美國運通 (AXP) 2003 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to the American Express third quarter earnings release conference call. [operator instructions]

I will turn the call over now to Ron Stovall, SVP of investor relations. You may begin.

Thank you, and welcome to everyone. I appreciate all of you joining us for today's discussion.

Now, before we get started I just want to remind everyone that the discussion today contains certain forward-looking statements about the company's future financial performance and business prospects which are subject to risks and uncertainties and speak only as of today.

The words believe, expect, anticipate, optimistic, intend, plan, aim, will, should, could, likely and similar expressions are intended to identify forward-looking statements. Factors that could cause actual results to differ materially from these forward-looking statements including the company's financial and other goals are set forth within today's earnings press release which was filed in an 8K report and in the company's 2002 10-K report and second quarter 2003 10-Q report already on file with the SEC.

In the third 2003 earnings release and supplement which are now posted on our Web site at ir.americanexpress.com and on file with the SEC in an 8K report, we have provided information that compares and reconciles the managed basis financial measures to be discussed today with the TRS GAAP information as well as ((AEFA)) GAAP and net revenues.

These reconciliations explain why these presentations are useful to management and to investors. We urge you to review that information in conjunction with today's discussion.

Gary Crittenden, EVP and Chief Financial Officer of American Express will provide some introductory remarks highlighting the key points related to today's announcement. Once he completes his remarks, we will turn to the moderator who will announce your opportunity to get into the queue for the Q&A period. Up until then no one is actually registered to ask questions.

While we will attempt to respond to as many of your questions as possible before we end the call, we do have a limited amount of time. Based on this, we ask that you limit yourself to one question at a time during the Q&A.

With that, let me turn the discussion over to Gary.

Welcome, everyone And thanks for joining with us today.

As you have already seen, our third quarter diluted earnings per share of 59 cents increased 13% versus 52 cents last year and represented a record quarterly level of net income. The third quarter results continued to reenforce the positive aspects of our performance against the five sign posts Ken identified in February of 2002 which we used to assess the performance of the company and make decisions to implement spending for additional growth.

For instance, expenses have been well controlled, especially when you factor in the relatively high level of current investment spending in marketing and the impact of expensing stock options. Also the benefit of spending is evident within the strong momentum of our card related metrics which have performed well versus the competition.

Considering the relatively weak travel environment, our billed business is strong on an absolute basis and compared to the competition’s. Credit trends have been improving and outperformed our key competitors over recent quarters and in AEFA we have generated good traction against many aspects of our strategy. Although, sustained improvement in metrics and earnings does require continuation of the current more favorable market environment.

Overall, the third quarter reflected stronger business momentum, in addition to demonstrating the success of our efforts to create a more flexible business model and a better balanced risk profile.

In addition, our consolidated balance sheet remains strong. Card reserve coverage of past due accounts remains at the high end of historical ranges and the continued repositioning of AEFA's investment portfolio and AEB's loan portfolio have yielded a better balanced and more diversified risk profile.

These changes to our business model positioned the company to deliver on all of our long-term financial targets during the quarter while investing in our future competitive strength at a level well above recent historically high quarters.

Our progress continues to underscore the fact that our future growth will primarily be driven by the substantial organic growth opportunities that we have historically relied upon. However, as noted before, there are additional avenues to further supplement and strengthen those organic opportunities as evidenced by the two recently completed acquisitions.

First Threadneedle Asset Management, one of the premiere asset management organizations in the UK with more than $80 billion in assets under management was acquired on September 30th. While its assets had been consolidated within our period end numbers, there is no P&L impact of this acquisition during the quarter.

We also announced the closing of Rosenbluth international a leading global travel management company with over $3 billion in sales. This was acquired earlier this month and therefore it will not be reflected in our results until the fourth quarter.

Overall, TRS was characterized by strong absolute and relative performance verses our competitors. We reported double digit spending -- volume growth, driven by a greater number of cards in force and higher average card member spending. Strong U.S. and non-U.S. lending balance growth, excellent credit quality, continued year-over-year interest rate benefits, good expense controls, and strong overall earnings performance despite substantially higher levels of spending for growth.

AEFA's results reflected improved revenue generation on higher managed asset levels from better equity market comparisons and owned asset growth reflecting strength in various fixed rate products over the past year. As well as a substantially higher level of earnings versus recent quarters, even if you exclude a tax benefit which was pro actively used to further improve our investment profile risk profile and partially offset by various legal and acquisition related costs.

I should point out that I have noticed in some of the notes this afternoon a comment or two about the tax rate. If you compare our year-over-year tax rate on a blended basis for the total company, it is the same as last year.

Lastly, AEB's results reflected the continuation of strong performances within private banking and the Financial Institutions Group which were tempered by the negative influences from our ongoing exit from corporate banking activities and lower volumes within Personal Financial Services, mostly due to prior economic issues in Hong Kong.

With that now, let me review the details of each one of the businesses.

At Travel Related Services, managed net revenues increased 7% and net income rose 10%. On the revenue side, our ongoing expansion into every day spending categories and our investments in growth initiatives over the past year continued to drive strong card member spending, cards in force and lending balance growth.

These benefits allowed us to overcome the effects of relatively weak travel and travelers' check revenue trends. Billed Business volumes improved verses last year as strong growth in the consumer and small business sectors continued and Corporate Services volumes comparisons improved.

Worldwide Billed business increased 15% on a reported basis and 12% on a foreign exchange adjusted basis. In the U.S., consumer spending grew 15%, and small business spending rose 20%, while corporate volumes improved 7%.

In total, U.S. non-T&E related volumes grew 18% while T&E related spending rose 8%.

Outside the U.S., reported volumes were up 16% which equated to 7% growth on a foreign exchange adjusted basis. Within our proprietary business foreign exchange adjusted consumer and small business volumes grew 9 % and Corporate Services spending increased 3%.

The discount rate rose one basis point from the second quarter of 2003 but declined three basis points from the third quarter of last year. The increase in the quarter reflects the relative improvement in our T&E related volumes, while the decline versus last year reflects the ongoing shift in mix of spending towards every day spend categories, which continued to generated stronger than average growth.

Worldwide cards in force rose 6% versus last year as a result of more proactive acquisition efforts within our consumer and small business segments, as well as an improved average customer retention level.

Managed net finance charge revenue grew 8% on 15% growth in average worldwide lending balances. The quarter end balances were up 14% worldwide reflecting 11% growth in the U.S. and 29% growth outside the U.S. Spreads in the U.S. were flat versus the second quarter, but declined versus last year as the proportion of the portfolio on introductory rates was higher and the mix of products reflected more lower rate offerings. As you would expect, Travel and TC revenues were relatively weak compared with the stronger card related results.

Consistent with our second quarter guidance, marketing, promotion, rewards and card member services expenses on a managed basis rose 26% on top of last year's already increased level. As we maintained our more aggressive stance towards card acquisition and rewards programs -- as rewards programs costs rose, reflecting a continued increase in card member loyalty program participation.

The managed provisions for losses declined 7%, as overall credit quality re-remained strong during the quarter. Within our charge card business, the loss ratio and past due rate improved verses last quarter and last year. And within our lending business, the write off rate continued to improve and the past due level was relatively stable.

In light of the strong credit indicators, reserves declined slightly. However, coverage of past due receivables and loans was maintained at the high end of historical levels. As expected, interest expense declined on a lower cost of funds that was partially offset by higher receivables.

Human resources expense rose 8% as merit increases, higher employee benefits costs and greater management incentive costs outweighed the positive effects of the slightly lower employee count.

Other operating expenses rose 9% versus last year, reflecting higher business and service volume related cost. The effective tax rate rose to 32% versus 31% last year, principally due to a relatively lower traveler's check income contribution.

I'll now turn to American Express Financial Advisors where net income increased 30% and net revenues rose 10%, reflecting improvement in the equity market environment and the continuation of relatively strong annuity and insurance related activities. Results also reflected the negative impact of the current low interest rate environment on spread based products and a tax benefit which was partially offset by net losses in the investment portfolio, and legal and acquisition related costs.

The investment losses resulted from a repositioning of assets during the normal course of business and a decision to not fully offset those investment losses with gains as we would typically do. As far as investment performance go, we continue to be pleased with our progress towards our goal of 60% to 70% of our internally managed funds above the median of their respective peer groups, with no more than 10% to 15% in the fourth quartile.

Despite some deterioration in our overall equity comparisons in the last two quarters, we have seen substantial improvement since 2000 in our one year performance rankings using either Lipper or Morningstar peer group comparisons and are seeing initial benefits in fixed income since we implemented the new fixed income organizational model at the end of the first quarter of this year.

We also expect to see performance improvement in our U.S. retail international equity mutual funds now that those portfolios have been transferred to the Threadneedle staff.

Investment income was up 7%, reflecting higher invested assets resulting from strong client demand for the underlying fixed rate products over the past year, which more than offset a lower average yield. The portfolio yield decline versus last year as a result of cash inflows invested at relatively lower rates and the impact of our portfolio repositioning activities.

The yield was flat when compared to the second quarter. The overall credit quality of the portfolio continued to improve as the default rates have declined throughout the past year. On a net basis we took an investment loss of $13 million versus a net $3 million loss last year.

As of the end of the quarter, the portfolio had $1.2 billion of net unrealized depreciation. Management and distribution fees rose 10% on a 4% increase in management fees and an 18% growth in distribution fees. The 68% increase in the managed asset base versus last year reflected the addition of $84 billion of Threadneedle assets, market appreciation and net outflows within both our retail and institutional channels.

Excluding Threadneedle, managed assets grew 9%. For the second consecutive quarter, the retail channel had net inflows. Distribution fees grew 18% on greater limited partnership product sales, increased brokerage related activities and greater mutual fund fees. Total cash sales declined 5% on lower retail, institutional and third-party sales.

Branded advisor generated sales decreased 5% on a cash basis but increased 11% as measured on the internally used gross dealer concession basis, which weighs the sales of various products to reflect their individual profitability dynamics. While we will have to wait to see how trends develop going forward, we did see improving retail sales comparisons during the quarter as investor confidence appeared to strengthen.

Institutional sales levels, which are variable quarter to quarter, have suffered somewhat as a result of our historical investment performance. Third-party sales last year were particularly strong, but actions to improve product pricing and structure have reduced sales this year.

Other revenues rose on strong property casualty and higher life insurance revenue. In addition, planning and advice service fees rose 28%. The provision for losses and benefits increased 10%, reflecting higher in force levels of insurance annuities and certificates and higher claim costs.

These increases were partially offset by lower crediting rates. In addition the impact of appreciation in the S&P 500 on equity indexed annuities and the stock market certificate product added to the provision.

Human resource expenses increased 12% as merit increases, higher employee benefit expenses, greater management incentive costs and larger fuel force compensation related costs were partially offset by the benefit of a 3% reduction in the average home office employee base, and a net $21 million higher favorable DAC amortization adjustment this year.

The advisor base rose 3% versus last year and 1% versus last quarter and veteran advisor retention rates remained strong.

Other operating expenses rose 7% versus the third quarter of last year but were basically flat versus last quarter. The year-over-year increase reflects higher marketing and promotion costs in addition to greater legal expenses.

As noted above, both Human Resources and Other Operating Expenses were impacted by adjustments to ((AEFA's)) annual third quarter review to update DAC amortization assumptions. In the third quarter of 2003, these actions resulted in a $2 million net amortization expense reduction through a $22 million benefit in human resources and a $20 million additional expense in other operating expenses.

There were three components within this net adjustment. First, a $106 million amortization expense reduction from extending the DAC amortization period for certain flex annuity products to 20 years based on current measurements of their expected life.

Second a $92 million amortization expense increase to recognize the premium deficiency within our long-term care products.

And, third, a $12 million amortization expense increase reflecting various other adjustments coming out of the review.

As you remember, last year we saw a net $18 million expense increase for DAC balance adjustments coming out of the same review process. The effective tax rate declined to 12% from 26% last year due to a $29 million reduction in tax expense due to adjustments related to the finalization of our 2002 return filed in the quarter, and the publication of favorable technical guidance related to the taxation of dividend income.

And finally, at American Express Bank, the bank continued to make progress on its strategy shift and delivered solid earnings on flat revenues verses last year and last quarter. The bank's results reflect the positive impact of growth within its private banking and financial institutions group partially offset by loan and other activity reductions within corporate banking and within its Personal Financial Services lending business, particularly in Hong Kong.

Results benefited from higher fee levels within Private Banking and the Financial Institutions group, and a provision decline of 47% versus last year due to the continued stabilization of writeoffs in Hong Kong and reduced activities within the PFS leaning portfolio.

Private Banking Client holdings and loans increased 18% and 38% respectively. Loans within the Financial Institutions group grew 25%, Personal Financial Services loans declined 14% and Corporate Banking and other loans continued to decrease and now represent 5%of the total loan portfolio or approximately $340 million.

I would also just like to mention the adoption of FIN 46. As I complete our review of our results for the quarter. We have made a decision to delay until December 31 the adoption of ((fas)) -- interpretation number 46 -- consolidation of variable interest entities.

Earlier this month, the FASB issued a statement delaying the effective date of the rule from July 1st to December 31st. Since detailed interpretations of the rule continue to emerge and the FASB itself indicated it would issue further interpretations in the next few months, we decided to delay our planned July 1st adoption until December 31st.

We previously estimated that the third quarter net income would be reduced by a below the line non-cash after tax charge of approximately $150 million as we consolidated up to $2 billion of high yield loans and bonds, underlying collateralized debt obligations and the cash collateral related to the secured loan trust that AEFA manages and invests in. However, based on our prior interpretation of the results, we now believe the charge will be lower than originally estimated due to continued improvements in the default rate environment and the market values of the underlying assets.

The actual non-cash non-recourse charge, upon adoption, will be dependent upon further interpretations of the rules and market factors as of December 31.

With that discussion completed, let me conclude with a few comments on our outlook. Our results for the quarter further illustrate the benefits of the fundamental changes we have made over the last two years to our business model and the strong momentum resulting from the business building investments over the last year.

Our payments business continued to deliver strong results with business metrics and credit indicators that compare very well to key industry participants. The quality of our customer base, the breadth of our product portfolio, the benefits of our rewards based spend oriented business model, our everyday spend initiatives and our improved revolving credit capabilities, combined to create a competitive advantage which is being leveraged effectively to deliver strong results at TRS despite relatively weak travel and traveler's check contributions.

TRS's 15% volume growth was above the high end of the six to 10% industry growth we have indicated underlies [indiscernible] meet our financial targets. At AEFA we are confident that the foundations put in place through new products and enhanced investment management capabilities, position us for stronger results if market conditions continue to improve.

We have indicated that an 8% equity market appreciation level is needed for them to achieve targeted growth. Fortunately the market's tone has improved in recent quarters and appears to be stimulated increased retail/investor activity.

We met all three of our long term financial targets in the quarter while significantly increasing business building expenditures. In fact the third quarter showed an acceleration of revenue growth from earlier in the year.

Our reengineering activities are on track to deliver the additional $1 billion of benefits targeted for the year. In past years you saw strong across the boards results among major credit card issuers. More recently you are seeing a clear demarcation. While some continue to grow at double digit levels, others are showing much slower growth. This translates into our opportunities we think we can take advantage of.

Therefore our first priority is to continue the higher level of investment spending through the fourth quarter to ensure strong momentum within the business as we enter 2004. Our momentum and recent strengthening of the economy gives us greater confidence in the remainder of the year.

In light of this, we believe that our 2003 EPS, before accounting changes, will be at the high end of our previous guidance of $2.26 to $2.29 per share.

So on balance we feel very good about the quarter's results and our prospects for continued growth. However, we plan to maintain our flexibility when it comes to controlling expenses, driving re-engineering, and setting the pace at which we allow earnings to flow to the bottom line verses investing for future growth.

Thank you for listening And I think we are now ready to take your questions

Thank you, sir. We will begin the question and answer session. [operator instructions]

The first question comes from Brad Ball from Prudential. Please go ahead.

Thanks. Hi, Gary.

Hi, Brad.

Would you comment on the link quarter decline in your net finance charge revenues? And talk about the trade off between loan receivables growth and the net interest margin? You mentioned that you got a higher proportion of lower yielding or introductory rates. Could you talk about how high that's gone and how high it is likely to go? And a comment on the competitive environment?

Sure.

You know, the number that we reported in the quarter, 8.9%, as you appropriately pointed out, was the same as we had reported last quarter, essentially. Down somewhat from where we were last year at this time. But if you trace back over the last four years and look at this on a quarterly basis, you know, it's varied from kind of a high of about 9.8% to a low of 7.4%. And it ties in relatively closely with the growth in the portfolio.

So as we have had, you know, more rapid growth rate in receivables base and therefore had a higher percentage of the total on introductory rates, then obviously, you know, that net interest income number comes down. And because of the recent growth rate that we've experienced, which is a very positive thing in our lending balances over the last couple of quarters, we are near a high point but not at our historical high. But near a high point in terms of the percentage of our portfolio that’s on introductory rates.

So I think it actually is more than anything else kind of underlies where we are in the cycle of growing the receivables part of the business right now. It is very consistent with the kinds of numbers that we have had historically.

And frankly, is not being driven in any particular way by, you know, by competitive forces, other than - you know, we always, obviously, monitor what our competitors do and have a firm commitment not to do anything that we believe is non-economic or below our cost of capital in terms of acquiring new cards.

I will say that our decision, you know, historically has been to compete based on the quality of our offering, the value proposition that we offer to our customers, primarily through our various rewards programs. And that certainly continues to be the case.

What is the percentage currently on ((intra)) rates?

In this quarter we are at about 22%. And to put it into context for you a little bit, that has been as low back in the early part of 02 of 18% or so and it has been as high, if you go back to the fourth quarter of '99, as 25%.

So you know, just to kind of give you a sense of how that’s moved. So it cycles around. The net interest margin tends to move with the growth rate in the receivables balance. But it is, I think, very consistent with what you have seen from us historically.

Our next question comes from Joshua Steiner from Lehman Brothers. Go ahead.

Hi. This is Joshua Steiner for Bruce Harding (ph). Actually, you were at investor day back in August you indicated making, you know, operating margin increases a priority and possibly getting back to '96 levels. I’m just wondering if you could ycomment on what room there is left in the re-engineering outlook? And where and, you know, roughly in what magnitude we could expect to see further gains there?

Sure, I would be happy to, Joshua.

In fact let me just elaborate a little bit on operating expenses. There are two factors they are up for substantially in the quarter. One is human resource expenses which are driven primarily by our decision to expense stock options last year. Head count is basically flat even with the addition of the Threadneedle head count in the quarter we still were essentially flat with head count in the company overall.

So, with the decision to expense stock options that really is driving that number, and the associated decision to shift from stock options to other forms of compensation that you are seeing coming through in that number.

Additionally we obviously have increased our marketing and our rewards expense very significantly. In the second quarter, we split out separately how much our rewards expense was. We split out very clearly what our marketing expense was. And we have been very clear about the fact that our intention is, because we really do see a competitive opportunity to substantially increase the spending that we have done in marketing rewards and we've clearly done that.

If you exclude those two items from the calculation, the remainder of our expenses are up one and a half percent from the prior year. And I think I've said on a couple of occasions that there are two factors that go into your operating expense ratio. One is revenue and one is expense. And there are certain windows of time where we see competitive opportunities to improve our revenue growth rateand that's obviously what we are doing here.

We are increasing our marketing expenditures and we have every expectation that that is going to continue to lead to improved revenue growth, just like we said in this quarter. And that will, over time, help us to manage our operating expense to revenue growth in conjunction with the re-engineering commitment that we have.

With regards to re-engineering, our feeling about that remains as enthusiastic and unchanged from the last few quarters as it ever has been. We fully expect that we will hit the one point -- the billion dollars in re-engineering savings for this year that we have communicated was our target. And I think we've listed pretty comprehensively the set of things that we are working on that will allow us to get there.

And so I won't take the time to do that on this call. But we believe there is still substantial room for us to improve our operating expense margin and, you know, we are getting there in the way that we think is most effective for us to do that, through a combination of prudent investment spending to grow our revenue and then appropriate, you know, constraining of expense growth. Where we have the opportunity to do that through re-engineering.

Thank you.

Thank you. Our next question comes from Chris Brendler (ph) from Legg Mason Equity. Go ahead.

Hi, Gary, how are you?

Good, Chris, thanks.

Good. A question for you. If you could elaborate a little further on your marketing expense, I know you were giving us a little more detail last quarter when you broke out membership rewards for the first time. But at least from my sources it looks like that your mail volume in the third quarter was down sequentially and so I was a little surprise to do see the significant increase in TRS marketing expense. Was there an increase in brand spending that I'm not picking up? Or is there – is the high spending levels you picked up in the card business actually increasing the MR accrual this quarter?

Yes. Both MR and marketing were up strongly in the quarter.

So, it wasn't all MR. It wasn't all marketing. And by the way, the reason why we report these two numbers together is because in the way we actually manage the business, we do move back and forth between these items over the course of a year. And so it truly does represent the way we are marketing the product. And that's why we've combined these. But we thought it was appropriate, obviously, to set a base number that you could kind of go back to rely on in the second quarter.

But I think everything you said actually is correct. We did in fact reduce our mail volume slightly in the third quarter from the second quarter. Nothing unusual about that. It ties in with what our planned marketing program is going to be for this year and as we go into early next year. If you have been alive and watching TV, you certainly have seen that we have been very active in brand building and brand advertising over the last few months.

And we are going to continue to do that to reinforce the strength of the American Express brand. We have, I believe, a very well thought out marketing program. If you think about the various aspects that have come in waves this year, the early part of the year with the O.S.B.N program that we did with the very high spending cards that that represents for us, the efforts that we put behind our charge card products during the second quarter.

And then most recently, I'm sure you've seen the whole cash back blue program that we have had on Television. These are all very carefully timed and carefully thought through programs that at the end of the day allow us to drive up our average spending. And in the quarter, as you saw average spending was up about ten percent over prior year - it always focused on insuring that our average spending is increasing so the value proposition that we have to offer to merchants remains strong and intact.

One quick follow up if I could. Does the [indiscernible] is there any changes in redemption behavior or - the assumptions that went into that?

We have seen consistently, frankly over the last while an increase in the use of our programs. In fact, from time to time I see something written somewhere that suggests that people don't have appropriate redemption options. But the vast majority of our points are redeemed, the (inaudible) our programs seem to be increasing, the customers are using them more than they have historically and that is increasing over time. And that is true internationally as well as domestically.

So our desire is to make these programs as relevant for our customers as we possibly can because we think that will influence all of their other positive behavior. It reduces our attrition, it improves their payment rates to us, they spend more on the card as they participate in the rewards program. So it has on a total systems basis a very positive impact for us. Now with that being said it is not as though we don't ever consider controlling this expense either.

We have very active programs going on within the company to look at membership rewards expense and to analyze how we can maintain the effectiveness of the program while working on the overall expense of that program. And so we are very sensitive to those issues and continue to work on them as an organization.

Great. Thanks.

Thank you, our next question comes from Mike Hughes from Merrill Lynch.

Could you talk a little bit about what kind of margins directionally relative to AEFA as a whole we should expect, as they are not fully consolidated.

Well, it’s that – Mike that's such a general question it is very difficult for me to respond.

Well - you can be very specific, but I don't think you will be.

[laughter] Well, It depends on what level - if you are talking about spreads, obviously the spreads here have been under some pressure as we have seen some reduction in rates overall, and our reinvestment rate - opportunities have come down some. And as rates are down somewhat - minimum crediting rates become somewhat of an issue.

And so, spreads there have been under some pressure and obviously the general direction of that will be – will be impacted somewhat over time as well. You know, what you see in terms of operating expense, I think, is pretty similar to what we have seen throughout the year. We have had some increase in our human resource expenses at AEFA. And it’s being driven by the factors that I talked about just a minute ago. And we’ve had some increase in our other operating expense primarily driven by the marketing programs that we have had at AEFA this year that hopefully you have seen.

In this particular quarter if you look on a net managed margin basis we’ve had an increase in net managed margins because we had good revenue growth rate because distribution and management fees were up nicely in the quarter.

And so you know, the increase in those revenue growth rates when you took out the effect of the spread impact on this thing, allowed the net pretax margin to actually go up, I think, almost a percent or so versus last year.

So I realize that's a very general kind of set of comments, but those are the basic trends I think that are evident in the third quarter. I don't know, Ron, would you add anything to those comments?

No. I think that's fine. Mike, are you also interested in what the margins do with Threadneedle?

That was the thrust of my question, yes.

Oh, okay. I mean, you know, I think as you know, we haven't provided any specifics around Threadneedle. Certainly it would seem that the operating expense goals would not change. I mean, we don't see Threadneedle as something that is going to change our overall view of operating margin trends and forecast and the like.

I think though one thing we did talk about when we announced the acquisition was if you looked at the relative revenue rate for the assets being acquired, that was reflected in the purchase price that we paid for Threadneedle. So, there was some.

We talked about the fact that the price seemed low relative to the assets. We certainly spoke to the fact that if you looked at that price, we thought it was a fair price and it reflected the fact that you had a chunk of the assets that were Zurich related and where there was pricing that would not be quite as consistent as you would find with a third-party type relationship.

So, I think you'll see a little bit of an influence there on the management fee per se for the assets under management. But overall, I think the view of margin trends and our goals and the like would not change substantially.

Just one minor addition to that. We did have – there is some minor cost associated with the, you know, the shut down of our own operation in the UK which will be consolidated into the Threadneedle activities, but that is really the only substantial charge associated with that and really the only synergy associated with this transaction. This is really about improving the capability of our international management team.

Thank you.

You're welcome, Mike.

Thank you. The next question comes from ((Mike Cohen)) from ((U.S. CIBC Markets)).

Hi, I was wondering if you could comment on the trends in Corporate Bills business. I noted that – or obviously you guys noted that it was up 7% in the quarter? And that's probably the largest increase in some time. Could you provide a little more color commentary on that?

Yeah, it's better. We have seen some improvement here obviously. It had been kind of bumping around the flat category over the last little while and now we are seeing for the first time, you know, some improvement in those numbers.

So let me just kind of take you through a little bit what the pattern had been. So as we came into this year, we were, I think, up 1 percent in the first quarter. We were down 1 percent in the second quarter. And then up 7% here in the third quarter. If you take the split of that from international to domestic, the international side was up less than what we have seen on the domestic side. So it wasn't as strong. But domestically corporate has really turned the corner a bit here in this quarter. Now, that was helped by the fact that T&E spending for the first time was up about 8% here as well and it's been awhile since we've seen that kind of performance from T&E, which helps us.

And also, you know, if you dissect the corporate number you can dissect it into the middle market as well as large corporate. And the middle market performance has been really outstanding. I think as you all know we invested in the sales force in the United States now two years ago. And we have seen very good results out of that. And we have a sales force now in Europe that we invested in last year that was targeting directly on middle market customers. And the combination of those things as well as an improvement in our middle market offering, I think, really is providing some lift in that business. So, there's a lot of different influences, Mike, right now that impact it, but generally we are seeing some positive news there.

I don't recall and maybe you have, have you guys provided any context as to what middle market is as a percent of sort of the corporate slice? The large corporate slice as you --?

No, what we have done, is we’ve said that small market, our small business and corporate together represent about a third of our total. That's what we’ve discussed. It's been a couple years since we disclosed that. So, my guess is you would find a higher number today.

Okay. Great, thank you for your time.

Thank you. Our next question comes from Eric Wasserstrom from UBS Warburg. Please go ahead.

Sorry to return to this expense issue, but I'm still having a little bit of difficulty understanding where we are actually seeing the benefit of the, you know, of the re-engineering, that billion dollars. In other words, if those engineering efforts were not in place, would we see HR and other costs up by a greater degree than where they have been?

You know, the short answer to that is yes. But the way to think about it is really in two different categories. There is – as we work on re-engineering, we work on revenue re-engineering opportunities. That is, identifying ways that we can actually increase the revenues that we are able to get in different ways. An example of that that we often refer to is the transition that we made domestically and that we are still making internationally to have our customers pay directly for our travel services as opposed to getting that as a discount fee from airlines.

And I think we said in the supplement, that roughly 25 % of the benefit that we are seeing in re-engineering this year comes from revenue related activities. The remaining say $750 million, if you use the billion dollars as the total, represents real cost reductions that we have achieved throughout the business that then help us pay for the cost of things like the additional stock option program, the additional marketing expenses that we have incurred during the year, other expenses that are related to the increase in the, you know, business activities that we have going on as our billed business grows at 15% as it did in this last quarter, offsetting all of those kinds of increases are a very substantial reduction in the way we do business on a day-to-day basis. And those benefits are flowing from many different areas.

We’ve talked about the improvements that we've gotten from, you know, procurement activities, from the IBM out-sourcing arrangement that we have, the shifting of our activities to on line based activities from off line activities So, there's a whole series of initiatives that we have underway that represent at the end of the day gross cost reductions which then are offset by increases that we spend in other areas. And at any point in time we have the decision as a company as to whether we would allow those benefits to flow through or whether we would in fact, you know, use a substantial portion of those benefits to increase our business building activities.

And right now we have substantial momentum. We feel very good about where the business is and we really have chosen to take a very large piece of that benefit and put that benefit behind strengthening our rewards programs and strengthening our marketing activities in the belief that long term that will increase our revenue growth rate, our metric performance, all of the factors which lead to having long-term health in our franchise and so, that's really the way it – I think is appropriate to think about it

Thanks. And just to follow up on one point there, can you give us a sense of what the alternative compensation structures are? Is it effectively restricted costs?

Sure. Yes -- the, we provided a little bit of detail about this at the time that we made the announcement, but we cut the amount of stock options as a percentage of our float that were issued every year from just north of 3 percent to just north of 1%. And for the vast majority of our management, substituted slight increase in the merit pay out, or the merit increase that people got during the year, a somewhat of an adjusted pay out in terms of their incentive and then also a restricted stock program. And taken together end to end, all of those things obviously had to offset what we were paying in compensation through stock options before.

We didn't actually reduce compensation for the most part. We actually didn't reduce compensation of the people who are working at the company. But we changed that from compensation that we accounted for through stock options and put it into other forms of pay. And so when we make the statement in, you know, our public releases that the stock option expense had an immaterial impact on us, that is specifically true. But if you translate the total cost of the program we had before into the things that we now have to appropriately account for as compensation expense, that's why you see the increase in the HR cost.

: All right. Thanks very much.

Yeah. And this is the first year obviously of that transition. This transition goes on as you -- the restricted stock will vest over time obviously and there will be further expenses associated with this. And – but it's part of the reason why the re-engineering activities are so active are to allow us to offset this cost.

Thank you. Our next question comes from Vincent Daniel from Keefe Bruyette & Woods. Go ahead.

Gary, I had a quick question on loans or receivables at the bank. We saw an increase for the first time in awhile. Could you be more geographic, specifically geographically where those loans came from?

Well, there is in the supplement -- I'm not going to be totally clear on this, I'm afraid, because I don't have an awful lot of detail to provide you beyond where we are. But if you look on page 17 of the supplement, what we do provide is some pretty good detail split out by country of what our position was as of September 30.

So you can kind of go down the page there and what we do is, we show a comparison of our total exposure versus the supplement that we published at the end of the second quarter. But if you wanted to split out the loan piece of this specifically, you could go back to the second quarter supplement and contrast country by country where the changes are.

Thanks, Gary.

I think the upper paragraph indicates basically the two businesses where loans are growing are the private banking business, where we have seen strong growth in loans. Those tend to be highly collateralized and then the fixed income -- I mean the financial -- (Overlapping speakers)

The group where we‘ve got kind of shorter term trade related type activities that have been growing.

The corporate types come down and we pull back on the personal financial services business reflective of some of the issues that we met in Hong Kong and, you know, a more conservative position there.

As I mentioned, the corporate loan book is now at about $350 million. We really have made huge progress on this. And you know, if you look at our current coverage of our non-performing loans, it stands at 138 percent of non-performing loans, about where it was at the end of the second quarter.

Thanks.

Thank you. Our next question comes from Phil Marriott at Arnold Blanchard.

I have two questions. I guess I was hoping to get a little more detail on the -- your NTRS, your line on marketing promotion rewards and card member services. You’d mentioned that both the membership rewards portion and the marketing were both up strongly in the quarter. I was hoping you could provide a little more detail, were they up – both up 26 or was it one up more than the other?

That's the first question and then the second question is – just relates to the discussion about guidance for the year and I guess what is implied by the quarter. Where you talk about 226 to 229, and being at the high end of your previous guidance. I thought there was a commentary earlier in the quarter that talked about not going higher than 229. So I just wonder how I should interpret this new discussion about earnings for the year.

Yeah. In terms of the marketing, the best way actually to kind of ground yourself and I'm sure you've done this, is to go back to the 10-Q for the second quarter and give obviously the split between the two and detail, in a pretty detailed way what goes into the membership rewards and card member expense categories. Obviously the vast majority of the rewards and card member services categories is in the rewards category. And this is all of our rewards programs.

This is obviously not just the membership rewards, but it’s the broad range of rewards that we have associated with our products. You know, what we don't want to do is quarter to quarter get into a specific discussion about how each of these move because they are just different parts of a marketing program. I mean, the way to think about it is, we have brand advertising, we have membership rewards expense, sometimes we do double point promotions.

We have a full range of marketing levers that we pull as a company and they will move back and forth from time to time. But in this particular quarter, both were up very substantially. I think overall, we were up 26%. I think, you know, you could take away that both of those numbers were up a lot. And so it's very much, I think, consistent with the strategy that we talked about back in the second quarter and that we replicated from last year that really has served us very well this year in terms of driving up our metrics. And we are seeing real good results from that and our expectation is obviously since we're spending the money, that we are going to see that benefit next year. Or we wouldn’t be spending the money now to see that benefit.

With regards to the second question ... oh, the guidance. If you look at the, what we said in the second quarter, basically what we said was that given that we were going to spend more money on business building activities, that we thought it was unlikely that we would exceed $2.29 a share on a full year basis which I think was an EPS increase of about 14%. You know, our business has been good in this quarter. We’ve had really from a revenue standpoint, we now have been at or above our revenue target. Our income obviously is growing nicely.

Our return on equity is, you know, right at the top of the industry. And our belief is as a result of that that kind of the range of 2.26 to 2.29, is likely that we will be at the top end of that range in the fourth quarter barring something that is completely unforeseen that we don't know about right now. So the last quarter has reinforced our confidence that there is no reason why we can't perform right at the top end of the range that we thought we would not exceed.

Thank you.

That you can. The next question comes from David Hochstim from Bear Stearns. Please go ahead.

Hi. I had I guess a clarification and a question. But in terms of the disclosure on the, that Phil was asking about, is it possible maybe on an annual basis you could give us some breakdown so we could better understand --.

Well, I won't make disclosure decisions on the fly, but I appreciate the recommendation, David, and we will think about it.

Okay, and then the question is, could you just give us some sense of what is going on at AEFA. And the funds business in terms of market timing. It seems to be in the news a lot at other fund managers.

Sure. We obviously, like many other mutual fund companies, have got very clear policies against market timing activities and have had very clear disclosures for the last couple of years in our prospectuses about – that this was not an activity that was, something that was allowed under the guidelines for our funds and have actively tried to manage that over time and disciplined people who didn't -- [indiscernible] you know, adhere to the guidelines that we had identified.

We are, I think, like virtually every other large mutual fund company now working to go through and ensure that we have had excellent compliance with the procedures which we have outlined for our funds and are going through a process here which actually takes quite awhile, given all of the advisors we have and all of the mutual fund customers that we have to evaluate the degree of compliance that we have had with those measures and we haven't completed that yet and we are probably awhile away from it. But you know, we are actively engaged in looking at it right now

Have you found any evidence of failure to comply with the policies?

You know, it's honestly too early for us to comment on what the total result of that effort will be.

Okay, thanks.

Thank you. Our next question comes from Joel Houck from Wachovia Securities.

Could you talk a little more about the transient large corporate spending? I know you talked about 7 % overall, but I wasn't clear on the breakdown between middle market and large corporate.

You know, we don’t – we just don't split it out between the two. It's just a degree of detail that we just haven’t provided. But large corporate is starting to respond. Our cards in force at the large corporate level are still down from where they were before driven primarily by the fact that there's been lay offs among the large corporate customers that we have.

And we haven't offset that by growth in contracts. [inaudible] is down, but spending in large corporate is up now for the first time, at least I guess, since the fourth quarter of last year is up nicely. But if you take the average of 7% that we talked about and split it between middle market and large corporate, middle market is higher than that and large corporate is lower.

And has that – has that effect been felt each month during the quarter [indiscernible] strengthened and kind of direction where you see it go.

We just generally don't provide the detail of what happened during the month, I mean what happened on a monthly basis during the quarter. We feel really good about the momentum of our corporate services business. The team has done a superb ((sub-ish)) job in terms of their win loss ratio recently versus the people that they compete with. We think they are doing a very fine job in what has been, up until recently a pretty difficult environment. With the return of some travel spending, T&E spending, you know, we hope that they can come back to a position where they are making the kind of contribution that we would hope they can.

Okay and then if I could have one on AEFA. If you guys made some public comments about the progress you're making seeing out of the, I guess investment of the Boston San Diego.

Yes, I made kind of a reference to it in my notes. We are actually very pleased. You know, the first quarter and the second quarter of this year, you know, continued to trend where we saw that a substantial portion of our funds were performing very well, kind of in line with the targeted levels that we had hoped that they would.

The last couple of quarters or so have been a bit of a turn around in that and the performance has not been as strong relative to their peer groups. That being said, the kinds of things that performed well, as you all know very well in the second and third quarters are a little bit unusual. You had companies with very low stock prices, companies with no earnings that actually didn't -- that performed very well from a stock price perspective. Those are typically not the focus that we have in our funds, particularly if you look at the new dimension fund, which is a technology based fund, growth fund out in San Diego.

That’s really not the focus of that fund. So, I think the performance of the fund is somewhat understandable given the way, you know, various equities have performed over the last couple of quarters. So we feel good about the progress. Certainly the, both San Diego and the team in Boston, I think, feel very good about the work that they are doing right now. If you take kind of a 12-month, the last 12-months basis, we feel good about the results

All right, thanks for the color.

Next question comes from Matt Vetto from Smith Barney. Go ahead.

Hi, just two quick follow-ups, if I could. First just on the corporate bill business, if I'm not mistaken, fourth quarter of last year you had actually a pretty decent year-over-year growth, like 13%. Is there anything particularly menacing about the comp in the fourth quarter or in absolute terms? Is that reasonable enough that we ought to expect solid trends there? And then on the portfolio rebalancing at AEFA, is there anything particularly thematic there or is that just more normal maintenance?

I'll give you the answer to both of those here. The corporate number, last year in the fourth quarter we were growing over the fourth quarter of '01 which included, obviously, the September 11th, or the aftermath of September 11th in the number. And so the absolute dollar levels in the fourth quarter of last year were not terrific. It's just that the numbers from the prior year were very depressed. So there shouldn't be anything unusual in the fourth quarter’s performance of this next year that would be -- [gap in audio].

Over shadowed by that earlier performance. But I actually appreciate you pointing that out. On the investment portfolio, actually the things that we worked on during the course of the quarter were very much [inaudible] of the fact that we had this tax rate reduction at AEFA to make some adjustments in the overall level of MBS (ph), you know, the mortgage backed securities that we have there. We – at the overall scheme of things it kind of peaked out at about 54 percent of the overall portfolio being at MBS [inaudible] 45% and so we have just been redeploying that. Where we saw a particular risk for prepayment, for example, we took advantage of trying to reposition some of those securities into areas where we didn't foresee that risk. So nothing really unusual. It's kind of ongoing activities. But it primarily impacted our MBS portfolio

That's helpful, thanks.

Thank you. The next question comes from Michael Hughes. Go ahead.

Most of my questions have been addressed, but I was hoping you could help us focus in a little bit on the non-T&E related volume. I noticed it was up 18%. Can you give us a flavor for how much is coming through rewards based programs or some of the newer initiatives over the last 12 months? There's quite a robust growth rate there.

Well I don’t – I'm trying to think of what would be useful to you. We now have about 60 % [inaudible] of our customers on rewards based programs, up from about 31%. But there is no particular linkage between rewards based program and the non-T&E spending. Obviously some of our cash back rewards programs which we’re obviously promoting very heavily right now are focused on people who value that kind of a reward relative to some of the membership rewards options that might include planes and hotels and that kind of thing. But generally, the, what we are seeing in our non-T&E spending is what we talked about at some length in the analyst meeting in August.

There's a whole series of new channels that we are pretty excited about the potential that, you know, represent opportunities for spending. So grocery stores, large box warehouse club type spending. We mentioned EZ pass as an example of reoccurring billing. The use of the card to pay cell phone bills. The use in drugstores, the use in – for health care, going to the doctor's office, that kind of thing. If you kind of split out our [gap in audio], the highest growth rates that we have are taking place in those channels. And those are very large channels where our penetration level is very low today and where we think there's just really good opportunity for continued penetration. I think all of the major fast food chains, large fast food chains now have – accept the card.

We just have real good expectations for what that is going to mean. There's even some enterprising landlords that now accept the American Express card because they want to provide rewards to people who come in and rent apartments. There's a very large untapped source of spending that doesn't require people to add to their balance sheet in additional debt. Where we are uniquely well suited to address the needs of those customers with a rewards based spend oriented product. And I think that's why you are seeing such strong growth in this every day category for us, is because we match up well with where the growth opportunities are.

Thanks a lot.

I think we will take one more question.

Thank you, sir. Next question comes from Moshe Orenbuck of Credit Suisse First Boston.

Funding on the charge card, please?

Did you say the funding, what the funding plans will be for the charge card?

Where it is right now, yeah.

Generally the approach that we have had, as, you know, we’ve talked about it a number of different times, is in periods of low rates that we particularly when the yield curve is flat, that we extend out our maturities. We’ve obviously had the benefit over the last couple of years of having low rates and had a number of times when the yield curve was flat. And it provided the opportunity to extend our maturity somewhat.

At this point in time, you know, we are at one of those positions where we've got a position that is fairly well hedged as we look out over the future here for awhile. You know, the interesting thing, obviously, about our P&L is that there are various aspects of it that change as the economy changes.

So as the, you know, as the economy improves and typically interest rates go up, then you have the opportunity to have offsets and increases in billed business and offsets that take place through reduced credit losses. Through a combination of all these things, our hedging and kind of the natural dynamics of the P&L, we historically have managed through these changes in interest rate cycles pretty well.

But given that now you are at a low end interest rates and low end credit losses on the charge card and in fact that you have probably the rewards cost, a good chunk of that increase is kind of dollar for dollar with spending, wouldn't there be a little less of that as you went forward from here?

Well, you know, actually it sounds like you are describing an excellent performing company to me. We have got great billed business, we’ve got excellent credit management. We have got low interest rates. And I think we've managed each of those things very well. I think our expectation is that we can continue to have very good progress on billed business as we go into the next year.

We certainly think that, you know, a lot of the business building initiatives that we have under way today will continue to contribute to that. And as I said, it’s a – we try and work each of these levers together. The objective is to obviously manage the overall picture of the company with all of the levers that we have to pull. Fortunately we have a lot of those levers at our disposal.

Great, thanks.

Thank you.

Okay. I guess that is it. Maricel, we appreciate your help for the call and appreciate all you folks joining us. And obviously we will be available through tomorrow to respond to any follow-up questions. So thanks very much and good night

Thank you. Ladies and gentlemen this concludes today's conference for today. You may disconnect at this time. Thank you for participating.