For the fiscal year ended December 31, 2010

 

Exhibit 13

 

 

2010 FINANCIAL RESULTS

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

 

The financial section of American Express Company’s (the Company) Annual Report consists of this Financial Review, the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements. The following discussion is designed to provide perspective and understanding regarding the Company’s consolidated financial condition and results of operations. Certain key terms are defined in the Glossary of Selected Terminology, which begins on page 61.

This Financial Review and the Notes to Consolidated Financial Statements have been adjusted to exclude discontinued operations unless otherwise noted.

 

EXECUTIVE OVERVIEW

American Express is a global service company that provides customers with access to products, insights and experiences that enrich lives and build business success. The Company’s principal products and services are charge and credit payment card products and travel-related services offered to consumers and businesses around the world. The Company’s range of products and services include:

 

 

The Company’s products and services are sold globally to diverse customer groups, including consumers, small businesses, mid-sized companies and large corporations. These products and services are sold through various channels, including direct mail, on-line applications, targeted direct and third-party sales forces, and direct response advertising.

The Company has also recently created an Enterprise Growth Group to focus on generating alternative sources of revenue on a global basis, both organically and through acquisitions, in areas such as online and mobile payments and fee-based services.

The Company’s products and services generate the following types of revenue for the Company:

 

 

In addition to funding and operating costs associated with these types of revenue, other major expense categories are related to marketing and reward programs that add new cardmembers and promote cardmember loyalty and spending, and provisions for anticipated cardmember credit and fraud losses.

Historically, the Company sought to achieve three financial targets, on average and over time:

 

 

In addition, assuming achievement of such financial targets, the Company sought to return at least 65 percent of the capital it generates to shareholders as a dividend or through the repurchase of common stock.

The Company met or exceeded these targets for most of the past decade. However, during 2008 and 2009, its performance fell short of the targets due to the effects of the continuing global economic downturn. The Company’s share repurchase program was suspended in 2008 and, as a result, the amount of capital generated that has been returned to shareholders has been below the levels achieved earlier in the decade. Refer to Share Repurchases and Dividends below for further discussion of the Company’s share repurchase activity.

The Company is retaining its on average and over time revenue and earnings growth targets. However, evolving market, regulatory and debt investor expectations will likely cause the Company, as well as other financial institutions, to maintain in future years a higher level of capital than they have historically maintained. These higher capital requirements would in turn lead, all other things being equal, to lower future ROE than the Company has historically targeted. In addition, the Company recognizes it may need to maintain higher capital levels to support acquisitions that can augment its business growth. In combination, these factors have led the

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

Company to revise its on average and over time ROE financial target to 25 percent or more.

In establishing the revised ROE target, the Company has assumed that it will target a 10 percent Tier 1 Common ratio. The actual future capital requirements applicable to the Company are uncertain and will not be known until further guidance is provided in connection with certain initiatives, such as Basel III and the implementation of regulations under the recent United States financial reform legislation. International and United States banking regulators could also increase the capital ratio levels at which banks would be deemed to be “well capitalized”. Refer to Capital Strategy below. The revised ROE target also assumes the Company would need to maintain capital to finance moderate-sized acquisitions, although the actual magnitude of these transactions cannot be determined at this time. If the Company achieves its EPS target as well as the revised ROE target, it would seek to return, on average and over time, at least 50 percent of the capital it generates to shareholders as a dividend or through the repurchase of common stock rather than the 65 percent level referred to above.

Certain of the statements in this Annual Report are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Refer to the “Forward-Looking Statements” section below.

 

BANK HOLDING COMPANY

The Company is a bank holding company under the Bank Holding Company Act of 1956 and the Federal Reserve Board (Federal Reserve) is the Company’s primary federal regulator. As such, the Company is subject to the Federal Reserve’s regulations, policies and minimum capital standards.

 

CURRENT ECONOMIC ENVIRONMENT/OUTLOOK

The Company’s results for 2010 reflected strong spending growth and improved credit performance. Throughout the year cardmember spending volumes grew both in the United States and internationally, and across all of the Company’s businesses. Cardmember spending levels in 2010 reached record levels by the end of the year.

During 2010, the Company continued to see a sharp divergence between the positive growth rates in customer spending on credit cards and lower borrowing levels, due in part to changing consumer behavior and the Company’s strategic (e.g., additional focus on charge and co-brand products) and risk-related actions. While the offsetting influences of stronger billings growth and lower loan balances challenged overall revenue growth, the year-over-year benefits from improving credit trends have provided an ability to invest in the business at significant levels and also generate strong earnings. Some of these investments are focused on near-term metrics, while others are initiatives focused on the medium to long-term success of the Company. These investments are reflected not only in marketing and other operating expenses, but also involve using the Company’s strong capital base for acquisitions such as Accertify and Loyalty Partner, which were announced during the fourth quarter of 2010. Refer to “Acquisitions” below.

The improving credit trends contributed to a significant reduction in loan and receivable write-offs and in loss reserve levels over the course of 2010 when compared to 2009. Despite the reduction in loss reserve levels, reserve coverage ratios remain strong. It is expected that the year-over-year benefits from improving credit trends will decrease over the course of 2011. While the Company invested at historically high levels in 2010, it intends to maintain the flexibility to scale back on investments as business conditions change and the benefits realized from improving credit trends lessen.

Net interest yield declined over the course of 2010. The lower yield reflects higher payment rates and lower revolving levels, and the implementation of elements of the Credit Card Accountability Responsibility and Disclosure Act of 2009 (the “CARD Act”), which were partially offset by the benefit of certain repricing initiatives effective during 2009 and 2010. The Company expects the net interest yield in the US Consumer business to decline, moving closer to historic levels, but this remains subject to uncertainties such as cardmember behavior and the requirement under the CARD Act to periodically reevaluate annual percentage rate (APR) increases.

Despite improvement in parts of the economic environment, challenges clearly remain for the Company, both in the United States and in many other key regions. These challenges include weak job creation, volatile consumer confidence, uncertain consumer behavior, an uncertain housing market, and the regulatory and legislative environment, including the uncertain impact of the CARD Act, of the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act and of the proceeding against the Company recently brought by the Department of Justice (DOJ) and certain state attorneys general alleging a violation of the U.S. antitrust laws. In addition, during 2011 the Company will stop receiving quarterly Visa and MasterCard litigation settlement payments, and year-over-year comparisons will be more difficult in light of the strong 2010 results. Refer to “Certain Legislative, Regulatory and Other Developments”, “Other Information — Legal Proceedings” and “Risk Factors” below.

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

REENGINEERING INITIATIVES

On January 19, 2011, the Company announced that it was undertaking various reengineering initiatives resulting in charges aggregating approximately $113 million pretax (approximately $74 million after-tax), which were recorded in the fourth quarter of 2010. The charges for the reengineering initiatives include a fourth quarter restructuring charge in the amount of approximately $98 million pretax (approximately $63 million after-tax) relating to employee severance obligations and other employee-related costs.

The $98 million restructuring charge is pursuant to a plan, approved by the Company’s management in December 2010, that resulted in a consolidation of facilities within the Company’s global servicing network due to reduced service volumes as a greater number of routine transactions have migrated to online and mobile channels. In addition, the Company expects to record further restructuring charges in one or more quarterly periods during 2011 relating to these restructuring activities in the aggregate amount of approximately $60 million to $80 million pretax (approximately $38 million to $51 million after-tax). The total expected additional charges include approximately $25 million to $35 million in costs associated with additional employee compensation and approximately $35 million to $45 million in other costs principally relating to the termination of certain real property leases.

The reengineering activities, in total, are expected to result in the elimination of approximately 3,500 jobs (including approximately 3,200 jobs relating to the above noted restructuring charge). However, overall staffing levels are expected to decrease only by approximately 550 positions on a net basis (including 400 positions related to specific restructuring activities), as new employees are hired at the locations to which work is being transferred.

Substantially all of these reengineering activities are expected to be completed by the end of the fourth quarter of 2011.

The Company also announced that it expects the reengineering charges recorded in the fourth quarter of 2010 and to be recorded during 2011 to result in annualized cost savings to the Company of approximately $70 million pretax, starting in 2012. The Company announced that it intends to reinvest a portion of such savings into new servicing capabilities and other business building initiatives.

During 2008 and 2009, the Company undertook major reengineering initiatives that were expected to produce significant cost benefits in 2009. These initiatives included reducing staffing levels resulting in lower compensation expenses and reducing certain operating costs for marketing and other business building initiatives. As the Company has previously disclosed, benefits related to better than initially forecasted credit and business trends for 2009 were utilized to increase spending on marketing and other business-building initiatives during the second half of 2009, reducing the expected reengineering benefits.

 

ACQUISITIONS

During the course of the year, the Company purchased Accertify (November 10, 2010) and Revolution Money (January 15, 2010) for a total consideration of $151 million and $305 million, respectively. Accertify is an on-line fraud solution provider and Revolution Money is a provider of secure person-to-person payment services through an internet-based platform. These acquisitions did not have a significant impact on either the Company’s consolidated results of operations or the segments in which they are reflected for the year ended December 31, 2010.

On March 28, 2008, the Company purchased Corporate Payment Services (CPS), General Electric Company’s commercial card and corporate purchasing business unit.

 

The following table summarizes the assets acquired and liabilities assumed for these acquisitions as of the acquisition dates:

 

 

 

On December 16, 2010, the Company announced an agreement to acquire Loyalty Partner, a leading marketing services company known for the loyalty programs it operates in Germany, Poland and India. The purchase, which has received regulatory approval, is expected to close in the first quarter of 2011. The transaction, which values Loyalty Partner at approximately $660 million (subject to currency movement and other adjustments), consists of an upfront cash purchase price of approximately $566 million and an additional $94 million equity interest that the Company will acquire over the next five years at a value based on business performance.

 

DISCONTINUED OPERATIONS

For the applicable periods, the operating results, assets and liabilities, and cash flows of American Express International Deposit Company (AEIDC), which was sold to Standard Chartered in the third quarter of 2009, have been removed from the Corporate & Other segment and reported separately within the discontinued operations captions on the Company’s Consolidated Financial Statements. Refer to Note 2 to the Consolidated Financial Statements for further discussion of the Company’s discontinued operations.

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

FINANCIAL SUMMARY

A summary of the Company’s recent financial performance follows:

 

 

 

See Consolidated Results of Operations, beginning on page 31, for discussion of the Company’s results.

Upon adoption of new accounting standards related to transfers of financial assets and consolidation of variable interest entities (VIEs) effective on January 1, 2010 (new GAAP effective January 1, 2010), the Company was required to change its accounting for the American Express Credit Account Master Trust (the Lending Trust), a previously unconsolidated VIE which is now consolidated. Prior period results have not been revised for the change in accounting for the Lending Trust. Refer to Note 1 and Note 7 for further discussion.

The Company follows U.S. generally accepted accounting principles (GAAP). For periods ended on or prior to December 31, 2009, the Company’s non-securitized cardmember loans and related debt performance information on a GAAP basis was referred to as the “owned” basis presentation. For such periods, the Company also provided information on a non-GAAP “managed” basis. This information assumes, in the Consolidated Selected Statistical Information and U.S. Card Services (USCS) segment, there have been no cardmember loans securitization transactions. Upon adoption of new GAAP effective January 1, 2010, both the Company’s securitized and non-securitized cardmember loans are included in the consolidated financial statements. As a result, the Company’s 2010 GAAP presentations and managed basis presentations prior to 2010 are generally comparable. Refer to “Cardmember Loan Portfolio Presentation” on page 54.

Certain reclassifications of prior year amounts have been made to conform to the current presentation.

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

 

CRITICAL ACCOUNTING POLICIES

Refer to Note 1 to the Consolidated Financial Statements for a summary of the Company’s significant accounting policies referenced, as applicable, to other notes. The following chart provides information about five critical accounting policies that are important to the Consolidated Financial Statements and that require significant management assumptions and judgments.

 

RESERVES FOR CARDMEMBER LOSSES

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

RESERVES FOR MEMBERSHIP REWARDS COSTS

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

FAIR VALUE MEASUREMENT

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

FAIR VALUE MEASUREMENT (CONTINUED)

 

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

FAIR VALUE MEASUREMENT (CONTINUED)

 

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

GOODWILL

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

INCOME TAXES

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

AMERICAN EXPRESS COMPANY CONSOLIDATED RESULTS OF OPERATIONS

Refer to “Glossary of Selected Terminology” for the definitions of certain key terms and related information appearing in the tables below.

 

SUMMARY OF THE COMPANY’S

FINANCIAL PERFORMANCE

 

 

 

SELECTED STATISTICAL INFORMATION

 

 

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

 

AMERICAN EXPRESS COMPANY

 

SELECTED STATISTICAL INFORMATION

 

 

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

CALCULATION OF NET INTEREST YIELD ON CARDMEMBER LOANS^(a)

 

 

 

The following discussions regarding Consolidated Results of Operations and Consolidated Liquidity and Capital Resources are presented on a basis consistent with GAAP unless otherwise noted.

 

CONSOLIDATED RESULTS OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 2010

The Company’s 2010 consolidated income from continuing operations increased $1.9 billion or 90 percent to $4.1 billion and diluted EPS from continuing operations increased by $1.81 to $3.35. Consolidated income from continuing operations for 2009 decreased $734 million or 26 percent from 2008 and diluted EPS from continuing operations for 2009 declined $0.93 or 38 percent from 2008.

Consolidated net income for December 31, 2010, 2009 and 2008 was $4.1 billion, $2.1 billion and $2.7 billion, respectively. Net income included losses from discontinued operations of nil, $7 million and $172 million for 2010, 2009 and 2008, respectively.

The Company’s total revenues net of interest expense and total expenses increased by approximately 13 percent and 20 percent, respectively, while total provisions for losses decreased by 58 percent in 2010. Assuming no changes in foreign currency exchange rates from 2009 to 2010, total revenues net of interest expense and total expenses increased approximately 12 percent and 19 percent, respectively, while provisions for losses decreased approximately 59 percent in 2010¹.

The Company’s total revenues net of interest expense, provisions for losses and total expenses decreased by approximately 14 percent, 8 percent and 14 percent, respectively, in 2009. Assuming no changes in foreign currency exchange rates from 2008 to 2009, total revenues net of interest expense, provisions for losses and total expenses decreased approximately 12 percent, 7 percent and 12 percent, respectively, in 2009¹. Currency rate changes had a minimal impact on the growth rates in 2008.

 

Results from continuing operations for 2010 included:

 

 

Results from continuing operations for 2009 included:

 

 

Results from continuing operations for 2008 included:

 

 

 

 ¹  These currency rate adjustments assume a constant exchange rate between periods for purposes of currency translation into U.S. dollars (i.e., assumes the foreign exchange rates used to determine results for the current year apply to the corresponding year-earlier period against which such results are being compared). Management believes that this presentation is helpful to investors by making it easier to compare the Company’s performance from one period to another without the variability caused by fluctuations in currency exchange rates.

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

Total Revenues Net of Interest Expense

Consolidated total revenues net of interest expense for 2010 of $27.8 billion were up $3.3 billion or 13 percent from 2009. The increase in total revenues net of interest expense primarily reflects new GAAP effective January 1, 2010, which caused the reporting of write-offs related to securitized loans to move from securitization income, net in 2009 to provisions for cardmember loan losses in 2010. In addition, total revenues net of interest expense reflects higher discount revenues, increased other commissions and fees, greater travel commissions and fees, and higher net interest income, partially offset by lower other revenue, and reduced net card fees. Consolidated total revenues net of interest expense for 2009 of $24.5 billion were down $3.8 billion or 14 percent from 2008, due to lower discount revenue, lower total interest income, reduced securitization income, net, lower other commissions and fees, reduced travel commissions and fees, and decreased other revenues, partially offset by lower total interest expense.

Discount revenue for 2010 increased $1.7 billion or 13 percent as compared to 2009 to $15.1 billion as a result of a 15 percent increase in worldwide billed business and a slightly higher discount rate. The lower revenue growth versus total billed business growth reflects the relatively faster billed business growth rate of 28 percent related to GNS, where discount revenue is shared with card issuing partners, and higher contra-revenues, including cash-back rewards costs and corporate incentive payments. The 15 percent increase in worldwide billed business in 2010 reflected an increase in proprietary billed business of 13 percent. The average discount rate was 2.55 percent and 2.54 percent for 2010 and 2009, respectively. Over time, certain repricing initiatives, changes in the mix of business and volume-related pricing discounts and investments will likely result in some erosion of the average discount rate.

U.S. billed business and billed business outside the United States were up 13 percent and 19 percent, respectively, in 2010. The increase in billed business within the United States reflected an increase in average spending per proprietary basic card, partially offset by a slight decrease in basic cards-in-force. The increase in billed business outside the United States reflected an increase in average spending per proprietary basic card and basic cards-in-force.

 

The table below summarizes selected statistics for billed business and average spend:

 

 

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

Assuming no changes in foreign exchange rates, total billed business outside the United States grew 22 percent in Asia Pacific, 18 percent in Latin America, 10 percent in Europe and 9 percent in Canada.

During 2009, discount revenue decreased $1.6 billion or 11 percent to $13.4 billion compared to 2008 as a result of a 9 percent decrease in worldwide billed business. The greater decrease in discount revenue compared to billed business primarily reflected growth in billed business related to GNS where the Company shares the discount rate with card issuing partners, as well as a slight decline in the average discount rate. The 9 percent decrease in worldwide billed business in 2009 reflected a decline in proprietary billed business of 11 percent, offset by a 7 percent increase in billed business related to GNS.

Net card fees in 2010 decreased 2 percent, partially due to a non-renewal reserve adjustment in the prior year. Net card fees in 2009 remained unchanged compared to 2008 as the decline in total proprietary cards-in-force was offset by an increase in the average fee per card.

Travel commissions and fees increased $185 million or 12 percent to $1.8 billion in 2010 compared to 2009, primarily reflecting a 19 percent increase in worldwide travel sales, partially offset by a lower sales revenue rate. Travel commissions and fees decreased $416 million or 21 percent to $1.6 billion in 2009 compared to 2008, primarily reflecting a 28 percent decrease in worldwide travel sales, partially offset by higher sales commission and fee rates.

Other commissions and fees increased $253 million or 14 percent to $2.0 billion in 2010 compared to 2009, driven primarily by new GAAP effective January 1, 2010 where fees related to securitized receivables are now recognized as other commissions and fees. These fees were previously reported in securitization income, net. The increase also reflects greater foreign currency conversion revenues related to higher spending, partially offset by lower delinquency fees in the non-securitized cardmember loan portfolio. Other commissions and fees decreased $529 million or 23 percent to $1.8 billion in 2009 compared to 2008, due to lower delinquency fees reflecting decreased owned loan balances and the impacts of various customer assistance programs, in addition to reduced spending-related foreign currency conversion revenues.

Securitization income, net decreased $400 million to nil in 2010 compared to 2009, as the Company no longer reports securitization income, net, in accordance with new GAAP effective January 1, 2010. Securitization income, net decreased $670 million or 63 percent to $400 million in 2009 compared to 2008, primarily due to lower excess spread, net, driven by increased write-offs and a decrease in interest income on cardmember loans and fee revenues. These unfavorable impacts were partially offset by a decrease in interest expense due to lower coupon rates paid on variable-rate investor certificates, as well as a favorable fair value adjustment of the interest-only strip.

Other revenues in 2010 decreased $160 million or 8 percent to $1.9 billion compared to 2009, primarily reflecting the $211 million gain on the sale of 50 percent of the Company’s equity holdings in ICBC in 2009, lower insurance premium revenues and higher partner investments which appear as a contra-other revenue, partially offset by higher GNS partner-related royalty revenues, greater merchant fee-related revenue and higher publishing revenue. Other revenues in 2009 decreased $70 million or 3 percent to $2.1 billion compared to 2008, primarily reflecting decreased revenues from CPS, due to the migration of clients to the American Express network and lower publishing revenues, partially offset by the ICBC gain.

Interest income increased $2.0 billion or 37 percent to $7.3 billion in 2010 compared to 2009. Interest and fees on loans increased $2.3 billion or 52 percent, driven by an increase in the average loan balance resulting from the consolidation of securitized receivables in accordance with new GAAP effective January 1, 2010. Interest income related to securitized receivables is reported in securitization income, net in prior periods, but is now reported in interest and fees on loans. The increase related to this consolidation was partially offset by a lower yield on cardmember loans, reflecting higher payment rates and lower revolving levels, and the implementation of elements of the CARD Act. These reductions to yield were partially offset by the benefit of certain repricing initiatives effective during 2009 and 2010. Interest and dividends on investment securities decreased $361 million or 45 percent, primarily reflecting the elimination of interest on retained securities driven by new GAAP effective January 1, 2010 and lower short-term investment levels. Interest income from deposits with banks and other increased $7 million or 12 percent primarily due to higher average deposit balances versus the prior year. Interest income decreased $1.9 billion or 26 percent to $5.3 billion in 2009 compared to 2008. Interest and fees on loans decreased $1.7 billion or 27 percent due to decline in the average owned loan balance, reduced market interest rates and the impact of various customer assistance programs, partially offset by the benefit of certain repricing initiatives. Interest and dividends on investment securities increased $33 million or 4 percent, primarily reflecting increased investment levels partially offset by reduced investment yields. Interest income from deposits with banks and other decreased $212 million or 78 percent, primarily due to a reduced yield and a lower balance of deposits in other banks.

Interest expense increased $216 million or 10 percent to $2.4 billion in 2010 compared to 2009. Interest expense related to deposits increased $121 million or 28 percent, as higher customer balances were partially offset by a lower cost of funds. Interest expense related to short-term borrowings decreased $34 million or 92 percent, reflecting lower commercial paper levels versus the prior year and a lower cost of funds. Interest expense related to long-term debt and other increased $129 million or 7 percent, reflecting the consolidation of long-term debt associated with securitized loans previously held off-balance sheet in accordance with

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

new GAAP effective January 1, 2010. Interest expense related to this debt was reported in securitization income, net in prior periods, but is now reported in long-term debt and other interest expense. The increase was partially offset by lower average long-term debt. Interest expense decreased $1.3 billion or 38 percent to $2.2 billion in 2009 compared to 2008. Interest expense related to deposits decreased $29 million or 6 percent, primarily due to a lower cost of funds which more than offset increased balances. Interest expense related to short-term borrowings decreased $446 million or 92 percent, due to significantly lower short-term debt levels and a lower cost of funds. Interest expense related to long-term debt and other decreased $873 million or 33 percent, primarily reflecting a lower cost of funds driven by reduced market rates on variably priced debt, as well as a lower average balance of long-term debt outstanding.

 

Provisions for Losses

Provisions for losses of $2.2 billion in 2010 decreased $3.1 billion or 58 percent, compared to 2009. Charge card provisions for losses decreased $262 million or 31 percent, driven by lower reserve requirements, due to improved credit performance, partially offset by higher receivables. Cardmember loans provisions for losses decreased $2.7 billion or 64 percent, primarily reflecting lower reserve requirements during the year, due to improving credit performance, partially offset by an increase related to the inclusion of the 2010 expense for written-off securitized loans, which in 2009 was reported in securitization income, net. Other provisions for losses decreased $105 million or 55 percent primarily reflecting lower merchant-related debit balances.

Provisions for losses of $5.3 billion in 2009 decreased $485 million or 8 percent compared to 2008. Charge card provisions for losses decreased $506 million or 37 percent, primarily driven by improved credit performance. Cardmember loans provisions for losses increased $35 million or 1 percent, primarily due to a higher cardmember reserve level due to the challenging credit environment, partially offset by a lower owned-loan balance.

 

Expenses

Consolidated expenses for 2010 were $19.6 billion, up $3.2 billion or 20 percent from $16.4 billion in 2009. The increase in 2010 reflected greater marketing and promotion expenses, increased cardmember rewards expense, higher salaries and employee benefits, greater professional services expenses, higher other, net expenses, and increased cardmember services expenses, partially offset by lower occupancy and equipment expense and lower communications expense. Consolidated expenses for 2009 were $16.4 billion, down $2.6 billion or 14 percent from $19.0 billion in 2008. The decrease in 2009 was primarily driven by lower other, net expenses, reduced salaries and employee benefits expenses, lower marketing and promotion expense and decreased cardmember rewards expense, partially offset by greater cardmember services expense. Consolidated expenses in 2010, 2009 and 2008 also included $127 million, $190 million and $449 million, respectively, of reengineering costs, of which $96 million, $185 million and $417 million, respectively, represent restructuring charges.

Marketing and promotion expenses increased $1.2 billion or 60 percent to $3.1 billion in 2010 from $1.9 billion in 2009, as improved credit and billings trends led to increased investment levels in 2010. Marketing and promotion expenses decreased $516 million or 21 percent to $1.9 billion in 2009 from $2.4 billion in 2008, due to lower spending levels in the first three quarters of 2009, partially offset by higher expense in the fourth quarter of 2009.

Cardmember rewards expenses increased $993 million or 25 percent to $5.0 billion in 2010 from $4.0 billion in 2009, reflecting higher rewards-related spending volumes and co-brand expense, and a benefit in the third quarter of 2009 relating to the adoption of a more restrictive redemption policy for accounts 30 days past due. Cardmember rewards expenses decreased $353 million or 8 percent to $4.0 billion in 2009 from $4.4 billion in 2008, reflecting lower rewards-related spending volumes, partially offset by higher redemption rates and costs in Membership Rewards and higher costs with relatively lower declines in co-brand spending volumes.

Salaries and employee benefits expenses increased $486 million or 10 percent to $5.6 billion in 2010 from $5.1 billion in 2009, reflecting a 2 percent increase in total employee count, merit increases for existing employees, higher benefit-related costs, including the impact of reinstating certain benefits that were temporarily suspended during the recession, higher management incentive compensation expense and greater volume-related sales incentives, partially offset by lower net reengineering costs in 2010 versus 2009. Salaries and employee benefits expenses decreased $1.0 billion or 17 percent to $5.1 billion in 2009 from $6.1 billion in 2008, reflecting lower employee levels and costs related to the Company’s reengineering initiatives, as well as the restructuring charge in the fourth quarter of 2008.

Professional services expenses in 2010 increased $398 million or 17 percent compared to 2009, reflecting higher technology development expenditures, greater legal costs, and higher third-party merchant sales force commissions, partially offset by lower credit and collection agency costs. Professional services expenses in 2009 compared to 2008 remained flat.

Other, net expenses in 2010 increased $218 million or 9 percent to $2.6 billion compared to 2009, reflecting the $180 million ($113 million after-tax) benefit in the third quarter of 2009 related to the accounting for a net investment in the Company’s consolidated foreign subsidiaries, as well as higher investments in business building initiatives and higher travel and entertainment costs in 2010, partially offset by lower postage and telephone-related costs and a charge of $63 million in 2009 for certain property exits. Other, net expenses in 2009 decreased $708 million or 23 percent to $2.4 billion compared to 2008, reflecting the full

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

year of settlement payments from MasterCard in 2009 versus two quarters in 2008, a $180 million third quarter benefit related to the accounting for a net investment in the Company’s consolidated foreign subsidiaries (as discussed further in Business Segment Results — Corporate & Other below), a $59 million benefit in the second quarter of 2009 from the completion of certain account reconciliations related to prior periods, and lower travel and entertainment and other expenses due to the Company’s reengineering activities. These were partially offset by a $9 million favorable impact in the fourth quarter of 2008 related to fair value hedge ineffectiveness.

 

Income Taxes

The effective tax rate was 32 percent in 2010 compared to 25 percent in 2009 and 20 percent in 2008. The tax rates in all years reflect the level of pretax income in relation to recurring permanent tax benefits.

 

Discontinued Operations

Loss from discontinued operations, net of tax, was nil, $7 million and $172 million in 2010, 2009 and 2008, respectively. Loss from discontinued operations, net of tax, primarily reflected AEIDC and AEB results from operations, including AEIDC’s $15 million ($10 million after-tax) and $275 million ($179 million after-tax) of losses related to mark-to-market adjustments and sales within the AEIDC investment portfolio in 2009 and 2008, respectively.

 

CASH FLOWS

Cash Flows from Operating Activities

Cash flows from operating activities primarily include net income adjusted for (i) non-cash items included in net income, including the provision for losses, depreciation and amortization, deferred taxes, and stock-based compensation and (ii) changes in the balances of operating assets and liabilities, which can vary significantly in the normal course of business due to the amount and timing of various payments.

For the year ended December 31, 2010, net cash provided by operating activities of $9.3 billion increased $3.0 billion compared to $6.3 billion in 2009. The increase was primarily due to higher net income in 2010, increases in non-cash expenses for deferred taxes, acquisition costs and increases in accounts payable and other liabilities in 2010, partially offset by lower provisions for losses and an increase in other assets in 2010.

For the year ended December 31, 2009, net cash provided by operating activities of $6.3 billion decreased $1.5 billion compared to $7.8 billion in 2008. The decrease was primarily due to a decrease in deferred taxes, acquisition costs and other, fluctuations in the Company’s other receivables, accounts payable and other liabilities, as well as a reduction in income from continuing operations, partially offset by changes in other assets.

 

Cash Flows from Investing Activities

The Company’s investing activities primarily include funding cardmember loans and receivables, securitizations of cardmember loans and receivables, and the Company’s available-for-sale investment portfolio.

For the year ended December 31, 2010, net cash used in investing activities of $1.2 billion decreased $5.6 billion compared to net cash used in investing activities of $6.8 billion in 2009, primarily due to higher maturity and redemption of investments and lower purchases of investments, partially offset by increases in cardmember loans and receivables.

For the year ended December 31, 2009, net cash used in investing activities was $6.8 billion, compared to net cash provided by investing activities of $7.6 billion in 2008. The year-over-year change was primarily due to lower proceeds from cardmember loan securitizations, decreased maturities and redemptions of investments, and an increase in restricted cash required for related securitization activities.

 

Cash Flows from Financing Activities

The Company’s financing activities primarily include issuing and repaying debt, taking customer deposits, paying dividends and repurchasing its common and preferred shares.

For the year ended December 31, 2010, net cash used in financing activities of $8.1 billion increased $3.5 billion compared to $4.6 billion in 2009, due to a reduced level of growth in customer deposits during 2010 as compared to 2009 and an increase in principal payments of long-term debt, partially offset by a net increase in short-term borrowings in 2010 and the repayment of preferred shares in 2009.

For the year ended December 31, 2009, net cash used in financing activities of $4.6 billion decreased $5.8 billion compared to $10.4 billion in 2008, primarily due to an increase in customer deposits in 2009 and a reduction in cash used in financing activities attributable to discontinued operations from 2008 to 2009.

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

CERTAIN LEGISLATIVE, REGULATORY AND OTHER DEVELOPMENTS

As a participant in the financial services industry, the Company is subject to a wide array of regulations applicable to its businesses. The Company, as a bank holding company and a financial holding company, is subject to the supervision of the Federal Reserve. As such, the Company is subject to the Federal Reserve’s regulations and policies, including its regulatory capital requirements. In addition, the extreme disruptions in the capital markets that commenced in mid-2007 and the resulting instability and failure of numerous financial institutions have led to a number of changes in the financial services industry, including significant additional regulation and the formation of additional regulatory bodies. The Company’s conversion to a bank holding company in the fourth quarter of 2008 has increased the scope of its regulatory oversight and its compliance program. In addition, although the long-term impact on the Company of much of the recent and pending legislative and regulatory initiatives remains uncertain, the Company expects that compliance requirements and expenditures will continue to rise for financial services firms, including the Company, as the legislation and rules become effective over the course of the next several years.

 

The CARD Act

In May 2009, the U.S. Congress passed, and the President of the United States signed into law, legislation, known as the CARD Act, to fundamentally reform credit card billing practices, pricing and disclosure requirements. This legislation accelerated the effective date and expanded the scope of amendments to the rules regarding Unfair or Deceptive Acts or Practices (UDAP) and Truth in Lending Act that restrict certain credit and charge card practices and require expanded disclosures to consumers, which were adopted in December 2008 by federal bank regulators in the United States. Together, the legislation and the regulatory amendments include, among other matters, rules relating to the imposition by card issuers of interest rate increases on outstanding balances and the allocation of payments in respect of outstanding balances with different interest rates. Certain other provisions of the CARD Act require penalty fees to be reasonable and proportional in relation to the circumstances for which such fees are levied and require issuers to evaluate past interest rate increases twice per year to determine whether it is appropriate to reduce such increases.

The Company has made changes to its product terms and practices that are designed to mitigate the impact on Company revenue of the changes required by the CARD Act and the regulatory amendments. These changes include instituting product-specific increases in pricing on purchases and cash advances, modifying the criteria pursuant to which the penalty rate of interest is imposed on a cardmember and assessing late fees on certain charge products at an earlier date than previously assessed. Although the Company believes its actions to mitigate the impact of the CARD Act have, to date, been largely effective (as evidenced in part by the net interest yield for its U.S. lending portfolio), the impacts of certain other provisions of the CARD Act are still subject to some uncertainty (such as the requirement to periodically reevaluate APR increases). Accordingly, in the event the actions undertaken by the Company to date to offset the impact of the new legislation and regulations are not ultimately effective, they could have a material adverse effect on the Company’s results of operations, including its revenue and net income.

 

Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Reform Act”)

In July 2010, President Obama signed into law the Dodd-Frank Reform Act. The Dodd-Frank Reform Act is comprehensive in scope and contains a wide array of provisions intending to govern the practices and oversight of financial institutions and other participants in the financial markets. Among other matters, the law creates a new independent Consumer Financial Protection Bureau, which will regulate consumer credit across the U.S. economy. The Bureau will have broad rulemaking authority over providers of credit, savings, payment and other consumer financial products and services with respect to certain federal consumer financial laws. Moreover, the Bureau will have examination and enforcement authority with respect to certain federal consumer financial laws for some providers of consumer financial products and services, including the Company and its insured depository institution subsidiaries. The Bureau will be directed to prohibit “unfair, deceptive or abusive” practices, and to ensure that all consumers have access to fair, transparent and competitive markets for consumer financial products and services.

Under the Dodd-Frank Reform Act, the Federal Reserve is authorized to regulate interchange fees paid to banks on debit card and certain general-use prepaid card transactions to ensure that they are “reasonable and proportional” to the cost of processing individual transactions, and to prohibit debit and general-use prepaid card networks and issuers from requiring transactions to be processed on a single payment network. The Company does not offer a debit card linked to a deposit account, but does issue various types of prepaid cards. The Dodd-Frank Reform Act also prohibits credit/debit networks from restricting a merchant from offering discounts or incentives to customers in order to encourage them to use a particular form of payment, or from restricting a merchant from setting certain minimum and maximum transaction amounts for credit cards, as long as any such discounts or incentives or any minimum or maximum transaction amounts do not discriminate among issuers or networks and comply with applicable federal or state disclosure requirements.

The Dodd-Frank Reform Act also authorizes the Federal Reserve to establish heightened capital, leverage and liquidity standards, risk management requirements, concentration limits on credit exposures, mandatory resolution plans (so-called “living wills”) and stress tests for, among others, large bank holding companies, such as the Company, that have greater than

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

$50 billion in assets. In addition, certain derivative transactions will be required to be centrally cleared, which may create or increase collateral posting requirements for the Company.

Many provisions of the Dodd-Frank Reform Act require the adoption of rules for implementation. In addition, the Dodd-Frank Reform Act mandates multiple studies, which could result in additional legislative or regulatory action. These new rules and studies will be implemented and undertaken over a period of several years. Accordingly, the ultimate consequences of the Dodd-Frank Reform Act and its implementing regulations on the Company’s business, results of operations and financial condition are uncertain at this time.

 

Other Legislative and Regulatory Initiatives

The credit and charge card sector also faces continuing scrutiny in connection with the fees merchants pay to accept cards. Although investigations into the way bankcard network members collectively set the “interchange” (that is, the fee paid by the bankcard merchant acquirer to the card issuing bank in “four party” payment networks, like Visa and MasterCard) had largely been a subject of regulators outside the United States, legislation was previously introduced in Congress designed to give merchants antitrust immunity to negotiate interchange collectively with card networks and to regulate certain card network practices. Although, unlike the Visa and MasterCard networks, the American Express network does not collectively set fees, antitrust actions and government regulation relating to merchant pricing could ultimately affect all networks.

In addition to the provisions of the Dodd-Frank Reform Act regarding merchants’ ability to offer discounts or incentives to encourage customers’ use of a particular form of payment, a number of U.S. states are also considering legislation that would prohibit card networks from imposing conditions, restrictions or penalties on a merchant if the merchant, among other things, (i) provides a discount to a customer for using one form of payment versus another or one type of credit or charge card versus another, (ii) imposes a minimum dollar requirement on customers with respect to the use of credit or charge cards or (iii) chooses to accept credit and charge cards at some of its locations but not at others. Such legislation has recently been enacted in Vermont, and similar legislation has been introduced in other states.

Also, other countries in which the Company operates have been considering and in some cases adopting similar legislation and rules that would impose changes on certain practices of card issuers and bankcard networks.

Any or all of the above changes to the legal and regulatory environment in which the Company operates could have a material adverse effect on the Company’s results of operations.

Refer to “Consolidated Capital Resources and Liquidity” for a discussion of the series of international capital and liquidity standards published by the Basel Committee on Banking Supervision.

 

CONSOLIDATED CAPITAL RESOURCES AND LIQUIDITY

The Company’s balance sheet management objectives are to maintain:

 

 

CAPITAL STRATEGY

The Company’s objective is to retain sufficient levels of capital generated through earnings and other sources to maintain a solid equity capital base and to provide flexibility to satisfy future business growth. The Company believes capital allocated to growing businesses with a return on risk-adjusted equity in excess of its costs will generate shareholder value.

The level and composition of the Company’s consolidated capital position are determined through the Company’s internal capital adequacy assessment process (ICAAP), which reflects its business activities, as well as marketplace conditions and credit rating agency requirements. They are also influenced by subsidiary capital requirements. The Company, as a bank holding company, is also subject to regulatory requirements administered by the U.S. federal banking agencies. The Federal Reserve has established specific capital adequacy guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items.

The Company currently calculates and reports its capital ratios under the measurement standards commonly referred to as Basel I. In June 2004, the Basel Committee published new international guidelines for determining regulatory capital (Basel II). In December 2007, the U.S. bank regulatory agencies jointly adopted a final rule based on Basel II.

The Dodd-Frank Reform Act and a series of international capital and liquidity standards known as Basel III published by the Basel Committee on Banking Supervision (commonly referred to as Basel) will in the future change these current quantitative measures. In general, these changes will involve, for the U.S. banking industry as a whole, a reduction in the types of instruments deemed to be capital along with an increase in the amount of capital that assets, liabilities and certain off-balance sheet items require. These changes will generally serve to reduce reported capital ratios compared to current capital guidelines. The specific U.S. guidelines supporting the new standards and the proposed Basel III capital standards have not been finalized, but are generally expected to be issued within the next 12 months. In addition to these measurement changes, international and United States banking regulators could increase the ratio levels at which banks would be deemed to be “well capitalized”.

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

The following table presents the regulatory risk-based capital ratios and leverage ratio for the Company and its significant banking subsidiaries, as well as additional ratios widely utilized in the market place, as of the fourth quarter of 2010:

 

 

 

On December 16, 2010, the Basel Committee on Banking Supervision issued the Basel III rules text, which presents details of global regulatory standards on bank capital adequacy and liquidity agreed to by Governors and Heads of Supervision, and endorsed by the G20 Leaders at their November 2010 summit. Basel III, when implemented by the U.S. banking agencies and fully phased-in, will require bank holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity. While final implementation of the rules related to capital ratios will be determined by the Federal Reserve, the Company estimates that had the new rules been in place during the fourth quarter of 2010, the reported Tier 1 risk-based capital and Tier 1 common risk-based ratios would decline by approximately 50 basis points. In addition, the impact of the new rules on the reported Tier 1 leverage ratio would be a decline of approximately 150 basis points.

 

The following provides definitions for the Company’s regulatory risk-based capital ratios and leverage ratio, all of which are calculated as per standard regulatory guidance:

 

Risk-Weighted Assets — Assets are weighted for risk according to a formula used by the Federal Reserve to conform to capital adequacy guidelines. On and off-balance sheet items are weighted for risk, with off-balance sheet items converted to balance sheet equivalents, using risk conversion factors, before being allocated a risk-adjusted weight. The off-balance sheet items comprise a minimal part of the overall calculation. Risk-weighted assets as of December 31, 2010 were $118.3 billion.

 

Tier 1 Risk-Based Capital Ratio — The Tier 1 capital ratio is calculated as Tier 1 capital divided by risk-weighted assets. Tier 1 capital is the sum of common shareholders’ equity, certain perpetual preferred stock (not applicable to the Company), and noncontrolling interests in consolidated subsidiaries, adjusted for ineligible goodwill and intangible assets, as well as certain other comprehensive income items as follows: net unrealized gains/losses on securities and derivatives, and net unrealized pension and other postretirement benefit losses, all net of tax. Tier 1 capital as of December 31, 2010 was $13.1 billion. This ratio is commonly used by regulatory agencies to assess a financial institution’s financial strength and is the primary form of capital used to absorb losses beyond current loss accrual estimates.

 

Total Risk-Based Capital Ratio — The total risk-based capital ratio is calculated as the sum of Tier 1 capital and Tier 2 capital, divided by risk-weighted assets. Tier 2 capital is the sum of the allowance for receivable and loan losses (limited to 1.25 percent of risk-weighted assets) and 45 percent of the unrealized gains on equity securities, plus a $750 million subordinated hybrid security, for which the Company received approval from the Federal Reserve Board for treatment as Tier 2 capital. Tier 2 capital as of December 31, 2010 was $2.4 billion.

 

Tier 1 Leverage Ratio — The Tier 1 leverage ratio is calculated by dividing Tier 1 capital by the Company’s average total consolidated assets for the most recent quarter. Average consolidated assets as of December 31, 2010 were $141.3 billion.

 

The following provides definitions for capital ratios widely used in the marketplace, although they may be calculated differently by different companies.

 

Tier 1 Common Risk-Based Capital Ratio — The Tier 1 common risk-based capital ratio is calculated as Tier 1 common capital divided by risk weighted assets. As of December 31, 2010, the Tier 1 common capital was $13.1 billion and is calculated as Tier 1 capital less (a) certain noncontrolling interests (applicable but immaterial for the Company), (b) qualifying perpetual preferred stock and (c) trust preferred securities. Items (b) and (c) are not applicable for the Company. While this was not one of the required risk-based capital ratios for regulatory reporting purposes, it was submitted to the Federal Reserve on January 7, 2011 as part of its 2011 Capital Plan Review.

 

Common Equity and Tangible Common Equity to Risk-Weighted Assets Ratios — Common equity equals the Company’s shareholders’ equity of $16.2 billion as of December 31, 2010, and tangible common equity equals common equity, less goodwill and other intangibles of $3.6 billion. Management believes presenting the ratio of tangible common equity to risk-weighted assets is a useful measure of evaluating the strength of the Company’s capital position.

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

The Company seeks to maintain capital levels and ratios in excess of the minimum regulatory requirements; failure to maintain minimum capital levels could affect the Company’s status as a financial holding company and cause the respective regulatory agencies to take actions that could limit the Company’s business operations.

The Company’s primary source of equity capital has been through the generation of net income. Historically, capital generated through net income and other sources, such as the exercise of stock options by employees, has exceeded the growth in its capital requirements. To the extent capital has exceeded business, regulatory and rating agency requirements, the Company has returned excess capital to shareholders through its regular common dividend and share repurchase program.

The Company maintains certain flexibility to shift capital across its businesses as appropriate. For example, the Company may infuse additional capital into subsidiaries to maintain capital at targeted levels in consideration of debt ratings and regulatory requirements. These infused amounts can affect the capital profile and liquidity levels for American Express’ Parent Company (Parent Company).

 

U.S. DEPARTMENT OF TREASURY CAPITAL PURCHASE PROGRAM

On January 9, 2009, under the United States Department of the Treasury (Treasury Department) Capital Purchase Program (CPP), the Company issued to the Treasury Department for aggregate proceeds of $3.39 billion: (1) 3.39 million shares of Fixed Rate (5 percent) Cumulative Perpetual Preferred Shares, Series A, and (2) a ten-year warrant (the Warrant) for the Treasury Department to purchase up to 24 million common shares at an exercise price of $20.95 per share. The Company repurchased the Preferred Shares from the Treasury Department at par on June 17, 2009, and repurchased the Warrant for $340 million on July 29, 2009. Refer to Note 14 to the Consolidated Financial Statements for further discussion of this program.

 

SHARE REPURCHASES AND DIVIDENDS

The Company has a share repurchase program to return excess capital to shareholders. These share repurchases reduce shares outstanding and offset, in whole or part, the issuance of new shares as part of employee compensation plans.

During the fourth quarter of 2010, the Company repurchased 14 million shares through the share repurchase program. On January 7, 2011 the Company submitted its Comprehensive Capital Plan (CCP) to the Federal Reserve requesting approval to proceed with additional share repurchases in 2011. The CCP includes an analysis of performance and capital availability under certain adverse economic assumptions. The CCP was submitted to the Federal Reserve pursuant to the Federal Reserve’s guidance on dividends and capital distributions, most recently updated in November 2010, and discussed further below in “Regulatory Matters and Capital Adequacy — Bank Holding Company Dividend Restrictions”. The Company expects a response from the Federal Reserve by the end of the first quarter. The Company cannot predict whether the Federal Reserve will approve additional share repurchases. No additional shares are expected to be repurchased prior to its response. No shares were repurchased during 2009 as share repurchases were suspended during the first quarter of 2008 in light of the challenging global economic environment and limitations while under the CPP.

On a cumulative basis, since 1994, the Company has distributed 64 percent of capital generated through share repurchases and dividends.

During 2010, the Company returned $1.5 billion in dividends and share repurchases to shareholders, which represents approximately 30 percent of total capital generated.

 

FUNDING STRATEGY

The Company’s principal funding objective is to maintain broad and well-diversified funding sources to allow it to meet its maturing obligations, cost-effectively finance current and future asset growth in its global businesses as well as to maintain a strong liquidity profile. The diversity of funding sources by type of debt instrument, by maturity and by investor base, among other factors, provides additional insulation from the impact of disruptions in any one type of debt, maturity or investor. The mix of the Company’s funding in any period will seek to achieve cost-efficiency consistent with both maintaining diversified sources and achieving its liquidity objectives. The Company’s funding strategy and activities are integrated into its asset-liability management activities. The Company has in place a Funding Policy covering American Express Company and all of its subsidiaries.

The Company’s proprietary card businesses are the primary asset-generating businesses, with significant assets in both domestic and international cardmember receivable and lending activities. The Company’s financing needs are in large part a consequence of its proprietary card-issuing businesses and the maintenance of a liquidity position to support all of its business activities, such as merchant payments. The Company generally pays merchants for card transactions prior to reimbursement by cardmembers and therefore funds the merchant payments during the period cardmember loans and receivables are outstanding. The Company also has additional financing needs associated with general corporate purposes, including acquisition activities.

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

FUNDING PROGRAMS AND ACTIVITIES

The Company meets its funding needs through a variety of sources, including debt instruments such as direct and third-party distributed deposits, senior unsecured debentures, asset securitizations, securitized borrowings through a conduit facility and long-term committed bank borrowing facilities in certain non-U.S. regions.

The following discussion includes information on both a GAAP and managed basis. The managed basis presentation includes debt issued in connection with the Company’s lending securitization activities, which were off-balance sheet. The adoption of new GAAP effective on January 1, 2010 resulted in accounting for both the Company’s securitized and non-securitized cardmember loans in the Consolidated Financial Statements. As a result, the Company’s 2010 GAAP presentations and managed basis presentations prior to 2010 are generally comparable. Prior period Consolidated Financial Statements have not been revised for this accounting change. For a discussion of managed basis and management’s rationale for such presentation, refer to “U.S. Card Services — Cardmember Loan Portfolio Presentation” below.

 

The Company had the following consolidated debt, on both a GAAP and managed basis, and customer deposits outstanding as of December 31:

 

 

The Company seeks to raise funds to meet all of its financing needs, including seasonal and other working capital needs, while also seeking to maintain sufficient cash and readily-marketable securities that are easily convertible to cash, in order to meet the scheduled maturities of all long-term borrowings on a consolidated basis for a 12-month period. The Company has $8.9 billion of unsecured long-term debt, $5.3 billion of asset securitizations and $5.6 billion of long-term deposits that will mature during 2011. See “Liquidity Management” section for more details.

The Company’s equity capital and funding strategies are designed, among other things, to maintain appropriate and stable unsecured debt ratings from the major credit rating agencies, Moody’s Investor Services (Moody’s), Standard & Poor’s (S&P), Fitch Ratings (Fitch) and Dominion Bond Rating Services (DBRS). Such ratings help to support the Company’s access to cost effective unsecured funding as part of its overall financing programs. Ratings for the Company’s ABS activities are evaluated separately.

 

 

 

Downgrades in the Company’s unsecured debt or asset securitization program’s securities ratings could result in higher interest expense on the Company’s unsecured debt and asset securitizations, as well as higher fees related to borrowings under its unused lines of credit. In addition to increased funding costs, declines in credit ratings could reduce the Company’s borrowing capacity in the unsecured debt and asset securitization capital markets. The Company believes the change in its funding mix, which now includes an increasing proportion of FDIC-insured (as defined below) U.S. retail deposits, should reduce the impact that credit rating downgrades would have on the Company’s funding capacity and costs. Downgrades to certain of the Company’s unsecured debt ratings that have occurred over the last several years have not caused a permanent increase in the Company’s borrowing costs or a reduction in its borrowing capacity.

 

SHORT-TERM FUNDING PROGRAMS

Short-term borrowings, such as commercial paper, are defined as any debt or time deposit with an original maturity of 12 months or less. The Company’s short-term funding programs are used primarily to meet working capital needs, such as managing seasonal variations in receivables balances. Short-term borrowings were fairly stable throughout 2010; however, the Company did reflect an increase in short-term borrowings in November and December 2010, due to the reclassification of certain book overdraft balances (i.e., primarily due to timing differences arising in the ordinary course of business). The amount of short-term borrowings issued in the future will depend on the Company’s funding strategy, its needs and market conditions.

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

The Company had the following short-term borrowings outstanding as of December 31:

 

 

Refer to Note 10 to the Consolidated Financial Statements for further description of these borrowings.

 

The Company’s short-term borrowings as a percentage of total debt as of December 31 were as follows:

 

 

As of December 31, 2010, the Company had $0.6 billion of commercial paper outstanding. Average commercial paper outstanding was $0.9 billion and $2.0 billion in 2010 and 2009, respectively.

American Express Credit Corporation’s (Credco) total back-up liquidity coverage, which includes its undrawn committed bank facilities, was in excess of 100 percent of its net short-term borrowings as of December 31, 2010 and 2009. The undrawn committed bank credit facilities were $5.7 billion as of December 31, 2010.

 

DEPOSIT PROGRAMS

The Company offers deposits within its American Express Centurion Bank and American Express Bank, FSB subsidiaries (together, the “Banks”). These funds are currently insured up to $250,000 per account through the Federal Deposit Insurance Corporation (FDIC). The Company’s ability to obtain deposit funding and offer competitive interest rates is dependent on the Banks’ capital levels. During the second quarter of 2009, the Company, through FSB, launched a direct deposit-taking program, Personal Savings from American Express, to supplement its distribution of deposit products through third-party distribution channels. This program makes FDIC-insured certificates of deposit (CDs) and high-yield savings account products available directly to consumers.

During 2010, within U.S. retail deposits the Company focused on continuing to grow both the number of accounts and the total balances outstanding on savings accounts and CDs that were sourced directly with consumers through Personal Savings from American Express. These accounts and balances grew during the year and financed the maturities of CDs issued through third-party distribution channels.

 

The Company held the following deposits as of December 31, 2010 and 2009:

 

 

 

LONG-TERM DEBT PROGRAMS

During 2010, the Company and its subsidiaries issued debt and asset securitizations with maturities ranging from 2 to 5 years. These amounts included approximately $0.9 billion of AAA-rated lending securitization certificates and $2.4 billion of unsecured debt across a variety of maturities and markets. During the year, the Company retained approximately $0.3 billion of subordinated securities, as the pricing and yields for these securities were not attractive compared to other sources of financing available to the Company.

 

The Company’s 2010 offerings are presented as follows:

 

 

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

ASSET SECURITIZATION PROGRAMS

The Company periodically securitizes cardmember receivables and loans arising from its card business, as the securitization market provides the Company with cost-effective funding. Securitization of cardmember receivables and loans is accomplished through the transfer of those assets to a trust, which in turn issues certificates or notes (securities) collateralized by the transferred assets to third-party investors. The proceeds from issuance are distributed to the Company, through its wholly owned subsidiaries, as consideration for the transferred assets.

The receivables and loans being securitized are reported as owned assets on the Company’s Consolidated Balance Sheets and the related securities issued to third-party investors are reported as long-term debt. Notes 1 and 7 to the Consolidated Financial Statements provide a description of the adoption of new GAAP effective January 1, 2010 and the impact on the Company’s accounting for its securitization activities.

Under the respective terms of the securitization trust agreements, the occurrence of certain events could result in payment of trust expenses, establishment of reserve funds, or in a worst-case scenario, early amortization of investor certificates. As of December 31, 2010, no triggering events have occurred that would have resulted in the funding of reserve accounts or early amortization.

The ability of issuers of asset-backed securities to obtain necessary credit ratings for their issuances has historically been based, in part, on qualification under the FDIC’s safe harbor rule for assets transferred in securitizations. In 2009 and 2010, the FDIC issued a series of changes to its safe harbor rule, with its new final rule for its securitization safe harbor, issued in 2010, requiring issuers to comply with a new set of requirements in order to qualify for the safe harbor. Issuances out of the Lending Trust are grandfathered under the new FDIC final rule. The trust for the Company’s cardmember charge receivable securitization (the Charge Trust) does not satisfy the criteria required to be covered by the FDIC’s new safe harbor rule, nor did it meet the requirements to be covered by the safe harbor rule existing prior to 2009. It was structured and continues to be structured such that the financial assets transferred to the Charge Trust would not be deemed to be property of the originating banks in the event the FDIC is appointed as a receiver or conservator of the originating banks. The Company has received confirmation from Moody’s, S&P and Fitch, which rate issuances from the Charge Trust, that they will continue to rate issuances from the trust in the same manner as they have historically, even though they do not satisfy the requirements to be covered by the FDIC’s safe harbor rule. Nevertheless, one or more of the rating agencies may ultimately conclude that in the absence of compliance with the safe harbor rule, the highest rating a Charge Trust security could receive would be based on the originating bank’s unsecured debt rating. If one or more rating agencies come to this conclusion, it could adversely impact the Company’s capacity and cost of using its Charge Trust as a source of funding for its business.

 

LIQUIDITY MANAGEMENT

The Company’s liquidity objective is to maintain access to a diverse set of cash, readily-marketable securities and contingent sources of liquidity, such that the Company can continuously meet expected future financing obligations and business requirements, even in the event it is unable to raise new funds under its regular funding programs. The Company has in place a Liquidity Risk Policy that sets out the Company’s approach to managing liquidity risk on an enterprise-wide basis.

The Company incurs and accepts liquidity risk arising in the normal course of offering its products and services. The liquidity risks that the Company is exposed to can arise from a variety of sources, and thus its liquidity management strategy includes a variety of parameters, assessments and guidelines, including but not limited to:

 

 

The Company’s current liquidity target is to have adequate liquidity in the form of excess cash and readily-marketable securities that are easily convertible into cash to satisfy all maturing long-term funding obligations for a 12-month period. In addition to its cash and readily-marketable securities, the Company maintains a variety of contingent liquidity resources, such as access to secured borrowings through its conduit facility and the Federal Reserve discount window as well as committed bank credit facilities.

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

As of December 31, 2010, the Company’s excess cash and readily-marketable securities available to fund long-term maturities were as follows:

 

 

 

The upcoming approximate maturities of the Company’s long-term unsecured debt, debt issued in connection with asset-backed securitizations and long-term certificates of deposit are as follows:

 

 

The Company’s financing needs for 2011 are expected to arise from these debt and deposit maturities as well as changes in business needs, including changes in outstanding cardmember loans and receivables as well as acquisition activities.

The Company considers various factors in determining the amount of liquidity it maintains, such as economic and financial market conditions, seasonality in business operations, growth in its businesses, potential acquisitions or dispositions, the cost and availability of alternative liquidity sources, and regulatory and credit rating agency considerations.

The yield the Company receives on its cash and readily-marketable securities is, generally, less than the interest expense on the sources of funding for these balances. Thus, the Company incurs substantial net interest costs on these amounts.

The level of net interest costs will be dependent on the size of its cash and readily-marketable securities holdings, as well as the difference between its cost of funding these amounts and their investment yields.

 

Securitized Borrowing Capacity

During December 2010, the Company entered into a $3 billion, 3-year committed, revolving, secured financing facility sponsored by and with liquidity backup provided by a syndicate of banks. The facility gives the Company the right to sell up to $3 billion face amount of eligible notes issued from the Charge Trust at any time through December 16, 2013. The purchasers’ commitments to fund any unfunded amounts under this facility are subject to the terms and conditions of, among other things, a purchase agreement among certain subsidiaries, the note purchasers and certain other parties. This facility will be used in the ordinary course of business to fund seasonal working capital needs, as well as further enhance the Company’s contingent funding resources. The borrowing cost of the facility includes a fixed facility fee. In addition, the drawn balance incurs a weighted average cost of funds to the participating banks plus 25 basis points. On December 16, 2010, the Company drew $2.5 billion from the facility, which was still outstanding as of December 31, 2010. The Company incurred an interest cost on the drawn amount that was equal to the weighted average cost of funds, which was approximately 1-month LIBOR, plus 25 basis points.

 

Federal Reserve Discount Window

The Banks are insured depository institutions that have the capability of borrowing from the Federal Reserve Bank of San Francisco, subject to the amount of qualifying collateral that they pledge. The Federal Reserve has indicated that both credit and charge card receivables are a form of qualifying collateral for secured borrowing made through the discount window. Whether specific assets will be considered qualifying collateral for secured borrowings made through the discount window, and the amount that may be borrowed against the collateral, remains in the discretion of the Federal Reserve.

The Company had approximately $32.5 billion as of December 31, 2010, in U.S. credit card loans and charge card receivables that could be sold over time through its existing securitization trusts, or pledged in return for secured borrowings to provide further liquidity, subject in each case to applicable market conditions and eligibility criteria.

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

Committed Bank Credit Facilities

The Company maintained committed bank credit facilities as of December 31, 2010, as follows:

 

 

 

The Company’s committed facilities expire as follows:

 

 

The availability of the credit lines is subject to the Company’s compliance with certain financial covenants, including the maintenance by the Company of consolidated tangible net worth of at least $4.1 billion, the maintenance by Credco of a 1.25 ratio of combined earnings and fixed charges to fixed charges, and the compliance by the Banks with applicable regulatory capital adequacy guidelines. As of December 31, 2010, the Company’s consolidated tangible net worth was approximately $13.1 billion, Credco’s ratio of combined earnings and fixed charges to fixed charges was 1.54 and Centurion Bank and FSB each exceeded their regulatory capital adequacy guidelines. The drawn balance of $4.1 billion as of December 31, 2010 was used to fund the Company’s business activities in the normal course. The remaining capacity of the facilities mainly served to further enhance the Company’s contingent funding resources.

The Company’s committed bank credit facilities do not contain material adverse change clauses, which might otherwise preclude borrowing under the credit facilities. The facilities may not be terminated should there be a change in the Company’s credit rating.

In consideration of all the funding sources described above, the Company believes it would have access to liquidity to satisfy all maturing long-term funding obligations for at least a 12-month period in the event that access to the secured and unsecured fixed income capital markets is completely interrupted for that length of time. These events are not considered likely to occur.

 

Parent Company Funding

Parent Company long-term debt outstanding was $10.3 billion and $10.2 billion as of December 31, 2010 and 2009, respectively.

The Parent Company is authorized to issue commercial paper. This program is supported by a $0.8 billion multi-purpose committed bank credit facility. The credit facility will expire in 2012. There was no Parent Company commercial paper outstanding during 2010 and 2009 and no borrowings have been made under its bank credit facility.

 

OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS

The Company has identified both on and off-balance sheet transactions, arrangements, obligations and other relationships that may have a material current or future effect on its financial condition, changes in financial condition, results of operations, or liquidity and capital resources.

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

CONTRACTUAL OBLIGATIONS

The table below identifies transactions that represent contractually committed future obligations of the Company. Purchase obligations include agreements to purchase goods and services that are enforceable and legally binding on the Company and that specify significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction.

 

 

The Company also has certain contingent obligations to make payments under contractual agreements entered into as part of the ongoing operation of the Company’s business, primarily with co-brand partners. The contingent obligations under such arrangements were approximately $7.5 billion as of December 31, 2010.

In addition to the contractual obligations noted above, the Company has off-balance sheet arrangements that include guarantees, retained interests in structured investments, unconsolidated variable interest entities and other off-balance sheet arrangements as more fully described below.

 

GUARANTEES

The Company’s principal guarantees are associated with cardmember services to enhance the value of owning an American Express card. As of December 31, 2010, the Company had guarantees totaling approximately $68 billion related to cardmember protection plans, as well as other guarantees in the ordinary course of business that are within the scope of GAAP governing the accounting for guarantees. Refer to Note 13 to the Consolidated Financial Statements for further discussion regarding the Company’s guarantees.

 

CERTAIN OTHER OFF-BALANCE SHEET
ARRANGEMENTS

As of December 31, 2010, the Company had approximately $226 billion of unused credit available to cardmembers as part of established lending product agreements. Total unused credit available to cardmembers does not represent potential future cash requirements, as a significant portion of this unused credit will likely not be drawn. The Company’s charge card products have no pre-set limit and, therefore, are not reflected in unused credit available to cardmembers.

Refer to Note 24 to the Consolidated Financial Statements for discussion regarding the Company’s other off-balance sheet arrangements.

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

RISK MANAGEMENT

GOVERNANCE

The Audit and Risk Committee of the Board approves the Company’s Enterprise-wide Risk Management Policy and all its subordinate risk policies. The Enterprise-wide Risk Management Policy defines risk management objectives, risk appetite, risk limits and escalation triggers, and establishes the governance structure for managing risk. The Policy focuses on the major risks that are relevant to the Company given its business model — credit risk (individual and institutional), operational risk, funding and liquidity risk, market risk and reputational risk. Internal management committees, including the Enterprise Risk Management Committee (ERMC), chaired by the Company’s Chief Risk Officer, and the Asset-Liability Committee (ALCO), chaired by the Company’s Chief Financial Officer, are responsible for implementing the Policy across the Company. Additionally, in 2010, the Risk Management organization developed a group to independently validate models used to manage the Company’s risk.

 

CREDIT RISK MANAGEMENT PROCESS

Credit risk is defined as loss due to obligor or counterparty default. Credit risks in the Company are divided into two broad categories: individual and institutional. Each has distinct risk management tools and metrics. Business units that create individual or institutional credit risk exposures of significant importance are supported by dedicated risk management teams, each led by a Chief Credit Officer. To preserve independence, Chief Credit Officers for all business units have a solid line reporting relationship to the Company’s Chief Risk Officer.

 

INDIVIDUAL CREDIT RISK

Individual credit risk arises principally from consumer and small business charge cards, credit cards, lines of credit, loans and prepaid products. These portfolios consist of millions of customers across multiple geographies, occupations, industries and levels of net worth. The Company benefits from the high-quality profile of its customers, which is driven by brand, premium customer servicing, product features and risk management capabilities which span underwriting, customer management and collections. Externally, the risk in these portfolios is correlated with broad economic trends, such as unemployment rates, GDP growth, and home values, which can affect customer liquidity.

The business unit leaders and their embedded Chief Credit Officers take the lead in managing this process. These Chief Credit Officers are guided by the Individual Credit Policy Committee which is responsible for implementation and enforcement of the Individual Credit Risk Policy. This policy is further supported by subordinate policies and operating manuals covering decision logic and processes of credit extension, including prospecting, new account approvals, authorizations, line management and collections. The subordinate risk policies and operating manuals are designed to assure consistent application of risk management principles and standardized reporting of asset quality and loss recognition.

Individual credit risk management is supported by sophisticated proprietary scoring and decision-making models that use the most up-to-date proprietary information on prospects and customers, such as spending and payment history, data feeds from credit bureaus and mortgage information. Additional data, such as new commercial variables, were integrated into the Company’s models in the early stages of the recent economic downturn to further mitigate small business risk. The Company has developed data-driven economic decision logic for each customer interaction to better serve its customers.

 

INSTITUTIONAL CREDIT RISK

Institutional credit risk arises principally within the Company’s Global Corporate Card Services, Merchant Services and Network Services, prepaid services, foreign exchange services businesses, and investment activities. Unlike individual credit, institutional credit risk is characterized by a lower loss frequency but higher severity. It is affected both by general economic conditions and by customer-specific events. The absence of large losses in any given year or over several years is not necessarily representative of the level of risk of institutional portfolios, given the infrequency of loss events in such portfolios.

Similar to Individual Credit Risk, business units taking institutional risks are supported by Chief Credit Officers. These officers are guided by the Institutional Risk Management Committee (IRMC) which is responsible for implementation and enforcement of the Policy and for providing guidance to the credit officers of each business unit with substantial institutional credit risk exposures. The committee, along with business unit Chief Credit Officers, make investment decisions in core risk capabilities, ensure proper implementation of the underwriting standards and contractual rights of risk mitigation, monitor risk exposures, and determine risk mitigation actions. The IRMC formally reviews large institutional exposures to ensure compliance with ERMC guidelines and procedures and escalates them to the ERMC as appropriate. At the same time, the IRMC provides guidance to business unit risk teams to optimize risk-adjusted returns on capital. A company-wide risk rating utility and a specialized airline risk group provide risk assessment of institutional obligors.

 

MARKET RISK MANAGEMENT PROCESS

Market risk is the risk to earnings or value resulting from movements in market prices. The Company’s market risk exposure is primarily generated by:

 

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

 

  Market Risk limits and escalation triggers within the Market Risk Policy are approved by ALCO and by the ERMC. Market risk is centrally monitored for compliance with policy and limits by the Market Risk Committee, which reports into the ALCO and is chaired by the Chief Market Risk Officer. Market risk management is also guided by policies covering the use of derivative financial instruments, funding and liquidity and investments.

The Company’s market exposures are in large part by-products of the delivery of its products and services. Interest rate risk arises through the funding of cardmember receivables and fixed-rate loans with variable-rate borrowings as well as through the risk to net interest margin from changes in the relationship between benchmark rates such as Prime and LIBOR.

Interest rate exposure within the Company’s charge card and fixed-rate lending products is managed by varying the proportion of total funding provided by short-term and variable-rate debt and deposits compared to fixed-rate debt and deposits. In addition, interest rate swaps are used from time to time to effectively convert fixed-rate debt to variable-rate or to convert variable-rate debt to fixed-rate. The Company may change the mix between variable-rate and fixed-rate funding based on changes in business volumes and mix, among other factors.

The Company does not engage in derivative financial instruments for trading purposes. Refer to Note 12 to the Consolidated Financial Statements for further discussion of the Company’s derivative financial instruments.

The detrimental effect on the Company’s annual pretax earnings of a hypothetical 100 basis point increase in interest rates would be approximately $149 million ($97 million related to the U.S. dollar), based on the 2010 year-end positions. This effect, which is calculated using a static asset liability gapping model, is primarily determined by the volume of variable-rate funding of charge card and fixed-rate lending products for which the interest rate exposure is not managed by derivative financial instruments. As of year end 2010, the percentage of worldwide charge card accounts receivable and loans that were deemed to be fixed rate was 65 percent, or $63.7 billion, with the remaining 35 percent, or $34.3 billion, deemed to be variable rate.

The Company is also subject to market risk from changes in the relationship between the benchmark Prime rate that determines the yield on its variable-rate lending receivables and the benchmark LIBOR rate that determines the effective interest cost on a significant portion of its outstanding debt. Differences in the rate of change of these two indices, commonly referred to as basis risk, would impact the Company’s variable-rate U.S. lending net interest margins because the Company borrows at rates based on LIBOR but lends to its customers based on the Prime rate. The detrimental effect on the Company’s pretax earnings of a hypothetical 10 basis point decrease in the spread between Prime and 1 month LIBOR over the next 12 months is estimated to be $34 million. The Company currently has approximately $34.3 billion of Prime-based, variable-rate U.S. lending receivables that are funded with LIBOR-indexed debt, including asset securitizations.

Foreign exchange risk is generated by cardmember cross-currency charges, foreign subsidiary equity and foreign currency earnings in units outside the United States. The Company’s foreign exchange risk is managed primarily by entering into agreements to buy and sell currencies on a spot basis or by hedging this market exposure to the extent it is economically justified through various means, including the use of derivative financial instruments such as foreign exchange forward and cross-currency swap contracts, which can help “lock in” the value of the Company’s exposure to specific currencies.

As of December 31, 2010 and 2009, foreign currency derivative instruments with total notional amounts of approximately $22 billion and $19 billion, respectively, were outstanding. Derivative hedging activities related to cross-currency charges, balance sheet exposures and foreign currency earnings generally do not qualify for hedge accounting; however, derivative hedging activities related to translation exposure of foreign subsidiary equity generally do.

With respect to cross-currency charges and balance sheet exposures, including related foreign exchange forward contracts outstanding, the effect on the Company’s earnings of a hypothetical 10 percent change in the value of the U.S. dollar would be immaterial as of December 31, 2010. With respect to earnings denominated in foreign currencies, the adverse impact on pretax income of a hypothetical 10 percent strengthening of the U.S. dollar related to anticipated overseas operating results for the next 12 months would be approximately $152 million as of December 31, 2010. With respect to translation exposure of foreign subsidiary equity, including related foreign exchange forward contracts outstanding, a hypothetical 10 percent strengthening in the U.S. dollar would result in an immaterial reduction in equity as of December 31, 2010.

The actual impact of interest rate and foreign exchange rate changes will depend on, among other factors, the timing of rate changes, the extent to which different rates do not move in the same direction or in the same direction to the same degree, and changes in the volume and mix of the Company’s businesses.

 

FUNDING & LIQUIDITY RISK MANAGEMENT
PROCESS

Liquidity risk is defined as the inability of the Company to meet its ongoing financial and business obligations as they become due at a reasonable cost. General principles and the overall framework for managing liquidity risk across the Company are defined in the Liquidity Risk Policy approved by the ALCO and Audit and Risk Committee of the Board. Liquidity risk is centrally managed by the Funding and Liquidity Committee, which reports into the ALCO. The Company’s liquidity objective is to maintain access to a diverse set of cash, readily-marketable securities and contingent sources of liquidity, such that the Company can continuously meet

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

expected future financing obligations and business requirements, even in the event it is unable to raise new funds under its regular funding programs. The Company balances the trade-offs between maintaining too much liquidity, which can be costly and limit financial flexibility, and having inadequate liquidity, which may result in financial distress during a liquidity event.

Liquidity risk is managed both at an aggregate company level and at the major legal entities in order to ensure that sufficient funding and liquidity resources are available in the amount and in the location needed in a stress event. The Funding and Liquidity Committee reviews the forecasts of the Company’s aggregate and subsidiary cash positions and financing requirements, approves the funding plans designed to satisfy those requirements under normal conditions, establishes guidelines to identify the amount of liquidity resources required and monitors positions and determines any actions to be taken. Liquidity planning also takes into account operating cash flexibilities.

 

OPERATIONAL RISK MANAGEMENT PROCESS

The Company defines operational risk as the risk of not achieving business objectives due to inadequate or failed processes or information systems, human error or the external environment (i.e., natural disasters) including losses due to failures to comply with laws and regulations. Operational risk is inherent in all business activities and can impact an organization through direct or indirect financial loss, brand damage, customer dissatisfaction, or legal and regulatory penalties.

The operational risk governance and the overall framework for managing operational risk across the Company are defined in the Operational Risk Policy approved by the Audit and Risk Committee of the Board of Directors. The Operational Risk Management Committee (ORMC) coordinates and oversees the operational risk mitigation efforts by Lead Operational Risk Officers in the business units and staff groups supported by the control groups.

In order to appropriately measure operational risk, the Company has developed a comprehensive operational risk framework. This framework assesses (i) risk events; (ii) root causes; (iii) impact and (iv) accountability. The impact on the Company is assessed from a financial, brand, regulatory and legal perspective. The operational risk model also assesses the frequency and likelihood that events may occur again so that the appropriate mitigation steps may be taken.

Additionally, the Company uses an operational risk framework to identify, measure, monitor and report inherent and emerging operational risks. This framework, supervised by the ORMC, consists of (a) operational risk event capture, (b) project office to coordinate control enhancements, (c) key risk indicators, and (d) process and entity-level risk self-assessments. The process risk self-assessment methodology is used to facilitate compliance with Section 404 of the Sarbanes-Oxley Act, and is also used for non-financial operational risk self-assessments. During the entity risk self-assessment, senior leaders identify key operational risks in a business unit or staff group and determine the Company’s risk mitigation plans.

Managing operational risk is an important priority for the Company, and projects and investments are underway to increase operational risk management effectiveness, which will benefit both shareholders and customers.

 

REPUTATIONAL RISK MANAGEMENT PROCESS

The Company defines reputational risk as the risk that negative publicity regarding the Company’s products, services, business practices, management, clients and partners, whether true or not, could cause a decline in the customer base, costly litigation, or revenue reductions.

The Company views protecting its reputation as core to its vision of becoming the world’s most respected service brand and fundamental to its long-term success.

General principles and the overall framework for managing reputational risk across the Company are defined in the Reputational Risk Management Policy. The Reputational Risk Management Committee (RRMC) is responsible for implementation and adherence to this policy, and for performing periodic assessment of the Company’s reputation and brand health based on internal and external assessments.

Business leaders across the Company are responsible for ensuring that reputation risk implications of transactions, business activities and management practices are appropriately considered and relevant subject matter experts are engaged as needed.

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

BUSINESS SEGMENT RESULTS

The Company is a global service company principally engaged in businesses comprising four reportable operating segments: U.S. Card Services (USCS), International Card Services (ICS), Global Commercial Services (GCS) and Global Network & Merchant Services (GNMS).

The Company considers a combination of factors when evaluating the composition of its reportable operating segments, including the results reviewed by the chief operating decision maker, economic characteristics, products and services offered, classes of customers, product distribution channels, geographic considerations (primarily U.S. versus non-U.S.) and regulatory environment considerations. Refer to Note 25 to the Consolidated Financial Statements for additional discussion of products and services by segment.

Results of the business segments essentially treat each segment as a stand-alone business. The management reporting process that derives these results allocates income and expense using various methodologies as described below.

Beginning in the fourth quarter of 2010, the Company completed its conversion to a new general ledger platform. This conversion enabled the Company to streamline its ledger reporting unit structure, resulting in a reconfiguration of intercompany accounts. These changes have the effect of altering intercompany balances among segments, thus altering reported total segment assets. Total segment assets as of December 31, 2010 and 2009 presented below reflect the changes described above. This conversion has no impact on segment results, segment capital or return on segment capital metrics.

Beginning in the first quarter of 2010, the Company made changes to the manner in which it allocates capital and the related interest expense charged to its reportable operating segments. The changes reflect modifications in allocation methodology that the Company believes more accurately reflect the funding and capital characteristics of its segments. The change to interest allocation also impacted the consolidated and segment reported net interest yield on cardmember loans. The segment results and net interest yield on cardmember loans for 2009 and 2008 have been revised for this change.

Beginning in 2009, the Company changed the manner by which it assesses the performance of its reportable operating segments to exclude the impact of its excess liquidity funding levels. Accordingly, the debt, cash and investment balances associated with the Company’s excess liquidity funding and the related net negative interest spread are not included within the reportable operating segment results (primarily USCS and GCS segments) and are reported in the Corporate & Other segment for 2010 and 2009. The segment results for 2008 have not been revised for this change.

As discussed more fully below, results are presented on a GAAP basis unless otherwise stated. Refer to “Glossary of Selected Terminology” for the definitions of certain key terms and related information appearing in the tables below.

 

TOTAL REVENUES NET OF INTEREST EXPENSE

The Company allocates discount revenue and certain other revenues among segments using a transfer pricing methodology. Segments earn discount revenue based on the volume of merchant business generated by cardmembers. Within the USCS, ICS and GCS segments, discount revenue reflects the issuer component of the overall discount rate; within the GNMS segment, discount revenue reflects the network and merchant component of the overall discount rate. Total interest income and net card fees are directly attributable to the segment in which they are reported.

 

PROVISIONS FOR LOSSES

The provisions for losses are directly attributable to the segment in which they are reported.

 

EXPENSES

Marketing and promotion expenses are reflected in each segment based on actual expenses incurred, with the exception of brand advertising, which is primarily reflected in the GNMS and USCS segments. Rewards and cardmember services expenses are reflected in each segment based on actual expenses incurred within each segment.

Salaries and employee benefits and other operating expenses, such as professional services, occupancy and equipment and communications, reflect expenses incurred directly within each segment. In addition, expenses related to the Company’s support services, such as technology costs, are allocated to each segment based on support service activities directly attributable to the segment. Other overhead expenses, such as staff group support functions, are allocated to segments based on each segment’s relative level of pretax income. Financing requirements are managed on a consolidated basis. Funding costs are allocated based on segment funding requirements.

 

CAPITAL

Each business segment is allocated capital based on established business model operating requirements, risk measures and regulatory capital requirements. Business model operating requirements include capital needed to support operations and specific balance sheet items. The risk measures include considerations for credit, market and operational risk.

 

INCOME TAXES

Income tax provision (benefit) is allocated to each business segment based on the effective tax rates applicable to various businesses that make up the segment.

 

AMERICAN EXPRESS COMPANY

2010 FINANCIAL REVIEW

 

 

U.S. CARD SERVICES

 

SELECTED INCOME STATEMENT DATA GAAP BASIS PRESENTATION

 

 

 

SELECTED STATISTICAL INFORMATION