American Express Company (AXP) Q3 2013 Earnings Conference Call October 17, 2013 5:00 PM ET
Rick Petrino - Senior Vice President, Investor Relations
Jeff Campbell - Executive Vice President and Chief Financial Officer
Sanjay Sakhrani - KBW
Don Fandetti - Citigroup
Craig Maurer - CLSA
Ryan Nash - Goldman Sachs
Betsy Graseck - Morgan Stanley
Moshe Orenbuch - Credit Suisse
David Hochstim - Buckingham Research
Bill Carcache - Nomura Securities
Sameer Gokhale - Janney Capital
Bob Napoli - William Blair
Mark DeVries - Barclays
Ladies and gentlemen, thank you for standing by and welcome to the American Express Third Quarter 2013 Earnings Call. At this time, all participants are in a listen-only mode and later, we will conduct a question-and-answer session with instructions being given at that time. (Operator Instructions) As a reminder, today’s conference is being recorded.
I would now like to turn the conference over to your host Mr. Rick Petrino. Please go ahead sir.
Thank you. Welcome. We appreciate all of you 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 based on management’s current expectations and are subject to risks and uncertainties. Factors that could cause actual results to differ materially from these forward-looking statements 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 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 third 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 Jeff Campbell, Executive Vice President and CFO 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. Once Jeff completes his remarks, we will move to a Q&A session.
With that, let me turn it over to Jeff.
Well, thanks Rick and good afternoon everyone. I am excited to be here on my first quarterly earnings call with American Express since joining the company on July 15 and listening as Dan Henry managed the Q2 earnings call later that week. I am also excited to have my first earnings call be one where we have such solid results to discuss. Our performance during the quarter produced strong EPS growth built upon improved billed business and revenue growth trends, a continuation of excellent credit performance and disciplined control over operating expenses. During the quarter we also made a number of strategic announcements which I’ll discuss later on the call.
To begin with the summary you can see on slide 2, FX adjusted growth in billed business of 9% is the primary driver of our FX adjusted revenue growth rate of 7%. This FX adjusted revenue growth rate is the highest we have seen this year and helped us grow net income by 9%. Our strong capital position allowed us to continue our share repurchase efforts which cumulatively resulted in our average shares outstanding declining by 5% versus the prior year. The combination of our solid operating performance and strong capital position drove our earnings per share to a $1.25 which was up 15% versus the prior year. These results helped to bring our ROE for the period ending September 30 to 24%. As a reminder ROE is calculated on a rolling full year basis. So this quarter will be the last one to include the impact of the three previously announced items we experienced in Q4, 2012.
Excluding these items the adjusted ROE for Q3, ’13 is 27%. We feel good about this improved performance especially considering the continued moderate pace of the economic recovery. Now focusing first on our billed business, loan and revenue performance. You can see on slide 3 that billed business growth remained healthy across all of our segments as it increased sequentially from 8% to 9% overall on an FX adjusted basis we continue to see particularly strong performance in GNS which grew by 16% year-over-year on an FX adjusted basis. GNS volume growth in Asia including China and Japan remained particularly strong. Also worth noting was that corporate card billings growth improved to 7% on an FX adjusted basis from 5% in Q2 as we lapped the slowdown in corporate spending that we saw beginning with the second half of 2012.
Looking at billed business growth by geographical region on slide 4, you see the growth rates accelerated slightly across all regions sequentially versus the second quarter. Of particular note here is that EMEA FX adjusted growth improved to 8% during Q3 which is the highest growth we have seen in that region since 2011.
Turning to loans we continue to see modest growth in loan balances as shown on slide 5. Worldwide loans grew by 2% versus the prior year. Our growth rate in loans in the U.S. was 3% which continues to outpace the industry average. Now I would remind you that our loan growth is really an outcome of our continued focus on and growth in our spend-centric customer base and it's not necessarily an objective in itself. Putting it all together on the revenue side you see on slide 6 that overall revenue growth was 6% on a reported basis and on an FX adjusted basis accelerated from 4% in Q2 to 7% in Q3.
Consistent with our spend-centric model this revenue growth was driven primarily by higher discount revenue from increased spending volumes. Secondarily, revenue growth was aided by net interest income increasing by 9% versus the prior year as we experienced lower funding costs along with the increase in average loan balances. Probably also worth calling out that the 5% increase in travel commissions in fees growth looks like a significant uptick from Q2 where we saw a 5% decline. Both of these year-over-year changes however where impacted by the timing around the re-signing of certain supplier contracts.
Turning to the provision, overall our credit performance remains excellent and helped provide us the financial resources we need to continue to grow the business. Looking at the metrics highlighted on slide 7, you see that worldwide lending write-off rates which were already at historically low levels declined further during the third quarter and also remained best-in-class. Our strategy to focus our lending acquisition efforts on premium lending products continues to help attract lower risk card members into our franchise. While we would expect that lending write-off rates will eventually increase from today’s historically low levels, we will also see on Slide 7 that we have not yet seen any signs of credit deterioration overall as total delinquency rates remained consistent with the prior quarter.
Slide 8 shows that our lending reserve coverage levels also remained relatively consistent with the prior quarter. We believe that our coverage levels remain appropriate given the risk level inherent in the portfolio.
Finally, as you can see on Slide 9, despite the improvement in write-off rates, our provision was slightly higher than prior year as decreased write-offs in the current year were more than offset by higher volumes and a lower level of reserve releases.
Turning now from the revenue side to the expense side, as you can see on Slide 10, total expenses grew by 5% versus the prior year. As you would expect, growth rates differed across the various expense lines as we prioritized our spending across the business. At a high level, you see a few things in these lines. The year-over-year growth in rewards expense was relatively consistent with our billed business growth during the quarter, while card member services was relatively flat. We continue to show good control over operating expense, which I will come back to in a minute. All of this is aimed at providing the ability to invest in growth, which primarily though not completely flows through the marketing and promotion line while still seeking to achieve our financial targets. And as I mentioned, we do remain very focused on controlling operating expenses to make our business more efficient and provide additional resources for growth initiatives.
Slide 11 shows you some of the detail of our operating expenses for the quarter. Most importantly, from a recurring perspective, salaries and employee benefits expenses were up only 2% versus the prior year demonstrating our strong controls in this area. While total operating expense growth of 4% was higher than what we have seen earlier this year, this was due in part to some choices we made to increase investments in technology as well as some costs we incurred associated with the two transactions we announced during the quarter, the potential Business Travel joint venture and the sale of our Publishing business.
So while growth rates can fluctuate in any given quarter, our year-to-date operating expense performance is flat versus the prior year and remains well below our annual target as shown on Slide 12. We remain confident in our ability to have operating expenses grow by less than our 3% target for the full year. It is also important to point out that these results reflected many of the benefits of the reengineering actions we announced earlier this year, which has helped us continue to proactively adapt and strengthen every aspect of our business as well as allowing us to address changes in customer preferences towards online and mobile servicing in particular.
In my first month at American Express, I would further say that one of the things that I have been particularly impressed with is the company’s ability to achieve our reengineering and cost targets while not just maintaining, but actually improving the level of service provided to our customers. In addition, we have been able to achieve these results while funding growing investments in our critical control and compliance efforts. As a result of all these improvements, customer service remains a key competitive differentiator for American Express as evidenced by the announcement last month from our winning our seventh consecutive J.D. Power award for achieving the highest customer satisfaction in the U.S. credit card industry.
So to come back to the prioritization we do across all our expenses, during the third quarter, we were able to deliver excellent financial results while still funding substantial investment opportunities. As we think about these investment opportunities, we balance our mix of spend between shorter and longer term horizons as well as between traditional versus newer opportunities. As you would expect the largest portion of our investment dollars targets the significant opportunities we see in our existing card businesses. In the U.S. as well as around the world given our focus on international growth for the past several years. These initiatives include card and merchant acquisition, building loyalty with the existing card members and the expansion of our GNS business. Many of these initiatives were the drivers of our marketing and promotion expense growing by 8% versus the prior year which put us at a higher level than we have seen in recent quarters as you can see on slide 13.
We continue to see many attractive opportunities in the marketplace including those for new customer acquisitions. In particular we believe that there continue to be significant opportunities to grow our volumes around the world by acquiring new charge and premium lending prospects on our products. Our solid control over operating expenses is helping us to fund these efforts. But I also want to remind you that while a significant amount of our investments are still included within the marketing and promotion line overtime an increasing percentage of our key investments are occurring within operating expenses including expansion of our merchant and corporate sales force, technology development and enhancements to our control and compliance activities. It's also worth noting that we continue to invest in and see great progress in expanding our network business around the world. Our new partnership with Wells Fargo which we announced in August clearly illustrates the value that other see in our global network as well as the potential opportunities we have to grow the network business both internationally and in the U.S. As I said earlier we also target a portion of our investments for longer term opportunities including many initiatives in the digital space that we believe are attractive opportunities but that will take longer to pay back.
Two of our larger efforts in this area are around reloadable prepaid, our products that help you move and manage your money which we extensively discussed at our recent financial community meeting as well as our loyalty partner rewards coalition program. On the former we were pleased last week to announce the relaunch of the certain product. And on the latter we continue to see the number of customers in our loyalty partner rewards coalition programs growing nicely. Both of these efforts along with our many other digital initiatives we believe provide potential new opportunities for growth over the longer term.
So turning now to capital, our strong capital position and the sizeable amount of new capital we generate through net income each quarter provide significant flexibility. This allows us to balance the capital needs in our businesses, our desire to maintain strong capital ratios and the potential for significant capital returns to our shareholders. The benefits of our strong capital position were on display this quarter as we returned 86% capital generated to shareholders while still maintaining the capital ratios you can see on slide 14.
We’re of course working hard on the planning for our 2014 CCAR submission and are continuously improving and evolving our process. We remain committed to maintaining our strong capital position while also leveraging that strength to create value for our shareholders, part of our commitment to maintain strong capital position has been working to evolve the mix of our funding sources which you can see on slide 15. We have worked hard to improve the diversity of our funding sources by driving a significant increase and the contribution from deposits. We have seen excellent traction in the growth of our personal savings direct deposit program and deposits now makeup over 40% of our total funding.
Overall our liquidity position remained strong and we continue to hold enough cash to cover our next 12 months of funding maturities. Given today’s political climate as I will come back to it at the end. It's probably also worth noting that the majority of our cash is held on deposit with the Fed, and our direct holdings of treasuries constitutes less than 1% of our liquid assets. Turning to other events of the last quarter let me make just a few comments on the two other announcements we made. First, in September, we announced plans to create a joint venture designed to accelerate the transformation of our Global Business Travel division. American Express has a long history in business travel. And we believe this proposed joint venture would create greater investment capacity for the business allowing it to further enhance its suite of products and services, attract new customers and grow internationally to deliver additional value to customers. This should all serve to strengthen the linkages with our corporate card and other businesses. We will plan to update you with more information about the proposed transaction and its financial impact as we progress towards a potential closing date, which we currently estimate will be Q2 2014.
On a much smaller scale, we also announced in September the sale of our Publishing business to Time Inc. and this transaction closed in early October. Publishing constitute a relatively small percentage of our revenues and earnings during the past several years. It did however provide a valued benefit to our customers, card members. So while banking regulations will limit our ability to engage in non-financial activities, our operating agreement with Time will help ensure a seamless transition. From a financial perspective, the Publishing business will no longer be reflective in our financial statements beginning in Q4.
Before I conclude, I feel it’s only prudent to add a few comments regarding the government shutdown and debt ceiling as we all watch by the hour what is happening in DC. We have not yet seen any direct impact on our business here at American Express, but we are not immune from the broader economies in which we operate, no one is. Now, as we started this call, it looks like our leaders in DC are finally coming to an agreement in both the Senate and the House. Resolving the stalemate is critically important. The alternative is now come that would erode consumer confidence and jeopardize a still uncertain economic recovery.
So in summary, coming back to our results, we feel very good about our overall performance in the current economic environment. During the quarter, we saw modest improvements in billings growth across all regions. We also saw improved revenue growth, which then combined with best-in-class credit metrics, discipline on controlling operating expenses and a strong capital position to generate healthy earnings growth. Our financial strength allowed us to achieve this growth while still investing in the growth opportunities we currently see in the marketplace. Looking forward, we continued to believe that the flexibility of our business model enables us to deliver significant value to our shareholders.
With that, I will turn the call back to the operator for your questions. I would ask that you limit yourself to one question with one follow-up, so that we can ensure we give as many people as possible the chance to participate. Operator?
Earnings Call Part 2: