American Express Company (AXP) Q3 2011 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the American Express Third Quarter 2011 Earnings Release Conference Call. [Operator Instructions] As a reminder, this call is being recorded. I would now like to turn the conference over to our host, Mr. Rick Petrino. Please go ahead.

Thank you. Good evening. We appreciate everyone joining us for today's discussion. Before I turn it over to our CFO, Dan Henry, I do need to remind you that 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, which was filed in an 8-K report and in the company's 2010 10-K report, already on file with the SEC. In the third quarter 2011 earnings release and earnings supplement, as well as the presentation slides, all of which are now listed on our website at ir.americanexpress.com, we have provided information that describes certain non-GAAP financial measures used by the company and the comparable GAAP financial information. 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 of -- some key points related to the quarter's earnings through the series of slides included with the earnings documents distributed, and provide some brief summary comments. Once Dan completes his remarks, we will open the line for Q&A. With that, let me turn the discussion over to Dan.

Okay, thanks, Rick. I'll start on Slide 2, Summary of Financial Performance. The revenues net of interest expense was $7.6 billion, 9% higher than the prior year. Now this growth rate is down slightly from the second quarter, but it is best-in-class compared to issuing competitors. On an FX-adjusted basis, it's 6% growth. Net income came in at $1.2 billion, 13% higher than last year, and EPS is $1.03. Return on equity is 28% and you can see that shares outstanding have decreased and that's a result of share repurchases, which I'll cover in more detail later. We move to Slide 3, Metric Performance. You can see the Billed business was $207.7 billion, up 16% and 13% on an FX-adjusted basis. So Billed business, again, showed strong growth. It's the seventh quarter in a row that we've had strong Billed business growth. We are growing over strong growth last year, while our competitors' spending growth last year -- while improving or growing the overall lower growth rates the year before. Cards-in-force are 95.8 million cards, up 8%. That represents 21% growth in cards in GNS and 2% growth in proprietary cards. Average spend continues to increase, reflecting the high level of engagement of our Cardmember base. Cardmember Loans are up 2%, the same growth rate that we saw in the second quarter. And travel sales grew 13%, driven primarily by air sales. Moving to Slide 4. So this is Billed Business Growth by Segment, and we continue to have broad-based growth across all segments. Total Billed business growth decreased about 2%, compared to the second quarter. If we look at USCS, it came in at 12%, down 1% from the second quarter; Global Corporate Products is at 14%, also down 1% from the second quarter; GNS continues to be very…

[Operator Instructions] We now go to our first question, Mr. Don Fandetti with Citigroup.

Dan, I was wondering if you could provide a little color on where Billed business trends are in October overall, and then maybe whether or not Europe's continued to sort of soften a bit or if that stabilized.

So spend growth continues to hold up well in the fourth quarter. However, we are just a few weeks into the quarter and we will watch spending trends closely as we go forward in the next coming months.

And on Europe?

I think -- I'd say we're holding up well, although we saw greater softness in Europe in the third quarter. So we'll have to see how that pans out as we go through this quarter.

Next, we go to the line of Bob Napoli with William Blair. Robert P. Napoli - William Blair & Company L.L.C., Research Division: Question on Rewards. The Rewards expense as a percentage of discount revenue was 37% this quarter. And if you go back a couple of years ago, it was running at the 30% level. And, I mean, you've been bringing up your redemption rate. You said you brought it up a little bit more this quarter. And I was redeeming some points myself the other day, it's awfully easy to do. And so I don't know why I wouldn't redeem all of them easily over time, but is there -- how much was the one-time hit this quarter for higher redemption rate? And, I mean, is this run rate, is that permanent?

So we're pleased you redeemed your points. We believe that to the extent cardmembers redeem points, we have greater engagement. They spend more with us. We have lower attrition. So the economics associated with that, we think, are very positive for the franchise over time. So in any given period, the Membership Rewards expense is going to be driven by 2 primary -- well, 3 primary factors. One, where the volumes are. And so to the extent we have volume growth, we're going to have growth in expense related to that. And the other 2 factors are the ultimate redemption rate and the weighted average cost per point. Now to the extent that we are having higher levels of engagement, higher redemptions by customers, we take that new information and put it into our calculation of what we think the ultimate redemption rate is going to be. And to the extent that it's higher, then we are going to have higher expense related to that. I went through a explanation on the call last quarter that says expense is really a combination of the activity and the current period, as well as repricing our bank which is very large, which is a good asset for us, but that repricing results in additional expense. To the extent the redemption rates are going up, we would see growth rates on that expense line in excess of the spend growth in the quarter. So what happens in the future is going to be very dependent on the behavior of our customers in future quarters. If, in fact, it runs at a slightly higher rate, then the growth in Billed business or spending, again, I would view that as a positive. The growth rate in this quarter is less than we saw in the second quarter, and that's because the growth in the redemption rate in the third quarter was somewhat less than the growth rate and the ultimate redemption rate that we saw in the second quarter. Robert P. Napoli - William Blair & Company L.L.C., Research Division: Okay. Follow-up question just on share repurchases, when and how do you go back to request more -- essentially, you bought back 2% of the company this quarter and your capital ratios didn't change. And I know you're looking at acquisitions, so maybe thoughts around the -- I mean, a little color on how you expect to reload the share repurchase authorization from the government, if you will, or from the fed.

Okay, last year, the fed had ourselves and I think all other bank holding companies submit filings, which reflected what our base plan was for the coming year. Also required us to have projections in an adverse and a more stressful environment that they reviewed. We made their request for share buybacks as part of that filing. Now our request for share buybacks was based on this notion that we would distribute about 50% of generated capital back to shareholders and retain about 50% for growth in the balance sheet and acquisitions. So the 2.3 was our amount. Now we performed well during this year. Balance sheet growth has not been significant and we've made some acquisitions, but not at the level that would warrant maintaining 50% of the capital. Now we could have ventured to make a new request to the fed in the recent month or so, but we thought it was more prudent just to address what we think our needs will be next year in the filing that we will do this January related to the required filing, not related to 2012. So we will be mindful of this year's experience as we make our request for next year.

Next, we go to the line of Ryan Nash with Goldman Sachs.

On the expense line, you guys came in at 75%, I think a little higher than some of us have been looking for, but you did mention there was, too, the tax credit. And I know that your guidance calls for -- the rate of change is slow. So can you just help us understand your ability to generate positive operating leverage? And at what point will we see revenue growth exceed expense growth? And I have another one after that.

As I think, we have been in a situation, really, over the past 2 years through 2010, 2011, where we have had very good credit performance. That results, as you know, in the release reserves, and we've had the Visa/MasterCard proceeds. And we've decided to use that money to, in part, improve earnings and, in part, invest in the future to drive business momentum. And that's what's really resulted in that ratio staying up at that 75% level or so. As we slow the growth in expense, as you would expect to see, that ratio come back down. It's going to come back down really in 2 ways. One is the growth in revenues and second is the slowing of the growth in expenses. In this period, if we hadn't had the tax benefit, then we would have ratcheted back investments and you would have actually seen that percentage come back down. But since we knew we had the tax benefit coming, we decided to invest it, and therefore, it starts -- it stayed at higher level. So you would think over the coming quarters, you would start to see that percentage to come down if we execute against our plans.

Okay. And just on the lending side, I think you had alluded to when you've had the conference last month that you would expect that losses would be lower than the 4.5% that you had historically had. But I guess numbers are running significantly lower than that, and your lending strategy has changed so much. So can you just help us understand either in numerically or contextually how you're thinking about where losses will eventually stabilize?

I'll do it contextually.

I figured I'd at least try.

So 4.5% is the rate we had over a 10-year period going back. As you said, we have changed our strategy. We are focused on premium lending. So I would expect it to, as I said before, be below that 4.5%, and I would expect it to be above where we are now. And these are really historic lows. And our desire at the end of the day is not driven by any target for a write-off rate. It is to make good, economic decisions that will benefit the franchise over the long term. That's the way we've always mirrored investment decisions. That's the way we'll continue to make them, and I suspect write-off rates are going to, obviously, settle somewhere between where we are now and that 4.5%. But to actually peg an exact number will be very dependent on the businesses decisions we're making. And as you know, there's a cyclical impact here, and in more robust times this is a lower number. And in times of economic stress, this is a higher number, but I think it will obviously be below where we were historically.

Next, we go to the line of Craig Maurer with CLSA. Craig J. Maurer - Credit Agricole Securities (USA) Inc., Research Division: Two questions. The first, if you could -- as a follow-up to the last question, be a little bit more specific on, did you reinvest the entire tax credit, one; and two, as it relates to that, a little bit more specific on what you might have spent it on so we can see the one-time nature in that spending. Secondly, have you seen any significant impact from the loss of Continental that you can point to?

So we did reinvest the 100% of the tax credit. It wouldn't be one isolated item. We knew that we had that resource going into the quarter. So as we've decided on our investment allocation, we took it into consideration. But you can see in marketing, while it's down from the third quarter of last year, it is at elevated levels. And as you look at expenses on the chart, maybe in Slide 19, you can see that we're investing in sales force, in GNS, in new business initiatives. So it really was part of the allocation of resources across all of those as opposed to just one isolated item. As it relates to Continental, at the end of the day, the removal of Continental from our MR program caused some increase in point redemption. However, quite frankly, the impact of Continental leaving so far has been less than we would have anticipated. I point out that even with Continental leaving the program, our Platinum Card base in the U.S. in the third quarter grew. And we believe that our MR program remains the industry-leading option for high-spending customers. So there was some customers that moved, but less than we expected. And we continue to have a very strong card base of affluent customers who spend at high levels.

Next, we go to the line of Brian Foran with Nomura.

I had a question, but actually I'll ask a follow-up to that. I mean, if U.S. Bank lost Northwest, held together much better than everyone have thought, didn't lose that many customers, you lost Continental, you're saying you're holding -- the cards holding together, you're not losing any customers. Does that imply the industry is just paying too much for these airline partnerships?

Well, I think, as we know, the cost of rewards related to co-brands are higher than our cost of our Membership Rewards program. We think our Membership Rewards program functions very well and is a program that many customers want because it provides a lot of options. Instead of being tied to just one redemption option, there are many redemption options, I think over 100 redemption options, which customers find to be very valuable. But when you look at co-brands, despite the higher cost from a rewards perspective of co-brands, those customers tend to spend at a higher level and the credit losses on those portfolios tend to be at the low end of the range. So the economics associated with co-brand products are good, and that's why we continue to have those programs and endeavor to make them more attractive. So while it was a different rewards mix, at the end of the day, when you look at the economics of a product, you need to look at a combination of what does it cost you to acquire the customer, what are their spending levels, what are their revolve levels, what will ultimately be the write-off rates within that group, determine the overall economics. So while rewards costs are higher, the economics of those programs are very good.

And then just in terms of pricing on cards, the environment is worrying to a lot of people in terms of mail volumes increasing, balance transfer options are out there. I guess looking at this quarter's data, your yields are up 30 bps, USPs are up 20, JPMorgans are up 2, some of the other guys are down, but even in the industry average is flat. I guess any more color you can provide on why the yields were up, 30 bps linked quarter? Is there seasonality in there? Is it the higher current 30 roll rates or is pricing competition not as bad this year?

I think we had indicated that we thought that yields would eventually migrate back to where we were before the CARD Act. And I think we've actually seen that now, but as you know there are a myriad of factors that come into play. Credit quality, to the extent you have more people in delinquency, unhealthy pricing that could drive it up to the extent you have more transactors that can drive it down. Most of our cards are variably priced. So when cost of funds go up or down, it doesn't have a huge impact. But as I said before, transactors are a decent part of our lending portfolio. So their interest costs really do matter. For us, as I indicated, the pay down rate in the third quarter this year improved compared to the third quarter of last year. But in fact, the pay down rate dropped out a little bit, 20 to 30 basis points, from the second quarter. So the fact that the revolve rate changed a little bit, I think that had an impact on the higher yield that we saw. But I think it's going to move around quarter by quarter based on all those factors. But to the extent it kind of stays in that range of the high 8s to 9%, I think that enables us to have good economics related to those products. And so I wouldn't focus so much on the little moves quarter to quarter, but more that we can sustain the appropriate yield over time in terms of assessing the economics of those products. I guess the other thing that I would note is that while others are doing BTs, we are doing very, very few in that area because our focus is not bringing on customers who are going to sit with a loan balance. Our objective is to bring customers who spend and occasionally revolve. And that is really at the heart of the difference between our business model and a competitor's business model. We want to generate fees from spending and allow our customers to revolve if they choose to, but it's not to bring customers who are going to sit with balances. We think that will put us in good stead over the long term because we think competitors, quite frankly, have a challenge. If you look back in history before the recession, loan balances were only growing at about 5%. And we can certainly see within our portfolio that there has been a separation between the growth in spending and lending products and the growth in loans as customer or consumers have decided to deleverage more. So that's going to present the challenge for them. But I think our business model is right for the environment as we go forward.

Next, we go to the line of Betsy Graseck with Morgan Stanley.

A couple of questions. Just one other angle on the expense question is that you are suggesting that you will be bringing it down this quarter. Can you just give us a sense of where you think you can do that in a way that doesn't impact your revenue growth, in particular, during this heavy spend holiday season. I'm just wondering where the flexibility is.

All right. Okay, so we haven't said that we're going to bring spending down. What we've said is that we are going to slow the growth rate in operating expense growth. Okay, so there's a little bit of distinction there. But I do think that we do see some opportunities. I mean, I think, we saw it in the third quarter, right? So in the third quarter, we saw that as credit is better, collections cost came down. I think we have brought down consulting services. So that's something that's very discretionary. We can decide to spend that at a higher level if we think we have an investment that we want to make in a new area or to enhance a product. But that's very discretionary at the end of the day. We also continue to be at elevated levels of spending on marketing and promotion. In this quarter, it's about 10% of revenues. Historically, we've been able to generate business momentum with marketing and promotions being about 9% of revenues. And then, as we've discussed, we set up Global Services group, which is really intended to be very focused on high-quality service by continually improving the efficiency in the way that we do things. We've set targets for that group that history has spoken about. We are being very successful at executing against those targets and achieving those goals that we've set for ourselves. So it's really across each of those types of areas that would enable us to slow the growth of operating expense while still having appropriate levels of resources to continue to drive the growth and the business momentum that we've generated in 2010 and 2011.

Next, we go to the line of Chris Brendler with Stifel, Nicolaus. Christopher Brendler - Stifel, Nicolaus & Co., Inc., Research Division: The recent hoopla on the debit card fees, that this may be causing some disruption in the debit card market. I remember, a year ago, you started to position your Charge Card as been tried as an alternative [ph] to the debit card. And I wasn't sure if you had any update on the results of that campaign and when you were thinking that this could be a potential opportunity for American Express to be able to share given what's going on in the debit card market.

I think we've also talked about the fact that Charge Card has some features that are very similar to debit and there are some aspects that are different. So while it's a pay-in-full product, it's not immediate, but there are some similarities. And if you're sufficiently disciplined to pay in full, then you can also get reward points and other services that are not available if you utilize the debit product. So I think a key here is that we've never been in the debit business. The profit pool in debit was never that large. With the changes required by Durbin, whatever profit pool was there is gone. So banks are looking to say, "How do we look at the overall economics of our relationship with a customer that they have?" And to the extent that relationship is relatively limited, then I think they've discussed that they really don't have the ability to provide that service for free without some kind of a cost. So I think what we're going to see is, over time, potentially a effort on the banks of -- on the part of banks to either charge for that service or to migrate customers either to Prepaid. And as you know, we have a very strong Prepaid offering. We issued a new Prepaid product that if you acquire that Prepaid product online, there are no fees to acquire it and no fees over time. So if people move in that direction, we have a product that is available. To the extent that banks push customers more towards credit, we think that, that would be an opportunity for us to grow our business as well. So we have to wait and see how this all plays out, but it could well be that this turns into more of an opportunity than a risk at the end of the day, although the whole script hasn't been written, so we'll have to see how that plays out. Christopher Brendler - Stifel, Nicolaus & Co., Inc., Research Division: It's fair to say that at this point there's no plans to restart that campaign. I guess I was also wondering were you happy with that campaign and the results you got? It seems like it is a different product from a consumer standpoint and I wasn't sure if the message you were sending last year really translated to consumers. A follow-up question would be actually on Serve. When should we expect Serve, if you had any update on it, when is it -- the volume metrics or any disclosure around Serve and how that's going -- that it starts?

Okay. So I don't think we ever really had a campaign to say that the Charge Card is the equivalent of a debit product. I think in different conversations with investors, we probably talked about the fact that there are some aspects of the product that are similar, but the fact that it's a payment in full when you receive the statement, I would say it's more fundamentally a different product. And the Charge Card product is maybe really targeted at different set of consumers than consumers who are using the debit product. Debit products, I think, are probably more for smaller ticket item, for people who have more limited resources and are trying to manage them very carefully. As you know, our Charge Card products are really targeted at more affluent customers. They have fees attached to them, but they also have substantial benefits associated with them. And we have, on the other hand, had a campaign to grow Charge Card over the last year and a half, and we have been really very successful at acquiring high-spending cardmembers and growing cards. And you could also see the Charge Card spend in this quarter grew by 14% compared to the prior period. So we're being successful at acquiring cards and having our customers grow their spending on those cards. So in terms of Serve, your second question, what we have been targeting over this year, 2011, is to, first, launch Serve, which we did in March. You remember that we acquired Revolution Money in January of 2010. From early 2010 through March of this year, we looked at building on the platform, in building the capabilities. The launch that we did in March is really kind of Serve 1.0. We're going to look to enhance that platform and we've been focused on building the capabilities on that platform throughout 2011. The metrics that we put out there that we wanted to accomplish in 2011 was really to enter into a number of partnerships where we can actually drive customers in the future to the Serve platform. So this year, we announced the partnership with Verizon that integrates Serve into their pay-by-phone service and they're embedding Serve in new Verizon phones. We also announced the partnership with Sprint to embed Serve into the Sprint Zone. So we've signed also some agreements with AOL as well. So we are kind of hitting, in our mind, our objectives for this year to improve the platform and to sign new partnerships that will enable us to bring customers on to our network and to have Serve product. So I think for this year, those are the guideposts that I would look to for success. As we look to 2012, I think, then we're going to look to actually seeing how successful we are actually bringing customers onto a Serve product and onto our network. So those are the guideposts that we are looking at in terms of success.

Next, we go to the line of Sanjay Sakhrani with KBW. Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc., Research Division: Maybe I could just follow up on that rewards cost question asked previously. Despite my rough math, I think the redemption rate moved up to about 93%, and I guess I was just wondering like how much higher can it go given the current trends? And secondarily, just to the extent that you do need to take that redemption rate assumption up, you guys still feel comfortable that you could hit your historical kind of efficiency ratio targets as shown on Slide 20, in that scenario. And then maybe just a second question to that is just reserve coverage. And obviously, you had very strong coverage levels right now. What is the normal level if we head into next year?

Okay. So on the first question, you remember that in last quarter, we indicated that we were at 92% related to active customers. And that in the first quarter, we actually rounded up to 92% and we said we had growth in the ultimate redemption rate and that we kind of round it down to 92%. So in this quarter, we again had growth in the ultimate redemption rate, but we're still rounding down to 92%. So it grew, but still rounds down to 92%. So we're not at 93% yet. Now how high can it go? That's difficult to forecast. It will be dependent on the behaviors of customers in the future. So certainly, customers who have a trend [ph from their program already, on average have tried it at a rate that's below 92%. But we look at the behaviors of the active customers. And then we draw our curves into the future in terms of what we think the ultimate redemption rate will be. So the 92% represents those behaviors to date. As customers become more engaged, it will potentially drive that rate up. Will it ever get to 100%? I think that's probably unlikely. But based on customer behaviors, it certainly could go above the rates that we are at today. So the question about how does it fit into the efficiency ratio, so we can look at efficiency ratio, but I think we need to look at really all expenses, including provision. So I think that we do need marketing and promotion over time on average, and over time to kind of be 9% of revenues. On the other hand, because write-off rates are going to be lower than historic levels, then I think that's going to allow the efficiency ratio to probably be a little higher than it may have been prerecession. But we're going to need to balance how we decide to utilize our resources between Rewards and operating expense over time. And that's a judgment we'll make in the normal course of business in terms of how we decide what to allocate to marketing, what to allocate to Rewards, what to allocate to other business initiatives to build the capabilities. And that's a map and planning that we are doing now, have always done and will do in the future. And we believe that even with higher Rewards cost, that we can continue to achieve our current financial objectives of revenue growth of 8% plus and 12% to 15% EPS growth and an ROE of 25% plus. So even with the high Rewards cost, we'll be -- -- had planned stay with our current financial targets. So I think... Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc., Research Division: And the reserve coverage?

Okay, reserve coverage. I think reserve coverage is obviously lower than it was a year ago or earlier this year. As credit improves, I would expect those ratios to gradually come down. This is an uncertain environment and so we're cautious as we release reserves. But to the extent we get to a point where there's less uncertainty, then I think you could potentially see lower reserve coverage than we have at the moment, but that will be driven by the fact and circumstances at the time.

Next, we go to Ken Bruce with Bank of America.

I was hoping you could provide a little bit more detail or decompose the corporate incentive payments and partnership payments that was in the contra revenues item this quarter. If there was one-time items, size it up in any way for me?

So I don't think there were any one-time items. I think we interact with our corporate customers and particularly our larger corporate customers, and we provide them incentives to do business with us. And certainly to the extent that their volumes increase above certain threshold levels, we provide incentives related to that as well. So these incentives are all around driving higher spend levels at the end of the day. So each quarter, we have new signings. And those new signings are reflected in the results. But again, even with these higher incentives that we're paying to corporate customers and partners, the economics around these agreements are very good. And we make that evaluation in terms of the returns that we're achieving and ensuring that they achieve our return thresholds. So I don't have more specifics than that, but these are good economic decisions that enable us to both grow the business and achieve our financial targets that we just discussed a moment ago. So I would think about these probably not differently than I think about Rewards. At the end of the day, you want to grow volumes and achieve the right economic returns, and these agreements are enabling us to do that. So let me just have this be the last question.

Okay. Can I have a follow-up?

Okay, go ahead. Well, one follow-up and then one last question.

Okay. And it will be a 2-part follow-up. On the discount rate, you've, in the past, guided to a few basis point erosion per year. I think as you pointed out in your earlier comments, much of that was a mix change issue on a year-over-year basis in the quarter. I'm wondering is there an order of magnitude that you could provide in terms of the net discount rate which would include the contra revenue items as we think about forecasting? And then as a second part, how do you think about the overall level of transactors in your overall lending book? I think you pointed out it had grown from 16% to 29%. Based on the number or the percentage of mail drops, where do you think that ultimately gets to?

Okay. So on the first question, in terms of the discount rate, to the extent we are successful and continuing to drive into new categories or are able to create greater engagement of existing customers into new categories, they will, in all likelihood, drive the average discount rate down by 2 or 3 basis points a year. Over the last 3 or 4 years, it's only been about 1 basis point as we've been successful or we're historically successful at increasing price in certain categories where it was warranted based on the value that we bring. There are less of those opportunities at the moment. And that's why I think we're seeing the 2% lower discount rate -- 2 basis points lower discount rate. But again, the economics are good here. It's part of our strategy. This is something that we are driving as opposed to just happening to us at the end of the day. I actually have not really thought about where it might go net of incentives. It's not something that we have done. So that's not a statistics that I thought about quite frankly. The other thing is that as you do the calculation where you're just taking discount revenue divided by billings, you need to be mindful of GNS. So GNS is a terrific success story. It is driving additional business. It's increasing relevance of our network around the world. But as you know, in GNS, we get a percentage of the discount rates and not the full 2.5. That's impacting that calculation. It's probably the biggest impact on that calculation. But the economics of the GNS business are very good. As you know, we don't have credit risk and has very good returns on equity. So we shouldn't think about that ratio going down…

Okay, that's a wrap.

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