American Express’s business model, focused on the prime and super prime market segments, has so far managed to avoid the escalating subprime woes in its core US market. The company has reported strong interim results, and says the prospects for future growth look promising, reports Truong Mellor
Despite the escalating US subprime mortgage market crisis and the spiralling effect it has had on the credit industry both in the US and abroad, American Express has posted strong half-yearly results that continue to build on the business momentum of both 2006 and the first quarter of 2007.
Revenues net of interest expense for the second quarter increased 12 percent to $3.6 billion, according to Amex, reflecting higher spending and borrowing by consumers and small businesses.
Year-to-date revenues net of interest were up 10 percent, while the company’s ROE grew by 38 percent. Within Global Network Services (GNS), its partnership with financial institutions that issue Amex cards such as Bank of America and Citi, billed business rose 62 percent, driven notably by continued triple-digit growth in the US.
“The fact is that, for anyone in the lending business, any time you grow your business you take on risk. If you add new customers, if you lend more to current customers, you automatically add to your risk levels. The only way to stop adding to your risk is to stop growing, period. Our 21 percent growth in balances as of June is an exceptional number, and is even more notable when compared against our peers. We saw an opportunity in the marketplace and we took advantage of it. Peers were cutting back on marketing; we ramped up,” said Kenneth Chenault, CEO of American Express, in an investor presentation at the start of August.
“Past investments clearly paid off in terms of our metric growth and profitability. And I have no reason to believe our recent investments won’t produce similar results. Now I’m not saying we’ll sustain a 20 percent plus growth over the long term. Twenty percent is a high hurdle for any company to consistently achieve. But, when we have the opportunity to responsibly grow our business, we will.”
Not all plain sailing
It was not all plain sailing: Amex’s core US Card Services division reported second-quarter net income of $580 million, down 2 percent from $594 million a year ago. Provisions for losses increased 85 percent, reflecting higher loan volumes and an increase in write-off and delinquency rates from what Amex said were the “unusually” low levels of a year ago.
Moreover, in a sign of the importance Amex places on marketing and its recently revamped loyalty schemes, total expenses increased 11 percent. Marketing, promotion, rewards and cardmember services expenses increased 16 percent year-on-year.
On 21 June, in a major strategic shift, Amex introduced new Membership Rewards programme levels aligned with specific card products. Amex cardmembers in the US now participate in one of three Membership Rewards programmes based on the credit or charge card they have: Membership Rewards Express, Membership Rewards, or, for the most affluent clients, Membership Rewards First.
Talking about the second-quarter and interim results, Chenault said Amex’s performance had been “consistently strong, whether looking at customer segments, geographies, or business lines… Continued growth in cardmember spending and excellent credit quality generated strong earnings for the [second] quarter. Spending on American Express cards rose 15 percent and we added more than 2 million cards during the last three months.
“Given that momentum, we will be looking to capitalise on opportunities to further strengthen our lead in the payments industry at a time when some key competitors may be cutting back or dealing with weakness in parts of their business.”
Over the course of the first half of 2007, the number of worldwide Amex cards in force rose 10 percent, with the addition of 2.3 million new cards during the second quarter and 7.8 million new cards since last year – a 5 percent growth in proprietary cards coupled with a 34 percent growth in network partner cards. Spending per proprietary basic card grew 8 percent worldwide, up from the previous year and well above overall economic growth and reported rates of consumer spending.
Consistent managed yield
According to Chenault, growth has not been generated at the expense of Amex’s credit performance. The company has not tried to achieve balance growth with offers of 0 percent APR, for instance; indeed, the percentage of the company’s portfolio on promotional rates has dropped, while its managed yield has remained consistent over the past few years.
The company has, he said, remained focused on pursuing steady growth in the prime and super-prime lending sectors, eschewing the temptation to make a play for the subprime market that is currently causing so many headaches across the industry.
“We’re not generating growth by loosening our standards and hunting in the subprime space. We continue to pursue growth in the prime and super-prime lending segments and, as a result, we continue to focus our acquisition efforts in the mid to upper tier of prospects,” he said.
The company’s customer acquisition efforts have remained focused on the mid to upper tier of prospects – 89 percent of newly approved Amex cards in the US have a FICO (Fair Isaac Company) credit rating score greater than 660.
Furthermore, the FICO scores across the company’s entire consumer and small business portfolio has remained consistent, with 84 percent of balances scoring over 660. According to Chenault, Amex’s proprietary credit models are more sophisticated than a simple reliance on FICO scores: he said he viewed the FICO numbers as the result of the company’s customer acquisition methods as opposed to an input.
Share of Wallet
To help the company better evaluate its customer base, Amex has developed a patent- pending analytical tool called Share of Wallet. The application, which looks to calculate and increase the overall percentage of an Amex customer’s spending compared to other payment cards, has helped the company identify particular growth areas by analysing factors such as spending patterns, income and the value of customer homes. This is what Amex has termed its “spend-centric” model: a concerted focus on high-spending, affluent cardmembers as opposed to the focus on account receivables (AR) from other issuers.
The company evaluates a range of factors before making an offer to a prospect. For example, it considers their total size of wallet; it segments a prospect’s needs between their spend and revolve capacities; and it looks at their home value.
“By using a wide range of factors we believe we’re far more knowledgeable about a prospect’s true creditworthiness before they even join our franchise,” said Chenault. “This Share of Wallet application is an important tool in that it shows us where to hunt more productively for future growth. We can identify which card members don’t give us the majority of their spend, and even those customer spend categories where we have the greatest opportunity, say, for example, in supermarkets or gas stations. In reality, one cardmember might be spending $30,000 with American Express and $3,000 on other general-purpose plastic, while the second may be spending $30,000 with us and $220,000 with competitors.
“Our spend strategy – with its focus on high-spending, high-value cardmembers – will remain at the core of our future growth… For all of the talk by our issuing competitors of success in the premium space, they are still predominantly dependent on lending to drive their financials. They still face the same hurdles they always have – restrictions on their ability to grow given their credit limit focus, and a dependency on APR levels in a highly competitive marketplace.”
How Amex’s spend-centric model differs from a lending model is evidenced in its measurement of what the company calls “spend velocity”, an internal indication of its efficiency in increasing the spend of its card base. In its worldwide lending and charge businesses, Amex currently generates $6 of spend for $1 of receivables, according to Chenault. Subsequently, the growth of its business requires less capital than one reliant on AR growth – it also plays a major role in creating a healthy ROE for the company.
Chenault said spending projections through the end of the decade continue to show fairly steady growth, with US spend expected to be up 5 percent a year over this period. Key markets outside of the US, such as India, China and Brazil, are projected to have even stronger spend gains.
He said: “Beyond economic growth are the penetration gains of plastic within the payments industry. In fact, as just one example, [card industry researcher] Nilson’s projection is that spending on plastic within the US consumer segment will grow by 12 percent between 2005 and 2010. This growth will be driven by [consumers] continuing to convert cash and cheque payments onto plastic. Even within the most penetrated segment of spend, the growth projection is quite substantial. This implies that the other, less-penetrated segments will also expand their use of plastic, with industries such as B2B and health care offering sizable potential.
“Some people outside of the card business mistakenly view this as a mature industry. As you might imagine, with projected double digit growth rates, I tend to disagree with that characterisation.”