American Express Company (AXP) Management Discusses Q2 2013 Results - Earnings Call Transcript

Jul. 17, 2013 6:50 PM ETAmerican Express Company (AXP)

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American Express Company (NYSE:AXP) Q2 2013 Earnings Conference Call July 17, 2013 5:00 PM ET

Executives

Richard Petrino – Senior Vice President, Investor Relations

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

Jeffrey C. Campbell – Interim Chief Financial Officer

Analysts

Craig Maurer – CLSA Limited

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

Bill Carcache – Nomura Securities International, Inc.

Brian D. Foran – Autonomous Research

Richard B. Shane – JPMorgan Securities LLC

Kenneth Bruce – Bank of America Merrill Lynch

Ryan M. Nash – Goldman Sachs & Co.

Donald Fandetti – Citigroup Global Markets Inc.

James Friedman – Susquehanna International Group, LLP

Mark C. DeVries – Barclays Capital, Inc.

Chris Brendler – Stifel, Nicolaus & Co., Inc.

Bradley G. Ball – Evercore Partners Inc.

Operator

Ladies and gentlemen, thank you for standing by and welcome to the American Express Second Quarter 2013 Earnings Call. At this time, all participants are in a listen-only mode. Later there will be an opportunity for questions. (Operator Instructions) As a reminder, this conference is being recorded.

And I would now like to turn the conference over to your host, Senior Vice President Investor Relations, Mr. Rick Petrino. Please go ahead.

Rick Petrino

Thank you. Welcome and thank you for joining us for today’s call. The discussion today contains certain forward-looking statements about the Company’s future financial performance and business prospects, which are 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 and earnings supplement, which were filed in an 8-K report and in the Company’s 2012 10-K and Q1 2013 10-Q already on file with the SEC.

The discussion today also contains certain non-GAAP financial measures. Information relating to comparable GAAP financial measures may be found in the second quarter 2013 earnings release, earnings supplement and presentation slides, as well as the earnings materials for prior periods that may be discussed, all of which are posted on our website at ir.americanexpress.com. We encourage you to review that information in conjunction with today’s discussion.

Today’s discussion will begin with Dan Henry, Executive Vice President and Chief Financial Officer, who will review some key points related to the quarter’s earnings through the series of slides included with the earnings documents distributed and provide some brief summary comments.

Before I turn the discussion over to Dan, I did want to acknowledge that this will be Dan’s last earnings call as our CFO. He will be leaving Amex after a distinguished 23 year career, including the past six years as CFO, where he has played an important role in building relationships with the investment community.

On behalf of all of my colleagues throughout the finance organization, I want to sincerely thank Dan for his many contributions and to wish him the best of luck on his retirement.

I also want to recognize that Jeff Campbell is joining us on the call today. Jeff joined Amex from McKesson Corporation where he was Executive Vice President and CFO of the largest healthcare services company in the U.S. Jeff will be assuming CFO duties in early August after we file our second quarter financial results and are we are excited to have him as part of American Express.

And with that, let me turn the discussion over to Dan.

Daniel T. Henry

Okay. Thanks, Rick. So I’ll start on slide two, the second quarter 2013 summary of financial performance slide. Total revenues came in at $8.2 billion. That’s 4% higher than a year ago. On an FX adjusted basis it’s also 4%.

In the first quarter, the growth rates were 4% on a reported basis and 5% on an FX adjusted basis. I will speak about the impact of cardmember reimbursements on revenue growth a little later.

Net income came in at $1.4 billion, 5% higher; EPS is $1.27, 10% higher as you can see the benefit of our share buyback program. And on the last line you can see that shares outstanding are declining.

Return on average equity was 24% in the second quarter. Without the three adjustments in the fourth quarter of 2012, as this is a 12-month rolling calculation, ROE in the second quarter of 2013 would be 27%.

Moving to slide three, our metric performance; billed business came in at $237 billion. That’s 7% higher or 8% higher on an FX adjusted basis. That compares to the first quarter when we grew at 6% reported and 7% FX adjusted. So this quarter it’s about 100 basis points better growth rate than the first quarter.

Total cards in force are $104 million. That’s a growth of 4%. Proprietary cards grew 2%, which is comparable to what we’ve seen in recent quarters.

Average basic cardmember spending is $4,097 in the quarter. That’s up about 4% and reflects the continued strong cardmember engagement that we have seen. Cardmember loans are $63 billion. That’s an increase of 3%, 4% on an FX adjusted basis and reflects continued modest growth in loans.

Moving to slide four, this is billed business growth by segment on an FX adjusted basis. So total billed business, the red line, you can see the growth rate increased from 7% in the first quarter to 8% in the second quarter. Both ICS, which is International Consumer, the light blue line and GCS, Global Corporate Services, the green line, increased by about 100 basis points.

GNS, the yellow line, increased from 12% in the first quarter growth rate to 17% growth in the second quarter, driven by continued strong growth in Japan and accelerated growth in China and Korea due to new partners and product launches. Markets like China have high growth and are strategically important.

Moving to slide five, so this is billed business growth by region. So the U.S., the dark blue line, growth is 7% consistent with the first quarter. EMEA, the light blue line and LACC, the yellow line, both have increased their growth rate compared to the first quarter. EMEA is growing at 6% and LACC at 10%. JAPA, the green line, increased from 9% growth to 13% growth driven by Japan, China and Korea.

So before I leave this regional section, let me just comment on EC draft proposal that has been in the news today. We put out a press release earlier today based on how the preliminary report has been characterized to us and we made a number of points. First, the publication of the formal proposal by the commission will start a lengthy legislative process and review period. We expect these proposals to prompt extensive debate among many market participants.

The proposals focus primarily on and cap interchange fees charged by four-party payment systems, such as Visa and MasterCard. The discount rate that American Express charges to merchants would not be regulated. Our proprietary consumer and corporate card businesses are not covered by the pricing caps.

Three-party systems, such as American Express, would only be covered when they license other institutions to issue cards, as in our Global Network Services business. GNS represents a relatively small percentage of our European business. The provisions that focus on separating the payment network and processing functions do not appear to impact proprietary networks like ours.

Given the potential impact on consumers and competition within the European payments sector, American Express has been in touch with senior policy makers at the Commission and will continue to represent its positions vigorously throughout the process.

Now, let me be more specific what we mean by GNS represents a relatively small percentage of our European business. EMEA represents about $100 billion of billed business in 2012. GNS billed business in European Union markets are less than 15% of total EMEA billed business.

On page 110 in our Annual Report in footnote number 25, EMEA pre-tax income for 2012 was $505 million. GNS European Union pre-tax income was approximately 12% of EMEA pre-tax income in 2012. So I just wanted to dimensionalize that further for you. There are many aspects to the EC draft proposal. They will play out over time. Some will impact us directly, some will impact us indirectly. We are accustomed to changing business environments and reacting to them in an appropriate manner and we will do the same in this situation.

So let me go to slide six. So this is U.S. Consumer Card loans. So the bar represents U.S. cardmember loans and they totaled $54.6 billion in the second quarter of this year. We have a growth rate of 4% and that’s the same as the past two quarters. As I mentioned before, worldwide loans grew 3% and 4% on an FX adjusted basis. The 4% loan growth is driven by growth in billed business. Loan growth is about half the rate of growth in billings on our lending products.

Net interest yield, which is at the bottom of this chart, is up 10 basis points compared to the second quarter of 2012. It is down sequentially from the first quarter of 2013, which included a reserve reversal for cardmember reimbursements that have been set up in prior periods. As you’ll see in a minute, our credit performance continues to be excellent. But let me comment on interest rates, which have been the focus area in the industry before I move to the next slide.

As disclosed in our 10-K, 100 basis point immediate increase in all interest rates would reduce the Company’s net interest income by approximately $220 million over a one-year period. Historically, an increase in long-term rates generally has a minimal impact on our business. However, movements in short-term rates impact earnings. The impact is primarily driven by the fact that we fund a portion of charge card receivables and transacting loan balances, which should not have interest rate revenue streams with variable rate debt. However, historically in rising interest rate environments has also coincided with strong billings and revenue growth.

So let me move to slide seven, revenue performance. But before I go, do a review of the individual P&L line items, I want to touch on cardmember reimbursements, which is driven by our continuing commitment to proactively review card practices, identify any issue and remediate them quickly. In both the second quarter of 2013 and second quarter of 2012 these efforts resulted in costs that impacted year-over-year variances on some of our P&L lines. The overall cost related to this work was similar in both this quarter and the second quarter of 2012. However, in the current quarter most of the reimbursements were recorded in revenue reducing revenue.

Therefore the revenue growth rate in the second quarter of this year, which was 4% on both our reported and FX adjusted basis, would have been 5% on an FX adjusted basis excluding the impacts of the cardmember reimbursements, same as the first quarter of 2013. A year ago most of the costs were reported in operating expense. The operating expense growth rate in the second quarter of this year is lower due to the reimbursement costs incurred in the prior year. And I’ll provide more detail on adjusted operating expense on slide 13. We’ve also included a reconciliation of the adjustments in Annex 9.

We continue to place a premium on self identifying and resolving any customer related issue and we clearly believe that this is the right thing to do for our customers.

Now let me go through the specific line items on slide 7. Discount revenue increased 6%, reflecting 7% growth in billed business, partially offset by a decrease in discount rate and faster growth in GNS billings than the overall Company billings growth rate. The discount rate is 2.52% in the second quarter of this year, down 2 basis points from the second quarter of 2012 and flat with the first quarter of 2013.

Net card fees increased 5%, as we had higher average fees per card due to fee increases, also due to the increase in the number of proprietary Cards-in-force, and a greater mix of premium products.

Travel commissions and fees decreased 5%, driven by a 1% decrease in worldwide travel sales and lower supplier revenues due to the timing of certain contracts.

Other commissions and fees are up 5% due to slightly higher late fees and foreign currency conversion revenues.

Other revenue is lower by 13%, due to cardmember reimbursements in the second quarter of this year, which I discussed a minute ago, as well as the benefit in second quarter of 2012 related to a revised estimate of the liability for uncashed Travelers Cheques.

The second quarter of 2013 includes a gain of $36 million related to the sale of ICBC shares. The second quarter of 2012 had a gain of $30 million related to the sale of ICBC shares.

Net interest income increased 7% compared to the second quarter of 2012 reflecting a 3% increase in average cardmember loans. Lower funding costs on the charge card portfolio and an increase in the worldwide net interest yield to 9.1% from 9% a year ago. In the second quarter of 2013, our international consumer segment included the impact of some cardmember reimbursements.

Moving to slide eight, provisions for losses, the Charge Card provision is $38 million or 23% higher than the second quarter of 2012 and this reflects the fact that we have higher receivables up about 6% year-over-year, slightly higher write-offs and a slightly lower reserve release which was $24 million this year compared to $32 million last year.

Cardmember loan provision increased $78 million or 31% reflecting lower reserve releases, this year it was $25 million and last year it was $133 million. So this is the primary driver of the higher provision expense. That was somehow offset by lower write-offs in the second quarter of this year, which were $348 million and that compares to the second quarter of 2012, write-offs of $370 million. So provision is increasing while credit metrics remain stable or improved slightly as we’ll see on the next slide.

So slide nine, our lending credit metrics, on the left side of the chart you can see that we continue to have excellent write-off rates at historically low levels of 2%. On the right side is the 30-day past due, which is also stable or slightly improving and again these are historically low numbers. As I say each quarter, our objective is not to have the lowest possible write-off rate, but to achieve the best economic gains when we invest.

Moving to slide 10, so these are our lending reserve coverage metrics and you can see that reserves as a percentage of loans and principal months coverage are lower in the second quarter of this year compared to the first quarter of 2013 and the second quarter of 2012, as our credit metrics continue to either be stable or improving.

Reserves as a percentage of past due are slightly higher than the first quarter as delinquency rate has improved this quarter compared to the first quarter. Our reserves in these metrics are appropriate to the risk in our portfolio.

So I’ll move to slide 11, which is expense performance. So total expenses improved or grew rather 1% year-over-year. Marketing and promotion increased 2% compared to last year and represents 9.5% of revenues, and I'll cover this in more detail on the following slide.

Cardmember rewards reflect higher spending volumes on co-brand and membership reward products. The membership reward ultimate redemption rate is 94% and that's comparable to the ultimate redemption rate that we had in the first quarter. Cardmember services reflect enhanced benefits on our premium card products.

Total operating expense decreased 4% reflecting strong expense control as well as cardmembers reimbursement costs in Q2 2012. And I’ll cover this on another slide as well.

Our effective tax rate for the second quarter of 2013 was 29.6% reflecting the resolution of certain prior year tax items, while discrete tax items lowered the tax rate in both the second quarter of 2013 and 2012 to be below 30%. Over the past three quarters our tax rate has been 32% or 33% in each of those quarters.

So I’ll move to slide 12, so this is marketing and promotion expense as a percentage of managed revenues. So marketing expense in the second quarter of this year was $786 million compared to $773 million in the second quarter of 2012. As you can see on the right side of the chart, the second quarter was 9.5% of revenues and on track to achieve 9% growth for the year or potentially slightly higher. We continue to invest in our business despite the slow growth economy.

Moving to slide 13, so this is operating expense performance, so total operating expense is 4% lower year-over-year, salaries and benefit is flat year-over-year and this reflects some of the benefits from the restructuring that we announced in January.

Employee count is 1,300 lower than in the second quarter of 2012. Employee count in the first quarter decreased to 1,100 compared to year-end 2012, but picked up slightly by 200 in the second quarter. We estimate employee count at year-end 2013 will be 4% to 6% lower than the year end 2012.

Professional services increased reflecting higher technology development and other net decreased 48% reflecting 89 million more in cardmember reimbursements in the second quarter of 2012 compared to the second quarter of 2013. And you can see this on Annex 9. The second quarter of 2012 also included an asset impairment. The second quarter of this year includes the Canadian value added tax benefit that lowered other net expenses.

So, moving to slide 14 – so, this chart shows the adjusted operating expense growth over the past three years. In 2013 and 2014 our target is to grow operating expense at less than 3% each year. You can see the first quarter grew at 1% and while the second quarter decreased 4% after adjusting for the cardmember reimbursements I just discussed, the second quarter of 2013 would have been a reduction in year-over-year expense of 1%. So we were on track to achieve our target of less than 3% annual growth in operating expense for this year.

Moving to slide 15, so, this is adjusted expense as a percentage of managed revenue, and this excludes credit provision. In 2012, we committed to migrate this ratio over time back towards historical levels in two ways; first through revenue growth; and second, controlling operating expense while continue to invest in the business.

In 2012, in those bars the dotted line is excluding the restructuring charge in cardmember reimbursements that we have had in the fourth quarter of 2012.

As you can see on the chart, we are making substantial progress in reducing adjusted expense as a percentage of managed revenue. Well both the first quarter and the second quarter of 2013 round to 69%, the second quarter ratio is actually slightly lower than the first quarter, if you carry without one more decimal point.

Slide 16, so these are our capital ratios. In the second quarter of 2013 our Tier 1 common ratio is 12.5%. In the quarter, we generated $1.7 billion of capital, $1.4 billion from net income and $300 million from employee plans. We also distributed $1.7 billion in capital, $1.4 billion through share buybacks and $300 million in dividends. Risk weighted assets increased slightly due to higher receivables.

The Basel III implementation from Basel I would have reduced Tier 1 common by 30 basis points, but I would remind you that we have not yet implemented Basel III advanced approach.

So there has been much conversation about the new supplemental leverage calculation. So the Tier 1 leverage calculation for us as you can see on the chart is 10.5%. If it is the calculation in the second quarter on a leverage supplementary level basis, it would be 8%, well above the required level of 3%. So our Tier 1 common ratio and leverage ratio provides the Company with a strong capital position.

So moving to slide 17, so this is our payout ratio. So our share repurchases are governed by our performance, and our CCAR submission in January 2013. Our plan for 2013 is to repurchase $4 billion. The $1.4 billion in repurchases in the second quarter is consistent with our CCAR submission in January.

Moving to slide 18, so this is our U.S. retail deposit balances. So the U.S. retail deposit activity in the quarter, you can see decreased slightly. Our overall funding strategy is to utilize unsecured, securitizations and deposits. In the second quarter we issued $2 billion of unsecured debt. Therefore we did not need to increase deposits. Therefore we decreased deposits slightly. However, within deposits we continue to grow direct deposits by $1.2 billion to $23.1 billion, while third-party CDs and sweeps decreased slightly.

On the liquidity front, we continue to hold excess cash and marketable securities to meet our next 12 months of funding maturities. As of June 30 we had $15.4 billion in excess cash compared to funding maturities of $14.4 billion over the next 12 months thereby meeting our objective.

So with that let me conclude with a few final comments. We continue to feel positive about our performance, especially given the relatively slow growth in the economic environment. In the quarter our spending growth continued to be healthy and was relatively consistent with the past several quarters.

In addition we did see some improvements in our growth rate internationally. We also saw our average loans continue to grow modestly year-over-year and outpace the industry. Loan growth and slightly lower funding costs led to a 7% increase in net interest income. At the same time lending loss rates remain near all-time lows.

Revenue growth was 4%. We continue to consistently grow revenues despite the slow growth environment, and in this quarter the negative impact of cardmember reimbursements. In the quarter operating expense decreased by 4% first year reflecting the strong expense control as well as higher cardmember reimbursements cost in the prior year.

We are clearly off to an excellent start with our aim of having operating expense growth at an annual rate of less than 3% over the next two years. We’re also continuing to invest in the business as marketing and promotion and technology development spending both increased versus prior years. These investments are driving higher average spend and growth in our cardmember base while continuing to build capabilities for the future.

Second quarter EPS were $1.27 represents an all-time high, but this benefit from a lower tax rate than recent quarters. EPS growth rate of 10% outpaced revenue growth reflecting the progress we have made on improving operating leverage and our strong capital position. We continue to return significant capital to shareholders in the quarter through dividends and buybacks while maintaining strong capital ratios.

We’ve recognized that our business is not immune to the economic environment, but we continue to believe that the flexibility of our business model enables us to deliver significant value to our shareholders even in a slow growth environment.

So with that, let me turn it over to Jeff Campbell for a few remarks.

Jeffrey C. Campbell

Well, thank you Dan and good afternoon everyone. I am excited to have joined American Express this week, and I will look forward in the coming months to spending time with many of you on the call, and to continuing the strong legacy of performance that Dan’s leadership has helped to create here at American Express. So with that Rick?

Rick Petrino

Thanks, Jeff. Okay, so we are going to start the Q&A just before we kick it off, I do want to ask everybody as a courtesy to all those who do want to ask a question, that we strongly encourage you to limit yourself to one question and one follow-up, so we can get as many folks on the call as possible. And with that, let’s open up the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Craig Maurer of CLSA. Please go ahead.

Craig Maurer – CLSA Limited

Yeah, good afternoon. Dan, first let me congratulate you on your ride off into the sunset, it’s been a pleasure.

Daniel T. Henry

Okay, thank you.

Craig Maurer – CLSA Limited

A question regarding the GNS business in Europe and the 12% of the $505 million you discussed, I am not sure, I don’t think any of us know in terms of the breakdown of GNS revenue, is there any component of that that would be susceptible to the cap that they are placing on interchange or is that strictly network and acquiring fees or is there some level of interchange split with the issuer?

And as a follow-up, is there any guidance going forward on cardmember reimbursements that we can think about in terms of suppression of revenue or help on expenses. Thanks.

Daniel T. Henry

So yes the draft is not even out yet, so getting very specific in terms of answering all the elements of your question is really not possible. I think the main point that we wanted to make is that the cap relates to four party systems, and from our understanding does not relate to three party systems, which is our system therefore our proprietary business, the proprietary consumer business, and our corporate card business is not impacted.

However in our GNS business, we think the cap will apply as a result of that we’ll have an impact directly on that business, exactly how it’s going to play out will depend on, exactly what the draft says and the debate that will take place between now and the time that the final rules are issued, which will be several quarters in the future. So it’s hard to be more specific at this point and it is our intent, once we have a chance to read the draft, to touch on this topic at the Financial Community Meeting which will take place on August 8.

In terms of cardmember reimbursements, as we identify items we look for root [causes] [ph], and if there is a need for us to modify our procedures going forward, we’ll do that and if it’s appropriate to have reimbursements for customers we’ll do that as well, as I said in the second quarter of last year and this year the numbers are at a similar level. It has varied from quarter-to-quarter in terms of how much it is. Forecasting what might happen in the future is difficult because certainly anything we know about, we have addressed at this juncture, but certainly in the course of our work of reviewing our policies and our practices, it’s potential we could identify other items, and if they do we will remediate those, and if appropriate have reimbursements, but there is really no way to forecast what that might be.

Operator

Okay. And the next question from the line of Sanjay Sakhrani of KBW. Please go ahead.

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

Thank you, good evening and congrats Dan. Just two questions; one on Europe, I was just hoping, if you could just talk about, how you would deal with the competitive pressure of lower rates from Visa and MasterCard when domestic interchange rates go down and kind of how you would offset any potential impact to the extent that you have to take your pricing down. And also I just wanted to get a sense of how much of your volume is commercial as well. And then just second that Canadian VAT benefit you mentioned, I just want to know how much that was. Thank you.

Daniel T. Henry

Okay. So certainly as I said, there’s going to be a direct impact as it relates to GNS and the business we do with GNS partners. And then there will be an indirect impact, but that’s something again that will be very dependent on what the final rules actually say, and how we need to react in the marketplace. Certainly we have faced these types of challenges in other markets, and I think we have reacted in a way that's been beneficial in terms of our overall business. It’s hard to really specifically say, what's going to happen, because we don’t even know what the draft rules are exactly nor what the final rules will be. A whole lot will take place in the marketplace. This is something that I think will play out honestly not only over a couple of quarters, but likely over a couple of years, but we will be very thoughtful about how we approach that.

In terms of the commercial piece of the European business that’s not disclosure that we’ve historically made at this juncture. I thought the most useful information that was to actually share what percentage the GNS billings were of the total billings in Europe. So hopefully that was helpful.

Canadian benefit, kind of falls in this category of an amount we thought was large enough that we should mention, but not large enough to give the dollar amount, which is kind of in our practice on a fair number of items like this, but to let you know that there is something in there that is affecting the line item and therefore the growth rate.

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

All right, thank you.

Operator

Okay, the next question from the line of Bill Carcache of Nomura Securities. Please go ahead.

Bill Carcache – Nomura Securities International, Inc.

Thanks, good evening and Dan, I will also add my congratulations, and it’s been a pleasure working with you. I had a follow-up question on the comments that you made. You made it clear that the proprietary business is not covered by the proposed caps. Does that suggest that you will be able to generate premium economics and be able to offer greater rewards, and therefore you have greater value for your customers, and I guess that the logical thought process then, does that put you in a position where you can experience similar results to what you saw in Australia? And I have a follow-up.

Daniel T. Henry

Yeah, so I mean currently we have a premium position, right? And that’s what enables us to provide the value in our products that we provide to our customers. And certainly, initially the gap between what our discount rates are and the cap will probably widen that gap somewhat. But realistically we know we’ll have to react to a second place in the marketplace. I don’t want to analogize this exactly to Australia because every market is different, but what we did in Australia actually demonstrates the fact that we have a flexible business model and are thoughtful in terms of how we do react when the environment changes.

Bill Carcache – Nomura Securities International, Inc.

Okay. And to address some of the concerns that are out there around regulators focusing on the three-party system, can you just talk – your comments today were very helpful in the release and what you’ve said so far in the call, but can you just give us, I guess more broadly a perspective on whether you’ve ever heard of any regulator, you have any experience with any regulator anywhere around the world, really talk about bifurcating the negotiated merchant discount rate in your proprietary business with the goal of regulating it.

I think that's kind of where some people were going and it just seems, I remember from past meetings that we've had with your Head of Global Merchant Services, it seems pretty clear that regulators around the world kind of get your models different because your rates are negotiated. I wonder if that's still a fair, a reasonable way of thinking about it, if you can just comment on that. Thank you.

Daniel T. Henry

So I just said we negotiate our rates with the merchants around the world. Certainly in Australia that regulation didn't address our rates specifically. That was a four-party systems and your understanding of this draft as it was characterized us we don't believe addresses three-party system such as ours. So that seems to be the course of action that happens historically and our understanding of the same plays here. What may happen elsewhere, always time will tell, but that has been the focus historically when it's come to a change of regulation.

Operator

Okay. And the next question comes from the line of Brian Foran of Autonomous. Please go ahead.

Brian D. Foran – Autonomous Research

I guess maybe switching gears to capital, as these Basel III rules firm up, two things, one, is there any reason to think the advanced approach would be a meaningful change from the 12.2%, Basel III you kind of implied by the 30 basis point hit; and is there any reason to think the liquidity coverage ratio is a hurdle that would be an issue in terms of the way you manage the excess liquidity?

Daniel T. Henry

So the 30 basis points is when we go from Basel I over to Basel III, kind of skipping the Basel II piece, right. It’s hard for me to say what the impact will be until we actually complete the work on the advanced Basel III methodology. It requires the gathering of an enormous amount of information that we have to process with systems. That work is actually underway currently. We actually have scheduled to enter a parallel run in the beginning of 2014, at that juncture we will have a better sense of what the impact would be on capital ratios. So I don’t have an estimate for you at this juncture.

In terms of liquidity rules, I guess we don’t have final liquidity rules at this point although from what we understand so far, we think we have a strong liquidity position and don’t, at this moment based on our understanding, think that the new ratios that will phase in over time would have a substantial impact on us. So therefore I would say it wouldn’t necessarily have an impact on kind of how we think about liquidity at the moment.

Brian D. Foran – Autonomous Research

One follow-up, I guess on the other expense. All the dimensions you gave are very helpful. But if I just think about it simplistically, I mean, is the $219 million kind of a good run rate for that number or is it better to think about since the Visa and MasterCard benefit rolled off and excluding the quarters where you had the big reimbursements, it’s tended to be more in the kind of $260 million to $270 million range?

Daniel T. Henry

Well, the $219 million, as I said, includes the Canadian item. So I don’t know that I used that number in the first quarter. So in the first quarter of this year we didn’t have any items that we spiked out and it was $246 million.

Brian D. Foran – Autonomous Research

Perfect. Thank you very much.

Daniel T. Henry

Okay.

Operator

Okay. And next question comes from the line of Rick Shane of JPMorgan. Please go ahead.

Richard B. Shane – JPMorgan Securities LLC

Hey. Thank you guys for taking my questions. And Dan, I will miss these conversations and wish you all the best.

Daniel T. Henry

Thank you.

Richard B. Shane – JPMorgan Securities LLC

I’d love to talk a little bit about the nuance of your conversations with the regulators. We’re in a situation now where it appears that the press has seen the documents and what you guys have indicated is you had conversations, it doesn’t sound per se like you’ve actually seen the draft at this point. You guys are very deliberate in your communications, you’re very cautious and you come out with a strong interpretation of how this is going to play out for your guys. I’d love to understand what the dialog was like when it started and make sure that we understand the subtlety of this because it is pretty significant as you can see from how the stock traded around all those today?

Daniel T. Henry

Yeah. Well, I haven’t said that. I mean, we’re not necessarily intimating that the conversations of the people who have characterized this to us are the regulators, right? So it is based on our understanding, previously to this leak of the drafts where we would come out and based on the characterizations of those people who have seen the draft and discussed it with us, our sense is that in fact notably different than what we have been thinking about before.

However we actually see the draft and get a chance to read it and digest it, then we’ll all even be in a better position, but as you indicated there were certainly notable discussion in the press and activity in our stocks, and so we wanted our press release to share our understanding of where we are even though we haven't read the complete document. And so that's the state of play at the moment. After it is issued on the 24^th, we will read it and if there is anything – any refinements we can make, we will do that at the financial committee meeting on August 8.

Richard B. Shane – JPMorgan Securities LLC

Great, I guess we look forward to reading it at the same time you guys do. Thanks guys.

Daniel T. Henry

Okay.

Operator

Okay, thank you. Next question from the line of Ken Bruce of Bank of America. Please go ahead.

Kenneth Bruce – Bank of America Merrill Lynch

Thank you and good evening gentlemen and Dan, wish you good fortune in your retirement. So thank you very much for the help over the years. My question, I’ll stay around Europe for the moment. Looking at the average cardmember spend, that has been decelerating really for the last several quarters and that has always been one of the metrics that you all have really focused on in terms of the health of the business and obviously there has been a change in strategy, at least there has been some additional products that maybe impacting the numbers, but I guess what I’d like to understand is or get some response from you is, how you’re seeing the deceleration in the average cardmember spend growth?

What ultimately will turn that if it’s just purely the weak economy strengthening or if there is something specifically within your strategy set that will drive that or if you expect that to be less going forward just given the nature where you are adding new cards and the like?

Daniel T. Henry

Yes, so I think, historically our growth in billed business has come from both the combination of the growth in Cards-in-force, as well as growth in average spend. The growth in average spend comes from really two things, in recent history, that is just greater engagement on the part of our current customers who are spending at higher levels, but it’s also coming from our premium strategy. So we’re bringing on higher spending customers compared to what we were doing several years ago, and I think that shift to a more premium mix is influencing as well.

However, well first off, the broader economy has an impact here as well and certainly just consumer confidence is the fact in terms of how much people spend. That’s been shifting a little bit recently, certainly things like housing prices firming, stock market doing better are all things that can influence that. But as we have talked about a fair number of times, there is pretty good correlation between billed business for us and GDP and I think the average cardmember spend numbers we see now are being impacted by the fact that GDP is below the average rate that we’ve seen over the last 10 years. And if history is any barometer, and if GDP picks up, you would think, it would have a positive impact on average spend. There is obviously also totally contingent on us having the best value propositions in the marketplace and providing the best service, and that’s what we are focused on.

So it’s hard to spike out exactly how each of those things impact average spend, but certainly the general slow growth in the economy I think is a factor here.

Kenneth Bruce – Bank of America Merrill Lynch

Okay, thank you. And just on a clarification or maybe just, if you could provide some senses to what the differences are in the cardmember reimbursements that will either determine whether, it’s a revenue item or an expense, can you give us some examples as to what the cause of that change please?

Daniel T. Henry

So we think it’s, each items to talk one item this quarter, it’s a number of items in each quarter, and each item is unique. So each quarter we evaluate the items that are in front of us and make the judgment based on our view at that quarter of how it should be categorized, so you can have different types of items in different quarters. That’s really the thing that is the primary driver.

Kenneth Bruce – Bank of America Merrill Lynch

Okay, thank you and best of luck.

Daniel T. Henry

Thank you.

Operator

Okay. The next question is from the line of Ryan Nash of Goldman Sachs. Please go ahead.

Ryan M. Nash – Goldman Sachs & Co.

Hey, thanks. Just as a follow-up on Ken’s question related to spend growth, outside the acceleration we saw in GNS from new business wins. Do you think particularly here in the U.S., do you think the current run rates are good proxy for what we should see for spend over the next few quarters? Should we expect it to remain stable or just given the fact that we are seeing improvement from the [welfare] fact whether it’s higher home prices and higher markets, should we start seeing that manifesting into higher spend?

Daniel T. Henry

So as you know me, I don’t want to forecast here, I guess, one of the factors is the grow over later in the year although a lot of steeper thing were earlier in the year. But clearly I think where the economy goes and consumer confidence will also be significant factors about whether it accelerates from here or not.

Ryan M. Nash – Goldman Sachs & Co.

Okay, and then just a question on expenses, so Europe 69% as a percentage of managed revenues and I know you’ve talked about migrating towards 67% over time, so I guess should we expect to stay at these levels in near-term, and if revenue growth does have to accelerate and we could see a pickup in expenses from here?

Daniel T. Henry

So we say we went migrate back towards historical levels, okay. We are having to have 2007 on there, which is 67%, but we went and migrate back to the historical levels. If we are successful and it’s our plan to be successful of growing operating expense at less than 3%, that’s going to create leverage and should enable us to continue to improve that number over the next 18 months.

Ryan M. Nash – Goldman Sachs & Co.

Great. Thanks for taking my questions and congrats.

Daniel T. Henry

Thanks.

Operator

Thank you. Next question is from the line of Dan Fandetti of Citigroup. Please go ahead.

Donald Fandetti – Citigroup Global Markets Inc.

Hi, Dan. Just a conceptual question, I was looking back in your merchant discount rate, it’s down a couple of basis points over the last 2.5 years. And you just had very strong GNS growth, which I would think would naturally bring that down more and so. I guess my question is, do you really have any sort of core change in your merchant discount rate, when should we think about that as more flattish going forward, the mix?

Daniel T. Henry

Okay, so first GNS is not in the discount rate calculations, it’s really a calculation based on our proprietary business, so that’s not in there. So we have said, in the absence of increasing price anywhere because of our strategies drive further into everyday spend categories, in the normal course we’d expect the discount rate to drop by two or three basis points a year. We in fact have not seen that over the last several years as there have been opportunities where we are bringing greater value to merchants and then obviously we’ve been able to increase price in certain situations, so that the drop in discount rate has been probably more in the 1% or 2% level over the past several years.

So if we can drive sufficient volume by moving into new categories and driving volumes up, then I would expect to see some drop in discount rate as we go forward. But that's very much on strategy for what we want to accomplish over the long-term.

Donald Fandetti – Citigroup Global Markets Inc.

Okay. And then quickly any updates on Bluebird in terms of transaction over fees.

Daniel T. Henry

So I think we're going to do some updates of the data that we shared at the FCM in February, at the August, FCM. So we'll update that information on August 8.

Donald Fandetti – Citigroup Global Markets Inc.

Okay. Thanks.

Operator

Thank you. And the next question comes from the line of James Friedman of Susquehanna. Please go ahead.

James Friedman – Susquehanna International Group, LLP

Hi. Thanks, and let me echo the congratulations. I want to ask about cards in force, Dan. It was one of the faster growing numbers in the past year up 1.2 million. I guess question in two parts. One is, should that continue to be the emphasis going forward in terms of driving billed business? And two, it looked like about 700,000 of that 1.2 million came from GNS. Should we anticipate going forward that GNS will be the driver of cards in force? It sounded like in your introductory comments it suggests that some of the growth may have come from China. Is that a correct interpretation?

Daniel T. Henry

So, cards in force number, which is 4% was 2% on proprietary cards. So that’s pretty consistent. We’ve kind of been at the 2%, 3% growth rate over the last five or six quarters. So the growth rate there is very consistent with the last few quarters. The growth rate in the GNS cards at 7% is somewhat lower than what we’ve seen over the last several quarters. It had been kind of in the low-single digits, right. So the lower growth rate is driven by fewer GNS cards in out there.

So the growth in our business is going to come, as I said before, from both higher average spend as well as higher number of cards and the fact that cards are growing at 2% and 3% compared to maybe proprietary cards compared to higher levels historically is due to the change in strategy more focused on the premium cards as opposed to just being cards in.

In terms of new cards in China, part of what drove the strong performance in GNS and in JAPA, the answer to that is, yes, right. So both in China and Korea we’ve had some new partners signed and some new product launches in those countries, both by new partners and existing partners. So that is part of what’s driving the GNS and JAPA growth rates that we see.

James Friedman – Susquehanna International Group, LLP

Hi. And just as a follow-up housekeeping. So Bluebird is not included in that cards in force type of zone, imagine that’s a pretty big number, but…

Daniel T. Henry

It’s not included in cards in force, no.

James Friedman – Susquehanna International Group, LLP

Okay, okay. And at some point will you start to decompose the cards in force at that level? Thank you.

Daniel T. Henry

So, I mean currently we share information in terms of what the GNS piece is. I think we can do some geographic splits for you.

So, I think that I don’t know that we are going to give more detail on that, it wasn’t in our thinking, but certainly as we move forward we’ll provide information as it relates to new products like Bluebird but we think it’s appropriate.

Operator

Okay. Thank you. And the next question is from the line of Mark DeVries of Barclays. Please go ahead.

Mark C. DeVries – Barclays Capital, Inc.

Yeah, thanks. Dan just help me, if you could provide a little more color on what we can expect on the GNS growth in Asia, you referenced. Is it realistic to think that at least for the next three quarters you’ve got some fairly positive year-over-year comps on that, should we continue to expect to see that kind of robust mid-high teens billed business growth from Asia?

Daniel T. Henry

So, I don’t want to forecast. In China, it is an important market for us and we’re focused on the partners that we have and the [biologics] that will take place. So my sense is that will be a good growth market, but I don’t want to forecast exactly where our GNS growth is going to be over the next couple of quarters. And also potentially it will be impacted by the economy in China. But right now, our growth rates are being driven there by new partner signings and new product launches.

Mark C. DeVries – Barclays Capital, Inc.

Okay, got it. And then just a follow-up, with marketing and promotion expense kind of leveling off on a year-over-year basis, is it reasonable to expect or continue to see kind of the 4% to 5%, cards in force growth that you had over the last year or so?

Daniel T. Henry

Well, we have come up with this 9% number out there. And I don’t want it be a target or a guideline, but I think it’s recognition of the fact that on an annual basis, right we have fluctuations from quarter-to-quarter. On an annual basis, we need to increase investments at the rate they were growing the business, if we’re going to continue to have the type of business momentum that we want.

So my view is we are very committed to investing in the growth of business. You have seen us do that historically and we will continue to do that. So our view is we want to make sure that there are sufficient investment dollars to sustain the business momentum as we go forward. Certainly the whole focus on reengineering that we announced in January is designed to grow operating expense at a slower rate, so that it provides additional resources for investment in the growth of the business.

Mark C. DeVries – Barclays Capital, Inc.

Got it. Thanks, best of luck to you Dan.

Daniel T. Henry

Thanks.

Operator

Thank you. Next question is from the line of Chris Brendler of Stifel. Please go ahead.

Chris Brendler – Stifel, Nicolaus & Co., Inc.

Hi, thanks, good afternoon. A quick follow-up on the cards in force, it’s my understanding that you had some minor annual fee increases in some of your proprietary products this year and some – did you see that in the net cards in force, is there any pricing activity across your portfolio, I guess any (inaudible) but it’s significant, is that a contributing factor and is that something you continue to squeeze higher over the years, given the strength of your products and the consumers attraction and loyalty to your products?

Daniel T. Henry

As we said, there were selected price increases on certain products. We never tried to squeeze out higher fees, we don’t want to increase fees without improving the value proposition for customers, so our practice has been where we increase fees to also avail that increase the value propositions to our customers and we have been very successful at that and when we have had fee increases, we have not seen a notable attrition as a result of that. So it’s all tied into – we’re delivering value, we’ve increased the value, part of the increase in the fee and probably of course it goes into the bottom line, what portions goes back into increasing the value to the cardmember. That has been our strategy and I think it will be our strategy going forward.

Chris Brendler – Stifel, Nicolaus & Co., Inc.

Okay, great and then my follow-up question, enterprise growth and your initiatives there, the $3 billion target, I guess and possible with your Bloomberg update for the community meeting in early August, so ultimately feel an update there, I am just curious as to the investments you made over the past several years, serving particular, are we starting to see any meaningful contributions from those new initiatives yet? Any color there would be helpful.

Daniel T. Henry

Yeah, so we set a $3 billion target couple of years ago to exit 2014 at that rate. Simply when we set that target, we didn’t necessarily contemplate the economy being as slow as it has been over that period, that number as we’ve disclosed last year was $1.5 billion. So we have a lot of work to do between now and then, but we continue to think that it’s an appropriate target for us to inform. I don’t anticipate us updating that until we update what I just gave now.

Chris Brendler – Stifel, Nicolaus & Co., Inc.

And what about the Serve?

Daniel T. Henry

So, I think one of topics at the meeting will be Dan Schulman and he will talk about what’s taking place both in Serve as well as Bloomberg in particular.

Chris Brendler – Stifel, Nicolaus & Co., Inc.

Excellent. Congratulations Dan. Thanks a lot.

Daniel T. Henry

Okay, so we’ll just take one more question.

Operator

Okay and our final question then comes from the line of Brad Ball of Evercore. Please go ahead.