American Express Company (AXP) Q2 2013 Earnings Conference Call July 17, 2013 5:00 PM ET
Richard Petrino – Senior Vice President, Investor Relations
Daniel T. Henry – Executive Vice President and Chief Financial Officer
Jeffrey C. Campbell – Interim Chief Financial Officer
Craig Maurer – CLSA Limited
Sanjay Sakhrani – Keefe, Bruyette, & Woods, Inc.
Bill Carcache – Nomura Securities International, Inc.
Brian D. Foran – Autonomous Research
Richard B. Shane – JPMorgan Securities LLC
Kenneth Bruce – Bank of America Merrill Lynch
Ryan M. Nash – Goldman Sachs & Co.
Donald Fandetti – Citigroup Global Markets Inc.
James Friedman – Susquehanna International Group, LLP
Mark C. DeVries – Barclays Capital, Inc.
Chris Brendler – Stifel, Nicolaus & Co., Inc.
Bradley G. Ball – Evercore Partners Inc.
Ladies and gentlemen, thank you for standing by and welcome to the American Express Second Quarter 2013 Earnings Call. At this time, all participants are in a listen-only mode. Later there will be an opportunity for questions. (Operator Instructions) As a reminder, this conference is being recorded.
And I would now like to turn the conference over to your host, Senior Vice President Investor Relations, Mr. Rick Petrino. Please go ahead.
Thank you. Welcome and thank you for joining us for today’s call. 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 and earnings supplement, which were filed in an 8-K report and in the Company’s 2012 10-K and Q1 2013 10-Q already on file with the SEC.
The discussion today also contains certain non-GAAP financial measures. Information relating to comparable GAAP financial measures may be found in the second quarter 2013 earnings release, earnings supplement and presentation slides, as well as the earnings materials for prior periods that may be discussed, all of which are posted on our website at ir.americanexpress.com. 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 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.
Before I turn the discussion over to Dan, I did want to acknowledge that this will be Dan’s last earnings call as our CFO. He will be leaving Amex after a distinguished 23 year career, including the past six years as CFO, where he has played an important role in building relationships with the investment community.
On behalf of all of my colleagues throughout the finance organization, I want to sincerely thank Dan for his many contributions and to wish him the best of luck on his retirement.
I also want to recognize that Jeff Campbell is joining us on the call today. Jeff joined Amex from McKesson Corporation where he was Executive Vice President and CFO of the largest healthcare services company in the U.S. Jeff will be assuming CFO duties in early August after we file our second quarter financial results and are we are excited to have him as part of American Express.
And with that, let me turn the discussion over to Dan.
Daniel T. Henry
Okay. Thanks, Rick. So I’ll start on slide two, the second quarter 2013 summary of financial performance slide. Total revenues came in at $8.2 billion. That’s 4% higher than a year ago. On an FX adjusted basis it’s also 4%.
In the first quarter, the growth rates were 4% on a reported basis and 5% on an FX adjusted basis. I will speak about the impact of cardmember reimbursements on revenue growth a little later.
Net income came in at $1.4 billion, 5% higher; EPS is $1.27, 10% higher as you can see the benefit of our share buyback program. And on the last line you can see that shares outstanding are declining.
Return on average equity was 24% in the second quarter. Without the three adjustments in the fourth quarter of 2012, as this is a 12-month rolling calculation, ROE in the second quarter of 2013 would be 27%.
Moving to slide three, our metric performance; billed business came in at $237 billion. That’s 7% higher or 8% higher on an FX adjusted basis. That compares to the first quarter when we grew at 6% reported and 7% FX adjusted. So this quarter it’s about 100 basis points better growth rate than the first quarter.
Total cards in force are $104 million. That’s a growth of 4%. Proprietary cards grew 2%, which is comparable to what we’ve seen in recent quarters.
Average basic cardmember spending is $4,097 in the quarter. That’s up about 4% and reflects the continued strong cardmember engagement that we have seen. Cardmember loans are $63 billion. That’s an increase of 3%, 4% on an FX adjusted basis and reflects continued modest growth in loans.
Moving to slide four, this is billed business growth by segment on an FX adjusted basis. So total billed business, the red line, you can see the growth rate increased from 7% in the first quarter to 8% in the second quarter. Both ICS, which is International Consumer, the light blue line and GCS, Global Corporate Services, the green line, increased by about 100 basis points.
GNS, the yellow line, increased from 12% in the first quarter growth rate to 17% growth in the second quarter, driven by continued strong growth in Japan and accelerated growth in China and Korea due to new partners and product launches. Markets like China have high growth and are strategically important.
Moving to slide five, so this is billed business growth by region. So the U.S., the dark blue line, growth is 7% consistent with the first quarter. EMEA, the light blue line and LACC, the yellow line, both have increased their growth rate compared to the first quarter. EMEA is growing at 6% and LACC at 10%. JAPA, the green line, increased from 9% growth to 13% growth driven by Japan, China and Korea.
So before I leave this regional section, let me just comment on EC draft proposal that has been in the news today. We put out a press release earlier today based on how the preliminary report has been characterized to us and we made a number of points. First, the publication of the formal proposal by the commission will start a lengthy legislative process and review period. We expect these proposals to prompt extensive debate among many market participants.
The proposals focus primarily on and cap interchange fees charged by four-party payment systems, such as Visa and MasterCard. The discount rate that American Express charges to merchants would not be regulated. Our proprietary consumer and corporate card businesses are not covered by the pricing caps.
Three-party systems, such as American Express, would only be covered when they license other institutions to issue cards, as in our Global Network Services business. GNS represents a relatively small percentage of our European business. The provisions that focus on separating the payment network and processing functions do not appear to impact proprietary networks like ours.
Given the potential impact on consumers and competition within the European payments sector, American Express has been in touch with senior policy makers at the Commission and will continue to represent its positions vigorously throughout the process.
Now, let me be more specific what we mean by GNS represents a relatively small percentage of our European business. EMEA represents about $100 billion of billed business in 2012. GNS billed business in European Union markets are less than 15% of total EMEA billed business.
On page 110 in our Annual Report in footnote number 25, EMEA pre-tax income for 2012 was $505 million. GNS European Union pre-tax income was approximately 12% of EMEA pre-tax income in 2012. So I just wanted to dimensionalize that further for you. There are many aspects to the EC draft proposal. They will play out over time. Some will impact us directly, some will impact us indirectly. We are accustomed to changing business environments and reacting to them in an appropriate manner and we will do the same in this situation.
So let me go to slide six. So this is U.S. Consumer Card loans. So the bar represents U.S. cardmember loans and they totaled $54.6 billion in the second quarter of this year. We have a growth rate of 4% and that’s the same as the past two quarters. As I mentioned before, worldwide loans grew 3% and 4% on an FX adjusted basis. The 4% loan growth is driven by growth in billed business. Loan growth is about half the rate of growth in billings on our lending products.
Net interest yield, which is at the bottom of this chart, is up 10 basis points compared to the second quarter of 2012. It is down sequentially from the first quarter of 2013, which included a reserve reversal for cardmember reimbursements that have been set up in prior periods. As you’ll see in a minute, our credit performance continues to be excellent. But let me comment on interest rates, which have been the focus area in the industry before I move to the next slide.
As disclosed in our 10-K, 100 basis point immediate increase in all interest rates would reduce the Company’s net interest income by approximately $220 million over a one-year period. Historically, an increase in long-term rates generally has a minimal impact on our business. However, movements in short-term rates impact earnings. The impact is primarily driven by the fact that we fund a portion of charge card receivables and transacting loan balances, which should not have interest rate revenue streams with variable rate debt. However, historically in rising interest rate environments has also coincided with strong billings and revenue growth.
So let me move to slide seven, revenue performance. But before I go, do a review of the individual P&L line items, I want to touch on cardmember reimbursements, which is driven by our continuing commitment to proactively review card practices, identify any issue and remediate them quickly. In both the second quarter of 2013 and second quarter of 2012 these efforts resulted in costs that impacted year-over-year variances on some of our P&L lines. The overall cost related to this work was similar in both this quarter and the second quarter of 2012. However, in the current quarter most of the reimbursements were recorded in revenue reducing revenue.
Therefore the revenue growth rate in the second quarter of this year, which was 4% on both our reported and FX adjusted basis, would have been 5% on an FX adjusted basis excluding the impacts of the cardmember reimbursements, same as the first quarter of 2013. A year ago most of the costs were reported in operating expense. The operating expense growth rate in the second quarter of this year is lower due to the reimbursement costs incurred in the prior year. And I’ll provide more detail on adjusted operating expense on slide 13. We’ve also included a reconciliation of the adjustments in Annex 9.
We continue to place a premium on self identifying and resolving any customer related issue and we clearly believe that this is the right thing to do for our customers.
Now let me go through the specific line items on slide 7. Discount revenue increased 6%, reflecting 7% growth in billed business, partially offset by a decrease in discount rate and faster growth in GNS billings than the overall Company billings growth rate. The discount rate is 2.52% in the second quarter of this year, down 2 basis points from the second quarter of 2012 and flat with the first quarter of 2013.
Net card fees increased 5%, as we had higher average fees per card due to fee increases, also due to the increase in the number of proprietary Cards-in-force, and a greater mix of premium products.
Travel commissions and fees decreased 5%, driven by a 1% decrease in worldwide travel sales and lower supplier revenues due to the timing of certain contracts.
Other commissions and fees are up 5% due to slightly higher late fees and foreign currency conversion revenues.
Other revenue is lower by 13%, due to cardmember reimbursements in the second quarter of this year, which I discussed a minute ago, as well as the benefit in second quarter of 2012 related to a revised estimate of the liability for uncashed Travelers Cheques.
The second quarter of 2013 includes a gain of $36 million related to the sale of ICBC shares. The second quarter of 2012 had a gain of $30 million related to the sale of ICBC shares.
Net interest income increased 7% compared to the second quarter of 2012 reflecting a 3% increase in average cardmember loans. Lower funding costs on the charge card portfolio and an increase in the worldwide net interest yield to 9.1% from 9% a year ago. In the second quarter of 2013, our international consumer segment included the impact of some cardmember reimbursements.
Moving to slide eight, provisions for losses, the Charge Card provision is $38 million or 23% higher than the second quarter of 2012 and this reflects the fact that we have higher receivables up about 6% year-over-year, slightly higher write-offs and a slightly lower reserve release which was $24 million this year compared to $32 million last year.
Cardmember loan provision increased $78 million or 31% reflecting lower reserve releases, this year it was $25 million and last year it was $133 million. So this is the primary driver of the higher provision expense. That was somehow offset by lower write-offs in the second quarter of this year, which were $348 million and that compares to the second quarter of 2012, write-offs of $370 million. So provision is increasing while credit metrics remain stable or improved slightly as we’ll see on the next slide.
So slide nine, our lending credit metrics, on the left side of the chart you can see that we continue to have excellent write-off rates at historically low levels of 2%. On the right side is the 30-day past due, which is also stable or slightly improving and again these are historically low numbers. As I say each quarter, our objective is not to have the lowest possible write-off rate, but to achieve the best economic gains when we invest.
Moving to slide 10, so these are our lending reserve coverage metrics and you can see that reserves as a percentage of loans and principal months coverage are lower in the second quarter of this year compared to the first quarter of 2013 and the second quarter of 2012, as our credit metrics continue to either be stable or improving.
Reserves as a percentage of past due are slightly higher than the first quarter as delinquency rate has improved this quarter compared to the first quarter. Our reserves in these metrics are appropriate to the risk in our portfolio.
So I’ll move to slide 11, which is expense performance. So total expenses improved or grew rather 1% year-over-year. Marketing and promotion increased 2% compared to last year and represents 9.5% of revenues, and I'll cover this in more detail on the following slide.
Cardmember rewards reflect higher spending volumes on co-brand and membership reward products. The membership reward ultimate redemption rate is 94% and that's comparable to the ultimate redemption rate that we had in the first quarter. Cardmember services reflect enhanced benefits on our premium card products.
Total operating expense decreased 4% reflecting strong expense control as well as cardmembers reimbursement costs in Q2 2012. And I’ll cover this on another slide as well.
Our effective tax rate for the second quarter of 2013 was 29.6% reflecting the resolution of certain prior year tax items, while discrete tax items lowered the tax rate in both the second quarter of 2013 and 2012 to be below 30%. Over the past three quarters our tax rate has been 32% or 33% in each of those quarters.
So I’ll move to slide 12, so this is marketing and promotion expense as a percentage of managed revenues. So marketing expense in the second quarter of this year was $786 million compared to $773 million in the second quarter of 2012. As you can see on the right side of the chart, the second quarter was 9.5% of revenues and on track to achieve 9% growth for the year or potentially slightly higher. We continue to invest in our business despite the slow growth economy.
Moving to slide 13, so this is operating expense performance, so total operating expense is 4% lower year-over-year, salaries and benefit is flat year-over-year and this reflects some of the benefits from the restructuring that we announced in January.
Employee count is 1,300 lower than in the second quarter of 2012. Employee count in the first quarter decreased to 1,100 compared to year-end 2012, but picked up slightly by 200 in the second quarter. We estimate employee count at year-end 2013 will be 4% to 6% lower than the year end 2012.
Professional services increased reflecting higher technology development and other net decreased 48% reflecting 89 million more in cardmember reimbursements in the second quarter of 2012 compared to the second quarter of 2013. And you can see this on Annex 9. The second quarter of 2012 also included an asset impairment. The second quarter of this year includes the Canadian value added tax benefit that lowered other net expenses.
So, moving to slide 14 – so, this chart shows the adjusted operating expense growth over the past three years. In 2013 and 2014 our target is to grow operating expense at less than 3% each year. You can see the first quarter grew at 1% and while the second quarter decreased 4% after adjusting for the cardmember reimbursements I just discussed, the second quarter of 2013 would have been a reduction in year-over-year expense of 1%. So we were on track to achieve our target of less than 3% annual growth in operating expense for this year.
Moving to slide 15, so, this is adjusted expense as a percentage of managed revenue, and this excludes credit provision. In 2012, we committed to migrate this ratio over time back towards historical levels in two ways; first through revenue growth; and second, controlling operating expense while continue to invest in the business.
In 2012, in those bars the dotted line is excluding the restructuring charge in cardmember reimbursements that we have had in the fourth quarter of 2012.
As you can see on the chart, we are making substantial progress in reducing adjusted expense as a percentage of managed revenue. Well both the first quarter and the second quarter of 2013 round to 69%, the second quarter ratio is actually slightly lower than the first quarter, if you carry without one more decimal point.
Slide 16, so these are our capital ratios. In the second quarter of 2013 our Tier 1 common ratio is 12.5%. In the quarter, we generated $1.7 billion of capital, $1.4 billion from net income and $300 million from employee plans. We also distributed $1.7 billion in capital, $1.4 billion through share buybacks and $300 million in dividends. Risk weighted assets increased slightly due to higher receivables.
The Basel III implementation from Basel I would have reduced Tier 1 common by 30 basis points, but I would remind you that we have not yet implemented Basel III advanced approach.
So there has been much conversation about the new supplemental leverage calculation. So the Tier 1 leverage calculation for us as you can see on the chart is 10.5%. If it is the calculation in the second quarter on a leverage supplementary level basis, it would be 8%, well above the required level of 3%. So our Tier 1 common ratio and leverage ratio provides the Company with a strong capital position.
So moving to slide 17, so this is our payout ratio. So our share repurchases are governed by our performance, and our CCAR submission in January 2013. Our plan for 2013 is to repurchase $4 billion. The $1.4 billion in repurchases in the second quarter is consistent with our CCAR submission in January.
Moving to slide 18, so this is our U.S. retail deposit balances. So the U.S. retail deposit activity in the quarter, you can see decreased slightly. Our overall funding strategy is to utilize unsecured, securitizations and deposits. In the second quarter we issued $2 billion of unsecured debt. Therefore we did not need to increase deposits. Therefore we decreased deposits slightly. However, within deposits we continue to grow direct deposits by $1.2 billion to $23.1 billion, while third-party CDs and sweeps decreased slightly.
On the liquidity front, we continue to hold excess cash and marketable securities to meet our next 12 months of funding maturities. As of June 30 we had $15.4 billion in excess cash compared to funding maturities of $14.4 billion over the next 12 months thereby meeting our objective.
So with that let me conclude with a few final comments. We continue to feel positive about our performance, especially given the relatively slow growth in the economic environment. In the quarter our spending growth continued to be healthy and was relatively consistent with the past several quarters.
In addition we did see some improvements in our growth rate internationally. We also saw our average loans continue to grow modestly year-over-year and outpace the industry. Loan growth and slightly lower funding costs led to a 7% increase in net interest income. At the same time lending loss rates remain near all-time lows.
Revenue growth was 4%. We continue to consistently grow revenues despite the slow growth environment, and in this quarter the negative impact of cardmember reimbursements. In the quarter operating expense decreased by 4% first year reflecting the strong expense control as well as higher cardmember reimbursements cost in the prior year.
We are clearly off to an excellent start with our aim of having operating expense growth at an annual rate of less than 3% over the next two years. We’re also continuing to invest in the business as marketing and promotion and technology development spending both increased versus prior years. These investments are driving higher average spend and growth in our cardmember base while continuing to build capabilities for the future.
Second quarter EPS were $1.27 represents an all-time high, but this benefit from a lower tax rate than recent quarters. EPS growth rate of 10% outpaced revenue growth reflecting the progress we have made on improving operating leverage and our strong capital position. We continue to return significant capital to shareholders in the quarter through dividends and buybacks while maintaining strong capital ratios.
We’ve recognized that our business is not immune to the economic environment, but we continue to believe that the flexibility of our business model enables us to deliver significant value to our shareholders even in a slow growth environment.
So with that, let me turn it over to Jeff Campbell for a few remarks.
Jeffrey C. Campbell
Well, thank you Dan and good afternoon everyone. I am excited to have joined American Express this week, and I will look forward in the coming months to spending time with many of you on the call, and to continuing the strong legacy of performance that Dan’s leadership has helped to create here at American Express. So with that Rick?
Thanks, Jeff. Okay, so we are going to start the Q&A just before we kick it off, I do want to ask everybody as a courtesy to all those who do want to ask a question, that we strongly encourage you to limit yourself to one question and one follow-up, so we can get as many folks on the call as possible. And with that, let’s open up the lines for questions.
Earnings Call Part 2:
- Q&A with American Express Company CEO