American Express (AXP), issuer of the green charge cards that are synonymous with the expense account life, has long competed against banks and, by some measures, out-earned the deposit-and-loan crowd. Here’s Amex, as the company is known, in recent years leaving Bank of America (BAC) and Wells Fargo (WFC) in the dust when it comes to return-on-equity.
Investors appreciate that, so Amex also has tended to trade at a higher multiple of book value vs. the big banks, and also vs. banks that specialize in credit cards.
Amex pulled off this trick because it’s less reliant on loans than are the banks, getting lots of fee income from merchants who pay Amex a small percentage of every purchase made with the card. While Amex does loan money on its credit cards, its traditional green (and other colors) charge card typically gets paid off every month. So, Amex needs less capital relative to its charge activity because fewer of the purchases turn into loans.
The company’s financial goals have been lofty, but until the recent financial crisis, Amex often met them: Revenue growth of 8% or more; Earnings per-share growth of 12-to-15%; Return-on-equity of 33-to-36%.
Of course, if one keeps the equity number low, it’s at times easier to push ROE above 30%, and Amex did so by keeping the “E” low: paying out each year roughly 65% of the capital it generated in the form of dividends and stock buybacks. (That last multi-billion-dollar data point on the buybacks charts is Amex repurchasing stock from the government after the banking bailout).
But then along comes the crisis. Amex, like Goldman Sachs (GS) and Morgan Stanley (MS), received federal money to help stabilize its funding during the panic, and had to become a regulated bank holding company in late 2008. The Federal Reserve is now its primary regulator. And the Fed, seeking to avoid a repeat of the panic, wants banking concerns to amass lots of capital. Amex suspended its buyback program to build up capital. “These higher capital requirements would in turn lead, all other things being equal, to lower future ROE,” Amex sadly notes in its most recent 10-K. Amex figures it can beat 20% return-on-equity, but as of that filing was still trying to figure out precisely how the capital requirements would play out.
Of course, ROE above 20% isn’t shabby at all, but it isn’t the stratospheric 33-to-36% of yore.
The other problem facing Amex is competition. The fee it gets from merchants – retailers, hotels and the like – is generally higher than the fees collected by Visa (V) and MasterCard (MA). Amex feels it earns the higher fee by delivering its big-spending clientele; the average basic card member’s spending was over $11,000 last year. The merchants, understandably, don’t always see it that way and some even will ask customers to use a Visa or MasterCard instead of the Amex card. That, and competition, is driving Amex’s merchant fee premium down, if slowly.
Results for the first half of 2010 were much improved. The provision for loan losses was 53% lower, and charge volumes were up, so net income more than doubled to $1.9 billion, or $1.57 a share. “While the economic environment remains uneven, our net income and billed business (charge volume) are back at, or near, their pre-recession levels,” Kenneth Chenault, Amex’s CEO, said in a second-quarter statement.
But Chenault’s a banker now. And his return on equity for the first half was 23.2%. He’ll probably move the ROE number higher, with cost cutting and other initiatives. But it will be a long haul back to 33% and better.
Disclosure: No Positions