DBRS Comments on American Express Company’s 2Q13 Results, Senior Rating at A (high), Trend Stable

DBRS, Inc. (DBRS) has today commented that its ratings of American Express Company (Amex or the Company) and its related subsidiaries, including its Issuer & Long-Term Debt rating of A (high), remain unchanged following announcement of the Company’s 2Q13 earnings. The trend on all ratings is Stable. For the quarter, Amex reported net income of $1.4 billion, a 5% improvement YoY. Results benefited from the strength of the Amex spend-centric business model, good cost control and continued best-in class credit performance.

Importantly, while growth in the global economy continues to be uneven, Amex’s business metrics continue to demonstrate the strength of the global franchise and substantial cardmember loyalty to the brand. Total billed business grew 8% YoY to $237.7 billion on a foreign exchange (FX) adjusted basis. Growth in billed business volumes was underpinned by a 4% increase in cardmember spending and 4% growth in total cards in-force. DBRS notes that billed business growth was broad-based with volumes higher YoY across all business lines and geographies. Amex continues to advance on its strategic priority to expand its presence outside of the U.S. In fact, billed business outside the U.S. expanded 9%, on an FX adjusted basis, to approximately 33% of total billed business while cards in-force outside the U.S. grew 6% YoY, primarily driven by expansion in the Global Network Services (GNS) segment. Indeed, GNS billed business grew 17% YoY, on an FX adjusted basis, reflecting strong growth in Japan and accelerating growth in China and South Korea supported by new partnerships and new product launches.

DBRS notes the Company’s response to preliminary reports characterizing the contents of the European Commission’s forthcoming proposals on payment industry regulation, which is scheduled to be released next week. DBRS will review the proposed legislation when released next week and comment as warranted. Amex noted that the proposals focus primarily on and cap interchange fees charged to four-party payment systems and as such, would not impact the Company’s proprietary consumer and corporate card business. Under the proposal, Amex would only be covered when it licenses other institutions to issue cards, as in the Company’s GNS business. However, Amex noted that GNS represents a relatively small percentage of the Company’s European business; with GNS European Union pre-tax income accounting for approximately 12% of EMEA 2012 pre-tax income of $505 million. Moreover, the proposal would neither regulate the discount rate Amex charges merchants nor focus on separating the payment network and processing functions of proprietary networks like Amex.

For the quarter, total revenues, net of interest expense, increased 4%, on an FX adjusted basis, to $8.2 billion, supported by strong cardmember spending as well as expansion of net interest income and cardmember fees offset somewhat by the impact of cardmember reimbursements. During 2Q13, Amex incurred $91 million of cardmember reimbursement costs as the Company continues to proactively review card practices and remediate any issues in a timely manner. DBRS notes these reimbursement costs were largely in line with the costs incurred a year ago. However, in the current quarter, the costs were primarily recorded as contra-revenue compared to an expense in 2Q12. Excluding the impact of cardmember reimbursements, total revenues net of interest expense were 5% higher YoY, on an FX adjusted basis. Discount revenue grew 6% YoY to $4.7 billion underpinned by billed business growth partially offset by a slight decline in the discount rate and GNS billings growth outpacing overall Company billings growth. Net interest income grew 7% to $1.2 billion driven by higher average cardmember loans, a 10 basis point improvement in net interest yield to 9.1% and lower funding costs on the Charge Card portfolio. Net card fees were up 5%, reflecting higher average fees per card largely due to a greater mix of premium products as well as growth in proprietary cards in-force.

Cost control remains a key focus of management, which has set a target of below 3% growth in operating expenses in 2013 and 2014. For the quarter, operating expenses in the quarter were 4% lower YoY at $3.1 billion. Excluding the impact of the aforementioned cardmember reimbursements, operating expenses were 1% lower YoY. Marketing and promotion expense was up 2%, but at 9.5% of managed revenues remains within management’s guideline for marketing and promotion expense. Higher cardmember spending on co-brand and membership rewards products drove a 10% increase in cardmember rewards expense to $1.6 billion. Overall, adjusted expenses were 69% of managed revenue; a 200 bps improvement from 2Q12. Management has stated its goal is to return this ratio to pre-recession levels.

Asset quality metrics remain strong and continue to be near all-time lows. Net write-offs in the U.S. Charge Card receivables portfolio, were 10 basis points lower QoQ and YoY at 1.9%. Delinquencies (30-days past due) in U.S. Charge Card were 30 bps lower QoQ at a very low 1.6%. Worldwide lending credit metrics also continue to be at historical lows and best in industry. Net write-offs in the world-wide total lending portfolio were up slightly from the prior quarter, but were 20 bps lower YoY at 2.0%. Moreover, loans 30-days past due were 20 bps lower both QoQ and YoY at a very modest 1.1%. DBRS sees the credit performance of the lending book, which continues to best in industry, as evidencing the benefits of Amex’s focus on lending to prime affluent customers and adherence to its well-defined and controlled risk appetite. Provision for loan losses was 29% higher YoY at $593 million reflecting a smaller reserve release compared to the comparable period a year ago partially offset by the benefit of lower write-offs. DBRS views reserve coverage as solid and appropriate for the risk in the lending portfolio with reserves representing 12.5x of monthly average write-offs.

Amex continues to maintain a strong balance sheet supported by solid liquidity and sound capital levels. While total U.S. retail deposits declined slightly QoQ, the quality of deposits continues to improve with the shift to direct deposits and less reliance on third-party CDs and sweep accounts. To this end, direct deposits grew 5% QoQ to $23.1 billion and now constitute 58% of U.S. retail deposits up from 54% at the end of 1Q13. Liquidity is well-managed with excess cash exceeding the next 12 months of maturities. Capital remains sound with a Basel I Tier 1 common ratio of 12.5%.

Notes:
All figures are in U.S. dollars unless otherwise noted.

[Amended on May the 23rd, 2014 to remove unnecessary disclosures.]