Welcome to the American Express fourth quarter earnings call. (Operator Instructions) I’d now like to turn the conference over to our host, Senior Vice President of Investor Relations, Ronald Stovall. Please go ahead.
Welcome to everyone. We appreciate all of you joining us for today’s discussion. It is my job, as usual, 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, 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 included in 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 2007 10-K report already on file with the Securities and Exchange Commission.
In the fourth quarter 2008 earnings release, supplement and presentation slides which are now posted on our website at www.ir.americanexpress.com and on file with the SEC in an 8-K Report, we have provided information that describes the company’s managed basis and other non-GAAP financial measures and the comparable GAAP financial information and we explain why these presentations are useful to management and to investors. We urge you to review that information in conjunction with today’s discussion.
Kenneth Chenault, Chairman and Chief Executive Officer of American Express will provide some brief opening comments. Then Daniel Henry, Executive Vice President and Chief Financial Officer will review some key points related to the quarter’s earnings through the series of slides included with the earnings document provided and provide some brief summary comments.
Once Daniel completes his remarks, we will turn to the moderator who will announce your opportunity to get in to the queue for the Q&A period where both Kenneth and Daniel will be available to respond to your questions. Up until then no one is actually registered to ask questions. While we will attempt to respond to as many of your questions as possible before we end the call, we do have a limited amount of time. Based on this we ask that you limit yourselves to one question at a time during the Q&A.
With that, let me turn the discussion over to Kenneth.
Thanks Ron. Before Dan reviews the details I wanted to say a few words about the economic environment, our results and the outlook for 2009. I believe and I think most of you would agree that this is one of the most difficult operating environments we have seen in decades. The housing market has continued to deteriorate, unemployment has risen significantly and retailers have seen some of the biggest declines in many years.
Now, as we all know, consumer confidence has dropped off the charts and corporations have acted quickly to pull back on their expenses. What we have also seen following the bankruptcy of Lehman Brothers in mid-September, the wholesale credit markets came to a virtual standstill as concerns about the underlying value of troubled assets eroded trust in the banking sector and spurred a series of new initiatives from Washington.
Now our results for the quarter were significantly impacted by this environment. Revenues declined as spending by consumers, small businesses and corporations slowed significantly. As you have seen from recent headlines the slow down was more pronounced among high end retailers and throughout the travel sector as our card members cut back on discretionary spending. Now, as expected we continued to see rising delinquencies and loan write offs.
These trends, together with the restructuring charge we took to reduce our cost base drove our earnings decline for the quarter. Clearly we are disappointed with our overall results. Nevertheless, despite the environment there are a number of developments we can point to that show progress against our near-term priorities which are staying liquid, staying profitable and investing selectively to strengthen our competitive position over the longer term.
First, we continued to remain solidly profitable in the fourth quarter and generated $2.8 billion in earnings in 2008. Next, our spending declines while significant compared favorably to major competitors in the industry particularly in view of the overall cutbacks in travel and discretionary spending in the latter part of 2008. Very importantly average card fees and discount rates which generate two of our largest revenue streams were virtually unchanged reflecting the ongoing value that card members and merchants see in working with Amex.
Now this is in contrast to the pattern you have seen in much of the retailing industry. We are not cutting our premium prices in order to generate business volumes and I believe this is a very good indication of the underlying strength of our franchise. We have stepped up re-engineering efforts for which we took a significant restructuring charge in the quarter and we have already begun to reduce operating expenses which gives us additional flexibility as we move into 2009.
Now in terms of funding we are more than satisfied our requirements for the quarter and we have broadened our sources to include a retail certificates of deposit program that we launched in October. Since then we have been able to generate $6.2 billion from a standing start which I think is very strong evidence of the drawing power of the Amex brand.
For the longer term we continue to invest selectively in the business, strengthening our partnership with Delta Airlines in the quarter, continuing to build our global business with banks, to issue cards on the Amex network and successfully integrating the corporate card business we purchased from GE earlier in the year.
Beyond these specific business items, as you know we converted to a bank holding company in the fourth quarter. This means that we will be regulated by the Federal Reserve and it aligns us more closely with other financial services companies. In January we bolstered our capital position and we added $3.4 billion as part of the TARP program. Now this additional capital will enhance our ability to extend loans to credit worthy card members, thereby helping to spur economic growth in the U.S.
Looked at from the perspective of our charge card portfolio we authorized about $73 billion in spending from consumers, small businesses and corporate card members in the quarter. On the lending side our open credit lines were on par with last year despite the difficult conditions in the marketplace. Our aim here is to accommodate card members’ spending needs while helping to ensure that they don’t incur debt levels that are inappropriate for the current environment.
As you know, throughout the past year we were very cautious about the economic outlook. That certainly continues to be the case today and looking ahead we expect difficult economic conditions to continue through 2009. As we said last quarter card member spending in this environment is likely to remain very soft and we continue to expect past due loans and write offs to rise from current levels.
Our strategies for 2009 remain focused on keeping liquid, staying profitable and investing selectively to strengthen our franchise and remain in position to capitalize on opportunities when conditions improve.
We continue to believe in the long-term growth potential of the banking sector and that the investments we are making in our business including the business-to-business sector which is less reliant on credit will help ensure we can capitalize on those opportunities when the environment improves.
With that let me now turn things over to Dan.
Thanks Kevin. Let me start on slide two. Total revenues net of interest expense were $6.5 billion, 11% down from 2007. It was negatively affected by foreign exchange. On a foreign exchange adjusted basis it would have been down 7%. Income from continuing operations was $238 million. Diluted EPS from continuing operations came in at $0.21. Our ROE was 21.7%. This is a 12-month rolling average and it benefits from the stronger earnings earlier in the year.
All of these top line results reflect the current environment as well as certain significant items in each period. When we look at slide three we see these significant items. First for the fourth quarter of 2008 is the re-engineering charge of $273 million on a net income basis. Pre-tax it is $404 million. When we announced the restructuring reserve in October we estimated it would be between $370-440 million so we are within the range.
Next relates to Delta. In signing the new contract with Delta we agreed to reimburse them at a higher rate for membership rewards points that are converted to Delta miles and therefore we needed to re-price our reserve. It is $66 million on an after-tax basis, $106 million on a pre-tax basis.
In 2007 the fourth quarter included the Visa litigation settlement of $1.1 billion as well as additional business building, some litigation costs as well as a contribution to our charitable foundation. Net it had a beneficial impact on the fourth quarter of 2007 of $534 million.
2007 also included an enhancement in the way we estimate the ultimate redemption rate for membership rewards and resulted in a charge, after tax, of $430 million. In the fourth quarter of 2007 we also set up an additional credit related charge which had the impact of $274 million on the fourth quarter.
Let me take a minute on slide four and talk to some of the changes in reporting that you will see in the income statement. The first relates to interest income and the interest expense categories. Historically we showed interest income broken between card member lending finance revenue and other interest income. In the future we will show interest and fees alone, a second line, interest and dividends and investment securities and third deposits with banks and others.
In interest expense we previously broke interest expense between card member lending and interest on charge card and other. In the future we will show interest expense based on the source of the funding so we will show interest on deposits, short-term borrowings, long-term borrowings and other. In addition to that provision which previously was included in expense will now be moved up into revenues below the interest net of interest expense line and we will total to a total revenue net of interest expense after provision for losses.
I would also note that previously we had a line which was marketing promotions and card member services. Many of you will be pleased to know now we are going to break this into three lines which will be marketing and promotions, card member rewards and card member services. In the past we had called line item salaries and benefits or I guess we called it human resources which would now be called salaries and benefits. In addition there will be an impact on some of our metrics. It has always been our policy for charge cards to write off at 360 days. Bank holding company guidelines require us to write off at 180 days. So in the fourth quarter we are moving U.S. card services to a 100 day write off. If you were to look at the tables attached to the press release on pages 14-19, you will see write offs in the fourth quarter totaled $669 million. That includes $341 million which is the effect of moving us from 360 up to 180 days.
On those tables you should also see that the loss reserve coverage as a percentage of receivables is 2.5%. In the third quarter it was 3%. We have not gone back and restated prior periods. If we had continued the 360 day write off that ratio actually would have been 3.5%. So the increase in the third quarter to the fourth quarter reflecting our metrics in the fourth quarter.
As it relates to the international consumer as well as commercial card we will move those products to 180 days in the future. There are also a number of credit reserve re-classes but they had a minor impact on our metrics.
Moving to page five and looking at metrics, billed business came in at $160 billion, down 10% from last year or 5% on an FX adjusted basis. These results are in line with the industry. Given our affluent base with a high level of discretionary spending as well as the amount of [T&E] within our base we thought we may in fact come in at a lower amount than competitors but that was not the case. Notwithstanding that billed business has dropped significantly, on an FX adjusted basis we actually grew 11% in the first quarter, 10% in the second quarter, 7% in the third quarter and now have dropped to a decline of 5% and this reflects the impact of the economy on billed business.
Notwithstanding these lower results compared to last year if you look at total billed business for the full year which came in at $683 billion is the highest annual amount we have had in our history.
Total cards in force have held up very well at 7%. That is 2% growth in our proprietary cards as well as a 22% increase in network partner cards. Average spend per card member as you can see is down 14% or 10% on an FX adjusted basis and this is really the story that has led to the decline in billed business. Transactions in the United States basically flat, down 1% and transactions are actually up 6% internationally so it reflects card members spending less per transaction.
Loan growth on a managed basis was 7% down more than our competitors. This reflects both the economy, the credit actions we are taking and the fact that we have lower amounts of balanced transfer than we have historically.
Moving to slide six. Discount revenue is down 11%. On a managed basis it was down 7% and was also negatively impacted by foreign exchange. A positive note is that our average discount rate only declined 1%. As we can see from net card fees we are up 6%. This reflects the premiumness of our brand in the marketplace. Within that interest and securitizations, securitization income was down 39% with the major impact being credit losses. Net interest was down 16% on lower loans and was also impacted by the prime LIBOR dislocation that happened in October, however the normal relationship of those two metrics are back to normal levels now in January. It also reflects the higher cost of liquidity.
Now let me move to slide seven. Here you can see total provision on a reported basis was up 3%. However as I noted before one of the significant items was the additional provision we made in the fourth quarter of 2007. We added $96 million to the charge provision in 2007, $288 million to the lending provision and $384 million to the total provision. If we were to back those numbers out of the 2007 column provision on lending would have increased 36%, charge would have increased 32% and the total would have been up 32%. That higher provisioning reflects the higher credit loss metrics that I will discuss in a few minutes.
Moving to slide eight I will discuss the metrics within our business unit. In USCS the metrics are very much in line with total company metrics. Billed business in the first quarter was up 11%, 8% in the second quarter, 6% in the third quarter and now down 9%. That reflects 12% decline in the consumer business and a 3% decline in small business. The 2% increase in cards in force reflect investments we have been making. Again, here billed business is being driven down by average spend. As I said, transactions in the U.S. were only down 1%. Average spend was down really across most card groups and spending levels. Card member loans are down for the same reasons that I cited a few minutes ago.
Moving to slide nine is the metrics for international consumers. The international consumer actually held up better than the U.S. in the fourth quarter. While billed business was down 14% on a reported basis, it was actually up 1% on an FX adjusted basis. If we look across all the regions on an FX adjusted basis it was flat in each of the regions. Again, average card member spend is what is the driving force behind the lower growth business. Card member loans were lower by 15% on a reported basis but up 4% on an FX adjusted basis.
Moving to slide ten, global commercial services metrics, here again we see a drop in the fourth quarter. On an FX adjusted basis commercial card billed business at $28 billion was down 5% in the fourth quarter on an FX adjusted basis compared to actually an increase of 7% in the third quarter. If we look at the fourth quarter, billed business in the U.S. was down 6% and internationally on a reported basis was down 18% but only 3% on an FX adjusted basis. Cards in force are up 4% as we continue to bring in new customers and here we have a similar story as it relates to average card member spend which was down 8% on an FX adjusted basis.
Moving to slide 11, GNMS, here we can see that in total the U.S. billed business was down 8% and actually was up 3% outside the U.S. on an FX adjusted basis. Within the U.S. retail and every day spending declined 6% and that represents about 74% of U.S. billed. Travel and entertainment declined 10%. As I noted before the average discount rate at 2.53% has held up very well only down 1 basis point from last year.
Global network services continues to be a good store. Billed business was flat on a reported basis but grew 11% on an FX adjusted basis. Cards issued by network partners that ride on our network increased 22%.
Moving to slide 12 we will look at expenses. Here are the significant items that I mentioned on slide three as having a notable impact on these line items. If I were to adjust the items that are listed on slide three if we look at marketing and promotion and adjusted 2007 for the $143 million of incremental spending we did as a result of the Visa settlement marketing and promotions would be down 21% year-over-year. If we look at card member rewards and we adjust for the $106 million of additional provision we made in 2008 related to the Delta contract and we made an adjustment to 2007 for the increase related to the enhancement in the ultimate redemption rate estimate of $685 million card member rewards would actually be down 10% in line with volume.
If we look at salaries, employee benefits and other operating expenses if we adjusted 2008 to back out the restructuring impact of $404 million and the $16 million for the engineering in 2007 and we also adjusted for the Visa litigation settlement as well as the litigation costs and contribution to the charitable foundation we would actually be down 7%. If we look at income tax and the benefit that we had in the period it is the result of the consistent level of recurring permanent tax benefits and the impact of that benefit where we have lower pre-tax income as well as benefits related to the finalization of our state tax returns.
Moving to slide 13 and looking at charge card net write off rate you can see that the results are pretty consistent over the year and have held up reasonably well. The fourth quarter on this chart does not include the $341 million write off moving from 360 day write off up to 180 day write off.
If we move to slide 14 and look at charge card net loss ratio for international consumer and the global commercial services you can see that the international consumer net loss is increasing reflecting somewhat higher loss rates across most companies most notably Mexico. Commercial card net loss rate has remained reasonably stable.
Moving to slide 15 the charge card 30 day past due amount we can see that the card charge in the U.S. past due is increasing slightly as we continue to control credit losses very well within the charge card portfolio.
If you move to slide 16, charge card 90 days past due for international consumer and global commercial card you can see that the write off rate for 90 day past due is increasing in international and that is really across all of the international markets and also increasing somewhat in the global commercial. Both of these reflect the environment we are experiencing.
If we move to slide 17 in the middle you can see that the international consumer write off rate is holding up pretty well so I will focus on the U.S. lending numbers. The write off rate of 6.7% is up dramatically from the 3.4% rate in the fourth quarter 2007. We have moved from being the lowest rate in the industry to the middle of the pack. Our write off rate has grown at about 100 basis points faster than the industry year-over-year and this reflects what we have discussed before that we have a higher percentage of small business than the competition, we have more affluent customers in California and Florida and we also grew at a faster rate over the past two years. If we look at this sequentially from the third quarter to the fourth quarter our increase is very much in line with the industry.
Our write off rate when you look at a comparison to competitors because we have a decline in loan balances there is actually a negative impact in our relationship because as loans go down it reduces the denominator and is therefore impacting the write off calculation. The last point I would make here is when we set our higher or provided an additional reserve in the second quarter of this year we anticipated write off dollars would be higher in the third or fourth quarter and in fact they have come in and played out very much as we had expected back in June.
Moving to slide 18 lending managed 30 days past due, here you can see that the 30 day past due continued to rise in the fourth quarter in USCS increasing by 80 basis points and this was really very much in line with industry increases. Based on this increase in the 30 day past due we would expect the first quarter 2009 write off will be higher than the fourth quarter of 2008 and the second quarter of 2009 will be higher than the first quarter of 2009.
Moving to slide 19 we can look at capital. Here for the full year 2008 in the right hand column you can see we generated $1.9 billion of capital over the year. If we look at the fourth quarter even with the restructuring reserves we generated sufficient capital to cover our dividends.
Moving to slide 20 these are our capital ratios. Capital to total managed assets and total tangible capital to total managed assets. You can see these metrics strengthened over the first three quarters. The drop in the ratio in the fourth quarter is largely due to a decrease in OCI or other comprehensive income within the equity section due to lower net security valuations and pension valuations. Each ratio improved at the end of 2008 compared to the end of 2007.
Moving to slide 21 we are providing the three key bank holding company ratios. These ratio calculations are preliminary and have not been reviewed by the regulators. These ratios are generally comparable to our competitors and above the well capitalized bench mark. Historically our capital has been in line with an A rated company based on discussions with the rating agencies and regulators and endorsed by the marketplace as we were able to issue long-term debt to fund our business.
Without TARP we may have needed or had a desire to increase our total risk based capital ratio. If we had done that we may have had to constrain the granting of credit. However, with TARP we do not believe this is the case. As Ken indicated a good indicator of this is the unused line of credit. While we have been reducing lines on customers we viewed as risky we were also increasing lines to our existing customers who were credit worthy and we were bringing on new card members. So in total we think the unused line of credit at the end of this year will be on par with the amounts that we had at the end of last year. TARP is enabling us to continue to provide credit to the marketplace.
If we move to slide 22 let me spend a few minutes talking about liquidity. This slide is the exact slide that we had in the third quarter call. In that call we had a column for 6 months as well as for 12 months. This is the 12 month column. During the fourth quarter we have significantly enhanced our liquidity position. As of the third quarter we were basically looking at short-term liquidity to help us bridge to our contingent funding sources such as the $5 billion ABS financing conduit that we had with seven banks. While it was a very sound plan it was contingent upon drawing upon the facilities that we had in place.
If we actually move onto slide 23 and look at the activity that is taking place in the fourth quarter you can see that we have ending excess cash of $13 billion and if you include the TARP $3 billion funds that we received on the 9th of January we would have $16 billion of excess cash which could be used to help meet the long-term debt that is maturing in 2009. So we are not relying on contingent sources any longer we now have excess cash and marketable securities in hand.
So how did we get there? Since we are not relying on short-term assets to bridges to our contingent facilities we reduced short-term obligations by $10 billion. This big news is that we have been able to raise $9 billion in retail CD’s as well as sweep accounts in the fourth quarter. Brokered CD’s increased by $6 billion. This is a program that we actually started at the beginning of the quarter and we increased sweep deposits by $3 billion. This demonstrates the power of our brand in the marketplace.
We also issued $6 billion under the temporary liquidity guarantee program so at the end of December 2008 we had $21 billion in cash. We need about $4 billion of that to meet our working capital needs and we would need about $9 billion of that to pay off our short-term obligations. So after doing those two things if we add in our liquidity investment portfolio which is held in treasuries we have $13 billion of cash on hand at the end of December including the $3 billion of TARP we received early in January.
As we move to the next slide 24 you can see that our 2009 long-term debt maturities totaled about $20 billion. Now if we were growing volumes and loan balances and AR were increasing we would have higher funding requirements than the $20 billion. In a weak economy with lower billed business and lower loan balances it is likely we will actually have lower requirements than the $20 billion and we have $16 billion on hand to address that.
If we move to slide 25 it is our plan as we move into 2009 to use the excess cash that we have on hand to likely issue under the TLG Program where we could issue up to an additional $7 billion and we plan to continue to grow our retail deposits. As I mentioned the average maturity on retail CD’s is about 20 months. I also note that we have already raised in deposits an additional $1.5 billion in the month of January.
We also plan to launch a new direct deposit program in the second quarter of 2009. So going forward it is our plan at the end of each quarter to have excess cash and marketable securities equal to the next 12 months of maturities. In addition to that we still have commercial paper program, we have access to the Fed TALP as well as the discount window and we have our committed bank lines. If the ABS or unsecured markets were to open we would access those.
With that let me conclude with a few final comments. Despite the effects of a particularly difficult economic environment and the restructuring charge we remained profitable for the fourth quarter and for the full year generating $2.8 billion of earnings from continuing operations. While throughout the quarter card member spending was under pressure our decline in spending compared relatively well to other major card competitors. In light of our proportionately greater level of corporate and consumer discretionary spend we feel good about the relative strength of our business activities.
As we expected credit indicators weakened further during the quarter against the backdrop of rising unemployment, continued declines in the housing sector and overall deterioration in global stock market values. As Ken outlined at the beginning of the call for 2009 we remain focused on three key corporate goals; to stay liquid, to stay profitable and to selectively invest for the long-term. We believe that attaining these goals will best position us to emerge from this downturn as a strong competitor.
Through our fourth quarter funding activities we more than met our funding needs and built an excess cash position. This position reflects our $6 billion issuance of the TLG program as well as our success in building more retail deposits which now total $13.3 billion. We believe this excess cash position, our additional capacity under the TLG program and the potential to further grow our deposit base will satisfy all our maturing debt obligations and fund our normal business operations for in excess of 12 months even if access to the capital markets continues to be disrupted.
We continue to expect that the difficult economic conditions will persist throughout 2009 and further suppress card member spending. In addition our financial results will reflect continued deterioration in the credit environment as well as the negative denominator impact of lower overall lending balances. This decline in balances is a function of the tempered spending environment as well as our proactive credit actions that we have implemented in 2008.
As a result we expect U.S. and worldwide write off rates will be higher in the first quarter 2008 [sic] than we saw in the fourth quarter and this year’s second quarter rates will be higher than the first quarter. The $1.9 billion re-engineering program that we began implementing in the fourth quarter is an important factor in our ability to address these profitability challenges. However, we are committed to pursue additional expense initiatives in the event that further reductions are warranted.
Additionally the various pricing actions that we have implemented and the anti trust settlement payments expected from Visa and MasterCard provide us with additional sources of financial flexibility.
As we evaluate our investment decisions throughout this year we will work to prudently balance near-term performance against long-term profitability and growth. For the current economic turnaround to negatively impact our results our goal is to position the company to generate returns in excess of our dividend levels. Collectively we believe these strategies appropriately position us for the difficult period that lies ahead and should enable us to navigate through these conditions in the best possible position relative to our payment competitors and the overall industry.
In closing we remain committed to our business model. We have a strong and defined position within the payment industry, our brand is recognized and respected around the globe, our balance sheet is positioned with the capital funding and liquidity profile that should provide us with flexibility in these volatile times and across all our businesses we have instilled a strong focus on the customer. Someone we need stay close to regardless of the environment.
Thanks for listening and we are now ready to take questions.
(Operator Instructions) The first question comes from the line of Bruce Harting – Barclay’s Capital.
Bruce Harting – Barclay’s Capital
Can you speak in terms of the allowance for loan loss [inaudible audio] balance sheet during the course of the year and can you talk about the prospects for the prospects for the TALP program versus bringing loans back on the balance sheet and how we should model provisioning for that?
Your voice is very weak but I think I got the essence of your question which is how do we think about the loan loss reserve for credit losses. We have a methodology we have used for many years which is really a migration analysis using recent historical data but we also look at what our coverage is of delinquencies. We look at what our coverage is looking backwards in terms of write offs and also looking forward in terms of write offs. It is also informed by the recent actions we have taken in terms of the card members we are bringing on, what we have done from a credit actioning perspective as well and we also are cognizant of what is taking place in the economy. So it is not just one factor that determines how we set the reserve for credit losses. It is really a combination of all those factors that drive that decision and that is what is reflected in our results for both the year and for the quarter.
In terms of if securitizations come back onto the balance sheet, I think we have about $5 billion of maturing ABS during 2009. If we bring them back on the balance sheet then we have a line of credit reserve those and those would be reflected in our P&L in 2009 and to bring them back on at a level that we thought was appropriate based on the conditions that exist in the quarter that they come back on.
The next question comes from Mike Mayo – Deutsche Bank.
Mike Mayo – Deutsche Bank
Can you comment on this enormous growth in the retail CD’s? I think you said $9 billion so I guess the question is how are you getting this, who are you getting it from, what are the deposit rates, how sticky are these funds and what is the relative trade off in doing the retail CD’s versus other funding?
Let me talk first to the retail CD’s. We began that program in the beginning of October in the fourth quarter. They are retail CD’s that are issued through the national brokerage firm. Customers who want to place money have a choice of who they do it with. They can pick us or other companies that are offering those rates. The rates we have offered are market rates we have not paid up in terms of price but we [think] a flight to quality and is really reflective of the power of our brand.
So $6 billion in the quarter and the average maturity of those was 20 months as I mentioned. That is one source. For about a year we have had a different program with a different set of institutional companies where their customers, they actually set the rate but their customers can pick from a variety of firms that they offer and we actually increased the amount from those sweep accounts by $3 billion. So we think from a stickiness perspective that while who the customers are who are accessing the sweep accounts may change we still think the quality of our name will help the stickiness.
In terms of the stickiness of the retail CD as I said it is 20 months. There is only $2 million of that $6 billion that have maturities under a year and the other $4 million have maturities in excess of a year. So it is our sense that we will have good stickiness and as I mentioned we are also going to start a direct deposit program that will be both online and off line and we expect to roll that out in the second quarter of 2009.
The average rate I just mentioned to give you a sense on retail CD’s is 3.3%. So over time we will need to make an evaluation of whether we think deposits should be 20% of our funding base or 50% of our funding base but that is a decision we will make over time and will be based on having a good diversity of funding sources as well as based on price.
I think the point is in a relatively crowded field where the number of people are going to deposits and if you will a late entry with that as a result of the brand and what it represents we have been able to dramatically grow in a very short rate of time.
The next question comes from Robert Napoli – Piper Jaffray.
Robert Napoli – Piper Jaffray
I was wondering if you might be able to give a little bit of your feel, I know it is very difficult, but looking at the spending trends in the fourth quarter and the change in loan growth declining in the fourth quarter if you could try and give some outlook of what you are seeing so far in January versus the fourth quarter and has this deteriorated further? What is your best guestimate for spending and your loan portfolio for 2009?
I can give you some insight about what has happened so far in January. Spending levels have been pretty consistent with what we saw in December so not a further deterioration from there but consistent with what we saw in December. The factors that are contributing to the overall loan growth really is the low spending is the most impactful but the credit actions that we have put in place are also having an impact as we are focused on controlling credit losses in 2009. Although we continue to be very careful to balance between controlling credit losses and wanting to have very good relationships with our customers going forward so we can benefit from their spending both now and in the future when the economy improves.
I think the third factor is we are having less balance transfers than we have historically had. I think all three of those factors are contributing to the lower loan balances.
Robert Napoli – Piper Jaffray
Do you have a feel for, or do you expect your lines to decline 10% this year, somewhere in that range?
I wouldn’t give a forecast but I would say that there is a correlation between what spending levels are and where loan balances go.
The next question comes from Christopher Brendler – Stifel Nicolaus.
Christopher Brendler – Stifel Nicolaus
Can you give us a little more detail on the thinking in your lending provision and reserve? A lot of other issuers had a pretty big increase in their reserves. I know you took a big build in the second quarter but you really saw a pretty material decline in the ratio of reserves to your delinquencies. Fourth quarter economic performance was pretty abysmal across the board and I think a lot of people are getting a pretty bearish outlook for 2009 and therefore I think the lending provision could have been higher. Can you just talk a little about what’s behind your methodology with the reserve, unemployment rate you are benchmarking to as you go through 2009 and then also what is the driver of the negative 123 other in the reserve reconciliation?
I think our provisioning methodology as an answer to the first question is I guess I would note that our reserve as a percentage of past dues on a loan basis is 137% and that compares to last year we were at about 119%. While it was higher in the second and third quarter as I mentioned when we set up the reserve in the second quarter we were really looking forward and were anticipating higher levels of write off so the reserve as a percentage of past due at 137% we are pretty comfortable with.
If you also look at what the increase in write off rate was it increased about 75% and if you look at the percentage of reserves as a percentage of loans that has also increased a certain percentage. So as we think about our allowance levels triangulating from a variety of sources we are comfortable and I think the levels that we have today reflect the fact that we set up an additional provision in the second quarter of this year.
As it relates to the second part of your question in terms of 2009 as we are planning into 2009 while we don’t do a forecast of where unemployment is going to be for planning purposes we are thinking that 2009 unemployment for planning purposes will rise up to about 8.5%. So that is the unemployment we are thinking about when we are doing our planning for next year.
The $122 million other in the quarter reflects some of the reserve re-classes that I mentioned before. They are small in totality but that is really what is a part of the $122 million. The other part is there is some FX translation that is impacting the reconciliation. It is some reserve reclassification and the impact of foreign exchange is what has generated the $122 million in the quarter.
The next question comes from David Hochstim – Buckingham Research.
David Hochstim – Buckingham Research
Could you just talk about the trend in net interest yield and whether there was a lot of excess liquidity in the fourth quarter that played into the reduction or should that continue declining? Then I have two clarification questions. One on the Delta charge is that sort of a one-time charge or will you continue to have charges as you committed to higher cost of rewards and that the amount spent by Delta cardholders this quarter and how the overall higher cost will show up on the P&L? I also wasn’t clear on the tax rate or what kind of tax benefit you would expect in 2009?
Let me answer the Delta question first. The $106 million was a one-time adjustment to the reserve to bring it up to the pricing we needed to satisfy redemptions in the future that we think will be made through Delta. Obviously the high cost per point on an annual basis as the future spending will be reflected in the cost pertaining to full membership rewards although I will point out that we have done a very good job in terms of membership rewards cost per point which has stayed relatively flat over a number of years. So that is the Delta question.
David Hochstim – Buckingham Research
So the $106 million reflects your expectation of what people will spend over the life of that program on Delta cards that is incremental to what you would have been providing as they spend?
Well what we do is we use the historical average cost per point as an estimate for what our cost per point will be in the future but we have mixed in the fact we think Delta will be a bigger proportion of cost [inaudible] proportion and therefore reflected in cost per point.
David Hochstim – Buckingham Research
That is MR and the Delta lending?
That is just MR.
David Hochstim – Buckingham Research
How does the higher cost for lending products come in?
Are you talking about…?
David Hochstim – Buckingham Research
The Delta lending credit card. So you are going to…
We would hold the credit card agreement with them and we agree to reimburse them based on spending of customers who use the code red card and as they spend that we will reflect that in the P&L as we do today.
Moving to net interest income, I guess there are two factors. One is in October there was kind of a dislocation of the normal relationship between prime and LIBOR and on our variable rate lending products which is about 60% of the lending portfolio that spread between LIBOR and prime has generally run between 70-180 basis points. When LIBOR jumped up basically the spread between those for a couple of weeks was actually zero. Now today it has moved back to the normal relationship but for that month or so where it had moved away there was a negative impact with that and I think you are seeing that in the yield at the end of the day.
However, if you look at not only the yield but you are looking at net interest income to the extent we have moved to a space where our funding and liquidity is stronger because we are holding cash there is a cost to carry on that, the cost we are going to pay to borrow funds will be higher than the interest income we have for our investments because we plan to invest in relatively safe instruments either Treasuries, agencies or other instruments which are guaranteed by the government. So I think there will be some impact on net interest income on that.
Your last question about tax rate, I think it was your last question on tax rate, because the permanent difference is that we’ve been there except the impact on the tax rate has always been smaller when pre-tax income is very high. Now that pre-tax income is lower the permanent differences haven’t changed and it is having a bigger impact on taxes and that is why we actually have a benefit in the period.
I don’t know if I got all your questions but I think I tried to cover them.
The next question comes from Don Fandetti – Citigroup.
Don Fandetti – Citigroup
I was wondering if you could talk a little bit about how the regulatory environment and some of the funding issues made for it to be changing the way you look at your business near and long-term?
Well in terms of funding I think we have anticipated changes in the marketplace that took place in 2008. Earlier in the year we expanded our liquidity portfolio, we added the $5 billion conduit facility, we gained access to the Fed window and now we have moved to actually holding excess cash. So I think we have demonstrated the ability to adapt to the marketplace and develop very sound liquidity and funding programs and however the marketplace evolves we will be able to continue to adapt to the environment and fund clearly as we really have both in the past and in 2008.
In terms of other regulation that may come out as a result of changes in the TARP rules, we will have to wait and adapt to those. As they now stand I don’t think the regulations that are required for companies that take TARP will have a negative impact on us. If new rules come out then we will have to adapt to those as they come.
The next question comes from Sanjay Sakhrani – Keefe, Bruyette & Woods.
Sanjay Sakhrani – Keefe, Bruyette & Woods
I was trying to get a little bit more on this charge card accounting policy change. So the way to think about it is this is going to increase the run rate in the rate right? If yes, can you reconcile that with the reserve coverage decline?
It is not going to impact our P&L at the end of the day because when cards were 180 days past due we had them substantially reserved for. All we are really doing is changing the time period when we write them off. So we were writing them off at 360 days. We simply moved that up to 180 days and that is why you see the additional $341 million flowing through the write off line in the fourth quarter.
Now when they were at 360 obviously we had reserves to cover the vast majority of those historically. If you looked at reserve coverage as of the third quarter it was 3%. As you look at the table, I think on pages 14 and 19 of the attachments to the press release, that dropped down to 2.5%. But that is not a reduction in reserve coverage. What it really is is reflective of the fact we are not holding receivables on our books that are past 180 days. If you made that calculation for the fourth quarter if we had not changed to the 180 day write off and stayed at 360 that percentage of coverage would go from 3% up to 3.5% so it is actually a strengthening of the reserves in the fourth quarter but because of this change in write offs to 180 days it drops the calculation down to 2.5%. So it is actually a stronger reserve now than what we have had in the third quarter.
Sanjay Sakhrani – Keefe, Bruyette & Woods
So the rate won’t change much. I mean obviously all else equal is what I am saying.
All else equal it should have no effect on our P&L going forward. Our P&L will be driven by what the loss experience is in the future.
Sanjay Sakhrani – Keefe, Bruyette & Woods
I guess when we think about capital adequacy I understand regulatory capital is pretty strong but when we look at the tangible capital is there a minimum you are looking at from a tangible capital to managed asset standpoint and then maybe you could just tie that into some comments on the FAS 140 issues. What do you think about the implementation? Do you think it will be implemented or not?
Let me answer the second part of your question first. As far as FAS 140 right now I guess the rules have not been passed as yet. There is an exposure draft out there. If the receivables come back on balance sheet at the exposure draft’s date it will be the first quarter of 2010 and we would just bring all the assets back onto the balance sheet as well as the reserves. We don’t think that will have any impact on our business model or on our ability to do business going forward.
Remind me what the first part of that question was?
Sanjay Sakhrani – Keefe, Bruyette & Woods
[Audio break] implications and then just tie that in to your expectations for that tangible capital to managed assets ratio. Is there a specific minimum level you are looking to maintain?
We don’t have a specific minimum we would want to maintain. I think our tangible capital ratio is pretty strong. Certainly compared to our competitors. We don’t have a floor that we have set for ourselves. I think we absolutely in terms of if we took on additional intangibles then after that we would have an appropriate level of ratio of tangible equity to assets.
The next question comes from [Bill Karachi].
On the roll forward of the reserve on page 14 can you just comment on describing the difference between the net write offs or I’m sorry the provision being down 3% on an owned basis versus up 17% on a managed basis and then finally if you could also comment on the potential implications of some of the talk on bankruptcy law changes and write downs and related issues that would be great.
The major change is if you look at managed basis receivables went from $75 billion in the third quarter to $72 billion in the fourth quarter. If you look at the owned while $3 billion is on a smaller base it is a higher percentage so I think the difference is largely being driven by the fact the percentage decrease in owned receivables is larger than the percentage decrease in the managed receivables.
Switching to your second question about bankruptcy law I know there has been a lot of discussion about modifying mortgages and loans and the like but I am not aware of a conversation about the bankruptcy law judges changing or impacting how credit card companies are interfacing with their customers. Now we are very focused on credit as we have talked about many times and we are very focused on controlling credit losses but at the same time we do have care programs for customers who are having temporary difficulty and we work with them to see if we can accomplish something that both meets our needs and their needs. So we continue to focus on credit not only from a controlling expense and losses but we also focus on seeing if we have ways we can help customers when we think they are only in temporary difficulty.
The next question comes from Richard Shane – Jefferies & Co.
Richard Shane – Jefferies & Co.
Can you tell us in the context of the deposit growth where your programs were versus national average for the quarter so we can get some sense of how much of this is being driven by brand versus pricing?
The answer to that question I think the CD’s as I said have an average maturity of 20 months and the average rate that we gained was 3.3%. So I don’t have here exactly what the national averages are but we were pricing in the system with the market. We were not paying up to bring deposits. I think you will see those are pretty consistent with the rates that were offered in the quarter.
Richard Shane – Jefferies & Co.
Looking at the numbers the capital generated matched the dividend exactly. Would there have been any indication in terms of covenants or related to TARP in your ability to pay the dividend if those two numbers hadn’t been equal?
We have a very strong capital position. I am not aware of any contractual restrictions we would have based on other agreements we have in place we would have been able to pay the dividend and TARP does prevent you from doing repurchases, it does prohibit you from increasing the dividend while it is outstanding but I am not aware of any provisions of TARP that would prevent you from paying a common dividend even if you generated less capital in the quarter than you did when you were paying in the quarter.
Richard Shane – Jefferies & Co.
So there is no income test related to the dividend from TARP?
Not that I’m aware of.
The next question comes from Michael Dano – Sandler & O’Neill.
Michael Dano – Sandler & O’Neill
I have a question on discount rate pricing. As you renew contracts with the merchants or have over the past six months or so could you give us a sense of the degree of push back you are getting from merchants given the premium pricing if at all and could you maybe just remind us what is sort of the average duration of contracts that you have with merchants?
It is always the case when you are dealing with merchants or any business you negotiate. The person that is paying early would like to have a lower rate. As we have said in the normal course just based on the great continuing shift in every day spend at merchants in the normal course our discount rate if you took all the actions with the decline at 2-3 basis points a year but as you have seen over the last couple of years we have been actually able to go back to certain merchants where we are bringing greater value, have a discussion with them about that and agree to pay a higher price. So this is not us just dominating them or forcing up the price it is really based on the value that we bring to the merchants and they have agreed to in some cases pay a higher price. A combination of that shift to every day spend and us going to merchants because we bring significant value has enabled us really to only have a 1% decline this year in the discount rate which I think is really a testimony to our brand.
The other point I would make is the reality is we don’t have a monopoly position with any merchant and the reality is that choice. What is critical in these times is we have invested, as we told you through the years, in programs improving our information management capabilities, our marketing capabilities and our targeting capabilities. So very frankly a number of our conversations over the last several months have been with merchants saying we want to do more with you on your marketing programs so we can build volume because people really obviously are trying to generate sales and this is where our marketing skills and some of the rewards capabilities we have in bringing in business to the merchants is valuable. So I think what it represents is a strategy that we have had in place over the last 4-5 years that has allowed us to maintain in a pretty narrow rein our discount rate which has made a pretty important difference for us.
Michael Dano – Sandler & O’Neill
On the duration of the average contract can you share that with us?
I don’t have that at my fingertips right now. Generally they are multi-year contracts. I would say it is probably 2-3 years as the average life of a contract.
I would say on two levels they are multi-year contracts and what we have also concentrated on doing with a number of what I call working merchants we in fact over the last 6-7 years have focused on signing even longer term contracts. That has been a very effective strategy for us.
The next question comes from Robert Peruzzi – UBS.
Robert Peruzzi – UBS
On page 20 in discussing your capital position you discussed the change in OCI as the driver in the reduction of your tangible capital ratios. I’m just wondering if you can size that on a dollar basis and maybe talk a little bit about the types of securities that are driving that?
I think on the securities side it is really the B and C charge that relate to our securitization that is what driving that piece. I think it was about $300-400 million of impact from that reduction in valuation on the B and C trenche. The other piece was the pension valuation and I think that was somewhat of a similar number. The two of them together is what really had the impact on the capital ratios.
Robert Peruzzi – UBS
With regard to the restructuring charges I’m wondering can we use the allocation of those restructuring charges as kind of indicative as to where the expense reductions are going to occur? On a segment basis?
I guess I would also point out that employees who are part of our service delivery network are actually accounting wise held at corporate and then allocated out from an expense perspective so the restructuring charge related to those employees is actually in the corporate segment. Beyond that your assertion is right although the benefit of that lower number of employees that were relieved from the service center will get passed through the P&L over time in the segments.
The next question comes from Scott Valentin – Friedman, Billings, Ramsey.
Scott Valentin – Friedman, Billings, Ramsey
As you pursue deposit growth, any change in bank acquisition? I know you have been fairly [notive] on acquiring a bank. Is there any change there?
I think we have always said we will always evaluate every opportunity but generally if you were going to acquire deposits by acquiring existing banks the vast majority of them would also acquire the assets of that bank and we would have to be very satisfied the assets of that bank would be ones we would be comfortable with from an exposure perspective as it relates to our shareholders so we have found that pursuing the path of deposits, retail CD deposits through brokers, the sweep account and also having a direct deposit business is a way that is very prudent of gathering deposits without having to be focused on acquiring assets you may not otherwise want.
The next question comes from Moshe Orenbuch – Credit Suisse.
Moshe Orenbuch – Credit Suisse
I was wondering if you could just talk a bit since you said that the decline in the reserve relative to delinquencies in the quarter was because the reserve had been built in the past. What I guess level of metrics would cause you to actually have to raise that back up again?
I think we would look at the actual experience that we had in the quarter, the impact it had on the reserve, also I think we became significantly more pessimistic about how the inherent risk in the portfolio base and our outlook in the economy. I think both current period economics as well as our perspective of the inherent risk. Other things that could impact it is if we were bringing on customers that were riskier you would have to increase the reserve or if you are actually tightening credit that would be a basis for reducing the reserve. So I think we include all those factors in evaluating whether at some point in the future we need to have an additional reserve.
Moshe Orenbuch – Credit Suisse
What would be the best way for us from the outside to be able to measure that?
I think you do it the same we do. We look at a variety of factors, not just one factor, and we obviously have visibility into the credit actions we are taking, the customers we are bringing on that you don’t have and we also have visibility into our migration analysis which is not public but you can certainly triangulate against delinquency coverage that we have. You can look at the increase in loans compared to the increase in write off rates. I think it is the normal thing you would look at in terms of evaluating that.
I think the other point Dan mentioned is the reserve that we took in the second quarter was projecting out several quarters and I think as you said the performance was within the estimates that we had set. So that goes back to how you balance off the different factors.
I don’t think we’d ever want to lock in to just one metric and keep it at that level forever. I don’t’ think we’d ever want to say we want to have a past due coverage of 130% and no matter what keep it there because in some cases you might be over-reserving and in some cases you may be under-reserving. I really do think from my perspective looking at a wide variety of factors including your method of base methodology is a thoughtful way of approaching provisioning and where the allowance should be set at the end of each quarter.
The next question comes from John Stilmar – SunTrust Robinson Humphrey.
John Stilmar – SunTrust Robinson Humphrey
As I look at the changes in actual number of card issuances this quarter it seems like there was about a 1% decline in the U.S., a smaller decline internationally and just over 1% in cards in the GCS business. Can you talk about it seems like there is a relative preference for investment of domestic versus international and commercial? Can you talk about whether or not that is true and what I should be inferring from that? Secondly, with regard to reserve and I hate to bring this topic back up again tonight but how should we be looking at the reserve as it relates to the amount of balance you expect in future periods because clearly one has expectations of loss and the second is the absolute balance that should be outstanding. I was wondering if you could provide a bit of clarity on that as well.
Just in the first question in terms of where we invest, we don’t have a preference of one business unit over another on a universal basis. I think we look every quarter to see what business opportunities present themselves. If we think there is an opportunity to invest in commercial card that provides us with a greater return than we would have in our next incremental investment say in consumer card we will place the investment there. I think we are always looking at what is going to create the greatest economic return over the life of the customer and that is what really drives our business decisions in terms of where we put investments and how much we put in the U.S. consumer and how much we put in the international consumer, how much we put in global commercial card and what we invest in the network. As you know there are always investments you can make that can get you immediate metrics and then there are investments you need to make in your capabilities and infrastructure that you need to make over time. So we try to balance all of those things as we make the investment decisions.
I think the important point is the optionality and flexibility we have in our card acquisition approach relative to other business models because we have a choice of a range of consumer products, charge card revolving, GNS our bank partnership obviously has limited risk and in these times that is something we obviously balance and look at and then when we look at the economics of our corporate card business and the penetration opportunities that we see both in the U.S. and around the world they are attractive. So this is something we are constantly calibrating but I think the key point is we have a range of options based on both the returns and the risk that we see out there in the marketplace.
As it relates to your second question we are setting reserves based on inherent risk on the balance sheet as of the balance sheet date so as of December 31. We are not taking into consideration whether the balance sheet and loan balances will go up or whether it will go down in the future. What we do look to the future is what do we think is happening in the economy and that is one of many factors that we will integrate into our thinking in terms of establishing our reserve balance.
The next question comes from John Williams – Macquarie Research.
John Williams – Macquarie Research
I just wanted to ask with regard to behavioral changes you have seen within the rewards expense line have you seen people change how they are treating rewards? Have you guys seen an uptick in redemption of rewards over the last few months or even into January?
We have had this question from a fair number of analysts thinking that the economy would cause people to utilize membership rewards to a significantly greater degree and quite frankly to date we have not seen that. People continue to do redemptions. They continue to value the program but we have not seen a notable uptick in redemptions as a result of the slow down in the economy.
I think we provide a wide variety of choices. People know we are going to innovate and they know we are going to be around.
Let me just close with a reminder that we will be hosting our financial community meeting on February 4 at 2:30 p.m. here at our company headquarters. At this meeting we will provide additional details on our results and our business strategies focusing on our goal to stay liquid, stay profitable and to selectively invest for the long-term. Thank you all for joining us.
Ladies and gentlemen this conference will be available for replay after 7 p.m. ET today through midnight February 2, 2009. (Operator Instructions) This does conclude our conference for today. Thank you for your participation.
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