American Express Company — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. Unaudited consolidated results; amounts are U.S. dollars unless noted. American Express is a global payments and financial services company. Its reportable segments are U.S. Consumer Services (USCS), International Consumer and Network Services (ICNS), Global Commercial Services (GCS), and Global Merchant Services (GMS).
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue net of interest expense | $7.774 billion | $8.193 billion | $24.097 billion | $24.427 billion |
| Provisions for losses | $504 million | $529 million | $1.401 billion | $1.416 billion |
| Total expenses | $5.535 billion | $5.726 billion | $15.761 billion | $16.527 billion |
| Net income | $1.142 billion | $1.266 billion | $4.583 billion | $4.264 billion |
| Diluted EPS | $1.20 | $1.24 | $4.76 | $4.15 |
- Revenue mix: Q3 discount revenue declined 5% to $4.516 billion; net card fees rose 10% to $747 million. Net interest income fell 11% to $1.334 billion, with lower reported loan balances and higher funding costs. For nine months, net interest income was nearly flat at $4.363 billion.
- Profit and expenses: Q3 net income fell 10% and diluted EPS fell 3%. Nine-month net income rose 7% and diluted EPS rose 15%, benefiting from $1.218 billion of gains on sales of the held-for-sale (HFS) card portfolios, recorded as a reduction in other expenses. Q3 marketing and promotion expense increased 10%; rewards expense declined 11%.
- Margins and returns: Reported return on average equity was 26.1% for the twelve months ended September 30, versus 26.8% a year earlier. The company reported Q3 Card Member loan net interest yield of 9.8%, compared with 9.5% a year earlier; this is a non-GAAP measure.
- Credit: Q3 total provisions declined 5%, but Card Member loan provisions rose 3%. Loan net write-off rate (principal only) was 1.7%, compared with 1.3% a year earlier; 30+ days past due was 1.1% versus 1.0%. Receivables’ principal-only net write-off rate improved to 1.4% from 1.8%.
- Cash flow: Nine-month operating cash flow was $4.9 billion, down from $7.8 billion. Investing activities provided $10.1 billion, versus $2.7 billion used in 2015, primarily reflecting the HFS portfolio sales. Financing used $11.2 billion, versus $7.3 billion. Cash and cash equivalents ended at $26.5 billion, up from $22.8 billion at year-end 2015.
- Balance sheet and funding: At September 30, total assets were $153.4 billion and shareholders’ equity was $21.0 billion. Total debt was $47.8 billion ($2.9 billion short-term and $44.9 billion long-term), down from $52.9 billion at December 31, 2015. Customer deposits were $53.5 billion, down from $55.0 billion.
- Capital and liquidity: Transitional Basel III CET1, Tier 1 and total risk-based capital ratios were 13.6%, 14.9% and 16.6%, respectively. Management reported compliance with applicable liquidity requirements, including the Liquidity Coverage Ratio. It targets liquidity sufficient for at least twelve months under stress scenarios.
Material changes and management commentary
- Reported Q3 worldwide billed business declined 3%; U.S. billed business declined 9%, while non-U.S. billed business grew 10%. Management attributed much of the reported weakness in revenue, billings, card counts and loans to the end of the Costco U.S. relationship and the sales of the Costco and JetBlue card portfolios. After adjusting for Costco-related prior-year activity, management cited underlying growth in billed business, loans and revenue.
- The Costco portfolio sale closed in June and the JetBlue sale in March 2016. The company completed sales of substantially all HFS loans and receivables in the first half and recognized $1.2 billion in aggregate gains. These transactions materially affect comparisons and cash-flow presentation.
- Management said it remained focused on revenue growth, investment optimization and resetting its cost base, citing progress on cost reduction and steady credit performance, partially offset by increased growth investment and a restructuring charge. It expected Q4 investment spending on growth initiatives, including marketing, to be significantly higher than Q3.
- Management expected provision expense to increase with continued adjusted loan growth and some modest upward pressure on write-off rates, partly from seasoning loans to newer Card Members. It also expected rewards costs, including cash-rebate costs, to grow faster than billings as card value propositions are enhanced. Management noted that the average discount rate may decline over time amid competition, merchant incentives, OptBlue expansion, mix changes and regulation.
Risks, contingencies and unusual items
- Competition in payments—particularly in the U.S.—and the ability to win or renew cobrand and other partnerships may pressure growth, merchant pricing and costs. Lower gas and airline prices were also cited as headwinds; large-corporate spending declined while middle-market and small-business spending grew after Costco adjustment.
- Regulatory changes in the EU and Australia may pressure merchant discount rates, affect network-partner economics and alter merchant steering or acceptance rules. Brexit had caused market volatility, with longer-term financial and operating effects still uncertain.
- The Second Circuit reversed the trial-court ruling in the DOJ merchant antitrust case on September 26, 2016, directing judgment for American Express. Other merchant claims remain. For material legal proceedings where a loss was reasonably possible and estimable, the company disclosed a range of zero to $190 million in excess of reserves; this is not the maximum possible exposure. Management said litigation outcomes could materially affect results, though it did not expect a material adverse effect on consolidated financial condition or liquidity based on current knowledge.
- The company identified expected credit loss accounting (CECL), effective in 2020, as potentially resulting in material changes to credit reserves. It also disclosed ongoing tax examinations and said unrecognized tax benefits could decrease by up to $527 million within twelve months, approximately $310 million of which would be recorded in equity if recognized rather than affect earnings or the effective tax rate.
- Shareholders received $4.2 billion through common dividends and repurchases in the first nine months. The company repurchased 8.8 million shares in Q3 at an average $64.39 and authorized repurchases of up to 150 million shares on September 26, subject to regulatory capital plans and market conditions.
- The filing disclosed limited third-quarter Iran-related travel visa activity, with negligible gross revenue and net profit.
Important facts for investors to verify
- Separate underlying operating trends from the lost Costco relationship and the Costco and JetBlue portfolio sales; review the company’s adjustment definitions and comparability assumptions.
- Assess whether Q4 marketing and other growth investment, restructuring efforts and cost reductions translate into sustainable revenue growth and profitability.
- Monitor loan growth, seasoning-related delinquencies and write-offs, reserve adequacy, and the possible impact of CECL.
- Review funding costs, deposit trends, liquidity resources, capital ratios and the conditions governing the repurchase authorization and dividends.
- Track merchant litigation and regulatory developments in the EU, Australia and the U.S.; the disclosed legal-loss range is not a maximum exposure.