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American Express (NYSE:AXP)

Q4 2010 Earnings Call

January 24, 2011 5:00 pm ET

Executives

Daniel Henry - Chief Financial Officer, Executive Vice President and Member of Operating Committee

Ron Stovall - Senior Vice President of Investor Relations

Analysts

Robert Napoli - Piper Jaffray Companies

Craig Maurer - Credit Agricole Securities (NYSE:USA) Inc.

Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc.

Michael Taiano - Sandler O’Neill & Partners

Richard Shane - JP Morgan Chase & Co

Betsy Graseck - Morgan Stanley

Donald Fandetti - Citigroup Inc

Bruce Harting - Barclays Capital

Bradley Ball - Evercore Partners Inc.

Kenneth Bruce - BofA Merrill Lynch

David Hochstim - Buckingham Research Group, Inc.

Brian Foran - Goldman Sachs

Christopher Brendler - Stifel, Nicolaus & Co., Inc.

Bill Carcache - Macquarie Research

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the American Express Fourth Quarter 2010 Earnings Release. [Operator Instructions] I'd like to now turn the conference over to our host, Mr. Ron Stovall. Please go ahead.

Ron Stovall

Okay. Thanks, Anne, and welcome, everybody. We appreciate all of you joining us for today's discussion. As usual, it's my honor to present to you some legal information and that is that the discussion today contain certain forward-looking statements about the company's future financial performance and business prospects, which are subject to risks and uncertainties and speak only as of today. The words believe, expect, anticipate, estimate, optimistic, intend, plan, aim, will, should, could, likely and similar expressions are intended to identify forward-looking statements.

Factors that could cause actual results to differ materially from these forward-looking statements including the company's financial and other goals are set forth within today's earnings press release, which was filed in an 8-K report, and in the company's 2009 10-K report and 2010 first, second and third quarter 10-Q reports already on file with the Securities and Exchange Commission, in the fourth quarter 2010 earnings release and earnings supplement as well as the presentation slides, all of which are now posted on our website at ir.americanexpress.com. We have provided information that describe certain non-GAAP financial measures used by the company and the comparable GAAP financial information. We encourage you to review that information in conjunction with today's discussion.

Today's discussion will begin with Dan Henry, Executive Vice President and Chief Financial Officer, who will review some key points relating to the quarter's earnings with a series of slides included with the earnings document distributed and provide some brief summary comments. Once Dan completes his remarks, we will turn to the moderator who will announce your opportunity to enter the queue for the Q&A period. Up until then no one is actually registered to ask questions.

While we will attempt 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 Henry

Okay. Thanks, Ron. As you all know, last Wednesday, January the 19th, we announced our EPS for the fourth quarter of 2010. We have made certain decisions regarding reengineering, and we plan to start to notify employees and therefore, we had an SEC disclosure obligation. Instead of leaving an open question for you to figure out in terms of how to think about the fourth quarter EPS considering the reengineering charge, we decided to announce EPS.

Looking at Slide 2, you can see that revenues are up 13%. But I remind you that in the fourth quarter of 2009, we still had securitized receivables that were off-balance sheet. Therefore, the more meaningful revenue growth is the managed total revenue net of interest expense of 4%. You can see that income from continuing operations was slightly over $1 billion, $1,062,000,000, and EPS was $0.88 and ROE had climbed to 27%.

If we look at Slide 3, we see that the reengineering costs in the fourth quarter on a pretax basis was $113 million. On an after-tax basis, the impact on net income was $74 million or $0.06. If you adjust for that reengineering cost, EPS was $0.94.

I'll remind you that the reengineering related primarily to a decision to consolidate locations within our company's global servicing network. We plan to close Greensboro, North Carolina, and transfer that work to other locations in the United States: Fort Lauderdale, Salt Lake City and Phoenix. We also plan to close Madrid after a consultation with local officials. That work will be transferred to Brighton in the U.K. and Buenos Aires in Argentina. We also plan to transfer some work from Sydney to Japan related to the Japanese card servicing. While 3,500 positions are impacted by the consolidation of locations, the decrease in staff levels is expected to be about 550.

If we move to Slide 4, we'll look at our metrics. Billed business growth continued to be strong, growing 15% or 14% on an FX-adjusted basis. And again, we are outpacing the growth in our major competitors. Billed business for the quarter and the full year are at record levels. Cards-in-force increased 4%, proprietary cards were flat, but GNS cards increased 10% and that averaged to a 4% increase in cards-in-force.

Average Cardmember spending increased, and it continued to be driven by higher Billed business. It reflects our strategy to focus on premium segments, both in Charge Card and the lending products. Loans on a managed basis are down 4%. They were down less than they had been earlier in the year. And in fact, in the quarter, sequentially, loans grew 6% and that is due impart to seasonal spending. And travel sales are up 12%.

Move to Slide 5, and this is a chart of monthly Billed business going back to October of '08. The bars are the dollar amount of Billed business per month and the green bars are the fourth quarter amounts for '08, '09 and 2010. The yellow and blue lines are the growth rates both on a reported and FX basis, and you can see the growth rates at the top of the chart. You can see that we've had strong growth throughout 2010 with a seasonal increase in the fourth quarter. The fourth quarter Billed business in 2010 are well above the '09 and '08 levels.

Moving to Slide 6. This is additional information on Billed business, and this is Billed business by growth by segment. And you can see you all segments have double-digit growth both on a reported and FX-adjusted basis. GNS continues to have the strongest growth, but all segments are contributing to the overall strength in Billed business growth.

Go to Slide 7. This is Billed business by region, and you can see that all regions, again, have double-digit growth on an FX-adjusted basis. And you can see that each quarter and for each region we've had double-digit growth throughout the year. JPAA (sic) JAPA continues to have the strongest growth, and that's the green dotted line where consumer, commercial card and GNS are all contributing to that strong growth.

Next, to Slide 8, and this is spending within USCS by product. And this slide has Billed business or spend by Cardmembers for U.S. consumer and small business over the last five quarters. The growth rate reflects our strategy and our investments that focus on co-brand lending and Charge Card, and those are the two sets of bars on the left side and in the middle of the slide. And also, just note that Charge Card Billed business accounts for 60% of worldwide billings and about 2/3 of proprietary billings.

If we move to Slide 9, this is looking at lending Billed business and managed loan growth. As we've discussed over the last several quarters, these metrics no longer are closely correlated. This is a combination of the actions we've taken in terms of credit actions, a reduction in the level of proprietary acquisition and our focus on premium lending, and therefore, a change in the mix where we have more transactions. It's also being impacted by Cardmember behavior as they decide to delever.

If you were to look at the lending trust in December, you would see that payment rates in December of 2010 was 29.63% and that's 2.6 basis points higher than December of '09. So we have more transactions in the portfolio and higher paydown rates, and that has lowered the risk profile of the portfolio. But it also has reduced loan growth and has impacted net interest income.

If we go to Slide 10, and this is looking at net interest yield and this is for USCS. And you can see back in '09, we had an increase in the yield as a result of repricing in anticipation of the CARD Act. And if you look at the fourth quarter of '10, you can see the yield is at 9.1% and this is in line with how we expected yields to migrate back to historical levels.

If we look at Slide 11, this is our revenue performance. Overall revenues on a managed basis are up 4%. You could see that in the lower right-hand corner. So while this is not robust growth, once again we are having better growth in most of our major competitors. If we look at discount revenue, it's up 12%. This is driven by a 15% growth in Billed business, and it's partially offset by the relatively faster growth in GNS Billed business where we capture a portion of the discount rate, also impacted by higher contra revenues, including higher levels of cash back rewards, and corporate incentive payments.

In the quarter, the average discount rate was 2.52%. That's up one basis point from last year, although it's down 4 basis points from last quarter, but that's just the influence of the seasonal spending to a greater degree in retail. And as we've discussed in the past, based on our strategy to drive deeper into everyday spend, it's likely that this will decline over time.

Net card fees are down 3%, but it's really the result of an $11 million reserve adjustment that we made last year. Excluding that, it would have been approximately flat in line with flat cards-in-force on a proprietary basis.

Net interest income is down 14% on a managed basis. And while loans were down at the end of the quarter by 1%, average loans were down 4% during the quarter. That, combined with the net interest yield decreasing from 10% in the fourth quarter of '09 down to 9.3% in the fourth quarter of this year, results in managed net interest income being down 14%.

Travel commissions is up about 8%. If we look at all other revenues, on a reported basis, it's 8%, but 1% on a managed basis. So the reported numbers benefit from the inclusion of fees related to securitized receivables. So those receivables came on the books in the first quarter and are therefore included in this year's number but not last year's number. In addition, on this slide we see greater foreign currency conversion revenue related to higher spending, higher GNS partner royalties and merchant-related fees, offset by higher levels of investments and partner initiatives and lower TC revenues.

So let me go to Slide 12, and this is looking at our provision for losses. So Charge Card credit continues to perform well, although the provision has increased by 30% compared to last year. That's a result of higher accounts receivable based on higher spend. Also the fact that last year, we released reserves as the 30 day past due rate was declining from 2.2% to 1.8%. And this year, we're building reserves slightly as the 30 day past due rate increased from 1% up to 1.6%. This is in line with our strategy to grow profitable share.

The lending provision on a reported basis this year is $37 million. That compares to $560 million on a GAAP basis. But if you had added to that the write-offs for securitized receivables, the managed number would be $1,320,000,000. So this is a significant reduction in provision reflecting the credit metrics that I'll discuss on the following slides. Reserves decreased $672 million in the fourth quarter compared to the third quarter, but we continue to have strong reserve coverage.

I'll move to Slide 13. This is looking at our expenses. So marketing and promotion increased 14% to $810 million, which is well above our historic level, which generally had run about $650 million per quarter. You don't see a very large percentage increase on this line because we started to ramp up spending on marketing and promotion in the fourth quarter of '09. Cardmember Rewards and Services grew at 13%, in line with the growth in Billed business.

You can see that salaries and benefits increased 31%. If we exclude $113 million of severance costs related to the reengineering that we announced last Wednesday, it increased 22%. This reflects merit increases, higher cost from the reinstatement of certain benefits that were temporarily suspended last year in the recession, such as profit-sharing, higher management incentive compensation, greater volume-related sales incentives as well as a 2% increase in staffing levels, which primarily relate to our growth initiatives and some to higher volumes.

So we are investing against our growth initiatives. These would include higher levels of sales force and client management for Commercial Card and Merchant Services; higher levels in technology, some of which is spent on supporting growth in revenues and some on creating efficiencies; investments in fee service initiatives as well as enterprise growth. So these are all areas that from a strategic aspect are important to us.

And I'll discuss the growth in operating expense in a little more detail on the following slides. But first, let me go to Slide 14, which is marketing and promotion expense. So marketing and promotion, each bar is the dollar amount of marketing in each quarter. As we discussed in prior quarters, the higher level of spending is enabled by the credit provision benefit from improving credit performance as well as strong Billed business performance.

As these provision benefits lessen over time, we have the flexibility to move investment spending towards historical levels. Higher spending is really across all segments, so we are spending at higher levels in terms of charge and premium lending acquisition, higher brand media, including spending back in November on Small Business Saturday, higher levels of international consumer acquisition and spend stimulation, perceptions of coverage and higher portfolio development consensus.

If we move to Slide 15, so this is a chart we've used for the last several quarters to look at operating expense. Operating expense grew 16%, if you exclude the restructuring. Overhead items such as support functions, including finance and human resources, as well as global services, are growing at a rate less than the average. And as you look at this chart, the different colors are indicative of whether its large. If its large, it's blue, medium is green and yellow is small. The items above 16% in terms of growth rate are really supporting our growth initiatives.

So first, looking at partner investments. So this is an important part of having the right value propositions for our customers and include payments to Delta, Costco and JetBlue. Global Network Services is to support the growth in this segment. For instance in this quarter, Billed business grew 24%, and throughout the year, we've been growing in the mid-20s. The sales force includes sales force for the Merchant business, as well as Commercial Card and is both the sales force and client management, both of these areas have been growing nicely from a Billed business perspective.

On the next page, I'll give you a little bit more detail in terms of new business initiatives and variable tech investments. So I go to Slide 16. Now on the left side, these are examples of the investments that we are making in our new fee revenue area.

So first, we look at LoyaltyEdge. Here we're using our Loyalty platform to generate fee revenues. Next is Revolution Money, which is we've renamed Serve, and here we're building capabilities in the digital space. Next is Business Insights, where we're using data mining capabilities to generate fee revenues while helping merchants to be successful. And for Loyalty Partners and Accertify is the fees that we pay as part of the acquisition. And I think you are all familiar with each of these as we've spoken about them over time.

When we look at variable technology investments, this is some of the items that are driving higher cost. Here, we're either investing to build capabilities to drive revenues or increase efficiency or in some cases, to support regulatory requirements.

So looking at the chart, clearly, investments in Business Insights is designed to drive revenues. We also have a project to consolidate our international A/R platform that would achieve efficiencies. And an example of regulatory implementation would be Basel II that we're investing against. In the digital capabilities, some of those items will drive revenues and some will achieve efficiencies.

Moving to Slide 17. So this is a slide that shows expenses excluding provision and excluding the Visa and MasterCard payments. If you look on the right side, the fourth quarter of '07 is above the historical levels because of a charge that we had back then related to Membership Rewards, and these are expenses as a percentage of total managed revenues net of interest expense.

So the main point of this slide is just to point out that we have elevated spending in 2010. It's been enabled by our strong Billed business growth and improving credit, and we've used this opportunity to invest against strategic objectives. These investments are designed to drive revenues in the future. However, we are doing this in a way that enables us to retain the flexibility to scale back on investments as business conditions change or the benefit from credit lessens.

Moving to Slide 18. So this is Charge Card reserve coverage, and this lays out our reserve coverage growth in the U.S. and international. Charge Card credit continues to perform very well, and reserves as a percentage of receivables and reserves as a percentage of 30 days past due remain consistent with prior quarters and strong given the continued favorable performance.

Moving to Slide 19. This is a slide that looks at managed lending write-off rate for USCS as well as International Consumer and then on a worldwide basis. So U.S., international and global write-off rates all continue to improve. In the U.S., our write-off rate for the quarter was 4.4%. That improved 310 basis points from the fourth quarter of last year and 80 basis points from the third quarter of this year.

International Consumer now stands at 4%, a 210 basis point improvement from last year and a 30 basis point improvement from last quarter. Our performance continues to outpace the industry reflective of the previous actions that we have taken and the quality of our customer base.

Moving to Slide 20. This slide is managed 30 day past due, and this continues to improve as well. In the U.S., it stands at 2.1%, 160 basis points better than the last year in the fourth quarter and 40 basis points improvement from the third quarter. In International, we now stand at 2.3%, 100 basis point improvement from last year and a 50 basis point improvement from last quarter.

Now we move to Slide 21. And we look at this slide to understand the write-off rates in this quarter and help our thinking about the write-off rate in the next quarter. So the write-off rate that is contractual relates to the two left-hand charts and early write-offs relate to the right-hand chart. We also need to factor in recoveries.

So looking at the left chart, the write-off rate for the current month are a function of the current to 30 day past due, is the upper left-hand chart, from five months prior, plus the 30 day past due to write-off rate, which is the bottom chart. So the write-off rates in the fourth quarter are a function of the green triangles in the upper left-hand and those are things that went past due from May to June of this year, plus the 30 day past due to write-off rate, which has remained relatively stable.

So if we look to the next quarter, the first quarter of 2011, the next three triangles in the upper left-hand chart are lower than the green triangles. So if the 30 day past due to write-off rate remains stable and if the first quarter of 2011 early write-off and recoveries are similar to the fourth quarter of 2010, the write-off rate in the first quarter of 2011 would be lower than the write-off rate in the fourth quarter of 2010. And as I always say, this is not a forecast. It's just useful information for you to think about the first quarter. As you know from the 8-K that we filed, the write-off rate in December was 4.1%.

Now moving to Slide 22. So this is a slide related to reserves. The left-hand chart is for 2009, and these are reserves related to the loans that were on the balance sheet. The right chart is for 2010, and it includes loans that are both securitized and not securitized, which are now on the balance sheet. So in the fourth quarter of 2009, reserves remained relatively flat. In the fourth quarter of 2010, given the improvement in our credit performance, we released $672 million of reserves in the quarter.

Moving to Slide 23. So this is lending reserve coverage. So in both the U.S. and worldwide, reserves as a percentage of loans continue to come down from the fourth quarter of '09 and the third quarter of 2010. Loans as a percentage of past due in both the U.S. and worldwide, as well as the principal months coverage, has started to come down reflective of our credit performance.

In 2010, we reduced reserves by about $500 million in each of the first, second and third quarter. And as I said a moment ago, reduced reserves by $672 million in the fourth quarter. We continue to be cautious in setting reserves given the uncertain economic environment. We think our reserves are reflective of the inherent risks in our portfolio.

So next, we move to Slide 24. And here, we see our capital ratios. So our capital ratios are down somewhat from the third quarter as you can see on the chart. Q1 common is down 60 basis points, driven by higher asset levels primarily reflecting the seasonal increase in AR and loans due to higher spending in the fourth quarter.

Another point that I'd make that I think is of interest, so while the final implementation of Basel III rules related to capital ratios will be determined by the Fed, the company estimates that had the new rules been in place during the fourth quarter of 2010, the reported Tier 1 common and Tier 1 capital ratios will decline by about 50 basis points. Our Tier 1 common remains among the best in the industry.

So next, I move to Slide 25. This is a snapshot of our liquidity. We had excess cash and marketable securities of $20 billion. We continue to hold excess cash and marketable securities to meet the next 12 months of funding maturities, which is our objective.

Next slide has to do with our deposit program. Now this slide provides some new information that we think that you will be interested in. We are now breaking out retail savings accounts between our direct program and our third-party programs. This is a roll forward from the end of 2009 through the end of 2010. And as you can see, we've increased direct deposits from $2.2 billion at the end of '09 to $8.7 billion at 12/31/2010. And it's our intent to continue to increase our direct deposit funding. You can also see on the chart our third-party brokered CDs, their maturities and the rates that we're paying on them, as well as our third-party sweep accounts, which have been at the current level for some time.

So with that, let me make a few concluding comments. Results for the quarter reflect the continuation of the positive business trends evident during the first nine months of the year. Spending growth remains strong across all of our businesses and segments. In fact, the 2010 fourth quarter and full year Cardmember spending levels are the strongest in our history.

We also saw further improvement in credit trends. Some of it is due to our strategic and risk-related actions, and some is reflecting the postrecession behavior of customers. The divergence between customer spending and borrowing levels, again, highlights that a key driver of our volume and receivable trends is charge and co-brand spending. The net effect of these factors is a lower risk profile for the company overall.

Revenue growth continue to outpace our large issuer competitors as strong Cardmember spending volumes more than offset the impact of lower loan balances and yields. Importantly, our strong Billed business growth and improving credit trends have once again provided the opportunity to invest in the business at high levels, while also generating strong earnings. These investments are focused on both driving current metrics and building capabilities that would benefit the medium- to long-term success of the company.

While many are reflected in marketing and operating expense, others involved using our strong capital base such as the Accertify and Loyalty Partner acquisitions announced during the quarter. Nevertheless, we recognize that there are headwinds in front of us. So even though there were signs of improving economic conditions, job creation still is relatively weak. Consumer behavior is evolving, and uncertainty continues to exist around the impact of regulatory and legislative initiatives that may impact aspects of our business.

In addition, during 2011, we will stop receiving quarterly Visa and MasterCard litigation payments, and year-over-year comparisons will be more difficult in light of the strong 2010 results. Despite these headwinds, we do believe that we can continue to invest at levels that can deliver attractive business growth as we move forward. The flexible nature of many of our investment decisions enable us to adjust those based on the evolving strength of our business.

In addition, our long-standing focus on driving efficiency as evidenced by the restructuring initiatives discussed earlier, reinforces our ability to invest. The bottom line is that our strong competitive position is yielding high-quality results, spending on our network continues to grow well above industry average and our credit performance remains the best among major card issuers. We are confident that our investments and business model are appropriately positioned to manage through the changing environment, capitalize on the opportunities in front of us and continue to win in the marketplace.

Thanks for listening, and we're now ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is coming from Rick Shane with JPMorgan.

Richard Shane - JP Morgan Chase & Co

Look, I think that when people go through the numbers, the most interesting slide and the most interesting data point is going to be related to expenses and frankly, Slide #17. When we look at those numbers, it suggests that if you look back at 2006, 2007, that might be a normal sort of expense year. As we head into the 2011, where do you think you're going to come out in the context of that 67% or 68% expense ratio on a managed basis? And how quickly can you respond? Is this something that you go into 2011 with a plan and if things are -- particularly, how quickly can you dial back spending?

Daniel Henry

So there are some aspects of the higher level of spending where we're investing that we believe are going to drive revenue growth going forward. So our investment in a higher level of sales force and client managers related to our Commercial Card business and Merchant business, those are going to continue. But we are confident in our ability to be successful, and those higher level expenses will be covered by revenues that we generate. We also are investing in fee services. So there the nature of the investment we make is different in marketing and promotion, which historically was the primary driver of future revenue growth. But if we're going to grow those businesses like Business Insights, we actually have to incur expenses that run through the operating line. So they're not going to go away. We will monitor our investments in some of these new fee revenues very closely. If they're successful, we'll invest more behind them. If they're not meeting our expectations, we'll dial back. So there are some that are going to continue on an ongoing basis. On the other hand, there are other investments that we're not incurring costs that are fixed, that give us the flexibility that we can dial them down as our benefit from either Visa, MasterCard or from improving credit start to weigh in. So there's really a mix within there. So I can't give you an exact percentage since they are different in nature, but we are watching this very closely. And we believe we have the ability to dial them up or down based on the resources that we have available, while still looking to achieve our financial targets on average and over time.

Operator

And we have Ken Bruce with BofA Merrill Lynch.

Kenneth Bruce - BofA Merrill Lynch

I have a question also that relates to the expense side, and I'm sure you're going to get several of these. But recognizing that you've got some flexibility in terms of how you're investing, whether it be in a revenue-generating expense or in fee services, is there anyway that you can size up maybe some of those bubbles so that we can have a better sense as to what the expense levels are that are generally speaking growing above the average and just give us a better sense as to how we can think about modeling your expense base going forward?

Daniel Henry

So we tried to add a few slides here to provide some additional information, because we knew this would be a focus that you would have since it's a focus that we have. On Slide 15, we tried to give some sense by using the different colors. So certainly, Global Services is a much larger expense base and, say, the additional costs that we're incurring related to regulatory cost, so we try to reflect that. In terms of variable tech SUP [ph], that line is up about $90 million. And on Slide 16, we tried to give you examples of some of the areas where we're spending above historic levels. And it really does go across the gamut from items like Business Insights that's going to drive revenues, to things like consolidating our A/R Platform that will enable us to be efficient from a cost perspective. So we're endeavoring to provide some additional information to give you some insight there. But in terms of exactly how you model where these expenses go, it's partly going to be driven by what's going to happen going forward in terms of the performance of credit. Actually the success we're having with the investments that we're making this year will all kind of calibrate around the level that will eventuate in 2011 and into 2012.

Kenneth Bruce - BofA Merrill Lynch

Are you effectively sticking with your guidance in terms of pretax margins in or around 20%?

Daniel Henry

Yes, I think if you look back over time, historically, that's where we've been. I think expenses as a percentage of revenues will probably run at a slightly higher level over the last four years, the period during which we've been receiving our Visa and MasterCard payments. That's exactly what we said we were going to do. I think we executed against that, but I think 20% is not a precise forecast for the future. But if you think about on average and over time, it would be in that range.

Operator

And Mike Taiano with Sandler O'Neill.

Michael Taiano - Sandler O’Neill & Partners

I guess a question on the revenue side of things. Year-over-year, up 4%, which I guess was down a little bit versus the 5% in the third quarter. Obviously, you have the big headwind on the loan shrinkage year-over-year. But just curious as to what do you think really needs to happen given that Billed business is growing sort of in the mid-teen levels? What needs to happen to sort of get you to your long-term target of sort of a high single-digit revenue growth rate?

Daniel Henry

So I think right now, we have consumers deleveraging. And so during the year, there were sometimes where loans were down from the high single digits, probably earlier in the year even more than that. So that is a headwind. At some point in the future, we'll start to grow. I don't think that it will go back to what it was like in '06 and '07 where loans were growing at the same rate as spending. I would estimate it will grow at a slower pace, but at some point, we'll start to get positive growth there. So that, combined with the levels of Billed business that we're seeing and growth in fee revenues, a combination of all those things, I think, will help get us back to high single digits. Now the other thing is in addition to the loan side impacting us, we're also being impacted this year as yields come down. So at some point, they're going to stabilize. So we have stable yield, some modest growth in loans combined with Billed business and new fee revenues, we think that can put as in a position that we'd like to be in.

Michael Taiano - Sandler O’Neill & Partners

So just to summarize, it sounds like maybe the loan growth and sort of margin headwind that exist today in 2010 should probably ease as we move through 2011?

Daniel Henry

So I don’t want to do and start forecasting here. I'm just trying to give you some sense about how we think about it kind of on average and over time.

Operator

And we have Sanjay Sakhrani from KBW.

Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc.

I guess my question is around the top line growth as well, and I was wondering if you guys provided any update on kind of year-to-date volume trends. And then, maybe just thinking about what near-term volume trends could be given the comps kind of get tougher the first half of this year. How should we think about it first half of this year and into the latter part of the year?

Daniel Henry

So as you know, I will do a forecast here. I will say that Billed business volumes for the first portion of January are comparable to what we saw in the fourth quarter. I think as you think about where our volumes will go going forward, we've often talked about the fact that Billed business correlates pretty closely to GDP. So we for our planning purposes, always look at the blue chip consensus to give us a grounding in terms of how we think about the balance of the year. And then as that changes during the year, we calibrate up or down depending on what we're seeing in the economy. So in reality, the way we think about it and a good way for you to think about it would be to look at forecast of GDP or your own opinion about that is a good way to think about where our Billed business growth will go as we go forward.

Operator

Betsy Graseck with Morgan Stanley.

Betsy Graseck - Morgan Stanley

I guess I just had a couple of questions. One was on the expense side and one is on the capital side. On the expense side, you indicated that you're expecting to keep on investing and hit your pretax margin goals. I'm just wondering, as reserve fleet goes away and as the Visa, MasterCard payments go away, do you expect a quick transition of the expense ratio or more moderate?

Daniel Henry

Yes, we've always been very mindful that Visa and MasterCard will end at some point, which will be later in 2011. And we have used the opportunity from both Visa and MasterCard, as well as our improving performance in Billed business and credit, to take this opportunity to invest at high levels. If we're successful at that, that will generate revenues into the future, and that was always our strategy as we go forward. Will the mix of expenses shift a little bit to the extent fee business has become a bigger part of the total? That would happen because that's not driven by marketing promotion. We just have to see how that evolves over time. But we've been very mindful that at some point, the benefits that are correlated to credit will lessen. And that 2011 is the last year that we have the Visa and MasterCard payments.

Operator

Craig Maurer with CLSA.

Daniel Henry

So maybe you want to go back at some point to hear the question about capitals.

Craig Maurer - Credit Agricole Securities (USA) Inc.

I had two questions. One, just to drill down a little further on expense, and I'm sure you guys are getting a little tired of it. But on the other expense line, two quarters ago, we saw that ramp up dramatically and that's where the contract expense from Visa MasterCard rolls on. So how should we expect to see that trend through this year as that begins to roll off in the back half of 2011? Will the expense -- just looking for a clear answer, will you be looking to get that expense to ratchet down in a way to compensate for that payment rolling down to, I believe, it's $77 million per quarter? And secondly, has the discussions you're having with retailers changed at all since the guidance given by the Fed on debit interchange in December?

Daniel Henry

Just in terms of expenses, as I said before, there are certain expenses that have increased during the year that will continue at higher levels. Examples of that would be our investments against enterprise growth, adding sales force, hiring employees to drive other fee revenues. Others, we've kept variable in nature. And instead of hiring employees, we've used certain outside professional groups to help us do that. That gives us the ability to have flexibility and variability so that we can take that down as appropriate. So could I just ask you the latter part of your question, if you could articulate that again as it relates to merchants?

Craig Maurer - Credit Agricole Securities (USA) Inc.

Sure. I was looking to understand if your discussion with merchants regarding American Express offering your cards to pricing has changed, the tone of it, has changed at all since the December 16th guidance or 14th guidance offered by the Fed on debit interchange pricing?

Daniel Henry

I think we're in constant discussion with merchants. We are always having discussions about the value that we can bring them, how we can help them to be successful. And they are always looking to see that they pay the appropriate price for the service that we provide. So I don't think the discussions with the merchants have changed notably over the last several months at this juncture.

Operator

We are now going to go back to Betsy Graseck with Morgan Stanley.

Betsy Graseck - Morgan Stanley

Just on the capital side, I know you can't talk about what you're asking for [indiscernible] for the capital plan, but maybe you could give us some sense as to what kind of capital ratios you would like to hold going forward and when you think you might begin a buyback program?

Daniel Henry

So many folks who have submitted to the Fed are looking to increase their dividend. I think as all of you know, we did not cut our dividend. But in our filing, we're starting from a position of strength from a Tier 1 common perspective. And in our submission, we requested that we could restart our share repurchase program. It's my understanding that they've committed to get back to companies by the end of March. And once we hear from them, if we get approval, then we would restart the share repurchase program. The guidance that we gave last summer when we were talking about where we said ROE, is that we would look on average and over time to return to shareholders about 50% of earnings through dividends and share repurchases and use about 50% to support the growth in our balance sheet and for bolt-on acquisitions.

Betsy Graseck - Morgan Stanley

And is that something you think you could get to in the first quarter, or is that something you would get to over time?

Daniel Henry

Well, I think they should really get back to companies at least 10 days before the end of March. I think we'd be in our blackout period by then. So if that's the time when they get back to us, I would assume we would start the repurchase program in the second quarter.

Betsy Graseck - Morgan Stanley

I guess what I'm saying is the first quarter in which you were able to restart your program, you would start with 50% payout ratio. You don't think you'd need to work out towards that?

Daniel Henry

I think our target is kind of an annual amount that we'd be targeting. So I would kind of be mindful of what our earnings were for the year and over the course of the year, look to get up to the 50% level.

Operator

And now go to Bob Napoli with Piper Jaffray.

Robert Napoli - Piper Jaffray Companies

A question on growth. You did seem to have an acceleration in growth in cards-in-force both U.S. and internationally in the fourth quarter. And I was wondering if there are specific programs or if there is momentum on the addition of new cardholders, if you're seeing better response rates, or what is driving that? Is there something unusual or is it just an acceleration of the success of the investments you've been making?

Daniel Henry

As you know, we are investing at elevated levels in terms of marketing and promotion we have throughout this year. I think the improved position from a cards-in-force perspective is a result of the success of that acquisition. I think we're seeing the success of that in our Billed business numbers as well. We are focused on the premium segment, and to acquire premium Cardmembers are more expensive. So I don't think you'll see us move to high single-digit growth in cards-in-force. It's really about the quality of the customers that we're focusing on. And I think you're seeing that in our average spend, which is a major driver of Billed business. So I think it is the investments that's helping to improve cards-in-force and to drive spending on our network. So now also, we were kind of flat on the proprietary side. We continue to have good acquisition of cards by our GNS partners, which is up about 10%. And the two of those together averaged the 4% growth in cards-in-force that we saw.

Robert Napoli - Piper Jaffray Companies

That's for the full year though, right?

Daniel Henry

It's year-over-year.

Robert Napoli - Piper Jaffray Companies

Right, and I was saying the acceleration I saw -- I mean, what I was talking about was specifically the fourth quarter. But has the net interest margin bottomed at this point? Did I hear you had approximately the decline in margins? And it's my last question, but I want to make sure I'm clear on that.

Daniel Henry

So I didn't say it bottomed. I said it was migrating in accordance with the way we expected. If you go back in history, you would see that our margins at some points were kind of in the high eights, 8.8%, 8.9%. So part of it is still some additional migration to take place. But that's going to be impacted by the mix of our customers, and the mix of our receivables or loans has changed a little bit. We have a lot more transactors in the portfolio, so that could come into play as well. But it's pretty much on line with what our expectations are.

Operator

Brad Ball with Evercore.

Bradley Ball - Evercore Partners Inc.

Dan, a couple of follow-up, quick ones. In terms of the capital, are you still thinking that a 10% Tier 1 common would be sort of the appropriate low mark for you now that you've got a sense for what Basel III looks like and you'd be coming in with a 10.6% number pro forma here for the fourth quarter. And then separately, with respect to the Fed's proposals for debit interchange cuts in Durbin, if those were to go through those 80%-plus cuts in debit interchange, what would be the implications for credit card interchange and for Charge Card interchange in your view? Would competitive forces drive Charge Card and credit card interchange down?

Daniel Henry

So on the capital side, I think when we put out our ROE target, we just had to make an assumption about capital levels. So we picked 10%. That wasn't a forecast for the future about where our minimum levels will be. I think as you know, to date the Fed hasn't even issued rules yet. But based on Basel, you would expect the minimum to be 7%, so 4.5% plus the buffer of 2.5%. Will this going to evolve over time? We're going to get a better sense over time about how they think about the countercyclical aspects as things will deteriorate. You may get a sense of what they look for from systemically large institutions. We know we're not part of the 19 global, but we are part of the 19 in the U.S. that they look at. So that will have some implication. So I don't want to pick a set number other than to say I think we would always want to have a capital position that gave us flexibility. And over time, we need to figure out exactly where that is. We feel relatively comfortable where we are today and even after the new Basel rules come into place. So we'll play that by ear as we go forward. As it relates to interchange, if anything, I would say the focus on credit interchange is probably less today than it was six or 12 months ago. So we don't see that imminently being on the horizon, although you never know what may take place. In terms of -- that's from a legislative point of view. From a marketplace point of view, I think we need to actually wait and see what the final rules are. And if they stay where they are, what would be the reaction of merchants? Will merchants look to shift, steer to debit or not? Some may decide to do it. They may decide not to do it, and I think we'll have to wait and see how that plays out in the marketplace. As we've discussed before, and many others have, there's a lot of complication in steering in terms of just the education within the firm that was going to do that, what the sharing of the benefit would be between consumers and the merchants. And then very importantly, what would be the reaction of customers to that. Would they be benign about it, or would they result in some consumers deciding to take their business elsewhere. All those things, which are a lot of things, need to play in the marketplace before we have clearer view about that.

Operator

Bill Carcache with Macquarie.

Bill Carcache - Macquarie Research

Dan, you've talked about your interest in prepaid in the past, but can you give us an update on when we can expect to hear more on what your plans are in the prepaid space? And then also, you mentioned earlier that the discount rate should come down over time as you try to capture greater percentage of every day spend. I believe that's what you'd said. Can you just give us a sense of what rate of, I guess, kind of compression that we can see in the discount rate we can expect to see in the discount rate and kind of over what period of time relative to what we've seen in the past?

Daniel Henry

So in the prepaid side, we've had very good growth in prepaid, although prepaid is a relatively small component of our total business. So we haven't broken that out. We think we have good capabilities and good products. In addition to that, Dan Schulman, who joined us recently, has a significant amount of experience in prepaid. So that will be a focus of ours going forward. At the moment, we don't have a plan to make any additional disclosures around that, but it is a space that we have done reasonably well over time. This past season we think was a good season, holiday season for gift cards across the industry and we participated in that. So we'll need to watch how the market place evolves, and we think we can play a significant role in that marketplace. In terms of discount rate, I think we've historically said that you could see a decline of two or three basis points per year over time as we pushed into everyday spend. And obviously, it depends on what rate we push in. Now you also know that over the past, really, two or three years, we haven't seen that rate of decline. As, when it's appropriate, we've talked to certain merchant categories about the value we bring and have agreed on higher pricing. So it's only been about, I guess, one basis point or so that we've seen. So that's kind of the way to think about it I think, and we'll see how the actual additional push into everyday spend goes and where there are pricing opportunities in the future, when it's appropriate from a value perspective and in certain categories.

Operator

Chris Brendler with Stifel, Nicolaus.

Christopher Brendler - Stifel, Nicolaus & Co., Inc.

Just one on the DOJ case and steering, do you currently allow for steering on the debit cards, or is that also part of their contention?

Daniel Henry

I think Durbin dealt with the ability to steer. So before legislation, people could steer to cash by offering a discount. Durbin allows steering from credit to debit. The DOJ had to do with steering from credit-to-credit.

Christopher Brendler - Stifel, Nicolaus & Co., Inc.

And just a separate question, the airline industry seems like a place where you might see discounting take place because this is such a big part of their fee structure. But you've had a fairly close relationship with several airlines over the past. Can you just give us any color a, on the airlines and the relationship you had with them and their fees and the pressure on those fees? And maybe also internationally where you do see some airlines either discount or surcharge for credit cards, what's been your experience there if you could share any of that color.

Daniel Henry

So our relationship with airlines has been long and important. They are very important merchant for us. I think we are a very important enabler for them in their business. So we have discussions with them on an ongoing basis each year and probably every quarter, and we'll continue to do that. We certainly talk to them about the value of the customers we bring. We have a strong Corporate Card business. We have a very affluent Consumer business. We have a strong position within small business. So all of those customers are not only our premier customers but their premium customers, and we work to really the mutual benefit of not only ourselves but then and our customers. So we look to strengthen the benefits that we give to our Cardmembers that are high spenders, many of those high spenders are frequent flyers. So for instance, recently we've ensured that we have lounge access with US Air. We have a program to waive baggage fees. We don't waive them, but we reimburse them to the extent that they incur them. So this is a very important merchant category for us that we are very focused on as I said. And the airlines are very focused on because it's important to them as well.

Christopher Brendler - Stifel, Nicolaus & Co., Inc.

Internationally?

Daniel Henry

Internationally, I think we've seen pockets on smaller airlines where they have had a differentiated charge depending on what your payment method is. It's not widespread though. It's generally been on some of the non-major airlines.

Christopher Brendler - Stifel, Nicolaus & Co., Inc.

And then they're also impacting your business basically?

Daniel Henry

I think anytime you lose $1 of revenue, it's an impact on your business, but it has not been significant.

Operator

Brian Foran with Nomura.

Brian Foran - Goldman Sachs

On Slide 26, when we calculate out the deposit repricing opportunity, should we assume that all falls to lower interest expense and benefits the NIM, or is some of that going to be offset by ABS funding or something like that rolling off?

Daniel Henry

So this is just one of the many pieces of our funding. And we want to keep a balance between our deposit program, unsecured and securitization because loans have not been growing. There haven't been a need for issuances of large amounts in either unsecured or the securitization area. But we'll continue to fund using all three sources even though they have somewhat different pricing. We want to have the right price, but we also want to have diversity, and we also want to have the right duration in our funding sources. So certainly, deposits is a good funding source for us. Although on average and over time, the cost of funds and deposits is about the same as that you would find in the unsecured and secured space. When rates are low, deposits are a little more expensive. When rates are high, deposits are a little less expensive. But our main focus is to have the right mix and diversity of funding over time.

Brian Foran - Goldman Sachs

And then putting together all your expense comments, I mean, my interpretation was operating leverage remains negative in '11 but maybe flips to positive in 2012. Is that what you were trying to say or is that me interpreting too much what you're saying?

Daniel Henry

So I wasn't attempting to forecast at all for 2012. I was trying to be helpful in terms about how you think about next year. I suspect that in next year, we continue to have Visa and MasterCard benefits. And so we'll spend at higher levels. We'll likely have credit benefits as well, not at the same level we have this year. So all those things enable us to continue to spend, to help drive our business. As I said before, we also have to look and see how our fee services initiatives play out. And you could see some mix change in expenses between historical amount and the mix between marketing and promotion and operating expense. But that will play out over some period of time.

Brian Foran - Goldman Sachs

Maybe I can ask a better way is what's the typical lead time between an investment in the fee services business translating to accelerating revenue growth in the fee services businesses?

Daniel Henry

So I think all investments we have even if it's an acquisition of Cardmembers, generally, in the first year, we have a loss because of the acquisition cost. It breaks even, starts to turn profitable kind of in the second year. When you look at sales force, you need to bring people in. You need to train them. There's an experience building process. So again, that takes probably 18 months or more to get a good payback. When you're building a new business, there's a requirement for investment before you actually start to get momentum. So I think all these investments take a little while before they actually start to payback regardless to which category it is.

Operator

David Hochstim with Buckingham Research.

David Hochstim - Buckingham Research Group, Inc.

A question about cards, if you could just clarify again. If you want to make the adjustments for the partner cards in prior quarters before the third quarter were to be about 1 million or 1.6 million for last year and...

Daniel Henry

It was 1.6 million cards.

David Hochstim - Buckingham Research Group, Inc.

In Q3. Would that be the right number for the prior quarters as well?

Daniel Henry

I think so.

David Hochstim - Buckingham Research Group, Inc.

And then just on the Professional Services expense, could you talk about how much of that contracts were, I guess, technology and how much is just kind of discretionary? You've kind of alluded a little bit to that, but could you clarify how much of that could be variable?

Daniel Henry

Yes, so that's across a broad spectrum of areas. Part of it is technology, part of it is moving forward some of our fee service investments. The good part about that line is it would tend to be more variable than other lines. And in part, we utilize that line for that very reason. So we had the ability to moderate it when appropriate. So I think there's a fair amount of flexibility in the line. There's some base in there that it's not, but I think the increase that you've seen is largely variable in nature.

David Hochstim - Buckingham Research Group, Inc.

And then just on card growth again in the U.S. If you look at the growth in marketing spending, it looks like marketing spending in USCS and limited card growth recently. Can you just talk about how longer term you drive Billed business growth without card growth or without account growth?

Daniel Henry

Yes. So I mean, I think if you think of the old model, where we were spending against charge, co-brand and a broad spectrum of proprietary lending, it costs significantly less to bring in a card that's going to spend $1,000 or $1,500 a year, it costs significantly more to bring in a card that is anywhere near our average spend per Cardmember. So our focus is really on the premium end. And so I don't think we'll return to high single-digit growth in cards-in-force. But to the extent -- and in every quarter, we have some attrition as we always have. So I think the key for us is bringing in the right customers that are in line with our strategy, that will enable us to improve the risk profile of our balance sheet. And at the same time, enable us to grow our Billed business at a rate that enables us to achieve our long-term financial targets.

Operator

And we have Bruce Harting with Barclays Capital.

Bruce Harting - Barclays Capital

Dan, are all the loans now tied to prime? I know on my monthly statement I just got a big disclosure attached to my statement talking about how my loan is tied to prime. And so is that complete now for all U.S. cards and international? And then do you have a managed revenue growth number for the quarter, and do you think that you'll sort of meet your 8% managed revenue growth number in '11?

Daniel Henry

So the vast majority of our cards in the U.S. are all variably priced. In international, I think the majority are variably priced, but not to the same degree that would be true in the U.S. But if you look at our total loans of $51 billion, the vast majority are variably priced at the end of the day. In terms of managed revenue growth, that's at about 4%. I think we're benefiting from the Billed business side, but certainly the loan side, a combination of the yield and the actual loan balances have a very dampening effect. Although we do think over time, we can get revenues back up into the high single digits. And by doing that, we think we can achieve our financial targets over time.

Bruce Harting - Barclays Capital

They're trying to figure out what the tax rate noise was. I think I discovered on Page 20 that the tax rate was just 5.6% in the International Card Services. Can you comment on that a little bit? And then just in the International, it seems like the discount revenues were somewhere between 18% and 20% of total. But then only 7% of the pretax dropped to the pretax line and then you didn't really have to pay taxes in that segment. Any specific issues in that International segment for the quarter?

Daniel Henry

So I don't think there's any specific issues. I think our international tax rate has always been very low, and it really has to do with how we do our internal allocations that really drives that lower tax rate. But our all-in tax rate within the company was really driven by some of the permit [ph] differences we have and the tax strategies that we have in place, which have been in place for a number of years. So there's nothing unique in this quarter related to taxes.

So I'll take one last question.

Operator

That will be coming from Don Fandetti with Citigroup.

Donald Fandetti - Citigroup Inc

Dan, I was wondering if you could provide us an update and thoughts on acquisitions? And also, as you look at alternative payments, have you made the investments that you need to make to sort of position American Express, or do you feel like there's still room for some decent moderate-sized acquisitions?

Daniel Henry

So I think acquisitions are going to be part of our business model going forward. I think we're generally going to focus on bolt-on acquisitions that support our strategy. I think the acquisitions that we've made so far ranging from Revolution Money and now Serve that will enable our digital strategy. I think it certifies a very good example where we can make an acquisition and leverage it to the benefit of both merchants and ourself. I think Loyalty Partners is the same thing. We're going to leverage our loyalty knowledge, our relationship with merchants, our global reach to take Loyalty Partners to a level that would have been difficult for them to do without the acquisition. And I think we'll continue to look and see what other acquisitions of that type we can do going forward. I would say that we've made great strides in terms of our capabilities in the digital space, although I think we will continue to look to build onto those capabilities to make the Serve platform even stronger and have greater utility in the marketplace as we go forward. So we want to use marketing promotions, we want to use operating expense to help grow the business organically. But we want to use the strong capital generation capabilities that the firm has and our strong capital position to also help further the strategies that we've been articulated to you.

Okay. So thanks, everybody, for joining the call, and have a very pleasant evening.

Operator

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