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American Express Company (NYSE:AXP)

Q4 2009 Earnings Call

January 21, 2010 5:00 pm ET

Executives

Ron Stovall – Senior Vice President Investor Relations

Daniel T. Henry – Executive Vice President & Chief Financial Officer

Analysts

Craig Maurer – Calyon Securities (NYSE:USA), Inc.

Bill Carcache – Macquarie Research Equities

Meredith Whitney – Meredith Whitney Advisors

Sanjay Sakhrani – Keefe, Bruyette & Woods

Robert Napoli – Piper Jaffray

Jason Arnold – RBC Capital Markets

Michael Taiano – Sandler O’Neill & Partners LP

Christopher Brendler – Stifel Nicolaus & Company, Inc.

Donald Fandetti – Citi

John McDonald – Sanford Bernstein

Scott Valentin – FBR Capital Markets

Bruce Harting – Barclays Capital

Kenneth Bruce – Bank of America Merrill Lynch

Operator

Welcome to the American Express fourth quarter earnings conference call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session. Instructions will be given at that time. (Operator Instructions) As a reminder, today’s call is being recorded. I would now like to turn the conference over to our host, Ron Stovall.

Ron Stovall

As usual, it is my responsibility 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 including company’s financial and other goals are set forth within today’s press release which was filed in an 8K report and in the company’s 20’08 10K report already on file with the Securities & Exchange Commission.

In the fourth quarter 2009 earnings release and earning supplement on file with the SEC in an 8K report as well as the presentation slides, all of which are now posted on our website at ir.AmericanExpress.com. We have provided information that describes the company’s managed basis and other non-GAAP financial measures and the comparable GAAP financial information. We encourage you to review that information in conjunction with today’s discussion.

Dan 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 documents and provide some brief summary remarks. Once Dan completes his remarks, we will turn to the moderator who will announce your opportunity to get into the queue for the Q&A period where Dan will be available to respond to your questions. Up until then, no one has 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 yourself to one question at a time during the Q&A. With that, let me turn the discussion over to Dan.

Daniel T. Henry

I’ll start on Slide Two. So while revenues and income are well below our pre-recession levels, they are heading in the right direction and represent the highest levels that we’ve achieved this year. So look at total revenues net of interest expense came in at $6.5 billion, about equal with the amount in the fourth quarter of ‘08. On an fx adjusted basis we’d be down about 4%. If you compare this to the third quarter year-over-year on a reported basis we were down 16%. So being approximately even with last year is a significant improvement.

Income from continuing operations was $710 million, up 132% from the prior year but we identified two significant items in last year’s result, a reengineering charge as well as an MR related item. If you were to normalize from those, we were really up modestly about 5% compared to the fourth quarter of ‘08. Diluted EPS from continuing operations came in at $0.59 and return on equity was 14%.

Moving to Slide Three, you can see that billed business came in at $172 billion, up 8% on a reported basis and 4% on an fx adjusted basis. Again comparing it to the growth rates we had in the third quarter, reported billed business was down 11% and on an fx adjusted basis was down 9%. So again, a significant improvement compared to the third quarter and this improvement is really across all business lines as you’ll see in a few minutes and it’s the first positive growth rate that we’ve had since the third quarter of ‘08.

Cards in force came in at $87.9 billion and that’s down 5% from last year. If you normalize to exclude the 3.3 million inactive cards that we cancelled this year, we would be down about 1%. Average basic card member spending was up 15% but if you were to normalize to exclude the inactive cards that I just referred to and adjust for fx we’re up about 5% which is a strong rebound from the prior quarter.

Managed loans continue to be well below ‘08 levels. You can see that it’s down 14% on a managed basis, although we did increase sequentially compared to the third quarter by about 2% and this is based on higher spending in our co-brand portfolio. Travel sales, while still down also improved, they are down 5%. That compares with 29% in the third quarter.

We move to Slide four, this is more on billings. If you look at the bars, they represent the dollar amount of monthly billings and the lines represent the year-over-year growth on both a reported and fx basis. You can see that in the May to September time frame of ‘09, billings stabilized at about $52 billion per month and billings have now moved higher in October, November, and December.

Now the growth rate is benefitting from easier comparisons as we saw drops in billings in the fourth quarter of ’08 but it’s also benefitting from higher levels of billed business. The growth rate comparison actually improved month-by-month in the quarter. So the growth rate in November was better than the growth rate in October and the December growth rate was stronger than what we saw in November.

Now the month of December ‘09 was the highest billed business month in AXP history on an fx adjusted basis. I point out that Global Commercial Services was particularly strong in December, up 13% on an fx adjusted basis. Just a little bit about holiday spending, so in the month of December US retail shops was up about 5% year-over-year, US department stores was flat and if you look at US online spending it was up about 11% and within that US retail online spend was up about 8%. So if you compare that to the industry which according to comScore was up about 4%, we fared a little bit better than the industry.

So moving to Slide Five, here we’re looking at a percentage change on a year-over-year basis on an fx adjusted basis. So you can see that billed business really across all segments has improved from the third quarter. USCS and ICS are flat year-over-year and Global Commercial Services is up about 3% on an fx adjusted basis. G&S which is spending on cards issued by our partners was up about 22%. Geographically outside the US we saw the strongest growth in Latin America with JPAA being next so really broad based improvement across all of our business lines.

If you move to Slide Six, this is a network perspective. Now the blue line represents number of transactions and the light blue line represents transaction size and the green line is total spend. So, both in number of transactions and the transaction size had positive growth in the quarter. Number of transactions grew 3% and transaction size increased by 2%. Now if you compare that again to the third quarter, transactions in the third quarter were actually down 1% and transaction size was down about 11%.

If you look at it geographically, average [rock] size in the US was down about 2% and international was up about 14% year-over-year. Now if you look at the trend in the growth in the number of transactions for the quarter, as I said it was up about 3%, October was about flat and the month of December was actually up about 5%, so a good trend.

If we move to Slide Seven, we’re looking at charge card billed business compared to receivable growth. The solid line represents the growth in billed business, the dotted line in card member receivables. So charge card billed business and receivable growth continues to move in tandem. You can see that we have an upward trajectory in billed business and charge card had positive growth in the quarter of 6% and AR was growing in line with billed business.

We move to Slide 11, this is lending billed business versus loan growth. The solid line is billed business again and the dotted line represents loan growth. So historically spending on lending products and loan balances have correlated pretty closely. However, in the fourth quarter, spending has improved significantly with growth of about 2% year-over-year, driven by our premium lending focus on co-brand cards, but loans while up sequentially from the third quarter by $1.1 billion is lower than the fourth quarter of ‘08 by 14%.

Now some of the contributing factors to this separation is that we are having higher pay down rates and these statistics are actually based on our trust data. So the pay down rate in December of ‘09 was 26.9% and that compares with 23% in December of ‘08. Now this is certainly being impacted in part, by the change in the mix of the products as we focus on premium lending. It’s also being impacted by the credit actions that we’re taking which are focusing on limiting high balance accounts in the lending portfolio and this is having an impact on total loans. In addition to that, BTs which used to be a source of growth are basically a zero and lending card acquisition is at lower levels and that also historically has contributed to the growth in loans.

Now if we move to Slide Nine, this is our US Card Services net interest yield on a managed basis. Now at the bottom of the chart, you can see certain of the factors that are impacting the yield in each quarter. Now the fourth quarter ‘09 net interest yield is similar to the two prior quarters but there really are a number of things that are taking place. So we’ve had some increases in pricing which has a positive impact on yield but there are various aspects that are reducing yield. One is the card member assistance programs we have where we forgive interest. That’s having a negative impact on yield. Now we’re focused on premium lending so the revolve rate is dropping, also impacting yield and then also the credit actions that we’re taking are having an impact.

In addition to that, we’re starting to see some of the impacts from the Credit Card Act affecting yield. Now we expect that the Credit Card Act will bring net interest yield down from ‘09 levels as we move into 2010. So I’m not making a forecast here, but I think in the future it’s likely that we’ll move to the historical levels that we saw in the ’06 to ‘08 time frame when you look at it on a managed basis.

So moving to Slide 10, we’re looking at revenue. Total revenues as I said were flat, on an fx adjusted basis, they’re down about 4%. So discount revenue is up about 5%. That’s a combination of billed business increasing at 8% and our average discount rate decreasing by two basis points year-over-year to 2.51%. Net card fees continue to be a strong story despite the weak economy. So clearly if you have the right value proposition, card members continue to renew on our fee-based products which is a positive. If you look at that interest income and securitization, that’s down about 7%. Net interest income decreased by 8% and averaged owned loans were down 26% partially offset by higher yield compared to the fourth quarter of ‘08. Securitization income is down 5% primarily driven by a decrease in interest income. Other revenues are down 12% driven primarily by lower delinquency fees which are a result of lower owned loans and the impact of various customer assistance programs.

Moving to Slide 11, this is a first in a series of slides on credit. Provision is significantly lower in the fourth quarter of ‘09 compared to ’08, down 47%. Both charge card and card member lending are making a large contribution. Charge card improved by 67% driven by improved write off rates and lower past due rates. Card member lending provision decreased by 40% due to average owned loans decreasing by 22% year-over-year and lower levels of past due accounts. I would note that sequentially compared to the third quarter, the lending provision decreased by 43% as write offs of past dues improved. I’ll cover this in more detail in a few slides.

So moving to Slide 12 looking at our expenses, marketing and promotion was up 36% compared to the fourth quarter of ‘08 and up 41% on a sequential basis or $200 million compared to the third quarter of ‘09. So the increase in marketing and promotion and other increases in investment spending has been enabled by the increase in card member spending and credit indicators showing further signs of improvement.

So M&P is at higher levels really across all of our businesses and if we now stop and look at rewards, you can see that that’s up 8%. Now if we exclude a Delta related charge in MR that we had last year, this slide is up 18% and this is being driven by higher card member spending as well as higher co-brand expenses in the period. Now on this chart, you see that S&B is improved by 28% but if you exclude net reengineering costs in both periods then S&B would decrease by 8% reflecting the lower employee levels that we have this year compared to last. Other operating expenses increased and this reflects higher spending on credit and collections, investment spending in higher technology and related costs and a charge to exit certain real estate properties this quarter.

Moving to Slide 13, so here we’re looking at marketing and promotion expense by quarter and you can see that the fourth quarter is significantly higher than the other quarters in this past year. The marketing and promotion is focused on charge card, co-brand products, brand advertising, receptions of coverage, product development and gift cards. All of these investments are on strategy for us.

So if we move to Slide 14, we’re looking at charge card write offs and 30 day past due rates as it relates to the US Consumer Services segment. Now this is really a start of a drill down on credit that will cover a number of slides but you can see that USCS write off rates and past dues have improved significantly compared to both the fourth quarter of ‘08 and the third quarter of this year. Both are contributing to the lower provision levels that we have and these metrics are really at historic lows.

If we move to Slide 15 and look at charge card net loss rates and 90 day past dues for our international consumer, business and Global Commercial Services, you can see here that the net loss ratios and the 90 day past dues are also performing very well. So in charge card really has performed well across all three units the US consumer, international consumer, and Global Commercial Services have performed well not only in this quarter but really all year. So the charge card provision for the full year of 2009 is down 37% compared to the full year of 2008 and it’s a very good story.

So we now move to Slide 16, charge card reserve coverage. So, now the provision in the fourth quarter of ‘09 and for the full year of 2009 are lower than 2008, you can see that the reserve coverage across all of the business units are up slightly compared to last year and reserves we think reflect the inherent risk in our portfolio.

Now let me move to lending in Slide 17. So this is lending managed net write off rates and this is the second quarter in a row that managed debt write off rates have improved. Now the improvement is being affected by a broad range of credit and business actions as well as the environment. These actions include really enhanced credit and collection policies and practices and in particular by our efforts to limit the number of high balance lending accounts which is having a large impact in bringing write offs down. Higher write offs in the second quarter of this year were really contributing to the higher write offs that we saw in Q209. It’s also benefitting from our focus on premium lending.

So let me move to Slide 18. This metric is important as we look forward and you can see that the managed 30 day past dues are improving in the US consumer business as well as international consumer. Within the US the states that were hardest hit such as California and Florida, while still at higher delinquency rates than the average, are improving at a slightly faster rate.

So let me move to Slide 19. This is a slide that we have focused on quite a bit over the last several quarters and if we look at the upper left chart which is current to 30 day past dues and you look at the yellow triangles which are July, August, and September, this is what will lead to write offs in the first quarter of 2010. You can see that they are similar to the prior three months which drove write offs in the fourth quarter of ‘09. So if the 30 day past due to write off rate stays unchanged and recoveries and bankruptcies remain constant, it would imply that the first quarter of 2010 write offs will be similar to the fourth quarter of ‘09. This is not a forecast, but if these assumptions were to take place that’s what we would see.

Now if you’ll look at the green triangles, these will write off in the second quarter of 2010. Now assuming the same caveats that all the other factors remain the same, it would imply slightly lower 2Q 2010 write offs than what we saw in the fourth quarter. But again, this is not a forecast it’s simply based on those assumptions. You can also see on the right of this chart, the bankruptcy filings have remained constant over the last three months.

So let me move to Slide 20. This provides a trend by month in the USCS managed lending credit metrics. So write offs in the fourth quarter were 7.5%. If you look at it by month, in October it was 7.8%, November it was 7.6%, and December it was 7.1% so an improving trend.

Now the 30 past due that we site for the quarter is really a month end number for December, so that’s a 3.7%. But again, we have a positive trend in that 30 past due at the end of October was 4.1%, end of November was 3.9%, and December was 3.7%. So we’re seeing improvement quarter-over- quarter and really a positive trend within the fourth quarter. So write off rates here are still very high on a historic basis and therefore they continue to have a negative impact on our P&L. The forecast is for unemployment to stay at relatively high levels and if this were true, it would obviously have an impact on the ability of these credit metrics to improve in the future so we need to keep that in mind.

So moving to Slide 21, this is lending provision compared to write off. So the dark bars are provision by quarter and the light bars are write off dollars by quarter. So the trend, going back to the first quarter of ‘07 is that the amount of the dollars or provision have been higher than the amount of write offs. So the fourth quarter of ‘09 is really the first quarter where provision is not higher than the amount of write offs and that reflects the lower write off rates and the improvements that we’ve seen in the 30 day past due amounts. Notwithstanding that we remain cautious about the environment in that it still remains uncertain.

So let us go to Slide 22 and look at our lending reserve coverage. Here you can see that the US card services and worldwide reserve metrics and even with provision in the fourth quarter lower than the write off files that we saw on the prior slide, we think that we have an appropriate level of reserve coverage given the inherent risk in our portfolio. You can see that most reserve coverage ratios are either similar or slightly higher than the amounts we had in the third quarter of this year.

So moving to Slide 23, these are our capital ratios compared to regulatory benchmarks. You can see that the capital ratios are all either the same or slightly higher than the third quarter. They’re all above the well capitalized current benchmarks. Both the actuals for the fourth quarter and the pro forma for the fourth quarter which assume that securitizations, loans that were securitized came back onto the balance sheet as of the end of December. As you know, securitized loans are scheduled to come back onto the balance sheet in the first quarter of next year. So again, both on an actual and a pro forma basis it’s well above the current benchmarks. I would point out that our Tier-1 common ratio is among the best in the industry.

If we move to Slide 24, this is a liquidity snapshot. Here as in other quarters, you can see that liquidity continues at a level where we’re holding excess cash and marketable securities at a sufficient level to cover the next 12 months of maturity. So excess cash and securities are $26 billion and funding maturities over the next 12 months are $20 billion.

Moving to Slide 25, this is a chart on our retail deposit program. As you can see we continue to grow deposits. We grew deposits by $2.4 billion in the third quarter. If you look at the retail CDs that we raised in the fourth quarter, the average duration was 23 months and the average rate was 1.4%.

So with that, let me conclude with a few final comments. Given the difficult environment over the past year and a half, we have focused on the basics of staying liquid, staying profitable, and investing selectively for growth. We leveraged the competitive strengths of our diversified business model to deliver on the first two of these priorities and have increasingly been shifting to a higher level of investments. Over the last six months improved credit trends, the benefits of our reengineering initiatives, and more recently somewhat better card member spending levels enabled us to invest in initiatives designed to position the company for growth over the moderate to long term.

Areas of focus for these investments include our premium lending products like our Delta, British Airways, Starwood, and Costco programs. Our more pro active charge card product and marketing efforts, merchant acceptance around the globe, G&S partner related product launches and signing efforts, corporate service product offerings and expense management services, brand building initiatives in the US and selected international markets, expanding our data and information management capabilities. And while still in the early stages of forming our enterprise growth unit, last week we closed the acquisition of Revolution Money, our first initiative within this unit.

Now certainly it is too early to say that all the economic challenges are behind us, but we have seen some encouraging signs of progress over the last several months. We expect the global economy to continue to recover gradually and the resulting environment to be characterized by billing’s growth that is more modest than we experienced before the recession as consumers and businesses remain cautious about their spending. In addition, unemployment levels are forecasted to remain relatively high. Without job creation, credit metrics can only improve so far from the still relatively high current level. Lastly, increase regulation could further impact profitability.

In light of these challenges, it is more important than ever to invest in initiatives that will position American Express to sustain growth and to continue to differentiate ourselves from our competitors. As such, our priorities in 2010 are to drive growth, drive efficiency, and deliver superior service. More specifically, while credit did turn positive for us in 2009, most company’s including us drove 2009 earnings by reducing expenses. In 2010 and beyond, it will be important to us to grow revenues as well as earnings. At the same time, we plan to have a closed structure that can help produce good returns and fuel investments even in a slower growth environment. Finally, service will be more important as a differentiator during these uncertain times when customers are looking for companies they can trust and rely on.

We believe American Express has the right products and services to be successful in this new economy. We are confident because our business model comprises a diverse set of activities that span the payment industry, our brand is a unique asset that is recognized and respected around the globe, our premium card member base remains a key advantage in retains the capacity to growth spending substantially as the economy improves. Our Global Merchant Network is positioned to capitalize on many future growth opportunities that are resident within the payment industry our capital planning has anticipated the 2010 consolidation of off balance sheet receivables and we’re focused on maintaining a capital funding and liquidity profile that is appropriate to these following times.

Lastly, we believe we have a set of winning strategies which position us to both capitalize on our core business opportunities today and evolve toward the emerging payments opportunities of the future. Thanks for listening and we are now ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Craig Maurer – Calyon Securities (USA), Inc.

Craig Maurer – Calyon Securities (USA), Inc.

I had a couple questions, the first was could you comment on what you’ve seen through January in terms of spending on a year-over-year basis? Have the gains that you saw in the fourth quarter held through January? While I know seasonally, it’s down month- on-month but year-on-year, how does that look?

Daniel T. Henry

The year-over-year growth that we’ve seen through the 20th of January is similar to what we saw in the fourth quarter.

Craig Maurer – Calyon Securities (USA), Inc.

In terms of the marketing spend, if you look at the total costs of marketing and promotion, card member rewards and card member services, as a percentage of revenue in the fourth quarter it was much higher than I’ve seen it at any other point in your history basically. I was wondering if you could give us sort of your outlook for the marketing spend and the card member rewards? In ’10 should we expect to see marketing be materially higher? What type of run rate should we expect and will there be additional marketing costs around the Olympics?

Daniel T. Henry

What I would say when we get to a steady state which I don’t think is going to be 2010 but sometime beyond that, I would think marketing expenditures would be a similar percentage. I don’t know of any reason for that not to be the case. Although I would say in a period where we are seeing improvements in billing and improvement in credit we’re going to be very focused on using those dollars really to invest for the medium to long term in a very similar way we did back in 2001 and 2002. We view this as really an opportunity to grow the business so we will continue I would think in 2010 to invest heavily to support that future growth.

Craig Maurer – Calyon Securities (USA), Inc.

And around the Olympics will there be any kind of pull forward?

Daniel T. Henry

I don’t see us doing anything beyond what we would normally do around that time. I guess the other thing that I would want to point out though is investment spending is not just marketing and promotion. When we invest to grow global commercial services most of those investments will not be on the M&P line. The same is true in merchant services and it is certainly true to the extent we’re investing in and building capabilities. So marketing and promotion is a line that gives you an idea of what we’re doing in investing but you’ll see our investments come through in other lines including other operating expense.

Craig Maurer – Calyon Securities (USA), Inc.

And when you decide on that marketing budget what is the time frame you are looking at in terms of returns whether it is through billed business or whatever metric you are using to gage that?

Daniel T. Henry

Each type of investment has a different time frame in terms of the returns but certainly the investments we make are driven generally to look at the life time profitability of either bringing on a set of consumers, a set of small businesses or investing in sales force to enable our commercial services or our merchant business. So, it is really a lifetime payback that we’re looking at for the investments that we make each year.

Operator

Your next question comes from Sanjay Sakhrani – Keefe, Bruyette & Woods.

Sanjay Sakhrani – Keefe, Bruyette & Woods

Just a quick question Dan on the net interest margin, you mentioned we could expect the margin to kind of revert back to ’06 ’08 levels I believe. Just so I’m thinking about this correct, come February 22nd when the Card Act is implemented we should see a down draft in the margin, right? Is there a rough estimate you can kind of help us think about as far as the margin -implications at that point in time?

Daniel T. Henry

I think it will be a down draft that probably takes several quarters because some aspects of the Card Act come in to effect in February, others come in to effect later in the year. Actually, by referring you back to ’06 and ’08 I was trying to give you an idea of where we might migrate to. But, the impact of the Card Act on yields will actually take place over a couple of quarters.

Sanjay Sakhrani – Keefe, Bruyette & Woods

Just so I understand it, come February 22nd there will be people that go delinquent that you can’t reprice for 105 days, right?

Daniel T. Henry

Correct.

Sanjay Sakhrani – Keefe, Bruyette & Woods

Then the other question was on capital management, is there a point in time that we could start to see the share buyback program be implemented again and what would you need to see?

Daniel T. Henry

I think one thing we would like to have a better sense on is just where regulators are going to be coming out in terms of where they want to set capital levels. Now, to the extent we get guidance of that sometime in the near term then that will be useful. If it is going to take [inaudible] return that we’re going to have to kind of pick a spot for ourselves. I would say we will see what earnings are like. I wouldn’t say that share buybacks are in the imminent future but some point in the future we’ll have to make a decision about the level of capital that we want to hold. We want to hold capital to kind of move to the higher levels that we’re expecting for a regulatory purpose, we also want to support the growth in our business but I think we also want to have the capacity to do bolt on acquisitions which are smaller acquisitions to help achieve our strategy.

Operator

Your next question comes from Robert Napoli – Piper Jaffray.

Robert Napoli – Piper Jaffray

I’d like to drill on a little bit more on the card member rewards line. If you look at card member rewards over the long term, as long as you’ve given us that data it has generally been running around 29% to 30% of the discount revenue. It jumped way up there this quarter. Is there anything unusually in that item? I see you market a lot of triple points and some things like that, is there some special marketing in there or have you adjusted your marketing? Are the redemptions higher? What’s going on there and is the 32% the right number long term or is the historical 29% more correct?

Daniel T. Henry

I would say that there are a couple of small items in there that are unique for the quarter but I would also say that as co-brands become more of a focus they do have a higher rewards cost than membership rewards. I’d also point out that in the fourth quarter of last year we bumped up our membership rewards reserve as a result of our contract with Delta. So that fourth quarter adjustment was to true up our reserve but on an ongoing basis there’s a higher cost related to that. So I think it is a combination of a few small unique items in the quarter as well as some higher rewards costs that we’ll see on a go forward basis.

Robert Napoli – Piper Jaffray

Obviously you are marketing a lot more than you were I mean it’s hard to turn on the TV and not see an Express commercial. Now historically we would expect to see relatively quickly an effect on the card growth. That historically has been a very good measure of the effectiveness of your marketing, the card growth and the spending per card but your total cards outstanding are still declining. What do you expect in that regard and should we not be judging the success of your marketing by cards outstanding at this point?

Daniel T. Henry

I have this observation, certainly to the extent that we’re doing brand advertising we think there’s a real benefit to that and you’ve probably noticed that during the first two or three quarters of this year we had that at very low levels and we wanted to bring that back. I think there’s some sustained level we want to have over time and there’s a real benefit to that. On the other hand there’s not a specific change in cards in force. I guess the other point that I would make out is to the extent we are more focused on premium lending in charge card you are going to not see the same kind of pop in cards in force when we bring up marketing you would have seen if we were bringing proprietary lending cards.

So to acquire higher spending costs a lot more dollars and you get fewer cards but they have a good long term benefit and they are very much in line with our strategy. So you may see a different correlation in terms of the growth in cards in force to our marketing dollars. We also are using a fair amount of our marketing dollars to invest in some of our other businesses whether it be commercial services or our merchant business. So I think you just need to calibrate your thinking a little bit based on the strategy that we’re employing as we go forward here.

Robert Napoli – Piper Jaffray

Last question, I just wondered if you could give a little bit of a comment on Revolution Money? I haven’t seen any clear financials for Revolution Money but indications are that there’s technology there but not a lot of P&L income statement and it seems like you paid a lot relative to what you got initially. Can you give us a little more color on your thoughts around Revolution Money and what are the key drivers and how can we get some feel for what kind of success you’re having with that investment?

Daniel T. Henry

Let me just do an addendum to my prior answer which I think is relevant. So while we haven’t seen out of our marketing dollars a pop in cards in force we did see very good growth in billed business so that marketing and the stimulation we did paid off and I think our growth in billed business is really differentiated from the competition. So I think we are getting good returns on the increase in marketing promotion that we did.

As it relates to Revolution Money we only closed last week so it is a little early to talk about what’s actually taking place. But to your point it is a capability in large measure that we were acquiring as opposed to a large revenue and income stream but we think they have terrific capabilities that we can build upon and I think it is important for us to continue to look at alternative payments because while they may not be large next quarter, over time we think it’s an area where we need to continue to invest because over time we do think it is going to be relevant in the payments market.

Operator

Your next question comes from Bill Carcache – Macquarie Research Equities.

Bill Carcache – Macquarie Research Equities

If you could just help us dissect the billed business number a bit more. We saw some evidence during the fourth quarter of some high end retailers experiencing some stronger year-over-year sales growth versus some lower end retailers. Can you help us understand the extent to which the growth in billed business is really being driven by the affluent customer base versus lower spending customers? Can you just give us some color on that?

Daniel T. Henry

I think as we pointed out in the slides the improvement was really across all our business lines which I think is very positive and geographically it was broad based as well so I think that is a positive as well. I think [Ed Gilligan at the Financial Community Meeting is going to drill down on exactly where we saw some of the spending benefits so I think you’ll get more details at that juncture. But, my sense is that by different spend levels of customers we saw again a broad based improvement in spending across all the categories. As I said, I think [Ed Gilligan will give more detail at the Financial Community Meeting.

Bill Carcache – Macquarie Research Equities

You also mentioned that you continue to see both near consumers and businesses kind of hold back a bit on spending but is there any sign at all or do you see any kind of early signs within corporate spending of whether some of the scaling back that business had done on travel and things like that where there may be some early signs of that kind of turning the corner a bit?

Daniel T. Henry

Corporate card commercial services has historically functioned more as a V, it usually holds on longer in a slowdown, drops more sharply and then comes up sharper than the rest of the business. You can see that on Slide Four in terms of totality and by business on Slide Five. But again, this time I think we’re seeing the same thing I think commercial services came back sharper than the rest of the businesses. As I pointed out in December their fx adjusted growth was actually 13% so we are seeing good improvement in the month of December in spending by corporations.

Bill Carcache – Macquarie Research Equities

Then finally could you comment on the American Express Business Insights group and just developments there and what we can expect from that in terms of your growth expectations going forward?

Daniel T. Henry

I think as we talk about looking for new revenue sources to help drive revenues and profits we think this is an area that has a lot of opportunity. I think we actually launched it, [Bill Glenn did last month with a presentation but really I think it is building on our close loop, it’s building on our data management capabilities in terms of providing insights to merchants in terms of their marketing and other business decisions that they need to make so we actually think this is one of those new revenue sources which will help in the future growth of the company.

Operator

Your next question comes from Meredith Whitney – Meredith Whitney Advisors.

Meredith Whitney – Meredith Whitney Advisors

My questions all relate to credit and I’m trying to figure the turn in credit out and what your specific guidance on credit is. So, given the fact that you said a couple of things that you’re credit metrics are clearly improving but the persistent unemployment will weigh on that so how do you reconcile both? Do you need a pickup in employment? If employment worsens what happens to credit? Can you sort of map that out more?

Then a general question which is why do you think credit is improving with such a persistently high unemployment rate? Is it burnout? What could lead to an improvement in credit or another leg down in credit beyond unemployment? And, should we just be looking at initial claims?

Daniel T. Henry

I think we have certainly outpaced the industry here in terms of credit performance over the last two quarters and we think that is a result of actions that we have taken. We have been very focused on enhancing our credit and collection practices which are helping quite a bit. That was in that because we are providing assistance to some customers and waiving some fees, we’re seeing the impact of that in our yield numbers but you’re also seeing a benefit of that within the metrics of write offs and delinquencies. We think that is a smaller part, we really think it is the other credit and collection activities that we have which is having the larger impact.

The other significant thing that we have done is we are very focused on high balance accounts. So in the early part of this year where our write off rate was really moving up and really moving up and really moving from being best in class to being the middle of the pack. A major factor that is affecting that is that the average write off amount had grown and we’ve been very focused to bring that down and we think that’s having a real positive impact in the write off rate in both the third quarter and the fourth quarter. So I think we’ll continue to be focused on that as we go forward.

Those are some of the things that we’ve done that I think has enabled us to distinguish ourselves from the industry and as I pointed out if you follow the chart with the triangles, it will give some insight about what is going to take place next year. But, I do want to be very clear that what’s going to happen longer term and even what’s going to happen in the first and second quarter of next year is going to be driven by what takes place in the economy broadly but particularly in unemployment. You really do need at some point to have job creation here to really help credit metrics improve over a longer period and really get back to the historic levels that we’ve seen.

Meredith Whitney – Meredith Whitney Advisors

If I could just ask a follow up, I forget which investor presentation it was, I think it was the summer of 2007 where you really honed in on limiting credit to certain states which were impacted the most by declines in housing. What are the variables on credit that are the guide posts for you making line decisions, etc. today?

Daniel T. Henry

I think it is the combination of the factors that we’ve always looked at but over the last 18 months we’ve also been very focused on integrating additional information in to our models to help us make better decisions. Also, increasing the frequency with which we update the information within the models so we’re constantly striving to improve and enhance how we can identify people who are going to default in the future. So it is really an ongoing process that we think we’ve made good progress on recently and we’ll continue to strive to make further progress on.

Now, next time there’s a slow down whether housing is a big factor or not we’ll have to wait and see. The other thing I would say is it is not reading all the factors exactly the same for every group of customers. For charge card high spenders there may be certain aspects that get higher weighting than for customers that say spend at a lower level. We actually have this refined by product and by spend level as we constantly strive to enhance the accuracy of our predictions.

Meredith Whitney – Meredith Whitney Advisors

Can I just follow up with one last question, I promise it is my last one. I know you went through the number of transactions but are you finding that a smaller group of your customers are spending more and using the card more or is it broad based within your entire customer base?

Daniel T. Henry

We think it is broad based not only by segment but also within consumer we think it is broad based across different spending levels as well and it is also broad based geographically.

Operator

Your next question comes from Jason Arnold – RBC Capital Markets.

Jason Arnold – RBC Capital Markets

Just a follow up on Meredith’s question, on credit do you believe that the more traditional correlations than between charge offs and unemployment will be the trend we should expect here ahead versus the continued divergence in trend?

Daniel T. Henry

When we’ve talked about correlations we’ve always talked about there’s a pretty tight correlation between GDP and billings but when you try and correlate credit and unemployment historically they’ve kind of moved directionally over time in the same direction but the correlation has not been nearly as tight. I think if you went back to either ’91 or 2001 the improvement in unemployment actually lagged the improvement in industry write off rates by about three quarters. So there is a correlation but it is not nearly as tight as we see in other areas.

Jason Arnold – RBC Capital Markets

Just one quick follow up, now that we’ve moved further through the down turn here and signs of stability in your business are more or less emerging here, I was wondering if you could give us a bit of an update on your outlook for return on equity? I think the last guide was about 20% but maybe when we get in to 2011, 2012 do you kind of have something in your mind to update us with?

Daniel T. Henry

We’ve been holding off in setting new ROE targets until we had a better sense of what regulatory requirements would be for capital levels and if we get that guidance within the next quarter or two we will quickly set our ROE target. So I guess I would also commit that even if we don’t get that guidance we will make an assumption and come out with guidance by say the middle of the year.

Operator

Your next question comes from Michael Taiano – Sandler O’Neill & Partners LP.

Michael Taiano – Sandler O’Neill & Partners LP

Just looking at Slide Four I was a little surprised US consumer billed business wasn’t a little stronger but it looks like through the course of the quarter the gap between the reported number and the fx adjusted narrowed. Was that driven more by the fx rate or a little bit of the strengthening of the dollar in December or did the US consumer start to pick up more in December?

Daniel T. Henry

I don’t have specific knowledge about what fx did in November versus December although I would say it was coming in a little bit so that was probably helping to close that gap somewhat. As I said before I think we saw greater strength in December, greater strength in the average for the quarter so I think it was probably a combination of both.

Michael Taiano – Sandler O’Neill & Partners LP

The driver behind the big jump in growth in the G&S segment, was there anything specific behind that?

Daniel T. Henry

I think G&S has really been strong throughout the last five or six quarters and has constantly performed better than the rest of the businesses which I think reflects that our partners see value in putting cards that run on our network out to their customers so I think this is probably a continuation of that. It is also probably benefitting by the fact that we’re putting new products out in the marketplace so a combination of all those activities are probably helping us.

Operator

Your next question comes from Christopher Brendler – Stifel Nicolaus & Company, Inc.

Christopher Brendler – Stifel Nicolaus & Company, Inc.

I was wondering if you could spend a little more time on the lending margins? I noticed it was up a little bit in the quarter and you referenced the card member assistance program. I think you did some repricing in the quarter as well. I would have thought with the charge off rate coming down so significantly that you would have seen the card member assistance program while still a drag actually drag less on the margin in the fourth quarter.

Then you referenced also the Card Act and I think what you’re referencing there is just the inability to do default rate repricing without giving 45 days notice to customers. I wasn’t sure if you had any ability to quantify any of those impacts? You’re giving a pretty broad range here for the margin ’06 to ’08 I think it was a lot higher in ’06 than it was in ’08 so just give me a little more color on what you saw in the quarter. I would think you’d see some upward pressure on the margin that didn’t appear this quarter and I’m a little bit concerned that maybe default rate pricing was a bigger impact than I estimated.

Daniel T. Henry

First of all this is net yields so write offs are not part of this calculation. This is the finance charge revenue that we’re getting from customers less our cost of funds. So I guess there are a number of things that are taking place. First it was pricing that took place in the quarter but it only impacted a portion of the quarter so the full effect of the pricing you see in the first quarter you’re only getting a piece of it in the fourth quarter. So if you put pricing in place in November you only get one month’s worth of that benefit in the quarter.

The other things that were having an impact is to the extent we have programs that are providing assistance to card members that have temporary liquidity issues we’re forgiving interest so that’s obviously having an impact of brining yields down. The Credit Card Act is negatively affecting it but it is again to the issue that you said it is really our inability to reprice immediately. We actually have to give customers 45 day’s notice so we’re starting to see the impact of that in the quarter. But the more significant impacts as you are aware of the Credit Card Act will come to us in the first and second quarter of next year.

It’s really a variety of things moving in here. Now, it is also being impacted by the fact that to the extent we are more focused on premium lending, some of those customers tend to act more like transactors and so that is going to reduce our revolve rate which is also having an impact on yields. So all of these things are happening at the same time some were full quarter impacts, some are partial quarter impacts.

Now, I guess the other thing that I would say just in terms of the guidance I was giving, if you look at kind of the ’06 to ’08 time frame on a managed basis that averaged about 9% and that was really the direction in guidance I was looking to give. Again, this is not a forecast but in terms of trying to be helpful in terms of how you might think about it over the long term I think that’s a pretty reasonable period to look at.

Christopher Brendler – Stifel Nicolaus & Company, Inc.

One quick follow up if I may, I didn’t quite catch if you said anything about lending balance growth, it obviously turned around a little bit this quarter seasonally I’m sure. But, do you expect to grow the lending book in 2010?

Daniel T. Henry

I think you’re right the sequential growth of $1.1 billion in the fourth quarter compared to the third was driven by seasonal spend and just higher spending levels year-over-year which was positive. As you can see from one of the slides there really was a break away in terms of spending from the loan balance and I think I went through the factors I thought were contributing to that including just our strategy focus on premium lending. My sense is over time the correlation between loan balance and spending growth will probably come back more in line but it wouldn’t surprise me if it took several quarters for that to actually take place.

Operator

Your next question comes from Donald Fandetti – Citi.

Donald Fandetti – Citi

Our understanding is the Card Act there is a clause to effectively look back at these rate increases from the issuers and I was just curious if this could have any impact and how you think the Fed might look at that? Will they just look at broadly all repricing or would it be just the really high risk? If you have any comments there?

Daniel T. Henry

I’m not aware that the law actually have a provision to do a look back but certainly there have been conversations in different forums of people alluding to whether that should be something that is considered so we will have to wait and see how that evolves over time. But, to my knowledge it’s not in the law or the regulations but it something that people are thinking it is something that maybe an aspect that should be considered.

Operator

Your next question comes from John McDonald – Sanford Bernstein.

John McDonald – Sanford Bernstein

Just one more question around the messaging around the investment spend and trying to understand the ramp up messaging. So is it fair to think of it that you’ve stepped up the investment spent in the third quarter and the fourth quarter as provision expense came down and perhaps at a new run rate but the idea is that it’s going to go up further kind of dependent on the billed business recovery and further credit improvement and we’re at a run rate that’s higher but you’re still going to look to invest more?

Daniel T. Henry

Well, it’s going to be very correlated to what takes place in billings and credit. To the extent that billings really moves up and credit improves then we could well spend above the levels we had in fourth quarter. But, if you look at fourth quarter compared to historical levels it was at some pretty high levels so we’re not committing we’re going to go higher or committing that it’s going to come down. I think we’re going to try and invest at a healthy rate in 2010 so that we can build momentum as we go in to 2011 but exactly where it comes out will be very calibrated by both billings and credit as it unfolds in 2010.

John McDonald – Sanford Bernstein

Then the decline in discount rate by about three basis points was partly due to seasonality and partly merchant mix shift. Any more color on how much is seasonality versus the shift?

Daniel T. Henry

It certainly was seasonality from the third quarter to the fourth quarter it always drops because of holiday spending. Now, in most quarters over the last year or two we’ve been dropping about one basis point year-over-year, this quarter if you compare the fourth quarter of ’09 to the fourth quarter of ’08 it dropped two basis points but we got to the point where there was some rounding involved so it was actually one point something that actually tipped us over to two basis points so I don’t think there is anything unusual about the trend that is being driven by us. We’re emphasizing every day spend and moving in to certain merchant categories which are at the lower end of the discount rate scale.

John McDonald – Sanford Bernstein

So as we look in to next year I mean the primary driver will be kind of the mix of billed business and what’s driving the billed business recovery?

Daniel T. Henry

It will continue to be the mix of business as well as our value recapture initiatives to increase rates for those categories where we can clearly demonstrate we are providing increased value to the merchants.

Operator

Your next question comes from Scott Valentin – FBR Capital Markets.

Scott Valentin – FBR Capital Markets

You mentioned the modification program, I was just wondering and you’ll disclose absolute levels but I was wondering about recidivism rates if once you’ve modified the borrowers do you see them falling delinquent again? If you have any type of information around that?

Daniel T. Henry

We are very, very focused on any one who’s received assistance and we are closing tracking. We assume that some of those customers once we help them out will be able to stay in the franchise and be customers for a long time. We also clearly recognize that some of those customers will not be able to comply with the agreement we have with them and will reage out. Now, they’re performing very much in line or better than our expectations when we started the program.

You can be sure that we’re tracking them closely and we in fact have set up special reserves for this group of customers because they are clearly more risky than the broader set of customers. So they haven’t gone in to delinquency or in some cases right off but we have higher levels of reserves set for this group of customers.

Scott Valentin – FBR Capital Markets

On the repricing initiatives a lot of your peers are repricing as well but have you noticed any attrition on any accounts that get repriced? Are you seeing high amounts of attrition there?

Daniel T. Henry

You would have thought because of the difficult economy that particularly on our fee based products that you would have seen a real jump up in attrition, non-credit attrition and we really haven’t seen it. It really has been very modest which we think is a great sign for the franchise because people really see the value in the product even though they are paying a fee. The answer is we haven’t really seen it either because of the economy and we really haven’t seen it due to repricing initiatives that we did earlier in the year. Certainly the repricing we have done more recently we wouldn’t have seen it yet but we did repricing earlier in the year and we really didn’t see any notable uptick in attrition.

Scott Valentin – FBR Capital Markets

Final question, the flip side of that, marketing spend is up, I assume solicitations are up, are you seeing a better response rate to those solicitations?

Daniel T. Henry

I think we have many different channels that we use from mail to Internet to other methods so I don’t think we’re seeing any marked increase in response rates but certainly the response rates that we have on our investments are such that they are good economic investments. As we think about marketing investments over time when we get to a more normal period we want to get to marketing levels that are similar to what we had historically when you had an economy that was more normal.

Operator

Your next question comes from Bruce Harting – Barclays Capital.

Bruce Harting – Barclays Capital

On your page 24 Dan the maturities, can you just rank the relative cost of money now as securitizations mature can you go back to that market either based on a cost advantage or would you probably replace? You’re showing here what your resources are but are you more likely to fund any growth with deposits or securitizations? And then, can you just remind us where long term unsecured debt costs are for you if you tried to go to market?

Daniel T. Henry

We want to have a balance between unsecured, securitization and deposits over time. We think it is prudent to have as diverse a set of sources as we can have. When we get back to more normal markets and more normal spreads I think we will probably move between those three categories based on whatever is the most cost effective at that moment in time but I think we will always endeavor to have a substantial amount of funding coming out of all three of those.

We had a slide in I think the August financial community meeting where we see, “Gee, if rates were the average that we’ve seen over the last I think three years including the very high rates that we have had recently and we had to replace all the debt that matured between now and 2012 at that rate that it would increase our interest expense by I think $120 or $140 million.” It would be slightly higher but certainly not dramatically higher than where we are.

But to your point, I think seeing how the unsecured markets and the securitization markets come back will be very important in terms of the spreads that we have to pay above benchmark. But, it is our intent to really use all three markets. Certainly recently we’ve seen our CDS spreads come in really pretty dramatically over the last several months. So we’ll see how long it takes to kind of get back to a more normal level but we would plan to use all three funding sources.

Bruce Harting – Barclays Capital

On page 23 where you show pro forma, what’s your new allowance? The allowance increased by more than the reduction in capital correct?

Daniel T. Henry

I think that we think the increase in the reserve will be about $2.5 billion and have about a $1.7 billion impact in reducing equity, approximately.

Bruce Harting – Barclays Capital

Did you comment on the administration tax if that applies to you or is it just too early to say?

Daniel T. Henry

It is certainly early to say and we’ll have to wait and see whether in fact it is passed by Congress or not. But, if it passed in the form that was described where you take your assets and you subtract deposits and you subtract Tier-1 capital the amount we would have to pay based on the December 31st balance sheet would be about $175 million on an annual basis. Some people have put estimates out there that are lower than that but you have to take in to consideration bring the securitized assets that are off balance sheet on to balance sheet. The $175 is a pretax amount.

Operator

Your next question comes from Kenneth Bruce – Bank of America Merrill Lynch.

Kenneth Bruce – Bank of America Merrill Lynch

Could you remind us on how you’re thinking about reserve methodology and obviously you had a release this quarter. You look still very well reserved relative to where credit is trending but at some point I expect that you’ll need to normalize that. Can you give us some sense to about how you’re thinking about that please?

Daniel T. Henry

We have a methodology that we constantly look at and look to refine periodically but basically it is looking at historical information to help us form a view of the inherent risk in the overall portfolio. Then we always step back and say are there certain aspects of the portfolio where we may need a specific reserve. What I described before relating to reaged accounts is a perfect example of that where we will identify that and look at an additional specific reserve. Then we’re also very mindful of changes in either our strategy or the environment that we want to factor in, in terms of setting reserves.

So at this juncture we are still concerned about the uncertainty in the environment and so we continue to be cautious in terms of how we set reserves. But, at the end of the day we’re looking to set reserves that reflect the inherent risk in the portfolio.

Kenneth Bruce – Bank of America Merrill Lynch

Just as a follow up recognizing that you don’t want to give ROE guidance certainly on capital, would you be willing to give us an ROE target?

Daniel T. Henry

I think as I said I’m committed to even if we don’t get regulatory guidance by the middle of this year we’ll come out with guidance in terms of an ROE target.

Operator

Your final question comes from Robert Napoli – Piper Jaffray.

Robert Napoli – Piper Jaffray

This is pretty basic but putting the loans back on the balance sheet in the first quarter if I think about the P&L affect is it as simple as it seems? You put the loans on and you now are recognizing the interest income and expense? It seems like it would be provisions within a declining credit loss environment is probably accretive to your earnings. You no longer obviously get securitization income.

Daniel T. Henry

Your basic point is exactly right we would expect to have no difference in pretax earnings but by bringing them back on we’ll be recognizing net interest income, we’ll be recognizing provision and so really we’ll just be taking these and spreading what’s now netted on securitization income and putting it back on the natural line items but there’s no change to the bottom line.

Robert Napoli – Piper Jaffray

On late fees I guess that’s one piece people are still waiting for and kind of guidance on what’s a reasonable late fee. Do you have any feel for what to expect out of Washington in that regard?

Daniel T. Henry

The answer to that question is no, we don’t have any sense of whether we’ll get any guidance or if we do when it will be. They certainly have passed a fair amount of legislation already that we’re working hard to enable through our systems and if they come out with future guidance we’ll deal with it when it comes but at this juncture we don’t have any sense of any guidance about late fees.

Robert Napoli – Piper Jaffray

Do you have any feel for timing as to when you will hear something?

Daniel T. Henry

At this juncture no, we really don’t have any sense of what will come or the timing of when it will come or if it will come.

Robert Napoli – Piper Jaffray

Then the last thing, the charge that you took on real estate this quarter was how much?

Daniel T. Henry

$63 million.

Robert Napoli – Piper Jaffray

Pretax?

Daniel T. Henry

Pretax, yes. Thanks everybody for joining the call and have a good evening.

Operator

Ladies and gentlemen that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference service. You may now disconnect.

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Source: American Express Company Q4 2009 Earnings Call Transcript
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