cards, lending, merchant and network services, and travel-related products. This unaudited quarterly report covers the three and six months ended June 30, 2018; balance-sheet comparisons are with December 31, 2017. The company reports Global Consumer Services Group (GCSG), Global Commercial Services (GCS), Global Merchant and Network Services (GMNS), and Corporate & Other. Segment structure and certain allocations changed in 2018; prior periods were revised to conform.
Key financial results
| Metric | Q2 2018 | Q2 2017 | Change |
|---|---|---|---|
| Revenue net of interest expense | $10.002 billion | $9.172 billion | +9% |
| Provisions for losses | $806 million | $583 million | +38% |
| Total expenses | $7.105 billion | $6.632 billion | +7% |
| Pretax income | $2.091 billion | $1.957 billion | +7% |
| Income tax provision | $468 million | $613 million | -24% |
| Net income | $1.623 billion | $1.344 billion | +21% |
| Diluted EPS | $1.84 | $1.47 | +25% |
| Dividend declared per common share | $0.35 | $0.32 |
For the six months ended June 30, revenue net of interest expense was $19.720 billion (+10% year over year), net income was $3.257 billion (+26%), and diluted EPS was $3.70 (+31%). The effective tax rate declined to 22.4% in Q2 from 31.3%, and to 22.0% for the half from 31.6%, mainly reflecting the lower U.S. federal tax rate under the Tax Act. Q2 return on average equity was 16.7%, versus 21.7% a year earlier; the filing calculates this using trailing one-year income and average equity.
Q2 total non-interest revenue rose 7% to $8.173 billion. Discount revenue increased 8% to $6.194 billion, net card fees rose 9% to $844 million, and other fees and commissions rose 5% to $786 million. Net interest income increased 19% to $1.829 billion: interest income rose 24% while interest expense rose 36%. The reported net interest yield on average Card Member loans was 10.6%, up from 10.3%.
Operating performance and changes versus prior year
- Worldwide billed business increased 10% in Q2 (11% for the first half); proprietary billed business grew 12% in Q2, while GNS billed business declined 1%. U.S. and non-U.S. billed business each rose 10% in Q2.
- Card Member loans reached $75.4 billion, up 14% year over year; receivables were $55.0 billion, up 11%. Loan growth reflected customer lending growth and the acquired Hilton cobrand portfolio.
- Provisions increased as portfolios grew and net write-offs rose. Q2 loan net write-off rate (principal only) was 2.1%, versus 1.8%; receivables’ comparable rate was 1.8%, versus 1.5%. Management attributed higher loan losses in part to seasoning of recent vintages and expected that trend to continue.
- Customer-engagement spending—marketing and business development, rewards, and Card Member services—rose 13% in Q2 to $4.512 billion. Rewards rose 11%, marketing and business development 14%, and Card Member services 22%. Operating expenses excluding these categories were described as modestly lower year over year.
- GCSG Q2 segment income rose 25% to $770 million; GCS segment income rose 18% to $564 million; GMNS segment income rose 14% to $543 million. Lower tax expense contributed to segment income growth. Corporate & Other reported a $254 million net expense, versus $224 million.
Cash flow, balance sheet, debt and liquidity
- For the first half of 2018, operating cash flow was $5.096 billion (versus $4.284 billion); investing cash flow was negative $8.381 billion (versus negative $4.146 billion); financing cash flow was positive $1.235 billion (versus $4.974 billion). Cash, cash equivalents and restricted cash decreased $2.001 billion to $31.263 billion, including $1.520 billion of restricted cash.
- At June 30, cash and cash equivalents were $29.743 billion; total assets were $184.861 billion and shareholders’ equity was $20.892 billion. Card Member loans, net, were $73.579 billion and receivables, net, were $54.424 billion.
- Total debt was $57.9 billion, comprising $2.0 billion short-term borrowings and $55.9 billion long-term debt, compared with $59.1 billion at year-end 2017. Customer deposits were $67.4 billion, up from $64.5 billion.
- Management stated liquidity resources are intended to cover at least 12 months of expected obligations and business needs under severe funding stress. The company had a $3.5 billion committed bank credit facility, undrawn at quarter-end; a $2.0 billion Charge Trust facility was drawn, while the $2.0 billion Lending Trust facility was undrawn. Approximately $293 billion of unused credit outstanding is not a forecast of likely draws.
- At June 30, the company’s CET1, Tier 1, total capital, Tier 1 leverage and supplementary leverage ratios were 10.1%, 11.1%, 12.8%, 9.7% and 8.3%, respectively. The company said it exceeded applicable regulatory capital requirements.
Outlook, management commentary and material items
- Management described Q2 performance as strong, citing spending growth, premium consumer and commercial card momentum, and continued investment in its network and digital capabilities. No specific full-year revenue or earnings guidance is provided in the supplied filing text.
- Management expected growth-initiative spending to remain above Q1 levels for the rest of 2018. It noted that net interest yield growth had moderated amid higher funding costs and that average discount rates were expected to decline over time because of merchant negotiations, competition, OptBlue migration, pricing discounts and regulation.
- The company suspended share repurchases in the first half to rebuild capital. After Federal Reserve non-objection to its capital plan, it expected to resume in Q3: up to $3.4 billion of repurchases through Q2 2019 and a proposed quarterly dividend increase from $0.35 to $0.39, subject to board approval and other conditions.
- In Q2 the U.S. Supreme Court affirmed the favorable appellate judgment for American Express in the government antitrust case concerning merchant anti-steering rules. Related individual merchant claims remain pending; a trial was scheduled for April 2019. Management said legal outcomes could affect results even though it did not expect pending matters to materially harm consolidated financial condition or liquidity.
- For disclosed material legal and VAT matters where losses were reasonably possible and estimable, the estimated range was $0 to $390 million in excess of recorded accruals. The company cautioned this is not a maximum exposure and actual results may vary significantly.
- The company cited rising interest rates, intense competition, global regulation, possible declines in discount rates, credit-loss trends, partner and merchant concentration, and cyber and operational security as risks. It said no material changes in market-risk exposures had occurred since year-end.
- CECL, effective for the company January 1, 2020 (early adoption not intended), may materially increase reserves through earlier recognition of expected lifetime credit losses. The company was still evaluating the impact. The 2017 Tax Act’s estimated $2.6 billion discrete tax charge remained provisional; no material revision was recorded in this quarter.
- Other unusual items included the first-quarter acquisition of approximately $1 billion of Hilton cobrand card loans and a first-half loss on a transaction involving the prepaid reloadable and gift card business. The filing also reports negligible GBT-related revenue and net profit from certain Iran-related travel transactions.
Important facts for investors to verify
- Whether billed-business growth and fee revenue can offset further declines in the average discount rate.
- Whether rising loan and receivables losses, including the seasoning of newer loan vintages, remain within management’s expectations and reserve coverage.
- How customer rewards, services, marketing and partner investment affect margins and future growth.
- The timing and actual scale of resumed buybacks and the proposed dividend increase, including capital and regulatory constraints.
- Potential outcomes and financial effects of merchant litigation, VAT matters and other contingencies; the disclosed loss range is not a maximum.
- The eventual balance-sheet and earnings effects of CECL adoption, lease accounting adoption in 2019, and any finalization of Tax Act estimates.