Exhibit 13
FINANCIAL REVIEW
CONSOLIDATED RESULTS OF OPERATIONS
1997 was an outstanding year for American Express. Our financial results were
good and our competitive position improved. During the year we introduced a wide
range of new card products with particular focus on international markets,
signed a large number of merchants worldwide, expanded the number and range of
alliances and partnerships with financial institutions and travel businesses,
and increased market share slightly in charge and credit volume in the United
States, travel and Travelers Cheques. At the core of our strong performance is a
continued focus on three basic operating principles: offering superior value to
customers, continually driving toward best-in-class economics and building the
American Express brand.
American Express Company (the company) reported record 1997 net income of
$1.99 billion, 14 percent higher than operating income of $1.74 billion in 1996;
net income was $1.56 billion in 1995. The 1996 operating income excluded two
fourth quarter items: a $300 million gain (after-tax) on the exchange of Debt
Exchangeable for Common Stock (DECS) for shares of common stock of First Data
Corporation (FDC) and a $138 million restructuring charge (after-tax). See Note
3 to the Consolidated Financial Statements for a discussion of this charge. The
company's 1997 results exceeded its long-term targets of achieving on average
and over time: 12-15 percent earnings per share growth, at least 8 percent
growth in revenues and a return on equity of 18-20 percent.
Primary earnings per share were $4.16, $3.57 and $3.11, basic earnings per
share were $4.29, $3.67 and $3.19 and diluted earnings per share were $4.15,
$3.56 and $3.10 in 1997, 1996 and 1995, respectively. All earnings per share
amounts increased 17 percent over the corresponding 1996 amounts. 1996 earnings
per share excluded the restructuring charge and the DECS gain referred to above,
as discussed in Notes 3 and 4 to the Consolidated Financial Statements,
respectively. The rise in earnings per share for 1997 and 1996 reflects revenue
growth, margin improvement and a reduction in average shares outstanding in both
years.
Consolidated net revenues rose 8 percent in 1997 to $17.8 billion, compared
with $16.4 billion and $15.5 billion in 1996 and 1995, respectively, excluding
revenues of American Express Life Assurance Company (AMEX Life) which was sold
in 1995. Contributing to the 1997 results were increases in worldwide billed
business, growth and wider interest margins in Cardmember loans outstanding, as
well as higher management and distributions fees. The improvement in 1996
resulted from growth in billed business and management and distribution fees.
The Year 2000 issue is the result of computer programs having been written
using two digits rather than four to define a year. Any programs that have
time-sensitive software may recognize a date using "00" as the year 1900 rather
than 2000. This could result in a major system failure or miscalculations which
could have a material impact on the operations of the company. A comprehensive
review of the company's computer systems and business processes has been
conducted to identify the major systems that could be affected by the Year 2000
issue. Steps are being taken to resolve any potential problems including
modifications to existing software and the purchase of new software. These
modifications are scheduled to be completed and tested on a timely basis. The
-1- (1997 Annual Report p. 22)
costs related to the Year 2000 issue, which are expensed as incurred, are not
expected to have a material impact on the company's results of operations or
financial condition. The company is also evaluating the Year 2000 readiness of
merchants, customers and other third parties whose systems failures could have
an impact on the company's operations. The potential materiality of any such
impact is not known at this time.
On January 1, 1999, certain European countries plan to adopt a single
currency (the euro). For countries adopting the euro, the exchange rate between
their local currency and the euro will be fixed as of June 30, 1998. The company
has carried out an assessment and identified business requirements for the
introduction of the euro. The company is making systems modifications to comply
with euro requirements and maintain its competitiveness in the marketplace. The
related costs, which are expensed as incurred, are not expected to have a
material impact on the company's earnings.
Accounting Developments
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 131, "Disclosures about Segments
of an Enterprise and Related Information," which is effective for fiscal
years beginning after December 15, 1997 and redefines how operating segments
are determined. The company will adopt the provisions of SFAS No. 131 in the
first quarter of 1998. As a result, the Travelers Cheque operations which
currently are included in the Travel Related Services segment will be reported
in the same segment as American Express Bank, consistent with our management
structure.
-2- (1997 Annual Report p. 22)
Travel Related Services (TRS) reported earnings of $1.35 billion in 1997, a 10
percent increase from $1.23 billion in 1996, excluding a $125 million
restructuring charge ($196 million pretax). 1995 earnings excluding the income
of AMEX Life were $1.09 billion.
-3- (1997 Annual Report p. 23)
TRS' net revenues rose 8 percent in 1997 compared with 1996. In the past two
years, TRS' net revenues benefited from growth in worldwide billed business and
Cardmember loans outstanding. Additionally, 1997 included wider interest margins
and increased recognition of recoveries on abandoned property related to the
Travelers Cheque business; these recoveries are included in other revenues and
were largely offset by higher investment spending on business building
initiatives. In both years, growth in billed business resulted from greater
spending per basic Cardmember, due in part to rewards programs and expanded
merchant coverage, and a larger number of cards outstanding. The increase in
worldwide cards in force in both years is primarily attributable to new credit
card product launches and a broader product portfolio.
Discount revenue rose in 1997 and 1996 from growth in billed business. Net
card fees decreased in both years due to declines in consumer charge cards and
the effect of TRS' strategy of building its lending portfolio through the
issuance of low- and no-fee credit cards. Travel commissions and fees improved
in 1997 and 1996 as a result of increased sales volumes, offset in part by the
continued efforts by airlines to reduce distribution costs and by corporate
travel and entertainment expense containment efforts. Interest and dividends
declined in 1997 and 1996, primarily as a result of a reduction in investments
related to the consolidation of certain legal entities within the U.S.
Consumer Lending business. The consolidation reduced interest revenue by
approximately $82 million and $119 million in 1997 and 1996, respectively, but
had no effect on net income as other interest expense decreased by a
corresponding amount. The remaining decline in 1997 is attributable to a
smaller investment pool at American Express Credit Corporation (Credco). In
addition, interest and dividends and other revenues declined in 1996 as a
result of the sale of AMEX Life. Lending net finance charge revenue was
reduced by the $1 billion asset securitization in the second quarter of 1996
and an additional $1 billion securitization in the third quarter of 1997.
(See TRS' Liquidity and Capital Resources discussion.) Excluding these,
lending net finance charge revenue rose 24 percent and 11 percent in 1997 and
1996, respectively. The increase in 1997 is due to higher worldwide lending
balances and a widening of interest margins on the U.S. portfolio resulting
from a smaller portion of the portfolio being subject to lower introductory
interest rates. The growth in 1996 resulted from larger worldwide lending
balances, partially offset by reduced interest margins on the U.S. portfolio
due to introductory interest rates on new products.
-4- (1997 Annual Report p. 23)
* Computed excluding Cards issued by strategic alliance partners and
independent operators as well as business billed on those Cards.
** Owned and managed Cardmember receivables and loans include securitized
assets not reflected in the Consolidated Balance Sheets.
The growth in marketing and promotion expense in 1997 reflected higher media
and merchant-related advertising costs. The increase in 1996 resulted from new
product activity. The worldwide Charge Card provision rose in 1997 primarily
driven by volume growth. In 1996, the Charge Card provision declined due to
improved credit quality, particularly in Latin America. The worldwide lending
provision increased in 1997 and 1996 as a result of portfolio growth as well as
higher loss rates. The growth in the lending provision was partly offset by the
securitizations of U.S. Cardmember loans in 1997 and 1996. The other provision
for losses declined in 1996 due to the sale of AMEX Life. Charge Card interest
expense rose in 1997 and 1996 as a result of higher volumes, partly offset by
lower borrowing rates. The decline in other interest expense mirrors the
decrease in interest revenue as a result of the reduction in investments
discussed previously. The growth in human resources expense primarily reflected
higher systems programmers' costs for technology projects and merit increases in
both years. Other operating expenses rose in 1997 and 1996 due to Cardmember
loyalty programs, business growth and investment spending. The increase in 1996
was partially offset as a result of the sale of AMEX Life.
The 1996 restructuring charge primarily related to a series of reengineering
initiatives in the card and travel businesses implemented in 1997. Approximately
two-thirds of the restructuring charge applied to TRS' international businesses.
It included $109 million pretax in severance costs and $87 million pretax to
close certain leased facilities, to consolidate or outsource certain operations,
and to write down certain assets. Approximately $125 million of the pretax
charge required cash outlays for severance, lease obligations and other
facilities costs.
TRS' asset securitization programs increased fee revenue by $195 million,
$157 million and $84 million in 1997, 1996 and 1995, respectively. The Charge
Card securitization program resulted in net discount expense of $597 million,
$554 million and $414 million in 1997, 1996 and 1995, respectively. The program
also reduced the Charge Card provision by $247 million, $246 million and $167
million in 1997, 1996 and 1995, respectively, and Charge Card interest expense
by $230 million, $183 million and $163 million in 1997, 1996, and 1995,
respectively. The revolving credit securitization program also reduced lending
net finance charge revenue by $167 million and $75 million and the lending
provision by $120 million and $43 million, in 1997 and 1996, respectively.
These securitizations had no material effect on net income for any year
presented.
-6- (1997 Annual Report p. 24)
* Excluding the effect of SFAS No. 115 and the fourth quarter 1996 restructuring
charge of $125 million after-tax.
In 1996, American Express Centurion Bank (Centurion Bank) and American Express
Receivables Financing Corporation II, a newly formed wholly owned subsidiary of
TRS, created a new trust, the American Express Credit Account Master Trust
(the Trust), to securitize revolving credit loans. The Trust securitized $1
billion of loans in 1996 and an additional $1 billion in August 1997, through
the public issuance of two classes of investor certificates and a privately
placed collateral interest in the assets of the Trust. The securitized assets
consist of loans arising in a portfolio of designated Optima Card, Optima Line
of Credit and Sign & Travel revolving credit accounts owned by Centurion Bank.
These securitized loans are not in the Consolidated Balance Sheets.
In addition, the American Express Master Trust securitizes charge card
receivables generated under designated American Express Card, Gold Card and
Platinum Card consumer accounts through the issuance of trust certificates. At
December 31, 1997 and 1996, TRS had securitized $3.25 billion and $3.75 billion,
respectively, of receivables, which are not in the Consolidated Balance Sheets.
In 1997, Credco issued and sold exclusively outside the United States and to
non-U.S. persons, $400 million Floating Rate Notes and an additional $400
million of 6.5% Fixed Rate Notes. These notes are listed on the Luxembourg Stock
Exchange and will mature in 2002. At December 31, 1997, Credco had approximately
$2.5 billion of medium and long-term debt and warrants available for issuance
under shelf registrations filed with the Securities and Exchange Commission.
TRS, primarily through Credco, maintained commercial paper outstanding of
approximately $14.5 billion at an average interest rate of 6.0 percent and
approximately $13.0 billion at an average interest rate of 5.7 percent at
December 31, 1997 and 1996, respectively. Unused lines of credit of
approximately $7.3 billion, which expire in increments from 1998 through 2002,
were available at December 31, 1997 to support a portion of TRS' commercial
paper borrowings.
-7- (1997 Annual Report p. 25)
Borrowings under bank lines of credit totaled $1.7 billion at December 31,
1997 and $1.4 billion at December 31, 1996.
American Express Financial Advisors (AEFA) reported increases in revenues of 12
and 11 percent, and earnings of 19 and 18 percent for 1997 and 1996,
respectively. Revenue and earnings in both years benefited primarily from higher
fees due to growth in managed assets and record mutual fund sales.
The improvement in investment income reflected higher average investments of
4 and 5 percent in 1997 and 1996, respectively, partly offset by lower
investment yields in 1996. Management and distribution fees rose in both years
due to greater management fee revenue from higher managed and separate account
assets. The increase in these assets in both years was due to strong market
appreciation and positive net sales. Distribution fees improved in both years
reflecting strong mutual fund sales. Other revenues rose in both years from
increased life insurance contract charges and premiums and from higher
financial planning and tax preparation fees in 1997.
-8- (1997 Annual Report p. 25)
Provisions for losses and benefits for annuities and insurance grew in both
years due to higher business in force, partially offset by lower credited rates.
Human resources expense rose in both years, reflecting rising financial
advisors' compensation from growth in sales and asset levels, and a greater
number of employees to support business expansion. The growth in other operating
expenses in both years primarily resulted from higher data processing,
technology spending and advertising expenditures. In 1997, there also were
increased occupancy and equipment costs. The lower effective tax rate in 1997 is
due to tax credits from low income housing investments.
-9- (1997 Annual Report p. 26)
* Excluding the effect of SFAS No. 115.
AEFA's total assets and liabilities grew primarily due to separate accounts as a
result of market appreciation and positive net sales. Investments comprised
primarily of corporate bonds and mortgage-backed securities, including $3.0
billion and $2.6 billion in below investment grade debt securities as well as
$3.8 billion and $3.7 billion in mortgage loans at December 31, 1997 and 1996,
respectively. Investments are principally funded by sales of insurance and
annuities and by reinvested income. Maturities of these investments are matched,
for the most part, with the expected future payments of insurance and annuity
obligations. Separate account assets, primarily investments carried at market
value, are for the exclusive benefit of variable annuity and variable life
insurance contract holders. AEFA earns investment management and administration
fees from the related accounts.
-10- (1997 Annual Report p. 26)
American Express Bank's (the Bank) 1997 net income was higher than last year
as a result of increased foreign exchange trading and net interest income,
partially offset by larger operating expenses. 1996 net income was below 1995 as
a result of lower revenues and a higher provision for losses, partly offset by
reduced expenses.
Net interest income grew in 1997 due to higher average balances in loans and
trading securities; in 1996 net interest income fell due to higher borrowing
rates and decreased business volumes. Commissions, fees and other revenues
increased in 1997 driven by higher fees from new product launches; the decrease
in 1996 was primarily due to exiting nonstrategic businesses. Foreign exchange
income rose significantly in 1997, reflecting very strong trading results.
The provision for credit losses rose in 1996 due to loan growth, slightly
higher consumer and commercial write-offs and lower commercial banking
recoveries. Human resources expense grew in 1997 as a result of merit increases
and higher incentive compensation; the improvement in 1996 reflected cost
reduction initiatives. Other operating expenses rose in 1997 with increased
systems technology expenses; the decline in 1996 was due to the transfer of
aircraft assets to the Bank's parent.
-11- (1997 Annual Report p. 27)
The Bank has exposures throughout the Asia/Pacific region, including
Indonesia, Korea, Thailand as well as Hong Kong and Singapore. Our Risk
Management group has been monitoring the Asian financial crisis as it has
evolved. The Bank had approximately $2.8 billion in loans outstanding in the
entire region at December 31, 1997. In addition to these, there are other
banking activities, such as forward contracts, various contingencies and market
placements, which add another approximately $1.5 billion to the regional number
at year-end. We should be in a better position to estimate any reserve
requirements in the relatively near future.
* Excluding the effect of SFAS No. 115.
The reserve for credit losses rose as a result of a loan recovery in 1997. The
Bank had net loan recoveries of $1.6 million and net loan write-offs of $16.2
million in 1997 and 1996, respectively. Other real estate owned declined
primarily due to a property sale.
CORPORATE AND OTHER
Corporate and Other net expenses were $152 million, $153 million and $141
million in 1997, 1996 and 1995, respectively. The 1996 amount excludes a $300
million after-tax gain on the exchange of the company's DECS ($480 million
pretax) and a $13 million after-tax charge ($20 million pretax) primarily
related to the early retirement of debt. Including the above items in 1996,
Corporate and Other had net income of $134 million.
Results for all three years include a benefit from an earnings payout from
Travelers Inc. (Travelers), related to the 1993 sale of the Shearson Lehman
Brothers Division (the 1993 sale). Results for 1997 also reflect preferred
dividends received from Lehman Brothers Holdings, Inc. Results for 1996 and 1995
-12- (1997 Annual Report pp. 27-28)
also include the company's share of the participation in Travelers' revenue in
accordance with the 1993 sale. Results for 1995 also included a gain from the
sale of common stock and warrants of Mellon Bank Corporation. In each year,
these gains were offset by certain business building initiatives.
CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES
The company believes allocating capital to businesses with a return on
risk-adjusted equity in excess of its cost of equity and sustained earnings
growth in its core business will continue to build shareholder value.
The company's philosophy is to retain enough earnings to help achieve its
goals of earnings per share growth in the 12 to 15 percent range. As further
described in Note 7 to the Consolidated Financial Statements, the company has
undertaken a systematic share repurchase program to offset new share issuances.
To the extent retained earnings exceed investment opportunities, the company has
returned excess capital to shareholders.
Financing Activities
The company has procedures to transfer immediately short-term funds within
the company to meet liquidity needs. These internal transfer mechanisms are
subject to and comply with various contractual and regulatory constraints.
The parent company generally meets its short-term funding needs through an
intercompany dividend policy and by the issuance of commercial paper. The Board
of Directors has authorized a parent company commercial paper program that is
supported by a $1.3 billion multi-purpose credit facility that expires in
increments from 1998 through 2002. No borrowings have been made under this
credit facility. There was no parent company commercial paper outstanding during
1997 and at December 31, 1996.
Total parent company long-term debt outstanding was $1,079 million at
December 31, 1997 and $666 million at December 31, 1996. In June 1997, the
parent company issued $500 million of 6.75% Global Notes due June 23, 2004. The
proceeds from this issuance were used for general corporate purposes. At
December 31, 1997 and 1996, the parent company had $550 million and $1.1
billion, respectively, of debt or equity securities available for issuance under
a shelf registration filed with the Securities and Exchange Commission. In
addition, TRS, Credco, American Express Overseas Credit Corporation Limited and
the Bank have established programs for the issuance, outside the United States,
of debt instruments to be listed on the Luxembourg Stock Exchange. In 1997,
Centurion Bank was added to this program. The maximum aggregate principal amount
of debt instruments outstanding at any one time under the program will not
exceed $3 billion. At December 31, 1997 and 1996, $1.1 billion and $300 million
of debt, respectively, has been issued under this program.
Risk Management
Management establishes and oversees implementation of Board-approved policies
covering the company's funding, investments and use of derivative financial
instruments and monitors aggregate risk exposures on an ongoing basis. The
company's objective is to realize returns commensurate with the level of risk
assumed while achieving consistent earnings growth. Individual business segments
are responsible for managing their respective exposures within the context of
Board-approved policies. See Note 11 to the Consolidated Financial Statements
for a discussion of the company's use of derivatives.
-13- (1997 Annual Report p. 28)
The sensitivity analysis of three different tests of market risk in the
following sections estimate the effects of hypothetical sudden and sustained
changes in the applicable market conditions on the ensuing year's earnings. The
market changes, assumed to occur as of December 31, 1997, are a 100 basis point
increase in market interest rates, a 10% strengthening of the U.S. dollar versus
all other currencies, and a 10% decline in the value of equity securities under
management at AEFA. Computations of the prospective effects of hypothetical
interest rate, foreign exchange rate and equity market changes are based on
numerous assumptions, including relative levels of market interest rates,
foreign exchange rates and equity prices, as well as the levels of assets and
liabilities. The hypothetical changes and assumptions will be different from
what actually occurs in the future. Furthermore, the computations do not
anticipate actions that may be taken by management if the hypothetical market
changes actually occurred over time. As a result, actual earnings effects in the
future will differ from those quantified below.
A variety of interest rate and foreign exchange hedging strategies are
employed to manage interest rate and foreign currency risks. TRS' hedging
policies are established, maintained and monitored by a central treasury
function. TRS generally manages its exposures along product lines.
For Charge Card products, TRS funds its Cardmember receivables using both
on-balance sheet sources such as long-term debt, medium-term notes, commercial
paper and other debt, and an asset securitization program. Such funding is
predominantly obtained by Credco and its subsidiaries. Interest rate exposure is
managed through the issuance of long- and short-term debt and the use of
interest rate swaps to achieve a targeted mix of fixed and floating rate
funding. TRS currently targets this mix to be approximately 100 percent floating
rate. In early 1998, TRS purchased interest rate caps to limit the adverse
effect of an interest rate increase on substantially all Charge Card funding
costs. The majority of the caps will mature by the end of 1998. TRS periodically
reviews and may change this policy.
For its lending products, TRS funds its Cardmember loans using a mixture of
long- and short-term debt, and an asset securitization program, primarily
through Centurion Bank. The interest rates on TRS' lending products are linked
to a floating rate base and typically reprice each month. TRS generally enters
into interest rate swaps, paying rates that reprice similarly with changes in
the base rate of the underlying loans.
The detrimental effect on TRS earnings of the hypothetical 100 basis point
increase in interest rates described above would be approximately $164 million
pretax. This effect, which is primarily due to the variable rate funding of the
Charge Card products, is based on December 31, 1997 positions. The interest rate
caps purchased in early 1998 would reduce that effect by nearly half.
TRS' foreign exchange risk arising from cross-currency charges and balance
sheet exposures is managed primarily by entering into agreements to buy and sell
currencies on a spot or forward basis. In the latter part of 1997, foreign
currency forward contracts were both sold ($562 million) and purchased ($92
million) to manage a majority of anticipated 1998 cash flows in major overseas
markets.
Based on the year-end 1997 foreign exchange positions, but excluding the
forward contracts managing the anticipated 1998 overseas cash flows, the effect
on TRS' earnings of the hypothetical 10% strengthening of the U.S. dollar would
-14- (1997 Annual Report pp. 28-29)
be immaterial. With respect to the forward contracts related to anticipated
1998 cash flows, the 10% strengthening would create a hypothetical net pretax
gain of $41 million. Such a gain, if any, would mitigate the negative impact
that a strengthening U.S. dollar would have on 1998 overseas earnings.
AEFA owned investment securities are, for the most part, held by its life
insurance and investment certificate subsidiaries which primarily invest in
long-term and intermediate-term fixed income securities to provide their clients
with a competitive rate of return on their investments while minimizing risk.
Investment in fixed income securities provides AEFA with a dependable and
targeted margin between the interest rate earned on investments and the interest
rate credited to clients' accounts. AEFA does not invest in securities to
generate trading profits for its own account.
AEFA's life insurance and investment certificate subsidiaries' investment
committees meet regularly to review models projecting different interest rate
scenarios and their impact on the profitability of each subsidiary. The
committees' objective is to structure their investment security portfolios based
upon the type and behavior of the products in the liability portfolios, to
achieve targeted levels of profitability and meet contractual obligations.
Rates credited to customers' accounts are generally reset at shorter
intervals than the maturity of underlying investments. Therefore, AEFA's margins
may be impacted by changes in the general level of interest rates. Part of the
committees' strategies include the purchase of derivatives, such as interest
rate caps, swaps and floors, for hedging purposes.
The negative effect on AEFA's earnings of the 100 basis point increase in
interest rates would be approximately $40 million pretax. It assumes repricings
and customer behavior based on the application of proprietary models to the book
of business at December 31, 1997 and also includes a small decline in AEFA's
fees earned on managed fixed income assets.
AEFA's fees earned on the management of equity securities in variable
annuities and mutual funds are generally based on the value of the portfolios.
To manage the level of 1998 fee income, AEFA has entered into a series of stock
index option transactions designed to mitigate, for a substantial portion of the
portfolios, the negative effect on fees that would result from a decline in the
equity market. The negative effect on AEFA's earnings of the 10% decline in
equity markets discussed above would be approximately $20 million pretax, net of
the impact of the index options.
The Bank employs a variety of on- and off-balance sheet financial
instruments in managing its exposure to fluctuations in interest and currency
rates. Derivative instruments consist principally of foreign exchange spot and
forward contracts, interest rate swaps, foreign currency options and forward
rate agreements. Generally, they are used to manage specific on-balance sheet
interest rate and foreign exchange exposures related to deposits and long-term
debt, equity, loans and securities holdings.
The negative effect of the 100 basis point increase in interest rates on the
Bank's earnings would be approximately $9 million pretax. The impact of the 10%
strengthening of the U.S. dollar described above would be negligible on earnings
and, with respect to translation exposure of foreign operations, would result in
a $14 million pretax charge against equity.
-15- (1997 Annual Report pp. 29-30)
The Bank also utilizes foreign exchange and interest rate products to meet
the needs of its customers. Customer positions are usually, but not always,
offset. They are evaluated in terms of the Bank's overall interest rate or
foreign exchange exposure. The Bank also takes limited proprietary positions.
Potential daily negative earnings effects from these activities are estimated
using a Value at Risk model that employs a parametric technique using a
correlation matrix based on historical data. At December 31, 1997, there was a
99.0% probability that any potential loss for one day would be less than $1
million.
Asset/liability and market risk management at the Bank is supervised by the
Asset and Liability (ALCO) and Risk Management Committees, respectively. These
committees are comprised of senior business managers and the Chairman of the
Bank. Both committees meet monthly and monitor (a) liquidity, (b) capital levels
and (c) investment portfolios. Both committees evaluate current market
conditions and determine the Bank's tactics within risk limits approved by the
Bank's Board of Directors. The Bank's treasury and global trading management
issues policies and control procedures and delegate risk limits throughout the
Bank's country trading operations.
The Bank's overall credit policies are approved by the Finance and Credit
Policy Committee of the Bank's Board of Directors. Credit lines are based on a
tiered approval ladder, with levels of authority delegated to each country,
geographic area, the Bank's Senior management, and the Bank's Board of
Directors. Approval authorities are based on factors such as type of borrower,
nature of transaction, collateral, and overall risk rating. The Bank controls
the credit risk arising from derivative transactions through the same
procedures. The Credit Audit department reviews all significant exposures
periodically. Risk of all foreign exchange and derivative transactions are
reviewed by the Bank on a regular basis.
-16- (1997 Annual Report p. 30)
See notes to consolidated financial statements.
-17- (1997 Annual Report p. 31)
See notes to consolidated financial statements.
-18- (1997 Annual Report p. 32)
See notes to consolidated financial statements.
-19- (1997 Annual Report p. 33)
See notes to consolidated financial statements.
-20- (1997 Annual Report p. 34)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying Consolidated Financial Statements include the accounts of
American Express company and its subsidiaries (the company). All significant
intercompany transactions are eliminated. Some amounts are based on estimates
and assumptions, e.g., reserves for Cardmember Receivables and Loans; Deferred
Acquisition Costs; and Insurance and Annuity Reserves. These reflect the best
judgment of management and actual results could differ.
Certain amounts from prior years have been reclassified to conform to the
current presentation.
Net Revenues
Cardmember Lending Net Finance Charge Revenue is presented net of interest
expense of $604 million, $507 million and $497 million for the years ended
December 31, 1997, 1996 and 1995, respectively. Interest and Dividends is
presented net of interest expense related primarily to the company's
international banking activities of $594 million, $536 million and $604 million
for the years ended December 31, 1997, 1996 and 1995, respectively.
Marketing and Promotion
The company expenses advertising costs in the year in which the advertising
first takes place.
Cash and Cash Equivalents
The company has defined cash equivalents to include time deposits with
original maturities of 90 days or less, excluding those that are restricted by
law or regulation.
Separate Account Assets and Liabilities
Separate account assets and liabilities are funds held for the exclusive
benefit of variable annuity and variable life insurance contract holders. The
company receives investment management fees, mortality and expense assurance
fees, minimum death benefit guarantee fees and cost of insurance charges from
the related accounts.
NOTE 2 EARNINGS PER COMMON SHARE
The company adopted Statement of Financial Accounting Standards (SFAS) No. 128,
"Earnings per Share," effective for the quarter and year-ended December 31,
1997. SFAS No. 128 requires the presentation of basic and diluted earnings per
common share (EPS) in the income statement. Under the new requirements, basic
EPS is computed using the average actual shares outstanding during the period.
Diluted EPS is basic EPS adjusted for the dilutive effect of stock options,
restricted stock awards (RSAs) and other securities that may be converted into
common shares. The following is a reconciliation of the numerators and
denominators of the basic and diluted EPS computations:
-21- (1997 Annual Report p. 35)
(a) $200 million of 7.75% convertible preferred shares were outstanding during
1995 but were not included in the computation of diluted EPS, as the
effect would be antidilutive. These shares were converted into common
stock of the company in May 1996.
NOTE 3 RESTRUCTURING CHARGE
In the fourth quarter of 1996, the company recorded a $138 million charge
($216 million pretax) primarily for restructuring costs related to a series of
reengineering initiatives that were implemented in 1997. Of the total charge,
$125 million ($196 million pretax) related to Travel Related Services (TRS),
approximately two-thirds of which applied to international businesses. Most of
the remaining $13 million ($20 million pretax) was due to the early retirement
of debt at the Corporate level. The pretax charge was included in Other Expenses
in the Consolidated Statements of Income. The TRS restructuring charge included
$109 million pretax in severance costs and $87 million pretax to close certain
leased facilities, to consolidate or outsource certain operations and to
write-down certain assets. As of December 31, 1997, the company has
substantially completed all restructuring activities.
-22- (1997 Annual Report pp. 35-36)
NOTE 4 INVESTMENTS
The following is a summary of investments included in the Consolidated Balance
Sheets at December 31:
(millions) 1997 1996
------- -------
Held to Maturity, at amortized cost $11,871 $13,063
Available for Sale, at fair value 23,727 20,978
Investment mortgage loans (fair value:
1997, $4,026; 1996, $3,827) 3,831 3,712
Trading 219 586
------- -------
Total $39,648 $38,339
======= =======
Investments classified as Held to Maturity and Available for Sale at
December 31 are distributed by type and maturity as presented below:
Mortgage-backed securities primarily include GNMA, FNMA and FHLMC
securities at December 31, 1997 and 1996.
The table below includes purchases, sales and maturities of investments
classified as Held to Maturity and Available for Sale for the year ended
December 31:
-24- (1997 Annual Report p. 37)
Investments classified as Held to Maturity were sold during 1997 and 1996 due to
credit deterioration. Gross realized gains and losses on sales were negligible.
The change in the Net Unrealized Securities Gains (Losses) component of
Shareholders' Equity was an increase of $193 million, a decrease of $489 million
and an increase of $1.3 billion for the years ended December 31, 1997, 1996 and
1995, respectively. The decrease in 1996 primarily reflected the exchange of the
company's Debt Exchangeable for Common Stock (DECS) for shares of First Data
Corporation (FDC) held by the company, which resulted in the realization of a
$300 million after-tax gain. An increase in the general level of interest rates
also contributed to the decline in 1996. The rise in market value during 1995
reflected a decline in the general level of interest rates and the
reclassification of the company's investment in FDC to Available for Sale
securities.
Gross realized gains and (losses) on sales of securities classified as
Available for Sale, using the specific identification method, were $67 million
and ($10 million), $65 million and ($25 million) and $46 million and ($12
million) for the years ended December 31, 1997, 1996 and 1995, respectively.
The change in Net Unrealized Gains on Trading securities, which is included
in income, was $24 million, $28 million and $12 million for the years ended
December 31, 1997, 1996 and 1995, respectively.
In connection with the spin-off of Lehman Brothers Holdings Inc. (Lehman)
in 1994, the company acquired 928 shares and Nippon Life Insurance Company
(Nippon Life) acquired 72 shares of Lehman's redeemable voting preferred stock
for a nominal dollar amount. This security entitles its holders to receive an
aggregate annual dividend of 50 percent of Lehman's net income in excess of $400
million for each of eight years ending in May 2002, with a maximum of $50
million in any one year. Prior to 1997, the company received no dividends in
connection with the earnout. In 1997, the company received a dividend of $7
million on these shares. In addition, the company and Nippon Life are entitled
to receive 92.8 percent and 7.2 percent, respectively, of certain contingent
revenue and earnings-related payouts from Travelers Inc. (Travelers), which were
assigned by Lehman to the company and Nippon Life in connection with the
spin-off transaction. The Travelers revenue-related payout was for three years
and ended in 1996. The company received $46 million in 1996 and 1995. The
earnings-related payout, which is in effect for a five-year period beginning in
1994, is 10 percent of after-tax profits of Smith Barney, a subsidiary of
Travelers, in excess of $250 million per year ($70 million, $56 million and $24
million was received by the company in 1997, 1996 and 1995, respectively).
-25- (1997 Annual Report p. 38)
NOTE 5 LOANS
Note:American Express Financial Advisors (AEFA) mortgage loans of $3.8 billion
and $3.7 billion in 1997 and 1996, respectively, are included in Investment
Mortgage Loans and are shown in Note 4.
NOTE 6 PREFERRED SHARES
In January 1990, the company sold four million of the company's $3.875
Convertible Exchangeable Preferred shares (Convertible Preferred shares) to
Nippon Life for $200 million. In May 1996, after receiving a redemption notice
from the company, Nippon Life converted all of the Convertible Preferred shares
into 4,705,882 of the company's common shares.
The Board of Directors is authorized to permit the company to issue up to
20 million preferred shares without further shareholder approval.
-26- (1997 Annual Report p. 39)
NOTE 7 COMMON SHARES
In October 1996, the company's Board of Directors authorized the company to
repurchase up to 40 million common shares over the next two to three years,
subject to market conditions. This authorization is in addition to two previous
repurchase plans, beginning in 1994, under which the company repurchased a total
of 60 million common shares. These plans are primarily designed to allow the
company to purchase shares systematically both to offset the issuance of new
shares as part of employee compensation plans and to reduce shares outstanding.
Under the 1996 authorization, the company has repurchased and cancelled
17,556,053 and 13,146,053 shares, respectively.
Of the common shares authorized but unissued at December 31, 1997, 71
million shares were reserved for issuance for employee stock, employee benefit
and the dividend reinvestment plan as well as debentures.
In 1987, Nippon Life purchased 13 million shares of Lehman 5% Series A
Preferred Stock for $508 million. In 1990, the company gave Nippon Life the
right to exchange these shares (subsequently exchanged by Lehman for Series B
shares) into 6.24 million common shares of the company at any time through
December 1999 at an exchange price of $81.46. In 1996, Nippon Life informed the
company that it had reduced its holding of such preferred shares by
approximately 30 percent but maintained the exchange rights related to the
shares sold. On December 16, 1997, Nippon Life exchanged all of its remaining
holdings of these preferred shares for approximately 4.4 million common shares
of the company. In January 1998, the company purchased all remaining exchange
rights of Nippon Life.
Common shares activity for each of the last three years ended December 31
was:
-27- (1997 Annual Report p. 40)
NOTE 8 STOCK PLANS
Under the 1989 Long-Term Incentive Plan (the 1989 Plan), awards may be granted
to officers and other key employees and other key individuals who perform
services for the company and its participating subsidiaries. These awards may be
in the form of stock options, stock appreciation rights, restricted stock,
performance grants and other awards deemed by the Compensation and Benefits
Committee of the Board of Directors to be consistent with the purposes of the
1989 Plan. The company also has options outstanding pursuant to a Directors'
Stock Option Plan. Under both of these plans, there were a total of 25.9
million, 32.1 million and 14.1 million common shares available for grant at
December 31, 1997, 1996 and 1995, respectively. Each option has an exercise
price at least equal to the market price of the company's common stock on the
date of grant and a maximum term of 10 years. Options generally vest at 33 1/3
percent per year. The company also sponsors the American Express Incentive
Savings Plan, under which purchases of the company's common shares are made by
or on behalf of participating employees.
On January 13, 1998, the Compensation and Benefits Committee approved the
addition of a restoration feature to existing and future stock option awards.
That feature provides that employees who exercise options that have been
outstanding at least five years by surrendering previously owned shares as
payment will automatically receive a new (restoration) stock option with an
exercise price equal to the market price on the date of exercise. The size of
the restoration option is equal to the number of shares surrendered plus any
shares surrendered or withheld to satisfy the employees' statutory income tax
requirements. The term of the restoration option, which is exercisable six
months after grant, is equal to the remaining life of the original option.
Senior officers must be in compliance with their stock ownership guideline to
exercise restoration options.
The company granted 1.4 million, 1.4 million and 1.7 million restricted
stock awards with a weighted average grant date value of $67.08, $46.14 and
$34.77 per share for 1997, 1996 and 1995, respectively. Restrictions generally
expire four years from date of grant. The compensation cost that has been
charged against income for the company's restricted stock awards was $48
million, $39 million and $31 million for 1997, 1996 and 1995, respectively.
The company has elected to follow APB Opinion No. 25, "Accounting for Stock
Issued to Employees," and related Interpretations in accounting for its employee
stock options. Therefore, no compensation cost has been recognized related to
stock options. If the company had elected to account for its stock options under
the fair value method of SFAS No. 123, "Accounting for Stock-Based
Compensation," the company's net income and earnings per common share would have
been reduced to the pro forma amounts indicated below:
-28- (1997 Annual Report p. 41)
The fair value of each option is estimated on the date of grant using a
Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 1997, 1996 and 1995, respectively:
The dividend yield reflects the assumption that the current dividend payout
will continue with no anticipated increases. The expected life of the options is
based on historical data, and is not necessarily indicative of exercise patterns
that may occur. The weighted average fair value per option was $14.76, $11.43
and $9.39 for options granted during 1997, 1996 and 1995, respectively.
A summary of the status of the company's stock option plans as of December
31 and changes during each of the years then ended is presented below:
The following table summarizes information about the stock options outstanding
at December 31, 1997:
-29- (1997 Annual Report pp. 41-42)
NOTE 9 RETIREMENT PLANS
Pension Plans
The company sponsors the American Express Retirement Plan (the Plan), a
noncontributory defined benefit plan, under which the cost of retirement
benefits for eligible employees in the United States is measured by length of
service, compensation and other factors, and is currently being funded through a
trust. In addition, the company sponsors an unfunded, nonqualified supplemental
plan for which the aggregate accrued liability is not material. Funding of
retirement costs for the Plan complies with the applicable minimum funding
requirements specified by the Employee Retirement Income Security Act of 1974,
as amended. Employees' accrued benefits are based on nominal account balances
which are maintained for each individual. These balances are credited with
additions equal to a percentage, based on age plus service, of base pay,
overtime, shift differential, certain commissions and bonuses, each pay period.
Employees' balances are also credited annually with a fixed rate of interest
based on the daily average of published five-year Treasury Note yields. Lump sum
payout at termination or retirement is available.
Most employees outside the United States are covered by local retirement
plans, some of which are funded, or receive payments at the time of retirement
or termination under applicable labor laws or agreements. Benefits under these
local plans are generally expensed and are not funded.
Plan assets consist principally of equities and fixed income securities.
Net pension cost consisted of the following
components:
-30- (1997 Annual Report pp. 42-43)
The following table sets forth the funded status and amounts recognized in
the Consolidated Balance Sheets for the company's defined benefit plans,
including certain unfunded, nonqualified supplemental plans. The underfunded
plans relate to foreign and supplemental executive plans.
The weighted average assumptions used in the
company's plans at December 31 were:
Other Postretirement Benefits
The company sponsors postretirement benefit plans that provide health care,
life insurance and other postretirement benefits to retired U.S. employees. Net
periodic postretirement benefit expenses were $15 million, $18 million, and $19
million in 1997, 1996 and 1995, respectively. The liabilities recognized in the
Consolidated Balance Sheets for the company's defined postretirement benefit
plans (other than pension plans) at December 31, 1997 and 1996 were $204 million
and $205 million, respectively.
-31- (1997 Annual Report p. 43)
NOTE 10 INCOME TAXES
Accumulated net earnings of certain foreign subsidiaries, which totaled
$873 million at December 31, 1997, are intended to be permanently reinvested
outside the United States. Accordingly, federal taxes, which would have
aggregated $202 million, have not been provided on those earnings.
The company's net deferred tax assets at December 31 were:
Deferred tax assets for 1997 and 1996, which are presented net of a $45
million valuation allowance, primarily reflect: reserves not yet deducted for
tax purposes of $1.8 billion and $1.6 billion, respectively, and deferred
Cardmember fees of $238 million and $233 million, respectively. Deferred tax
liabilities for 1997 and 1996 mainly comprise deferred acquisition costs of $826
million and $762 million, respectively, liabilities related to SFAS No. 115 of
$318 million and $242 million, respectively, and accelerated depreciation of
$150 million and $155 million, respectively.
-32- (1997 Annual Report p. 44)
The principal reasons that the aggregate income tax provision is different
from that computed by using the U.S. statutory rate of 35 percent are:
Net income taxes paid by the company during 1997, 1996 and 1995 were $878
million, $548 million and $595 million, respectively, and include estimated tax
payments, as well as cash settlements relating to prior tax years.
NOTE 11 DERIVATIVE AND OTHER OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
The company uses derivative financial instruments for nontrading purposes to
manage its exposure to interest and foreign exchange rates, financial indices
and its funding costs. In addition, American Express Bank (the Bank) enters into
derivative contracts both to meet the needs of its clients and, to a limited
extent, for proprietary trading purposes.
There are a number of risks associated with derivatives. Market risk is the
possibility that the value of the derivative financial instrument will change.
The company is not exposed to market risk related to derivatives held for
nontrading purposes beyond that inherent in cash market transactions. The Bank
is generally not subject to market risk when it enters into a contract with a
client, as it usually enters into an offsetting contract or uses the position to
offset an existing exposure. The Bank takes proprietary positions within
approved limits. These positions are monitored daily at the local and
headquarters levels against Value at Risk (VAR) limits. The company does not
enter into derivative contracts with features that would leverage or multiply
its market risk.
Credit risk related to derivatives and other off-balance sheet financial
instruments is the possibility that the counterparty will not fulfill the terms
of the contract. It is monitored through established approval procedures,
including setting concentration limits by counterparty and country, reviewing
credit ratings and requiring collateral where appropriate. For its trading
activities with clients, the Bank requires collateral when it is not willing to
assume credit exposure to counterparties for either contract mark-to-market or
delivery risk. A significant portion of the company's transactions are with
counterparties rated A or better by nationally recognized credit rating
agencies. The company also uses master netting agreements, which allow the
company to settle multiple contracts with a single counterparty in one net
receipt or payment in the event of counterparty default. Credit risk
approximates the fair value of contracts in a gain position (asset) and totaled
$1.4 billion and $361 million at December 31, 1997 and 1996, respectively. The
fair value represents the replacement cost and is determined by market values,
dealer quotes or pricing models.
-33- (1997 Annual Report p. 45)
The following tables detail information regarding the company's derivatives at
December 31:
* These are predominantly contracts with clients and the related hedges of
those client contracts. The company's net trading foreign currency exposure
was approximately $38 million and $151 million at December 31, 1997 and
1996, respectively.
The average aggregate fair values of derivative financial instruments held
for trading purposes were computed based on monthly information. Net derivative
trading gains of $103 million and $72 million for 1997 and 1996, respectively,
were primarily due to trading in foreign currency forward contracts and are
included in Other Commissions and Fees.
Interest Rate Products
The company uses interest rate products, principally swaps, primarily to
manage funding costs related to TRS' Charge Card and Cardmember lending
businesses. For its Charge Card products, TRS uses interest rate swaps to
achieve a targeted mix of fixed and floating rate funding. For its Cardmember
loans, which are linked to a floating rate base and generally reprice each
month, TRS generally enters into interest rate swaps paying rates that reprice
similarly with changes in the base rate of the underlying loans.
The Bank uses interest rate swaps to manage its portfolio of loans, deposits
and, to a lesser extent, securities holdings. The termination dates of these
swaps are generally matched with the maturity dates of the underlying assets and
liabilities.
-35- (1997 Annual Report pp. 46-47)
For interest rate swaps that are used for nontrading purposes and meet the
criteria for hedge accounting, interest is accrued and reported in Other
Receivables and Interest and Dividends or Accounts Payable and Interest Expense,
as appropriate. Products used for trading purposes are reported at fair value in
Other Assets or Other Liabilities, as appropriate, with unrealized gains and
losses recognized currently in Other Revenues.
AEFA uses interest rate caps, swaps and floors to protect the margin between
the interest rates earned on investments and the interest rates credited to
holders of investment certificates and fixed annuities. Interest rate caps and
floors generally mature within five years. The costs of interest rate caps and
floors are reported in Other Assets and amortized into Interest and Dividends
on a straight line basis over the term of the contract; benefits are recognized
in income when earned.
See Note 12 for further information regarding the company's use of interest
rate products related to short-and long-term debt obligations.
Foreign Currency Products
The company uses foreign currency products primarily to hedge net investments
in foreign operations and to manage transactions denominated in foreign
currencies. In addition, the Bank enters into derivative contracts both to meet
the needs of its clients and, to a limited extent, for trading purposes,
including taking proprietary positions.
Foreign currency exposures are hedged, where practical and economical,
through foreign currency contracts. Foreign currency contracts involve the
purchase and sale of a designated currency at an agreed upon rate for settlement
on a specified date. Foreign currency forward contracts generally mature within
one year, whereas foreign currency spot contracts generally settle within two
days.
For foreign currency products used to hedge net investments in foreign
operations, unrealized gains and losses as well as related premiums and
discounts are reported in Shareholders' Equity. For foreign currency contracts
related to transactions denominated in foreign currencies, unrealized gains and
losses are reported in Other Assets and Other Commissions and Fees or Other
Liabilities and Other Expenses, as appropriate. Related premiums and discounts
are reported in Other Assets or Other Liabilities, as appropriate, and amortized
into Interest Expense and Other Expenses over the term of the contract. Foreign
currency products used for trading purposes are reported at fair value in Other
Assets or Other Liabilities, as appropriate, with unrealized gains and losses
recognized currently in Other Commissions and Fees.
The company also uses foreign currency forward contracts to hedge its firm
commitments. In addition, for selected major overseas markets, the company uses
foreign currency forward contracts to hedge future income, generally for periods
not exceeding one year; unrealized gains and losses are recognized currently in
income. In the latter part of 1997, foreign currency forward contracts were both
sold ($562 million) and purchased ($92 million) to manage a majority of
anticipated 1998 cash flows in major overseas markets. The impact of these
activities was not material.
-36- (1997 Annual Report pp. 47-48)
Other Products
Included in Other Products are purchased and written index options used by AEFA
to hedge against adverse changes in the U.S. equities markets, which affect
revenues earned on assets under management. Index options are carried at market
value and included in Other Assets. Gains and losses on these options are
deferred until the revenues are earned. At December 31, 1997, the notional value
of these options was $1 billion.
Other Off-Balance Sheet Financial Instruments
The company's other off-balance sheet financial instruments principally relate
to extending credit to satisfy the needs of its clients. The contractual amount
of these instruments represents the maximum accounting loss the company would
record assuming the contract amount is fully utilized, the counterparty defaults
and collateral held is worthless. Management does not expect any material
adverse impact to the company's financial position to result from these
contracts.
The company is committed to extend credit to certain Cardmembers as part of
established lending product agreements. Many of these are not expected to be
drawn; therefore, total unused credit available to Cardmembers does not
represent future cash requirements. The company's Charge Card products have no
preset spending limit and are not reflected in unused credit available to
Cardmembers.
The company may require collateral to support its loan commitments based on
the creditworthiness of the borrower.
Standby letters of credit and guarantees primarily represent conditional
commitments to insure the performance of the company's customers to third
parties. These commitments generally expire within one year.
The company issues commercial and other letters of credit to facilitate the
short-term trade-related needs of its clients, which typically mature within six
months. At December 31, 1997 and 1996, the company held $744 million and $811
million, respectively, of collateral supporting standby letters of credit and
guarantees and $276 million and $504 million, respectively, of collateral
supporting commercial and other letters of credit.
Other financial institutions have committed to extend lines of credit to the
company of $9.7 billion and $9.2 billion at December 31, 1997 and 1996,
respectively.
-37- (1997 Annual Report p. 48)
NOTE 12 SHORT- AND LONG-TERM DEBT AND BORROWING AGREEMENTS
Short-Term Debt
At December 31, 1997 and 1996, the company's total short-term debt outstanding
was $20.6 billion and $18.4 billion, respectively, with weighted average
interest rates of 6.12% and 5.79%, respectively. At December 31, 1997 and 1996,
$1.6 billion and $625 million, respectively, of short-term debt outstanding was
covered by interest rate swaps. The year-end weighted average effective interest
rates were 6.17% and 5.84%, respectively. The company generally pays floating
rates of interest under the terms of interest rate swaps. Unused lines of credit
to support commercial paper borrowing were approximately $8.6 billion at
December 31, 1997.
(a)For floating rate debt issuances, the stated and effective interest
rates were based on the respective rates at December 31, 1997 and 1996;
these rates are not an indication of future interest rates.
(b)Weighted average rates were determined where appropriate.
The above interest rate swaps generally require the company to pay a
floating rate, with a predominant index of LIBOR (London Interbank Offered
Rate).
The company paid interest (net of amounts capitalized) of $2.5 billion,
$2.4 billion and $2.6 billion in 1997, 1996 and 1995, respectively.
Approximately $171 million of the long-term financing for the company's
headquarters building is secured by certain mortgages on the interests of the
company in the building.
Aggregate annual maturities of long-term debt for the five years ending
December 31, 2002 are as follows (millions): 1998, $1,680; 1999, $1,658; 2000,
$1,178; 2001, $1,427; and 2002, $921.
-39- (1997 Annual Report p. 49)
NOTE 13 FAIR VALUES OF FINANCIAL INSTRUMENTS
The following table discloses fair value information for most on- and
off-balance sheet financial instruments. Certain financial instruments, such as
life insurance obligations, employee benefit obligations and investments
accounted for under the equity method are excluded. The fair values of financial
instruments are estimates based upon market conditions and perceived risks at
December 31, 1997 and 1996 and require management judgment. These figures may
not be indicative of their future fair values.
The carrying and fair values of other off-balance sheet financial instruments
are not material as of December 31, 1997 and 1996. See Notes 4 and 11 for
carrying and fair value information regarding investments and derivative
financial instruments. The following methods were used to estimate the fair
values of financial assets and financial liabilities:
Financial Assets
ASSETS FOR WHICH CARRYING VALUES APPROXIMATE FAIR VALUES: The carrying values
of Cash and Cash Equivalents, Accounts Receivable and Accrued Interest, Separate
Account Assets and applicable Other Assets approximate their fair values.
LOANS: For variable rate loans that reprice within a year where there has
been no significant change in counterparties' creditworthiness, fair values are
based on carrying values. The fair values of all other loans, except for loans
with significant credit deterioration, are estimated using discounted cash flow
analysis, based on current interest rates for loans with similar terms to
borrowers of similar credit quality. For loans with significant credit
deterioration, fair values are based on revised estimates of future cash flows
discounted at rates commensurate with the risk inherent in the revised cash flow
projections, or for collateral dependent loans, on collateral values.
-40- (1997 Annual Report pp. 50-51)
Financial Liabilities
LIABILITIES FOR WHICH CARRYING VALUES APPROXIMATE FAIR VALUES: The carrying
values of Customers' Deposits, Travelers Cheques Outstanding, Accounts Payable,
Short-Term Debt and applicable Other Liabilities approximate their fair values.
FIXED ANNUITY RESERVES: Fair values of annuities in deferral status are
estimated as the accumulated value less applicable surrender charges and loans.
For annuities in payout status, fair value is estimated using discounted cash
flow, based on current interest rates. The fair value of these reserves excludes
life insurance-related elements of $1.3 billion and $1.2 billion in 1997 and
1996.
INVESTMENT CERTIFICATE RESERVES: For variable rate investment certificates
that reprice within a year, fair values approximate carrying values. For other
investment certificates, fair value is estimated using discounted cash flow
analysis, based on current interest rates. The valuations are reduced by the
amount of applicable surrender charges and related loans.
LONG-TERM DEBT: For variable rate long-term debt that reprices within a
year, fair values approximate carrying values. For other long-term debt, fair
value is estimated using either quoted market prices or discounted cash flow
based on the company's current borrowing rates for similar types of borrowing.
SEPARATE ACCOUNT LIABILITIES: Fair values of these liabilities, after
excluding life insurance-related elements of $1.7 billion and $1.2 billion in
1997 and 1996, are estimated as the accumulated value less applicable surrender
charges.
-41- (1997 Annual Report p. 51)
NOTE 14 SIGNIFICANT CREDIT CONCENTRATIONS
A credit concentration may exist if customers are involved in similar
industries. The company's customers operate in diverse economic sectors.
Therefore, management does not expect any material adverse consequences to the
company's financial position to result from credit concentrations. Certain
distinctions between categories require management judgment.
(a) Financial institutions primarily include banks, broker-dealers, insurance
companies and savings and loan associations.
(b) Charge Card products have no preset spending limit; therefore, the
quantified credit amount includes only Cardmember receivables recorded in
the Consolidated Balance Sheets.
(c) U.S. Government and agencies represent the U.S. Government and its
agencies, states and municipalities, and quasi-government agencies.
NOTE 15 INDUSTRY SEGMENTS AND GEOGRAPHIC OPERATIONS
Industry Segments
The company is principally engaged in providing travel related, financial
advisory and international banking services throughout the world. TRS' products
and services include, among others, Charge Cards, consumer lending products,
Travelers Cheques and corporate and consumer travel services. American Express
Financial Advisors' services and products include financial planning and advice,
investment advisory services and a variety of products, including insurance and
annuities, investment certificates and mutual funds. The Bank serves the
financial needs of wealthy entrepreneurs and their companies, financial service
institutions and retail customers by providing correspondent, commercial and
private banking, consumer financial services and global trading. The main market
for the travel related and financial advisory services is the United States; the
principal markets for international banking services are Europe and
Asia/Pacific.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information," which is
effective for fiscal years beginning after December 15, 1997 and redefines how
operating segments are determined. The company will adopt the provisions of SFAS
No. 131 in the first quarter of 1998. As a result, the Travelers Cheque
operations which currently are included in the TRS segment will be reported in
the same segment as the Bank, consistent with our management structure.
-42- (1997 Annual Report p. 52)
The following table presents certain information regarding these industry
segments at December 31, 1997, 1996 and 1995 and for each of the years then
ended. TRS' results for 1996 include a $125 million after-tax ($196 million
pretax) restructuring charge. Corporate and Other's results for 1996 include a
$300 million after-tax ($480 million pretax) gain on the exchange of the
company's DECS and a $13 million after-tax ($20 million pretax) charge related
to the early retirement of debt and certain restructuring costs.
Net revenues includes interest earned on the investment of funds
attributable to each industry segment. Pretax income before general corporate
expenses is net revenues less operating expenses, including interest, related to
each industry segment's revenues.
Net income (loss) includes a provision for income taxes calculated on a
separate return basis; however, benefits from operating losses, loss carrybacks
and tax credits (principally foreign tax credits) recognizable for the company's
consolidated reporting purposes are allocated based upon the tax sharing
agreement among members of the American Express Company consolidated U.S. tax
group.
-43- (1997 Annual Report pp. 52-53)
Assets are those that are used or generated exclusively by each industry
segment. The adjustments and eliminations required to determine the consolidated
amounts shown above consist principally of the elimination of intersegment
revenues and assets.
Geographic Operations
The following table presents certain information regarding the company's
operations in different geographic regions at December 31 and for each of the
years then ended.
Most services of the company are provided on an integrated worldwide basis.
Therefore it is not practical to separate precisely the U.S. and international
services. Accordingly, the data in the above table are, in part, based upon
internal allocations, which necessarily involve management judgments. The growth
in international net revenues and pretax income was curtailed by the impact of
the stronger U.S. dollar.
-44- (1997 Annual Report pp. 53-54)
NOTE 16 LEASE COMMITMENTS AND OTHER CONTINGENT LIABILITIES
The company leases certain office facilities and operating equipment under
noncancellable and cancellable agreements. Total rental expense amounted to $384
million, $397 million and $415 million in 1997, 1996 and 1995, respectively. At
December 31, 1997, the minimum aggregate rental commitment under all
noncancellable leases (net of subleases) was (millions): 1998, $271; 1999, $217;
2000, $169; 2001, $156; 2002, $127; and thereafter, $1,239.
The company is not a party to any pending legal proceedings that, in the
opinion of management, would have a material adverse effect on the company's
financial position.
NOTE 17 TRANSFER OF FUNDS FROM SUBSIDIARIES
The Securities and Exchange Commission requires the disclosure of certain
restrictions on the flow of funds to a parent company from its subsidiaries in
the form of loans, advances or dividends.
Restrictions on the transfer of funds exist under debt agreements and
regulatory requirements of certain of the company's subsidiaries. These
restrictions have not had any effect on the company's shareholder dividend
policy and management does not anticipate any effect in the future.
At December 31, 1997, the aggregate amount of net assets of subsidiaries
that may be transferred to the parent company was approximately $6.9 billion.
Should specific additional needs arise, procedures exist to permit immediate
transfer of short-term funds between the company and its subsidiaries, while
complying with the various contractual and regulatory constraints on the
internal transfer of funds.
NOTE 18 QUARTERLY FINANCIAL DATA (UNAUDITED)
(1) Fourth quarter 1996 amounts include a gain of $300 million ($480 million
pretax) on the exchange of the company's DECS and a $138 million ($216
million pretax) restructuring charge.
-45- (1997 Annual Report p. 55)
REPORT OF ERNST & YOUNG LLP INDEPENDENT AUDITORS
The Shareholders and Board of Directors
of American Express Company
We have audited the accompanying consolidated balance sheets of American Express
Company as of December 31, 1997 and 1996, and the related consolidated
statements of income, shareholders' equity, and cash flows for each of the three
years in the period ended December 31, 1997. These financial statements are the
responsibility of the management of American Express Company. Our responsibility
is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of American
Express Company at December 31, 1997 and 1996, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles.
/s/ Ernst & Young LLP
New York, New York
February 5, 1998
-46- (1997 Annual Report p. 56)
Note: Historical common share prices have been adjusted to reflect the Lehman
spin-off at a ratio based on the trading prices of the company's common shares
and shares of Lehman common stock on May 31, 1994. Pro forma cash dividends
declared and book value per share have also been adjusted to reflect the
Lehman spin-off. For purposes of the pro forma book value per share calculation,
it is assumed that the spin-off includes the book value of the company's
investment in Lehman at the balance sheet date plus the capital infusion of
approximately $904 million that was made immediately prior to the spin-off.
* Adjusted to exclude: in 1996 -- a $300 million gain on the exchange of the
company's DECS and a $138 million restructuring charge; 1993 -- a $433 million
gain on the sale of FDC shares.
**Return on average shareholders' equity is based on adjusted income from
continuing operations before accounting changes and excludes the effect of
SFAS No. 115 beginning in 1994. In addition, book value per share excludes
the effect of SFAS No. 115 beginning in 1994.
-48- (1997 Annual Report p. 57)
FINANCIAL REVIEW
CONSOLIDATED RESULTS OF OPERATIONS
1997 was an outstanding year for American Express. Our financial results were
good and our competitive position improved. During the year we introduced a wide
range of new card products with particular focus on international markets,
signed a large number of merchants worldwide, expanded the number and range of
alliances and partnerships with financial institutions and travel businesses,
and increased market share slightly in charge and credit volume in the United
States, travel and Travelers Cheques. At the core of our strong performance is a
continued focus on three basic operating principles: offering superior value to
customers, continually driving toward best-in-class economics and building the
American Express brand.
American Express Company (the company) reported record 1997 net income of
$1.99 billion, 14 percent higher than operating income of $1.74 billion in 1996;
net income was $1.56 billion in 1995. The 1996 operating income excluded two
fourth quarter items: a $300 million gain (after-tax) on the exchange of Debt
Exchangeable for Common Stock (DECS) for shares of common stock of First Data
Corporation (FDC) and a $138 million restructuring charge (after-tax). See Note
3 to the Consolidated Financial Statements for a discussion of this charge. The
company's 1997 results exceeded its long-term targets of achieving on average
and over time: 12-15 percent earnings per share growth, at least 8 percent
growth in revenues and a return on equity of 18-20 percent.
Primary earnings per share were $4.16, $3.57 and $3.11, basic earnings per
share were $4.29, $3.67 and $3.19 and diluted earnings per share were $4.15,
$3.56 and $3.10 in 1997, 1996 and 1995, respectively. All earnings per share
amounts increased 17 percent over the corresponding 1996 amounts. 1996 earnings
per share excluded the restructuring charge and the DECS gain referred to above,
as discussed in Notes 3 and 4 to the Consolidated Financial Statements,
respectively. The rise in earnings per share for 1997 and 1996 reflects revenue
growth, margin improvement and a reduction in average shares outstanding in both
years.
Consolidated net revenues rose 8 percent in 1997 to $17.8 billion, compared
with $16.4 billion and $15.5 billion in 1996 and 1995, respectively, excluding
revenues of American Express Life Assurance Company (AMEX Life) which was sold
in 1995. Contributing to the 1997 results were increases in worldwide billed
business, growth and wider interest margins in Cardmember loans outstanding, as
well as higher management and distributions fees. The improvement in 1996
resulted from growth in billed business and management and distribution fees.
The Year 2000 issue is the result of computer programs having been written
using two digits rather than four to define a year. Any programs that have
time-sensitive software may recognize a date using "00" as the year 1900 rather
than 2000. This could result in a major system failure or miscalculations which
could have a material impact on the operations of the company. A comprehensive
review of the company's computer systems and business processes has been
conducted to identify the major systems that could be affected by the Year 2000
issue. Steps are being taken to resolve any potential problems including
modifications to existing software and the purchase of new software. These
modifications are scheduled to be completed and tested on a timely basis. The
-1- (1997 Annual Report p. 22)
costs related to the Year 2000 issue, which are expensed as incurred, are not
expected to have a material impact on the company's results of operations or
financial condition. The company is also evaluating the Year 2000 readiness of
merchants, customers and other third parties whose systems failures could have
an impact on the company's operations. The potential materiality of any such
impact is not known at this time.
On January 1, 1999, certain European countries plan to adopt a single
currency (the euro). For countries adopting the euro, the exchange rate between
their local currency and the euro will be fixed as of June 30, 1998. The company
has carried out an assessment and identified business requirements for the
introduction of the euro. The company is making systems modifications to comply
with euro requirements and maintain its competitiveness in the marketplace. The
related costs, which are expensed as incurred, are not expected to have a
material impact on the company's earnings.
Accounting Developments
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 131, "Disclosures about Segments
of an Enterprise and Related Information," which is effective for fiscal
years beginning after December 15, 1997 and redefines how operating segments
are determined. The company will adopt the provisions of SFAS No. 131 in the
first quarter of 1998. As a result, the Travelers Cheque operations which
currently are included in the Travel Related Services segment will be reported
in the same segment as American Express Bank, consistent with our management
structure.
-2- (1997 Annual Report p. 22)
Travel Related Services (TRS) reported earnings of $1.35 billion in 1997, a 10
percent increase from $1.23 billion in 1996, excluding a $125 million
restructuring charge ($196 million pretax). 1995 earnings excluding the income
of AMEX Life were $1.09 billion.
-3- (1997 Annual Report p. 23)
TRS' net revenues rose 8 percent in 1997 compared with 1996. In the past two
years, TRS' net revenues benefited from growth in worldwide billed business and
Cardmember loans outstanding. Additionally, 1997 included wider interest margins
and increased recognition of recoveries on abandoned property related to the
Travelers Cheque business; these recoveries are included in other revenues and
were largely offset by higher investment spending on business building
initiatives. In both years, growth in billed business resulted from greater
spending per basic Cardmember, due in part to rewards programs and expanded
merchant coverage, and a larger number of cards outstanding. The increase in
worldwide cards in force in both years is primarily attributable to new credit
card product launches and a broader product portfolio.
Discount revenue rose in 1997 and 1996 from growth in billed business. Net
card fees decreased in both years due to declines in consumer charge cards and
the effect of TRS' strategy of building its lending portfolio through the
issuance of low- and no-fee credit cards. Travel commissions and fees improved
in 1997 and 1996 as a result of increased sales volumes, offset in part by the
continued efforts by airlines to reduce distribution costs and by corporate
travel and entertainment expense containment efforts. Interest and dividends
declined in 1997 and 1996, primarily as a result of a reduction in investments
related to the consolidation of certain legal entities within the U.S.
Consumer Lending business. The consolidation reduced interest revenue by
approximately $82 million and $119 million in 1997 and 1996, respectively, but
had no effect on net income as other interest expense decreased by a
corresponding amount. The remaining decline in 1997 is attributable to a
smaller investment pool at American Express Credit Corporation (Credco). In
addition, interest and dividends and other revenues declined in 1996 as a
result of the sale of AMEX Life. Lending net finance charge revenue was
reduced by the $1 billion asset securitization in the second quarter of 1996
and an additional $1 billion securitization in the third quarter of 1997.
(See TRS' Liquidity and Capital Resources discussion.) Excluding these,
lending net finance charge revenue rose 24 percent and 11 percent in 1997 and
1996, respectively. The increase in 1997 is due to higher worldwide lending
balances and a widening of interest margins on the U.S. portfolio resulting
from a smaller portion of the portfolio being subject to lower introductory
interest rates. The growth in 1996 resulted from larger worldwide lending
balances, partially offset by reduced interest margins on the U.S. portfolio
due to introductory interest rates on new products.
-4- (1997 Annual Report p. 23)
* Computed excluding Cards issued by strategic alliance partners and
independent operators as well as business billed on those Cards.
** Owned and managed Cardmember receivables and loans include securitized
assets not reflected in the Consolidated Balance Sheets.
The growth in marketing and promotion expense in 1997 reflected higher media
and merchant-related advertising costs. The increase in 1996 resulted from new
product activity. The worldwide Charge Card provision rose in 1997 primarily
driven by volume growth. In 1996, the Charge Card provision declined due to
improved credit quality, particularly in Latin America. The worldwide lending
provision increased in 1997 and 1996 as a result of portfolio growth as well as
higher loss rates. The growth in the lending provision was partly offset by the
securitizations of U.S. Cardmember loans in 1997 and 1996. The other provision
for losses declined in 1996 due to the sale of AMEX Life. Charge Card interest
expense rose in 1997 and 1996 as a result of higher volumes, partly offset by
lower borrowing rates. The decline in other interest expense mirrors the
decrease in interest revenue as a result of the reduction in investments
discussed previously. The growth in human resources expense primarily reflected
higher systems programmers' costs for technology projects and merit increases in
both years. Other operating expenses rose in 1997 and 1996 due to Cardmember
loyalty programs, business growth and investment spending. The increase in 1996
was partially offset as a result of the sale of AMEX Life.
The 1996 restructuring charge primarily related to a series of reengineering
initiatives in the card and travel businesses implemented in 1997. Approximately
two-thirds of the restructuring charge applied to TRS' international businesses.
It included $109 million pretax in severance costs and $87 million pretax to
close certain leased facilities, to consolidate or outsource certain operations,
and to write down certain assets. Approximately $125 million of the pretax
charge required cash outlays for severance, lease obligations and other
facilities costs.
TRS' asset securitization programs increased fee revenue by $195 million,
$157 million and $84 million in 1997, 1996 and 1995, respectively. The Charge
Card securitization program resulted in net discount expense of $597 million,
$554 million and $414 million in 1997, 1996 and 1995, respectively. The program
also reduced the Charge Card provision by $247 million, $246 million and $167
million in 1997, 1996 and 1995, respectively, and Charge Card interest expense
by $230 million, $183 million and $163 million in 1997, 1996, and 1995,
respectively. The revolving credit securitization program also reduced lending
net finance charge revenue by $167 million and $75 million and the lending
provision by $120 million and $43 million, in 1997 and 1996, respectively.
These securitizations had no material effect on net income for any year
presented.
-6- (1997 Annual Report p. 24)
* Excluding the effect of SFAS No. 115 and the fourth quarter 1996 restructuring
charge of $125 million after-tax.
In 1996, American Express Centurion Bank (Centurion Bank) and American Express
Receivables Financing Corporation II, a newly formed wholly owned subsidiary of
TRS, created a new trust, the American Express Credit Account Master Trust
(the Trust), to securitize revolving credit loans. The Trust securitized $1
billion of loans in 1996 and an additional $1 billion in August 1997, through
the public issuance of two classes of investor certificates and a privately
placed collateral interest in the assets of the Trust. The securitized assets
consist of loans arising in a portfolio of designated Optima Card, Optima Line
of Credit and Sign & Travel revolving credit accounts owned by Centurion Bank.
These securitized loans are not in the Consolidated Balance Sheets.
In addition, the American Express Master Trust securitizes charge card
receivables generated under designated American Express Card, Gold Card and
Platinum Card consumer accounts through the issuance of trust certificates. At
December 31, 1997 and 1996, TRS had securitized $3.25 billion and $3.75 billion,
respectively, of receivables, which are not in the Consolidated Balance Sheets.
In 1997, Credco issued and sold exclusively outside the United States and to
non-U.S. persons, $400 million Floating Rate Notes and an additional $400
million of 6.5% Fixed Rate Notes. These notes are listed on the Luxembourg Stock
Exchange and will mature in 2002. At December 31, 1997, Credco had approximately
$2.5 billion of medium and long-term debt and warrants available for issuance
under shelf registrations filed with the Securities and Exchange Commission.
TRS, primarily through Credco, maintained commercial paper outstanding of
approximately $14.5 billion at an average interest rate of 6.0 percent and
approximately $13.0 billion at an average interest rate of 5.7 percent at
December 31, 1997 and 1996, respectively. Unused lines of credit of
approximately $7.3 billion, which expire in increments from 1998 through 2002,
were available at December 31, 1997 to support a portion of TRS' commercial
paper borrowings.
-7- (1997 Annual Report p. 25)
Borrowings under bank lines of credit totaled $1.7 billion at December 31,
1997 and $1.4 billion at December 31, 1996.
American Express Financial Advisors (AEFA) reported increases in revenues of 12
and 11 percent, and earnings of 19 and 18 percent for 1997 and 1996,
respectively. Revenue and earnings in both years benefited primarily from higher
fees due to growth in managed assets and record mutual fund sales.
The improvement in investment income reflected higher average investments of
4 and 5 percent in 1997 and 1996, respectively, partly offset by lower
investment yields in 1996. Management and distribution fees rose in both years
due to greater management fee revenue from higher managed and separate account
assets. The increase in these assets in both years was due to strong market
appreciation and positive net sales. Distribution fees improved in both years
reflecting strong mutual fund sales. Other revenues rose in both years from
increased life insurance contract charges and premiums and from higher
financial planning and tax preparation fees in 1997.
-8- (1997 Annual Report p. 25)
Provisions for losses and benefits for annuities and insurance grew in both
years due to higher business in force, partially offset by lower credited rates.
Human resources expense rose in both years, reflecting rising financial
advisors' compensation from growth in sales and asset levels, and a greater
number of employees to support business expansion. The growth in other operating
expenses in both years primarily resulted from higher data processing,
technology spending and advertising expenditures. In 1997, there also were
increased occupancy and equipment costs. The lower effective tax rate in 1997 is
due to tax credits from low income housing investments.
-9- (1997 Annual Report p. 26)
* Excluding the effect of SFAS No. 115.
AEFA's total assets and liabilities grew primarily due to separate accounts as a
result of market appreciation and positive net sales. Investments comprised
primarily of corporate bonds and mortgage-backed securities, including $3.0
billion and $2.6 billion in below investment grade debt securities as well as
$3.8 billion and $3.7 billion in mortgage loans at December 31, 1997 and 1996,
respectively. Investments are principally funded by sales of insurance and
annuities and by reinvested income. Maturities of these investments are matched,
for the most part, with the expected future payments of insurance and annuity
obligations. Separate account assets, primarily investments carried at market
value, are for the exclusive benefit of variable annuity and variable life
insurance contract holders. AEFA earns investment management and administration
fees from the related accounts.
-10- (1997 Annual Report p. 26)
American Express Bank's (the Bank) 1997 net income was higher than last year
as a result of increased foreign exchange trading and net interest income,
partially offset by larger operating expenses. 1996 net income was below 1995 as
a result of lower revenues and a higher provision for losses, partly offset by
reduced expenses.
Net interest income grew in 1997 due to higher average balances in loans and
trading securities; in 1996 net interest income fell due to higher borrowing
rates and decreased business volumes. Commissions, fees and other revenues
increased in 1997 driven by higher fees from new product launches; the decrease
in 1996 was primarily due to exiting nonstrategic businesses. Foreign exchange
income rose significantly in 1997, reflecting very strong trading results.
The provision for credit losses rose in 1996 due to loan growth, slightly
higher consumer and commercial write-offs and lower commercial banking
recoveries. Human resources expense grew in 1997 as a result of merit increases
and higher incentive compensation; the improvement in 1996 reflected cost
reduction initiatives. Other operating expenses rose in 1997 with increased
systems technology expenses; the decline in 1996 was due to the transfer of
aircraft assets to the Bank's parent.
-11- (1997 Annual Report p. 27)
The Bank has exposures throughout the Asia/Pacific region, including
Indonesia, Korea, Thailand as well as Hong Kong and Singapore. Our Risk
Management group has been monitoring the Asian financial crisis as it has
evolved. The Bank had approximately $2.8 billion in loans outstanding in the
entire region at December 31, 1997. In addition to these, there are other
banking activities, such as forward contracts, various contingencies and market
placements, which add another approximately $1.5 billion to the regional number
at year-end. We should be in a better position to estimate any reserve
requirements in the relatively near future.
* Excluding the effect of SFAS No. 115.
The reserve for credit losses rose as a result of a loan recovery in 1997. The
Bank had net loan recoveries of $1.6 million and net loan write-offs of $16.2
million in 1997 and 1996, respectively. Other real estate owned declined
primarily due to a property sale.
CORPORATE AND OTHER
Corporate and Other net expenses were $152 million, $153 million and $141
million in 1997, 1996 and 1995, respectively. The 1996 amount excludes a $300
million after-tax gain on the exchange of the company's DECS ($480 million
pretax) and a $13 million after-tax charge ($20 million pretax) primarily
related to the early retirement of debt. Including the above items in 1996,
Corporate and Other had net income of $134 million.
Results for all three years include a benefit from an earnings payout from
Travelers Inc. (Travelers), related to the 1993 sale of the Shearson Lehman
Brothers Division (the 1993 sale). Results for 1997 also reflect preferred
dividends received from Lehman Brothers Holdings, Inc. Results for 1996 and 1995
-12- (1997 Annual Report pp. 27-28)
also include the company's share of the participation in Travelers' revenue in
accordance with the 1993 sale. Results for 1995 also included a gain from the
sale of common stock and warrants of Mellon Bank Corporation. In each year,
these gains were offset by certain business building initiatives.
CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES
The company believes allocating capital to businesses with a return on
risk-adjusted equity in excess of its cost of equity and sustained earnings
growth in its core business will continue to build shareholder value.
The company's philosophy is to retain enough earnings to help achieve its
goals of earnings per share growth in the 12 to 15 percent range. As further
described in Note 7 to the Consolidated Financial Statements, the company has
undertaken a systematic share repurchase program to offset new share issuances.
To the extent retained earnings exceed investment opportunities, the company has
returned excess capital to shareholders.
Financing Activities
The company has procedures to transfer immediately short-term funds within
the company to meet liquidity needs. These internal transfer mechanisms are
subject to and comply with various contractual and regulatory constraints.
The parent company generally meets its short-term funding needs through an
intercompany dividend policy and by the issuance of commercial paper. The Board
of Directors has authorized a parent company commercial paper program that is
supported by a $1.3 billion multi-purpose credit facility that expires in
increments from 1998 through 2002. No borrowings have been made under this
credit facility. There was no parent company commercial paper outstanding during
1997 and at December 31, 1996.
Total parent company long-term debt outstanding was $1,079 million at
December 31, 1997 and $666 million at December 31, 1996. In June 1997, the
parent company issued $500 million of 6.75% Global Notes due June 23, 2004. The
proceeds from this issuance were used for general corporate purposes. At
December 31, 1997 and 1996, the parent company had $550 million and $1.1
billion, respectively, of debt or equity securities available for issuance under
a shelf registration filed with the Securities and Exchange Commission. In
addition, TRS, Credco, American Express Overseas Credit Corporation Limited and
the Bank have established programs for the issuance, outside the United States,
of debt instruments to be listed on the Luxembourg Stock Exchange. In 1997,
Centurion Bank was added to this program. The maximum aggregate principal amount
of debt instruments outstanding at any one time under the program will not
exceed $3 billion. At December 31, 1997 and 1996, $1.1 billion and $300 million
of debt, respectively, has been issued under this program.
Risk Management
Management establishes and oversees implementation of Board-approved policies
covering the company's funding, investments and use of derivative financial
instruments and monitors aggregate risk exposures on an ongoing basis. The
company's objective is to realize returns commensurate with the level of risk
assumed while achieving consistent earnings growth. Individual business segments
are responsible for managing their respective exposures within the context of
Board-approved policies. See Note 11 to the Consolidated Financial Statements
for a discussion of the company's use of derivatives.
-13- (1997 Annual Report p. 28)
The sensitivity analysis of three different tests of market risk in the
following sections estimate the effects of hypothetical sudden and sustained
changes in the applicable market conditions on the ensuing year's earnings. The
market changes, assumed to occur as of December 31, 1997, are a 100 basis point
increase in market interest rates, a 10% strengthening of the U.S. dollar versus
all other currencies, and a 10% decline in the value of equity securities under
management at AEFA. Computations of the prospective effects of hypothetical
interest rate, foreign exchange rate and equity market changes are based on
numerous assumptions, including relative levels of market interest rates,
foreign exchange rates and equity prices, as well as the levels of assets and
liabilities. The hypothetical changes and assumptions will be different from
what actually occurs in the future. Furthermore, the computations do not
anticipate actions that may be taken by management if the hypothetical market
changes actually occurred over time. As a result, actual earnings effects in the
future will differ from those quantified below.
A variety of interest rate and foreign exchange hedging strategies are
employed to manage interest rate and foreign currency risks. TRS' hedging
policies are established, maintained and monitored by a central treasury
function. TRS generally manages its exposures along product lines.
For Charge Card products, TRS funds its Cardmember receivables using both
on-balance sheet sources such as long-term debt, medium-term notes, commercial
paper and other debt, and an asset securitization program. Such funding is
predominantly obtained by Credco and its subsidiaries. Interest rate exposure is
managed through the issuance of long- and short-term debt and the use of
interest rate swaps to achieve a targeted mix of fixed and floating rate
funding. TRS currently targets this mix to be approximately 100 percent floating
rate. In early 1998, TRS purchased interest rate caps to limit the adverse
effect of an interest rate increase on substantially all Charge Card funding
costs. The majority of the caps will mature by the end of 1998. TRS periodically
reviews and may change this policy.
For its lending products, TRS funds its Cardmember loans using a mixture of
long- and short-term debt, and an asset securitization program, primarily
through Centurion Bank. The interest rates on TRS' lending products are linked
to a floating rate base and typically reprice each month. TRS generally enters
into interest rate swaps, paying rates that reprice similarly with changes in
the base rate of the underlying loans.
The detrimental effect on TRS earnings of the hypothetical 100 basis point
increase in interest rates described above would be approximately $164 million
pretax. This effect, which is primarily due to the variable rate funding of the
Charge Card products, is based on December 31, 1997 positions. The interest rate
caps purchased in early 1998 would reduce that effect by nearly half.
TRS' foreign exchange risk arising from cross-currency charges and balance
sheet exposures is managed primarily by entering into agreements to buy and sell
currencies on a spot or forward basis. In the latter part of 1997, foreign
currency forward contracts were both sold ($562 million) and purchased ($92
million) to manage a majority of anticipated 1998 cash flows in major overseas
markets.
Based on the year-end 1997 foreign exchange positions, but excluding the
forward contracts managing the anticipated 1998 overseas cash flows, the effect
on TRS' earnings of the hypothetical 10% strengthening of the U.S. dollar would
-14- (1997 Annual Report pp. 28-29)
be immaterial. With respect to the forward contracts related to anticipated
1998 cash flows, the 10% strengthening would create a hypothetical net pretax
gain of $41 million. Such a gain, if any, would mitigate the negative impact
that a strengthening U.S. dollar would have on 1998 overseas earnings.
AEFA owned investment securities are, for the most part, held by its life
insurance and investment certificate subsidiaries which primarily invest in
long-term and intermediate-term fixed income securities to provide their clients
with a competitive rate of return on their investments while minimizing risk.
Investment in fixed income securities provides AEFA with a dependable and
targeted margin between the interest rate earned on investments and the interest
rate credited to clients' accounts. AEFA does not invest in securities to
generate trading profits for its own account.
AEFA's life insurance and investment certificate subsidiaries' investment
committees meet regularly to review models projecting different interest rate
scenarios and their impact on the profitability of each subsidiary. The
committees' objective is to structure their investment security portfolios based
upon the type and behavior of the products in the liability portfolios, to
achieve targeted levels of profitability and meet contractual obligations.
Rates credited to customers' accounts are generally reset at shorter
intervals than the maturity of underlying investments. Therefore, AEFA's margins
may be impacted by changes in the general level of interest rates. Part of the
committees' strategies include the purchase of derivatives, such as interest
rate caps, swaps and floors, for hedging purposes.
The negative effect on AEFA's earnings of the 100 basis point increase in
interest rates would be approximately $40 million pretax. It assumes repricings
and customer behavior based on the application of proprietary models to the book
of business at December 31, 1997 and also includes a small decline in AEFA's
fees earned on managed fixed income assets.
AEFA's fees earned on the management of equity securities in variable
annuities and mutual funds are generally based on the value of the portfolios.
To manage the level of 1998 fee income, AEFA has entered into a series of stock
index option transactions designed to mitigate, for a substantial portion of the
portfolios, the negative effect on fees that would result from a decline in the
equity market. The negative effect on AEFA's earnings of the 10% decline in
equity markets discussed above would be approximately $20 million pretax, net of
the impact of the index options.
The Bank employs a variety of on- and off-balance sheet financial
instruments in managing its exposure to fluctuations in interest and currency
rates. Derivative instruments consist principally of foreign exchange spot and
forward contracts, interest rate swaps, foreign currency options and forward
rate agreements. Generally, they are used to manage specific on-balance sheet
interest rate and foreign exchange exposures related to deposits and long-term
debt, equity, loans and securities holdings.
The negative effect of the 100 basis point increase in interest rates on the
Bank's earnings would be approximately $9 million pretax. The impact of the 10%
strengthening of the U.S. dollar described above would be negligible on earnings
and, with respect to translation exposure of foreign operations, would result in
a $14 million pretax charge against equity.
-15- (1997 Annual Report pp. 29-30)
The Bank also utilizes foreign exchange and interest rate products to meet
the needs of its customers. Customer positions are usually, but not always,
offset. They are evaluated in terms of the Bank's overall interest rate or
foreign exchange exposure. The Bank also takes limited proprietary positions.
Potential daily negative earnings effects from these activities are estimated
using a Value at Risk model that employs a parametric technique using a
correlation matrix based on historical data. At December 31, 1997, there was a
99.0% probability that any potential loss for one day would be less than $1
million.
Asset/liability and market risk management at the Bank is supervised by the
Asset and Liability (ALCO) and Risk Management Committees, respectively. These
committees are comprised of senior business managers and the Chairman of the
Bank. Both committees meet monthly and monitor (a) liquidity, (b) capital levels
and (c) investment portfolios. Both committees evaluate current market
conditions and determine the Bank's tactics within risk limits approved by the
Bank's Board of Directors. The Bank's treasury and global trading management
issues policies and control procedures and delegate risk limits throughout the
Bank's country trading operations.
The Bank's overall credit policies are approved by the Finance and Credit
Policy Committee of the Bank's Board of Directors. Credit lines are based on a
tiered approval ladder, with levels of authority delegated to each country,
geographic area, the Bank's Senior management, and the Bank's Board of
Directors. Approval authorities are based on factors such as type of borrower,
nature of transaction, collateral, and overall risk rating. The Bank controls
the credit risk arising from derivative transactions through the same
procedures. The Credit Audit department reviews all significant exposures
periodically. Risk of all foreign exchange and derivative transactions are
reviewed by the Bank on a regular basis.
-16- (1997 Annual Report p. 30)
See notes to consolidated financial statements.
-17- (1997 Annual Report p. 31)
See notes to consolidated financial statements.
-18- (1997 Annual Report p. 32)
See notes to consolidated financial statements.
-19- (1997 Annual Report p. 33)
See notes to consolidated financial statements.
-20- (1997 Annual Report p. 34)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying Consolidated Financial Statements include the accounts of
American Express company and its subsidiaries (the company). All significant
intercompany transactions are eliminated. Some amounts are based on estimates
and assumptions, e.g., reserves for Cardmember Receivables and Loans; Deferred
Acquisition Costs; and Insurance and Annuity Reserves. These reflect the best
judgment of management and actual results could differ.
Certain amounts from prior years have been reclassified to conform to the
current presentation.
Net Revenues
Cardmember Lending Net Finance Charge Revenue is presented net of interest
expense of $604 million, $507 million and $497 million for the years ended
December 31, 1997, 1996 and 1995, respectively. Interest and Dividends is
presented net of interest expense related primarily to the company's
international banking activities of $594 million, $536 million and $604 million
for the years ended December 31, 1997, 1996 and 1995, respectively.
Marketing and Promotion
The company expenses advertising costs in the year in which the advertising
first takes place.
Cash and Cash Equivalents
The company has defined cash equivalents to include time deposits with
original maturities of 90 days or less, excluding those that are restricted by
law or regulation.
Separate Account Assets and Liabilities
Separate account assets and liabilities are funds held for the exclusive
benefit of variable annuity and variable life insurance contract holders. The
company receives investment management fees, mortality and expense assurance
fees, minimum death benefit guarantee fees and cost of insurance charges from
the related accounts.
NOTE 2 EARNINGS PER COMMON SHARE
The company adopted Statement of Financial Accounting Standards (SFAS) No. 128,
"Earnings per Share," effective for the quarter and year-ended December 31,
1997. SFAS No. 128 requires the presentation of basic and diluted earnings per
common share (EPS) in the income statement. Under the new requirements, basic
EPS is computed using the average actual shares outstanding during the period.
Diluted EPS is basic EPS adjusted for the dilutive effect of stock options,
restricted stock awards (RSAs) and other securities that may be converted into
common shares. The following is a reconciliation of the numerators and
denominators of the basic and diluted EPS computations:
-21- (1997 Annual Report p. 35)
(a) $200 million of 7.75% convertible preferred shares were outstanding during
1995 but were not included in the computation of diluted EPS, as the
effect would be antidilutive. These shares were converted into common
stock of the company in May 1996.
NOTE 3 RESTRUCTURING CHARGE
In the fourth quarter of 1996, the company recorded a $138 million charge
($216 million pretax) primarily for restructuring costs related to a series of
reengineering initiatives that were implemented in 1997. Of the total charge,
$125 million ($196 million pretax) related to Travel Related Services (TRS),
approximately two-thirds of which applied to international businesses. Most of
the remaining $13 million ($20 million pretax) was due to the early retirement
of debt at the Corporate level. The pretax charge was included in Other Expenses
in the Consolidated Statements of Income. The TRS restructuring charge included
$109 million pretax in severance costs and $87 million pretax to close certain
leased facilities, to consolidate or outsource certain operations and to
write-down certain assets. As of December 31, 1997, the company has
substantially completed all restructuring activities.
-22- (1997 Annual Report pp. 35-36)
NOTE 4 INVESTMENTS
The following is a summary of investments included in the Consolidated Balance
Sheets at December 31:
(millions) 1997 1996
------- -------
Held to Maturity, at amortized cost $11,871 $13,063
Available for Sale, at fair value 23,727 20,978
Investment mortgage loans (fair value:
1997, $4,026; 1996, $3,827) 3,831 3,712
Trading 219 586
------- -------
Total $39,648 $38,339
======= =======
Investments classified as Held to Maturity and Available for Sale at
December 31 are distributed by type and maturity as presented below:
Mortgage-backed securities primarily include GNMA, FNMA and FHLMC
securities at December 31, 1997 and 1996.
The table below includes purchases, sales and maturities of investments
classified as Held to Maturity and Available for Sale for the year ended
December 31:
-24- (1997 Annual Report p. 37)
Investments classified as Held to Maturity were sold during 1997 and 1996 due to
credit deterioration. Gross realized gains and losses on sales were negligible.
The change in the Net Unrealized Securities Gains (Losses) component of
Shareholders' Equity was an increase of $193 million, a decrease of $489 million
and an increase of $1.3 billion for the years ended December 31, 1997, 1996 and
1995, respectively. The decrease in 1996 primarily reflected the exchange of the
company's Debt Exchangeable for Common Stock (DECS) for shares of First Data
Corporation (FDC) held by the company, which resulted in the realization of a
$300 million after-tax gain. An increase in the general level of interest rates
also contributed to the decline in 1996. The rise in market value during 1995
reflected a decline in the general level of interest rates and the
reclassification of the company's investment in FDC to Available for Sale
securities.
Gross realized gains and (losses) on sales of securities classified as
Available for Sale, using the specific identification method, were $67 million
and ($10 million), $65 million and ($25 million) and $46 million and ($12
million) for the years ended December 31, 1997, 1996 and 1995, respectively.
The change in Net Unrealized Gains on Trading securities, which is included
in income, was $24 million, $28 million and $12 million for the years ended
December 31, 1997, 1996 and 1995, respectively.
In connection with the spin-off of Lehman Brothers Holdings Inc. (Lehman)
in 1994, the company acquired 928 shares and Nippon Life Insurance Company
(Nippon Life) acquired 72 shares of Lehman's redeemable voting preferred stock
for a nominal dollar amount. This security entitles its holders to receive an
aggregate annual dividend of 50 percent of Lehman's net income in excess of $400
million for each of eight years ending in May 2002, with a maximum of $50
million in any one year. Prior to 1997, the company received no dividends in
connection with the earnout. In 1997, the company received a dividend of $7
million on these shares. In addition, the company and Nippon Life are entitled
to receive 92.8 percent and 7.2 percent, respectively, of certain contingent
revenue and earnings-related payouts from Travelers Inc. (Travelers), which were
assigned by Lehman to the company and Nippon Life in connection with the
spin-off transaction. The Travelers revenue-related payout was for three years
and ended in 1996. The company received $46 million in 1996 and 1995. The
earnings-related payout, which is in effect for a five-year period beginning in
1994, is 10 percent of after-tax profits of Smith Barney, a subsidiary of
Travelers, in excess of $250 million per year ($70 million, $56 million and $24
million was received by the company in 1997, 1996 and 1995, respectively).
-25- (1997 Annual Report p. 38)
NOTE 5 LOANS
Note:American Express Financial Advisors (AEFA) mortgage loans of $3.8 billion
and $3.7 billion in 1997 and 1996, respectively, are included in Investment
Mortgage Loans and are shown in Note 4.
NOTE 6 PREFERRED SHARES
In January 1990, the company sold four million of the company's $3.875
Convertible Exchangeable Preferred shares (Convertible Preferred shares) to
Nippon Life for $200 million. In May 1996, after receiving a redemption notice
from the company, Nippon Life converted all of the Convertible Preferred shares
into 4,705,882 of the company's common shares.
The Board of Directors is authorized to permit the company to issue up to
20 million preferred shares without further shareholder approval.
-26- (1997 Annual Report p. 39)
NOTE 7 COMMON SHARES
In October 1996, the company's Board of Directors authorized the company to
repurchase up to 40 million common shares over the next two to three years,
subject to market conditions. This authorization is in addition to two previous
repurchase plans, beginning in 1994, under which the company repurchased a total
of 60 million common shares. These plans are primarily designed to allow the
company to purchase shares systematically both to offset the issuance of new
shares as part of employee compensation plans and to reduce shares outstanding.
Under the 1996 authorization, the company has repurchased and cancelled
17,556,053 and 13,146,053 shares, respectively.
Of the common shares authorized but unissued at December 31, 1997, 71
million shares were reserved for issuance for employee stock, employee benefit
and the dividend reinvestment plan as well as debentures.
In 1987, Nippon Life purchased 13 million shares of Lehman 5% Series A
Preferred Stock for $508 million. In 1990, the company gave Nippon Life the
right to exchange these shares (subsequently exchanged by Lehman for Series B
shares) into 6.24 million common shares of the company at any time through
December 1999 at an exchange price of $81.46. In 1996, Nippon Life informed the
company that it had reduced its holding of such preferred shares by
approximately 30 percent but maintained the exchange rights related to the
shares sold. On December 16, 1997, Nippon Life exchanged all of its remaining
holdings of these preferred shares for approximately 4.4 million common shares
of the company. In January 1998, the company purchased all remaining exchange
rights of Nippon Life.
Common shares activity for each of the last three years ended December 31
was:
-27- (1997 Annual Report p. 40)
NOTE 8 STOCK PLANS
Under the 1989 Long-Term Incentive Plan (the 1989 Plan), awards may be granted
to officers and other key employees and other key individuals who perform
services for the company and its participating subsidiaries. These awards may be
in the form of stock options, stock appreciation rights, restricted stock,
performance grants and other awards deemed by the Compensation and Benefits
Committee of the Board of Directors to be consistent with the purposes of the
1989 Plan. The company also has options outstanding pursuant to a Directors'
Stock Option Plan. Under both of these plans, there were a total of 25.9
million, 32.1 million and 14.1 million common shares available for grant at
December 31, 1997, 1996 and 1995, respectively. Each option has an exercise
price at least equal to the market price of the company's common stock on the
date of grant and a maximum term of 10 years. Options generally vest at 33 1/3
percent per year. The company also sponsors the American Express Incentive
Savings Plan, under which purchases of the company's common shares are made by
or on behalf of participating employees.
On January 13, 1998, the Compensation and Benefits Committee approved the
addition of a restoration feature to existing and future stock option awards.
That feature provides that employees who exercise options that have been
outstanding at least five years by surrendering previously owned shares as
payment will automatically receive a new (restoration) stock option with an
exercise price equal to the market price on the date of exercise. The size of
the restoration option is equal to the number of shares surrendered plus any
shares surrendered or withheld to satisfy the employees' statutory income tax
requirements. The term of the restoration option, which is exercisable six
months after grant, is equal to the remaining life of the original option.
Senior officers must be in compliance with their stock ownership guideline to
exercise restoration options.
The company granted 1.4 million, 1.4 million and 1.7 million restricted
stock awards with a weighted average grant date value of $67.08, $46.14 and
$34.77 per share for 1997, 1996 and 1995, respectively. Restrictions generally
expire four years from date of grant. The compensation cost that has been
charged against income for the company's restricted stock awards was $48
million, $39 million and $31 million for 1997, 1996 and 1995, respectively.
The company has elected to follow APB Opinion No. 25, "Accounting for Stock
Issued to Employees," and related Interpretations in accounting for its employee
stock options. Therefore, no compensation cost has been recognized related to
stock options. If the company had elected to account for its stock options under
the fair value method of SFAS No. 123, "Accounting for Stock-Based
Compensation," the company's net income and earnings per common share would have
been reduced to the pro forma amounts indicated below:
-28- (1997 Annual Report p. 41)
The fair value of each option is estimated on the date of grant using a
Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 1997, 1996 and 1995, respectively:
The dividend yield reflects the assumption that the current dividend payout
will continue with no anticipated increases. The expected life of the options is
based on historical data, and is not necessarily indicative of exercise patterns
that may occur. The weighted average fair value per option was $14.76, $11.43
and $9.39 for options granted during 1997, 1996 and 1995, respectively.
A summary of the status of the company's stock option plans as of December
31 and changes during each of the years then ended is presented below:
The following table summarizes information about the stock options outstanding
at December 31, 1997:
-29- (1997 Annual Report pp. 41-42)
NOTE 9 RETIREMENT PLANS
Pension Plans
The company sponsors the American Express Retirement Plan (the Plan), a
noncontributory defined benefit plan, under which the cost of retirement
benefits for eligible employees in the United States is measured by length of
service, compensation and other factors, and is currently being funded through a
trust. In addition, the company sponsors an unfunded, nonqualified supplemental
plan for which the aggregate accrued liability is not material. Funding of
retirement costs for the Plan complies with the applicable minimum funding
requirements specified by the Employee Retirement Income Security Act of 1974,
as amended. Employees' accrued benefits are based on nominal account balances
which are maintained for each individual. These balances are credited with
additions equal to a percentage, based on age plus service, of base pay,
overtime, shift differential, certain commissions and bonuses, each pay period.
Employees' balances are also credited annually with a fixed rate of interest
based on the daily average of published five-year Treasury Note yields. Lump sum
payout at termination or retirement is available.
Most employees outside the United States are covered by local retirement
plans, some of which are funded, or receive payments at the time of retirement
or termination under applicable labor laws or agreements. Benefits under these
local plans are generally expensed and are not funded.
Plan assets consist principally of equities and fixed income securities.
Net pension cost consisted of the following
components:
-30- (1997 Annual Report pp. 42-43)
The following table sets forth the funded status and amounts recognized in
the Consolidated Balance Sheets for the company's defined benefit plans,
including certain unfunded, nonqualified supplemental plans. The underfunded
plans relate to foreign and supplemental executive plans.
The weighted average assumptions used in the
company's plans at December 31 were:
Other Postretirement Benefits
The company sponsors postretirement benefit plans that provide health care,
life insurance and other postretirement benefits to retired U.S. employees. Net
periodic postretirement benefit expenses were $15 million, $18 million, and $19
million in 1997, 1996 and 1995, respectively. The liabilities recognized in the
Consolidated Balance Sheets for the company's defined postretirement benefit
plans (other than pension plans) at December 31, 1997 and 1996 were $204 million
and $205 million, respectively.
-31- (1997 Annual Report p. 43)
NOTE 10 INCOME TAXES
Accumulated net earnings of certain foreign subsidiaries, which totaled
$873 million at December 31, 1997, are intended to be permanently reinvested
outside the United States. Accordingly, federal taxes, which would have
aggregated $202 million, have not been provided on those earnings.
The company's net deferred tax assets at December 31 were:
Deferred tax assets for 1997 and 1996, which are presented net of a $45
million valuation allowance, primarily reflect: reserves not yet deducted for
tax purposes of $1.8 billion and $1.6 billion, respectively, and deferred
Cardmember fees of $238 million and $233 million, respectively. Deferred tax
liabilities for 1997 and 1996 mainly comprise deferred acquisition costs of $826
million and $762 million, respectively, liabilities related to SFAS No. 115 of
$318 million and $242 million, respectively, and accelerated depreciation of
$150 million and $155 million, respectively.
-32- (1997 Annual Report p. 44)
The principal reasons that the aggregate income tax provision is different
from that computed by using the U.S. statutory rate of 35 percent are:
Net income taxes paid by the company during 1997, 1996 and 1995 were $878
million, $548 million and $595 million, respectively, and include estimated tax
payments, as well as cash settlements relating to prior tax years.
NOTE 11 DERIVATIVE AND OTHER OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
The company uses derivative financial instruments for nontrading purposes to
manage its exposure to interest and foreign exchange rates, financial indices
and its funding costs. In addition, American Express Bank (the Bank) enters into
derivative contracts both to meet the needs of its clients and, to a limited
extent, for proprietary trading purposes.
There are a number of risks associated with derivatives. Market risk is the
possibility that the value of the derivative financial instrument will change.
The company is not exposed to market risk related to derivatives held for
nontrading purposes beyond that inherent in cash market transactions. The Bank
is generally not subject to market risk when it enters into a contract with a
client, as it usually enters into an offsetting contract or uses the position to
offset an existing exposure. The Bank takes proprietary positions within
approved limits. These positions are monitored daily at the local and
headquarters levels against Value at Risk (VAR) limits. The company does not
enter into derivative contracts with features that would leverage or multiply
its market risk.
Credit risk related to derivatives and other off-balance sheet financial
instruments is the possibility that the counterparty will not fulfill the terms
of the contract. It is monitored through established approval procedures,
including setting concentration limits by counterparty and country, reviewing
credit ratings and requiring collateral where appropriate. For its trading
activities with clients, the Bank requires collateral when it is not willing to
assume credit exposure to counterparties for either contract mark-to-market or
delivery risk. A significant portion of the company's transactions are with
counterparties rated A or better by nationally recognized credit rating
agencies. The company also uses master netting agreements, which allow the
company to settle multiple contracts with a single counterparty in one net
receipt or payment in the event of counterparty default. Credit risk
approximates the fair value of contracts in a gain position (asset) and totaled
$1.4 billion and $361 million at December 31, 1997 and 1996, respectively. The
fair value represents the replacement cost and is determined by market values,
dealer quotes or pricing models.
-33- (1997 Annual Report p. 45)
The following tables detail information regarding the company's derivatives at
December 31:
* These are predominantly contracts with clients and the related hedges of
those client contracts. The company's net trading foreign currency exposure
was approximately $38 million and $151 million at December 31, 1997 and
1996, respectively.
The average aggregate fair values of derivative financial instruments held
for trading purposes were computed based on monthly information. Net derivative
trading gains of $103 million and $72 million for 1997 and 1996, respectively,
were primarily due to trading in foreign currency forward contracts and are
included in Other Commissions and Fees.
Interest Rate Products
The company uses interest rate products, principally swaps, primarily to
manage funding costs related to TRS' Charge Card and Cardmember lending
businesses. For its Charge Card products, TRS uses interest rate swaps to
achieve a targeted mix of fixed and floating rate funding. For its Cardmember
loans, which are linked to a floating rate base and generally reprice each
month, TRS generally enters into interest rate swaps paying rates that reprice
similarly with changes in the base rate of the underlying loans.
The Bank uses interest rate swaps to manage its portfolio of loans, deposits
and, to a lesser extent, securities holdings. The termination dates of these
swaps are generally matched with the maturity dates of the underlying assets and
liabilities.
-35- (1997 Annual Report pp. 46-47)
For interest rate swaps that are used for nontrading purposes and meet the
criteria for hedge accounting, interest is accrued and reported in Other
Receivables and Interest and Dividends or Accounts Payable and Interest Expense,
as appropriate. Products used for trading purposes are reported at fair value in
Other Assets or Other Liabilities, as appropriate, with unrealized gains and
losses recognized currently in Other Revenues.
AEFA uses interest rate caps, swaps and floors to protect the margin between
the interest rates earned on investments and the interest rates credited to
holders of investment certificates and fixed annuities. Interest rate caps and
floors generally mature within five years. The costs of interest rate caps and
floors are reported in Other Assets and amortized into Interest and Dividends
on a straight line basis over the term of the contract; benefits are recognized
in income when earned.
See Note 12 for further information regarding the company's use of interest
rate products related to short-and long-term debt obligations.
Foreign Currency Products
The company uses foreign currency products primarily to hedge net investments
in foreign operations and to manage transactions denominated in foreign
currencies. In addition, the Bank enters into derivative contracts both to meet
the needs of its clients and, to a limited extent, for trading purposes,
including taking proprietary positions.
Foreign currency exposures are hedged, where practical and economical,
through foreign currency contracts. Foreign currency contracts involve the
purchase and sale of a designated currency at an agreed upon rate for settlement
on a specified date. Foreign currency forward contracts generally mature within
one year, whereas foreign currency spot contracts generally settle within two
days.
For foreign currency products used to hedge net investments in foreign
operations, unrealized gains and losses as well as related premiums and
discounts are reported in Shareholders' Equity. For foreign currency contracts
related to transactions denominated in foreign currencies, unrealized gains and
losses are reported in Other Assets and Other Commissions and Fees or Other
Liabilities and Other Expenses, as appropriate. Related premiums and discounts
are reported in Other Assets or Other Liabilities, as appropriate, and amortized
into Interest Expense and Other Expenses over the term of the contract. Foreign
currency products used for trading purposes are reported at fair value in Other
Assets or Other Liabilities, as appropriate, with unrealized gains and losses
recognized currently in Other Commissions and Fees.
The company also uses foreign currency forward contracts to hedge its firm
commitments. In addition, for selected major overseas markets, the company uses
foreign currency forward contracts to hedge future income, generally for periods
not exceeding one year; unrealized gains and losses are recognized currently in
income. In the latter part of 1997, foreign currency forward contracts were both
sold ($562 million) and purchased ($92 million) to manage a majority of
anticipated 1998 cash flows in major overseas markets. The impact of these
activities was not material.
-36- (1997 Annual Report pp. 47-48)
Other Products
Included in Other Products are purchased and written index options used by AEFA
to hedge against adverse changes in the U.S. equities markets, which affect
revenues earned on assets under management. Index options are carried at market
value and included in Other Assets. Gains and losses on these options are
deferred until the revenues are earned. At December 31, 1997, the notional value
of these options was $1 billion.
Other Off-Balance Sheet Financial Instruments
The company's other off-balance sheet financial instruments principally relate
to extending credit to satisfy the needs of its clients. The contractual amount
of these instruments represents the maximum accounting loss the company would
record assuming the contract amount is fully utilized, the counterparty defaults
and collateral held is worthless. Management does not expect any material
adverse impact to the company's financial position to result from these
contracts.
The company is committed to extend credit to certain Cardmembers as part of
established lending product agreements. Many of these are not expected to be
drawn; therefore, total unused credit available to Cardmembers does not
represent future cash requirements. The company's Charge Card products have no
preset spending limit and are not reflected in unused credit available to
Cardmembers.
The company may require collateral to support its loan commitments based on
the creditworthiness of the borrower.
Standby letters of credit and guarantees primarily represent conditional
commitments to insure the performance of the company's customers to third
parties. These commitments generally expire within one year.
The company issues commercial and other letters of credit to facilitate the
short-term trade-related needs of its clients, which typically mature within six
months. At December 31, 1997 and 1996, the company held $744 million and $811
million, respectively, of collateral supporting standby letters of credit and
guarantees and $276 million and $504 million, respectively, of collateral
supporting commercial and other letters of credit.
Other financial institutions have committed to extend lines of credit to the
company of $9.7 billion and $9.2 billion at December 31, 1997 and 1996,
respectively.
-37- (1997 Annual Report p. 48)
NOTE 12 SHORT- AND LONG-TERM DEBT AND BORROWING AGREEMENTS
Short-Term Debt
At December 31, 1997 and 1996, the company's total short-term debt outstanding
was $20.6 billion and $18.4 billion, respectively, with weighted average
interest rates of 6.12% and 5.79%, respectively. At December 31, 1997 and 1996,
$1.6 billion and $625 million, respectively, of short-term debt outstanding was
covered by interest rate swaps. The year-end weighted average effective interest
rates were 6.17% and 5.84%, respectively. The company generally pays floating
rates of interest under the terms of interest rate swaps. Unused lines of credit
to support commercial paper borrowing were approximately $8.6 billion at
December 31, 1997.
(a)For floating rate debt issuances, the stated and effective interest
rates were based on the respective rates at December 31, 1997 and 1996;
these rates are not an indication of future interest rates.
(b)Weighted average rates were determined where appropriate.
The above interest rate swaps generally require the company to pay a
floating rate, with a predominant index of LIBOR (London Interbank Offered
Rate).
The company paid interest (net of amounts capitalized) of $2.5 billion,
$2.4 billion and $2.6 billion in 1997, 1996 and 1995, respectively.
Approximately $171 million of the long-term financing for the company's
headquarters building is secured by certain mortgages on the interests of the
company in the building.
Aggregate annual maturities of long-term debt for the five years ending
December 31, 2002 are as follows (millions): 1998, $1,680; 1999, $1,658; 2000,
$1,178; 2001, $1,427; and 2002, $921.
-39- (1997 Annual Report p. 49)
NOTE 13 FAIR VALUES OF FINANCIAL INSTRUMENTS
The following table discloses fair value information for most on- and
off-balance sheet financial instruments. Certain financial instruments, such as
life insurance obligations, employee benefit obligations and investments
accounted for under the equity method are excluded. The fair values of financial
instruments are estimates based upon market conditions and perceived risks at
December 31, 1997 and 1996 and require management judgment. These figures may
not be indicative of their future fair values.
The carrying and fair values of other off-balance sheet financial instruments
are not material as of December 31, 1997 and 1996. See Notes 4 and 11 for
carrying and fair value information regarding investments and derivative
financial instruments. The following methods were used to estimate the fair
values of financial assets and financial liabilities:
Financial Assets
ASSETS FOR WHICH CARRYING VALUES APPROXIMATE FAIR VALUES: The carrying values
of Cash and Cash Equivalents, Accounts Receivable and Accrued Interest, Separate
Account Assets and applicable Other Assets approximate their fair values.
LOANS: For variable rate loans that reprice within a year where there has
been no significant change in counterparties' creditworthiness, fair values are
based on carrying values. The fair values of all other loans, except for loans
with significant credit deterioration, are estimated using discounted cash flow
analysis, based on current interest rates for loans with similar terms to
borrowers of similar credit quality. For loans with significant credit
deterioration, fair values are based on revised estimates of future cash flows
discounted at rates commensurate with the risk inherent in the revised cash flow
projections, or for collateral dependent loans, on collateral values.
-40- (1997 Annual Report pp. 50-51)
Financial Liabilities
LIABILITIES FOR WHICH CARRYING VALUES APPROXIMATE FAIR VALUES: The carrying
values of Customers' Deposits, Travelers Cheques Outstanding, Accounts Payable,
Short-Term Debt and applicable Other Liabilities approximate their fair values.
FIXED ANNUITY RESERVES: Fair values of annuities in deferral status are
estimated as the accumulated value less applicable surrender charges and loans.
For annuities in payout status, fair value is estimated using discounted cash
flow, based on current interest rates. The fair value of these reserves excludes
life insurance-related elements of $1.3 billion and $1.2 billion in 1997 and
1996.
INVESTMENT CERTIFICATE RESERVES: For variable rate investment certificates
that reprice within a year, fair values approximate carrying values. For other
investment certificates, fair value is estimated using discounted cash flow
analysis, based on current interest rates. The valuations are reduced by the
amount of applicable surrender charges and related loans.
LONG-TERM DEBT: For variable rate long-term debt that reprices within a
year, fair values approximate carrying values. For other long-term debt, fair
value is estimated using either quoted market prices or discounted cash flow
based on the company's current borrowing rates for similar types of borrowing.
SEPARATE ACCOUNT LIABILITIES: Fair values of these liabilities, after
excluding life insurance-related elements of $1.7 billion and $1.2 billion in
1997 and 1996, are estimated as the accumulated value less applicable surrender
charges.
-41- (1997 Annual Report p. 51)
NOTE 14 SIGNIFICANT CREDIT CONCENTRATIONS
A credit concentration may exist if customers are involved in similar
industries. The company's customers operate in diverse economic sectors.
Therefore, management does not expect any material adverse consequences to the
company's financial position to result from credit concentrations. Certain
distinctions between categories require management judgment.
(a) Financial institutions primarily include banks, broker-dealers, insurance
companies and savings and loan associations.
(b) Charge Card products have no preset spending limit; therefore, the
quantified credit amount includes only Cardmember receivables recorded in
the Consolidated Balance Sheets.
(c) U.S. Government and agencies represent the U.S. Government and its
agencies, states and municipalities, and quasi-government agencies.
NOTE 15 INDUSTRY SEGMENTS AND GEOGRAPHIC OPERATIONS
Industry Segments
The company is principally engaged in providing travel related, financial
advisory and international banking services throughout the world. TRS' products
and services include, among others, Charge Cards, consumer lending products,
Travelers Cheques and corporate and consumer travel services. American Express
Financial Advisors' services and products include financial planning and advice,
investment advisory services and a variety of products, including insurance and
annuities, investment certificates and mutual funds. The Bank serves the
financial needs of wealthy entrepreneurs and their companies, financial service
institutions and retail customers by providing correspondent, commercial and
private banking, consumer financial services and global trading. The main market
for the travel related and financial advisory services is the United States; the
principal markets for international banking services are Europe and
Asia/Pacific.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information," which is
effective for fiscal years beginning after December 15, 1997 and redefines how
operating segments are determined. The company will adopt the provisions of SFAS
No. 131 in the first quarter of 1998. As a result, the Travelers Cheque
operations which currently are included in the TRS segment will be reported in
the same segment as the Bank, consistent with our management structure.
-42- (1997 Annual Report p. 52)
The following table presents certain information regarding these industry
segments at December 31, 1997, 1996 and 1995 and for each of the years then
ended. TRS' results for 1996 include a $125 million after-tax ($196 million
pretax) restructuring charge. Corporate and Other's results for 1996 include a
$300 million after-tax ($480 million pretax) gain on the exchange of the
company's DECS and a $13 million after-tax ($20 million pretax) charge related
to the early retirement of debt and certain restructuring costs.
Net revenues includes interest earned on the investment of funds
attributable to each industry segment. Pretax income before general corporate
expenses is net revenues less operating expenses, including interest, related to
each industry segment's revenues.
Net income (loss) includes a provision for income taxes calculated on a
separate return basis; however, benefits from operating losses, loss carrybacks
and tax credits (principally foreign tax credits) recognizable for the company's
consolidated reporting purposes are allocated based upon the tax sharing
agreement among members of the American Express Company consolidated U.S. tax
group.
-43- (1997 Annual Report pp. 52-53)
Assets are those that are used or generated exclusively by each industry
segment. The adjustments and eliminations required to determine the consolidated
amounts shown above consist principally of the elimination of intersegment
revenues and assets.
Geographic Operations
The following table presents certain information regarding the company's
operations in different geographic regions at December 31 and for each of the
years then ended.
Most services of the company are provided on an integrated worldwide basis.
Therefore it is not practical to separate precisely the U.S. and international
services. Accordingly, the data in the above table are, in part, based upon
internal allocations, which necessarily involve management judgments. The growth
in international net revenues and pretax income was curtailed by the impact of
the stronger U.S. dollar.
-44- (1997 Annual Report pp. 53-54)
NOTE 16 LEASE COMMITMENTS AND OTHER CONTINGENT LIABILITIES
The company leases certain office facilities and operating equipment under
noncancellable and cancellable agreements. Total rental expense amounted to $384
million, $397 million and $415 million in 1997, 1996 and 1995, respectively. At
December 31, 1997, the minimum aggregate rental commitment under all
noncancellable leases (net of subleases) was (millions): 1998, $271; 1999, $217;
2000, $169; 2001, $156; 2002, $127; and thereafter, $1,239.
The company is not a party to any pending legal proceedings that, in the
opinion of management, would have a material adverse effect on the company's
financial position.
NOTE 17 TRANSFER OF FUNDS FROM SUBSIDIARIES
The Securities and Exchange Commission requires the disclosure of certain
restrictions on the flow of funds to a parent company from its subsidiaries in
the form of loans, advances or dividends.
Restrictions on the transfer of funds exist under debt agreements and
regulatory requirements of certain of the company's subsidiaries. These
restrictions have not had any effect on the company's shareholder dividend
policy and management does not anticipate any effect in the future.
At December 31, 1997, the aggregate amount of net assets of subsidiaries
that may be transferred to the parent company was approximately $6.9 billion.
Should specific additional needs arise, procedures exist to permit immediate
transfer of short-term funds between the company and its subsidiaries, while
complying with the various contractual and regulatory constraints on the
internal transfer of funds.
NOTE 18 QUARTERLY FINANCIAL DATA (UNAUDITED)
(1) Fourth quarter 1996 amounts include a gain of $300 million ($480 million
pretax) on the exchange of the company's DECS and a $138 million ($216
million pretax) restructuring charge.
-45- (1997 Annual Report p. 55)
REPORT OF ERNST & YOUNG LLP INDEPENDENT AUDITORS
The Shareholders and Board of Directors
of American Express Company
We have audited the accompanying consolidated balance sheets of American Express
Company as of December 31, 1997 and 1996, and the related consolidated
statements of income, shareholders' equity, and cash flows for each of the three
years in the period ended December 31, 1997. These financial statements are the
responsibility of the management of American Express Company. Our responsibility
is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of American
Express Company at December 31, 1997 and 1996, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles.
/s/ Ernst & Young LLP
New York, New York
February 5, 1998
-46- (1997 Annual Report p. 56)
Note: Historical common share prices have been adjusted to reflect the Lehman
spin-off at a ratio based on the trading prices of the company's common shares
and shares of Lehman common stock on May 31, 1994. Pro forma cash dividends
declared and book value per share have also been adjusted to reflect the
Lehman spin-off. For purposes of the pro forma book value per share calculation,
it is assumed that the spin-off includes the book value of the company's
investment in Lehman at the balance sheet date plus the capital infusion of
approximately $904 million that was made immediately prior to the spin-off.
* Adjusted to exclude: in 1996 -- a $300 million gain on the exchange of the
company's DECS and a $138 million restructuring charge; 1993 -- a $433 million
gain on the sale of FDC shares.
**Return on average shareholders' equity is based on adjusted income from
continuing operations before accounting changes and excludes the effect of
SFAS No. 115 beginning in 1994. In addition, book value per share excludes
the effect of SFAS No. 115 beginning in 1994.
-48- (1997 Annual Report p. 57)