美國運通 (AXP) 2008 Q2 法說會逐字稿

Ladies and gentlemen, good afternoon.

Thank you for standing by, and welcome to the American Express 2008 second-quarter earnings conference call.

(OPERATOR INSTRUCTIONS).

As a reminder, today's conference is being recorded.

At this time I would like to turn the conference over to our host, Senior Vice President Investor Relations, Mr.

Ron Stovall.

Please go ahead.

Thank you, Tom, and welcome to everyone.

We appreciate all of you joining us for today's discussion.

As usual, it is my role to remind you 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 that 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 8-K report and in the Company's 2007 10-K reports already on file with the Securities and Exchange Commission.

In the second-quarter 2008 earnings release supplement and presentation slides, which are now posted on our website at ir.AmericanExpress.com and on file with the SEC in an 8-K report, we have provided information that describes the Company's managed, basis and other non-GAAP financial measures and the comparable GAAP financial information, and we explain why these presentations are useful to management and to investors.

We urge you to review that information in conjunction with today's discussion.

Ken Chenault, Chairman and Chief Executive Officer of American Express, will provide some brief opening comments addressing today's announcement and the current environment.

Then Dan Henry, Executive Vice President and Chief Financial Officer, will review the key points related to the quarter's earnings through the series of slides provided and then conclude with summary remarks.

Once Dan completes his remarks, we will turn to the moderator who will announce your opportunity to get into the queue for the Q&A period where both Ken and Dan will be available to respond to your questions.

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 Ken.

Thanks, Ron.

My comments will be brief.

Over the past month or so, we have seen clear signs that the US economy is weakening.

Unemployment rates, as we know, took the largest jump in over 20 years.

Home prices declined at the fastest rate in decades, and consumer confidence is at one of its all-time low points.

Now cardmember spending particularly among consumers slowed sharply during the latter part of the quarter.

Printed indicators as we signaled a few weeks ago deteriorated beyond our expectations, and by almost any measure the US economy and business environment are much weaker than the assumptions we first spoke to you about back in January and the conditions that existed in early June.

Now this fallout was evident across all consumer segments, even our longer-term super prime cardmembers.

While we are obviously disappointed with the bottom-line results, adding to our reserves this quarter translates into coverage levels that are substantially higher than at any point during the last two years.

Yet despite this challenging environment, our revenue growth for the quarter was solid, and our business metrics such as billings and card growth were strong.

As you have seen from some of the earnings releases within financial services this quarter, we have been able to generate substantial returns relative to other companies.

But having said that, we do not expect to meet or exceed our long-term financial targets until we see improvements in the economy.

Now given the environment, we will continue to scale back some card acquisition efforts and reduce credit lines selectively in the US.

At the same time, however, we also plan to take advantage of growth opportunities, particularly in international and in the Business-to-Business markets.

Our goal is to stay focused on gaining profitable market share, and I believe we have the strength and resources to do just that.

We obviously do not know the extent of the current downturn, but the position of our Company today is financially sound and competitively strong.

We've lowered our risk profile by divesting a number of businesses in recent years, and we are well-positioned to execute against growth opportunities in a manner that balances our short, medium and long-term objectives.

Now, as usual, Dan is going to review the major items and trends during the quarter.

He will also offer some additional summary and outlook comments.

And in light of the business and economic environment, as Ron said, I'm going to join him for the follow-up discussion, and we will be glad to take any of your questions.

With that, let me turn it over to Dan.

Thanks, Ken.

As Ron indicated, we are using slides today to facilitate the review of results.

So if you don't have those, you can find them at the Company's IR website.

So let me start with slide two, a summary of financial performance.

You can see that revenues grew 8% in the few slides I will talk about what that is on a managed basis.

Income came in at $655 million and EPS at $0.56.

This reflects strong performance in the International Consumer, Global Commercial Card and Network and Merchant Services businesses offset in part by higher credit losses in US Card Services.

I will speak about that more as we proceed.

Despite the higher credit losses, we earned in excess of $600 million, and ROE remains strong.

Looking at slide three, we have identified the significant items.

First is the addition to the lending credit reserves, $374 million after-tax or $600 million pretax.

This is a result of higher write-offs and deterioration in roll rates that we saw in June and reflects the inherent risk in the portfolio and higher anticipated write-offs in the balance of the year.

Second is an adjustment to the interest only strip.

The interest only strip relates to our securitized loans.

The $85 million after-tax or $136 million pretax is a write-down in the value also related to the higher credit losses we are experiencing.

The tax benefit relates to the settlement of prior year items with both the IRS and certain states.

Looking now at slide four, Capital Generation, you can see that we generated $756 million.

That is a combination of income in the period, as well as funds received related to either option or RSA activity.

You can see that we had no share repurchases in the quarter.

That is a decision that we made early in the second quarter given the economic uncertainty.

Going forward we will make decisions about share repurchases based on the economic conditions and Company performance quarter by quarter.

We are committed to maintaining a strong capital position.

Slide five, Metric Performance.

Metrics are a key measure of the health of the business.

The second-quarter metrics performed very well and excellent compared to our competitors.

Billed business grew 12% or 10% on an FX adjusted basis, down only 100 basis points from the first quarter.

Cards-in-force increased by 10%, reflecting investments in our proprietary business and growth in GNS cards.

Loan growth moderated to 12%, down from 19% in the first quarter based on a slowdown in consumer spending.

And travel sales remained very positive.

Slide six, Revenue Performance.

As I mentioned, revenues grew at 8% on a GAAP basis.

As you can see, interest in securitization income actually decreased by 7%, which reflects the higher credit losses.

On a managed basis, revenues increased 12%.

(inaudible) growth was very strong and reflects our customer's recognition of the value proposition of our products.

Other revenue reflects in part the purchase of the GE commercial portfolio, which helped that growth rate by about 600 basis points.

Now turning to the segments, if you look at slide seven, US Consumer Services, US Consumer Services billed business grew 6%, down from 8% in the first quarter.

Small-business or opened held up very well at 11%.

However, consumer continued to decline as we proceeded through the quarter.

Cards-in-force growth are down slightly as we shifted some investments to the International Consumer segment.

Average spend was flat, reflecting the economy and its impact on spending.

Loan growth again slowed in this segment linked to the slowdown in spending.

Moving to slide eight, here is a little bit more detail on the US Consumer Services billed business.

It shows you the monthly trend.

You will recall that we saw a drop in spending in December.

March's results are depressed and April's numbers are inflated based on where Easter fell in each respective year.

Easter in '07 was in April, and in '08 it was in March.

You can clearly see the drop in May and again in June driven by the slowdown in the US economy.

Moving now to slide nine, International Consumer Services.

On the other hand, International Consumer Services billed business held up very well, increasing 20% or 10% on an FX adjusted basis, the same growth as we saw in the first quarter.

Card acquisition focused on the premier sector.

As you can see, the average spend grew by 17%.

Cardmember loans grew with volume, and travel sales were strong.

Moving to slide 10, Global Commercial Services had a very strong quarter.

Billed business grew at 14% or 10% on an FX adjusted basis, again the same growth rate that we saw in the first quarter.

Cards-in-force and average spend growth was also very solid in this segment.

Moving to slide 11, Global Network and Merchant Services, we see strong billed business growth outside the US, and I will also note that the US retail and everyday spending grew at 9%, and that category represents 69% of our US billings.

The discount rate held up very well, only down 1% year-over-year, and GNS billed business and cards-in-force growth continues to be very impressive.

Moving to slide 12, Expense and Provision Performance.

Total expense increased 6% and was very well-controlled.

Marketing and promotion spending was comparable with the second quarter of 2007.

Rewards expense grew with volumes.

HR and other included increased investment in our merchant salesforce.

Now chargecard provision grew modestly, which reflects the lower US consumer spending, as well as credit actions.

The lending provision increased significantly, and I will address that over the next few slides.

The tax rate of 14% includes the $101 million significant item that I mentioned earlier.

Without that, the tax rate would have been approximately 28%.

Moving to slide 13, focusing first on chargecard net loss ratios, you can see that International Consumer and the Global Commercial Services remained very stable.

And I assure you that we're monitoring this very closely.

The US Consumer Services Group in the first quarter reflects a seasonal event, largely and also to a larger extent the impact of 2008 slowing billings.

So this calculation is the write-offs in the quarter which relate to accounts that went past-due in the third quarter of '07 when billings were very strong.

And at that time, we set up appropriate reserves for those past-dues.

And, therefore, their write-offs are not having a significant impact in the second quarter of '08.

That is divided by average billings for the past three months -- April, May and June -- where we had weaker billings.

So the 44 basis points you will see there in part has to do with the seasonal effect, but more than that with the time that we actually set up reserves related to accounts that went past-due in the third quarter.

Moving to slide 14, Chargecard 90 Days Past-due.

Again, you can see that International Consumer and Global Commercial Services are very stable, and US Consumer Services are actually improving, which is common on a seasonal basis and is also based on the credit actions we're taking.

Moving to slide 15, and our lending managed net write-off rate, and this is where we're seeing a significant negative impact in the P&L.

So let me start by reminding you that the way we report write-offs is different than the rest of the industry.

The rest of the industry includes in write-offs principal only.

We include principal, interest and fees.

So, for the US Consumer Services, we have reflected on the dotted lines what our reported write-off rate is, and then we have also noted what it is excluding interest and fees.

It is our intent in either the third or fourth quarter to move to the industry standard.

If you are doing comparisons between our write-off rates and the industry, the 3.5% is the correct number to use.

Let me just mention for a moment, as you can see, International Consumer continues to be very stable and down from 2007.

In June write-offs increased beyond our expectations, and you can see that on the next slide.

Slide 16.

Here what we have done is provided monthly write-off rates.

We have provided both the reported numbers and the numbers that are comparable to our competitors.

As we indicated in the first quarter, March was higher than the average for the quarter, and at the end of the first-quarter call, we also indicated that second-quarter write-offs were going to be higher than first quarter.

April and May was in line or slightly above our forecasts, but June increased well above our expectations.

Turning to slide 17, we see lending managed 30-day past-dues.

You can see that international is stable.

The US number is also consistent with the first quarter; however, roll rates deteriorated significantly in the second quarter, in particular in June.

Roll rates are the amount that move from either current to 30 or 30 to 60, and when roll rates increase, it is an indicator of what is going to take place in the future and why we're anticipating higher write-offs in the balance of the year.

If you move to slide 18, here we have included monthly information on our roll rates.

The top chart is roll rates current to 30 days past-due, and the bottom chart is 30 days past-due to write-off.

In the first quarter, if you look at the bottom chart, the 30 days to write-off, you can see that while the first quarter is higher than the fourth quarter, February and March were below January levels.

If you look at the current to 30, you can see that it was improving in February and March.

If you move to the second quarter, the 30-day to write-off number, while it increased in April, it improved in May.

And again, if you go to the top chart and look at current to 30, you can see that April and May was improving.

So for these reasons, we felt we were on track through May.

However, that changed in June.

You can see on the top chart that the current to 30 increased and that the 30 day to write-off increased sharply.

As a result in the second quarter, the 30 to write-off percentage increased by over 200 basis points compared to the first quarter.

These higher roll rates will lead to higher write-offs in the third and fourth quarter.

If we move to slide 19, this is US consumer services managed 30-day past-due by tenure.

Now, as you can see from this chart, the 24 to 36 and the 36 to 48 buckets are growing at a faster rate than the overall portfolio.

However, all tenures are increasing, including the 48 plus group.

So here we believe that the economy is affecting all tenures, not just the recent accounts that we have put on the books.

If you move to slide 20 now, then let me take a little time to explain this chart.

On the right you see the origination year, which means the year a cardmember joined the American Express franchise.

The time period or months across the bottom rate cardmember history with us into 12-month time periods.

Their respective plots of the write-off rates for each year of origination as the group seasoned through the normal curve.

If you follow 2001, which is the red line, write-offs increased in the 13 to 24 month and 25 to 36-month buckets but then improved.

Now for all years, 2003 and newer, the last two plot points are impacted by 2008 credit deterioration.

For cardmembers that joined us in 2003, in January through June they would be in the 61 month and greater bucket.

Cardmembers that joined July through December would be in the 48 to 60-month bucket.

So, as you can see for all years 2003 through 2007 have been impacted by the 2008 economy.

So if you follow the chart across, first you have blue, which was '03.

You can see the last two plot points increased.

The orange is 2004, the last two plot points increased, and that is true for 2005 and 2006 as well.

So the higher than normal last two plot points for 2006 and 2007 are due to the economy.

All tenures are being impacted.

For recent vintages, even if we experience higher write-offs for two years, these investments still have very strong economic returns.

Now let's go to slide 21.

We have shown this chart to you before, and it shows that FICO stores have not deteriorated, that we don't use FICO stores to do our acquisitions, we use our proprietary models.

But this is an indicator that we have not dropped our credit quality over the past several years.

Let me now make a few summary comments.

Despite the significant impact that the weakening US economic environment has had on our credit performance and bottom line this quarter, most of the key business metrics that serve as a long-term indicator of our competitive strengths indicate that our competitive strength has performed well.

We see that the overall billed business and cards-in-force growth rates where the gap between our performance and that of most major competitors demonstrates the effectiveness and ongoing benefit of our marketing and rewards investments over the past several years.

Once again, we benefit from the strong performance within our International Consumer, Global Commercial Services and Global Network and Merchant Services segments.

The performance of these parts of the franchise reflect the benefits of the diversity of our business activities and the balance they provide within our results.

Unfortunately the revenue growth from these relatively strong results were more than offset by credit deterioration within the US.

The severe decline in home prices and the marked rise in oil prices have had a fundamental impact on consumer budgets and behavior.

Not just as it relates to mortgages and home-related spending, but also across the full spectrum of the consumer economy.

We saw the first signs of weakness in our credit indicators at the end of last year and communicated this to you in January when we reported our fourth-quarter results.

At that time we took a credit-related charge in order to recognize the deterioration by strengthening our lending and chargecard reserves, coverage ratios and levels.

In the first quarter, US lending write-off rates rose further, and at that time we indicated that the second-quarter loan-loss rate would be higher than the first quarter, which has proven to be the case.

In April and May US lending write-off rates were generally consistent with the 4% to 6% EPS growth plan that we discussed with you in early June.

However, as I showed you on the slide package, we saw our credit deteriorate in June beyond our expectations as the write-off rates rose and roll rates within the portfolio deteriorated versus prior months.

In other words, more and more consumers who are falling behind in their payments are remaining delinquent.

This causes us to assume that a greater percentage of past-due loans will not be repaid.

In light of the magnitude of the negative economic trends and our experience, we now believe the economic weakness in the US will likely worsen throughout the remainder of the year and negatively impact credit and business trends.

Therefore, it was appropriate for us to further strengthen our lending reserves and reduce the fair value of our I/O strength.

This quarter reserve addition results in a coverage ratio of 135% of past-due owned loans, which is substantially above the coverage levels over the last three years.

We believe this elevated coverage is appropriate in the light of the continued economic uncertainty before us, the inherent risk in our portfolio and the higher write-off levels we expect.

As we discussed at the beginning of June, our 4% to 6% EPS growth forecast assumed an economic environment consistent with what we experienced throughout the first five months of the year.

We indicated then that if the environment weakened further, achieving these results would be difficult.

The environment has clearly weakened significantly since then.

Given the credit deterioration we experienced in June and the continued moderation in US volume growth, as well as our outlook for continued weakness in the economy, we are no longer tracking to this forecast.

In addition, we now expect that our lending write-off rate in the third and fourth quarter will be higher than June levels.

As we move forward, we will continue to be guided by our long-term on average and over time financial objectives.

Since we set our targets in 1993, we have generally performed consistent with those goals and, in fact, have outperformed them in recent years.

The ultimate goal is to ensure that American Express navigates through these challenging conditions in the best position possible relative to our payment competitors and relative to the overall industry.

Growth opportunities continue to exist in the marketplace, but over the coming quarters, we will be even more selective with our investment dollars, moving them to areas of current opportunities as we work to prudently balance near-term performance against long-term profitability and growth.

Throughout this decade, re-engineering has resulted in a well-controlled operating expense base.

But in light of our desire to maximize our ability to invest in the business, we are further intensifying our re-engineering efforts with an eye toward reducing cost structure and staffing levels.

While we have not yet quantified the impact of these activities, they will likely result in restructuring charges during the second half of the year.

The antitrust settlement we have reached with Visa and MasterCard also provides us with multi-year source of funds that can help to lessen the impact of the environment and when conditions improve give us the ability to step up investments in the business.

Collectively we believe these factors will position us to maximize our ability to invest for the long-term.

However, these investments, coupled with the economic environment, will challenge our ability to meet our financial targets until we see improvements in the economy.

While we are obviously disappointed with the impact that the current economic turmoil is having on our results, the position of the Company today is financially sound and competitively strong.

We divested certain businesses such as our international bank and have grown others such as B2B in order to lower our overall risk profile.

Our business model has generated particularly attractive returns that provide capital flexibility and strength.

Even with the substantial credit-related charges during the quarter, we generated in excess of $600 million of earnings.

We have shown our ability to adjust to the environment conditions whether it be to implement defensive measures or take advantage of competitive opportunities.

Our balance sheet is appropriately positioned.

We have access to diversified sources of funding, and our cash position and liquidity profile provide us additional protection in these volatile times.

Across all of our businesses, we have instilled a strong focus on the customer, someone we need to stay close to regardless of the environment.

And lastly, our competitive position is stronger than it has been for decades.

We will be impacted by the environment, but given the products, customers, geographic breadth of our franchise, we believe we are well positioned to execute against growth opportunities in a manner that continues to appropriately balance our short, medium and long-term business and financial goals.

Thanks for listening, and we are now ready to take your questions.

(OPERATOR INSTRUCTIONS).

Meredith Whitney, Oppenheimer.

Ken, it is so great to have you on the call.

Thank you.

I had a general question, which is you had talked about how all segments of the market were impacted from an economic standpoint.

You had talked at the investor day in January about how certain regions at the time were more impacted than others.

Today could you talk about the derivative impact of line reductions?

I know you guys had reduced lines in the high problem real estate areas, the high problem house price depreciation areas.

I assume that others did as well.

What type of impact did that have on consumer?

Was there any one catalyst aside from spending that you can attribute the real material increase in charge-offs?

I'm just looking for anything behaviorally that can help us understand what the sudden change was.

Well, I think clearly the reduction in line size impacts spending, and that has a negative impact on spending.

I think what we are certainly trying to do on a geographic basis is to be very, very targeted.

Because what you don't want to do in a situation is to apply a blunt instrument across the board.

Because we have a number of relationships across 10 years and across products that we want to preserve and grow.

So what we have been able to do is to be very, very surgical against those customers that we believe based on our modeling have a higher risk.

That is important both not only in setting up the models, but making sure we have the right operational controls in place as far as our credit management is concerned.

Is it too soon to tell when your competitors will cut lines in the same customers that you have?

I'm really interested in those derivative impacts and the strain that multiple line reductions caused and that is sort of littering your results in terms of higher defaults.

Is it too soon to draw those conclusions yet?

Well, I think if we -- we're continuing to learn as we go through this slowdown.

Every slowdown is different.

This is certainly one that has been different than what we have seen in the past.

And we look to incorporate our learnings as we make credit decisions.

We continue to see the greatest significance in geographies where housing prices have fallen the greatest.

But recently we have actually started to see greater impacts in customers who were in that middle cycle band.

Generally it is customers with low FICOs where you see the greatest impact, and we're certainly seeing it there.

But now we're seeing it creep into FICO scores with people who are between 650 and 750.

The other new thing that we're seeing is historically if someone had multiple mortgages, that was actually a positive factor.

But in recent months, we're starting to see people with multiple mortgages who are actually having greater difficulty.

Now to your point about what competitors are doing, we're keeping a close eye, and if we identified customers that we have a significantly higher open to buy than our competitors, that is another spot where we're seeing added risk, and we're reacting to that.

So we continue to integrate new learnings into our decisioning.

But at the same time, I want to emphasize that we are also being very focused on our care programs.

You know some customers who are having temporary difficulties will be terrific long-term customers for the franchise, and we want to make sure we balance the credit actions we're taking to reduce near-term credit losses with the overall economics of the customer and the customer who can be of great value to us in the future.

This is one where we're going to be very, very comprehensive, but we have got to be surgical.

And that is we're we're really using our modeling and different techniques to make sure we are focused on targeting those people that we think are highest risk.

And those customers that we can project out, we can manage better over a lifecycle.

We obviously want to continue to retain their business and loyalty.

Chris Brendler, Stifel Nicolaus.

Can you talk at all about the roll rates in the chargecard business?

Because I was a little bit surprised you did not bill provisions there.

Are you not seeing the same trends in the chargecard business?

And then also you commented on roll rates, particularly late stage roll rates in the month of July.

Do you have any early read on July that it is as bad as June?

Okay.

In the chargecard business, a lot of the provisioning takes place when the account goes past due.

And so the people who actually wrote off in the second quarter went past-due in the third quarter last year, and that is when the bulk of the provision was set up.

We're actually seeing that the percentage of customers that are going past-due in the second quarter seasonally is always long.

But we are also in the second quarter of '08 seeing the impact of lower spending, as well as our credit actioning.

So because we don't see the customers going past-due in the second quarter, we're not seeing a big pickup in the provision.

And, therefore, the provision for chargecard increased modestly only 3%.

So we are very comfortable with how we are handling chargecard and where that provision is at this time.

In terms of roll rates, you can see what we showed you on the charts in terms of what took place in June.

Before that when you combined what we were seeing in the current to 30 roll rates with what we were seeing in the 30 day to write-off, we were comfortable.

But when both of them moved up in June, which we had not expected, that caused us to be much more cautious about our outlook in the future and in terms of evaluating the inherent risk in our portfolio to set up the reserves.

Early read on July for those kind of roll rates and also for spending?

Not at this time.

Okay.

One final question on the lending provision.

I mean sort of lending growth you mentioned that the lending slowdown and balance growth was due to lower volumes.

Anything on the marketing side that you have done to slow down the lending growth as well?

I think on the marketing side, marketing spend obviously for acquisitions, which would not have a quick near-term impact on A/R growth.

It takes a little bit of time for customers to get their card and to spend and move into revolve.

We still are marketing at a healthy level across the Company.

You can see that we spent about the same that we did last year, although I will say that we have shifted dollars to international.

And that is helping our spending levels there, which are very good.

But to the extent we spend less on marketing in the US, that will have something of an effect in terms of growth in the US in addition to what is taking place in the economy.

But we want to shift our investment dollars to the place that has the best current opportunity.

We still have very good opportunities in the US as well, except we're doing those on a more surgical basis.

Yes, I think we have got to be and we're being more targeted in the US.

But I would just emphasize the overall opportunities we have in international and in B2B, GNS provide very strong growth opportunities.

And I think it demonstrates the broadness and attractiveness of our business portfolio that we have areas in our business mix that, in fact, are -- have a more conducive profile to some of the economic issues that we are facing.

And we clearly are reallocating some investments there, and then to Dan's point, we're being very targeted in surgical about the investments we're making in the US.

Bob Napoli, Piper Jaffray.

Ken, a question on market position and strategy of American Express saying that you're in a better position than you have been in the history of the Company.

The one period that is clearly going to continue to gain market share not only in the US but globally is the debit card product.

I just wondered if your thinking is that I know you have done 30 or 40 projects on debit cards or so over the years.

You're just in a position where you are going to be relegated to have a slower growth rate than the peers, the MasterCard and Visa, that are large obviously in those products globally.

Bob, the way I would answer that is I think, one, you have got to look at what the overall strategic objective is for us in payments, and that is obviously to get a greater share of plastic spend against cash and checks, and we have a variety of products to do that.

As I have said a number of times, without direct access to a demand deposit account, it makes us -- makes it difficult for us to offer a debit card.

However, when one looks at the economics of our chargecard products and impacts some of our lending products, we believe that we can meet the functional pay in full spending needs of those customers and prospects through our variety of card products at, frankly, more attractive economics than we could get with debit.

The other key point of where I think we are driving increased penetration is through our Business-to-Business products, corporate card, our middle market products, but also GNS.

And GNS allows us obviously with a very different risk profile and without having credit risk to go after that spending.

And so I think what you have got to look at is the range of products.

And what I would emphasize is that despite a very challenging economic environment, from a marketshare standpoint, the trends are encouraging relative to our growth overall.

In the US and certainly when you then add international to that, I think we have some very attractive growth prospects.

So the point is, the credit situation in the US is disappointing.

But what I would emphasize is, as I look at our topline metrics and I think what we have got to understand is we're managing this Company on average and over time to achieve some financial objectives that we think are ambitious, and we have been able to do that historically.

This is obviously a tough period right now in the US, but I'm confident because of our market-leading position and the way we have performed even this quarter from a metric standpoint, that the prospects for our card business in the future are, in fact, strong.

And obviously we need to see some improvements in the economic cycle in the US, but when I look at international, B2B and the opportunities in history of our business in the US going through different cycles, I do think we are at the strongest competitive position that we have been in a number of years.

However, we are dealing in a very challenging economic environment in the US.

Thanks.

Just a quick follow-up on GNS.

Your spending growth of 42% by revenue growth of 12% and higher provisions may be in that segment than we would expect over the last couple of quarters.

I just wondered if the revenue growth and spending growth kind of converge over time, and why the provisions are as high as they are in that business?

Okay.

So GNS growth at 42% is just a piece of that segment, the Global Network and Merchant Services segment.

That includes both GNS, as well as our proprietary business that is flowing through this segment.

So I think that certainly the growth rates that we have seen in GNS, which have been absolutely terrific, to think that any business could continue at 42% would be difficult.

But they have done a very nice job in terms of continuing to grow at a very high rate.

The 12% that you referred to is really all of the billed business, both proprietary and GNS.

And the provisions?

So the provisions within GNS, I think anytime you have a slowdown that while they are much less impacted by credit losses, there's reserves that we set up within this segment either related to small merchants who could potentially go out of business or large merchant reserves that we set up that is required under FIN 45.

And so in this quarter, we actually saw an impact as we increased that reserve during the quarter, primarily to reflect some of the difficulties that we see in the airline industry.

David Hochstim, Buckingham Research.

Can you provide a little more color on the contrasted differences in the spending behavior, discretionary spending between US chargecard customers and credit card customers?

And then how about the slide on -- slide 20, the damage loss curves, and how do the last few years of chargecard customers compare to what you see in US lending and how do small business compare to that in terms of loss development?

Okay.

So we don't provide a breakout between chargecards and lending products.

What I provide you with is the -- what is taking place on spending within the US Consumer segment, which includes small business as well as consumer charge and lending products.

I think as you can see from the chart small business growth in the quarter was 11% compared to 3% on the consumer side.

So small business is holding up better.

But on the consumer side, we're seeing a greater impact, and we're seeing it both on the chargecard side and spending on our lending products.

So we're seeing that across both those spectrums.

So you are saying that consumer charge card spending has fallen off the way consumer lending?

Both consumer lending and chargecard are being impacted by the economy.

And both are seeing the impact of the economy and resulting in slower spending by our cardmembers.

Both cardmembers who have lower FICO scores and cardmembers who have high FICO scores, both in cardmembers who carry blue card and people who carry a Centurion card.

The reality, David, is that affluent people, in fact, in some cases are cutting back on discretionary spending.

So they are not in the same situation as other segments, but the reality is we're seeing very affluent people who have had historically very, very strong spending history with us are cutting back on nondiscretionary that they deem items.

They are still very loyal to our product.

They are still putting a good percentage of their spending on our products.

So we don't believe we're losing share to other products based on our relative billings growth rate.

But we're seeing affluent customers change some of their spending behavior.

Is the 2% year-over-year growth rate in billed business for USCS kind of a run-rate going into the third quarter you think, or is there something funny in June and July like there was in March and April with Easter?

So I don't think there is an impact like Easter in the numbers.

I think as I mentioned I think there was a downward slope in the quarter.

The average was 3% for the quarter but 2% in June.

So we will have to see whether that continues or not.

We will have to see what happens in the third quarter before we know that.

Could you just clarify the impact of the GE portfolio?

Were their cards that were converted in the quarter?

Is there still business that you recognize from the GE acquisition?

I think the other income you referred to is about $60 million of that 150 increase, but I'm not sure if there is something else.

So we're very pleased with the progress we have made in terms of GE customers.

Our contacts with them, we have begun to sign those customers.

Until we actually sign them and move them over onto our platform, the revenues that we generate from them are included in other revenues.

And I was just commenting that of the 15% growth on that line, about 600 basis points related to the GE acquisition.

So you have not even converted the GE employee card yet?

So there is no billed business, in fact, this quarter?

No.

Okay.

Thanks.

I mean obviously as we said, that is going to occur over the next several months, but up to this point, no.

Sanjay Sakhrani, KBW.

I'm just trying to get my arms around the trajectory of the lending charge-off rates and US billed business on a go forward basis.

I think on the lending side you guys mentioned the third and fourth-quarter rates will be above the June levels.

But how should we think about it related to seasoning versus cyclical?

I mean will there be some kind of abatement from the seasoning pressure kind of at the end of the year?

And then on billed business, could you just talk about what caused such a pronounced slowdown in May and June?

Is it partly related to line reductions or largely related to line reductions?

And then finally, on lending reserves should we assume that coverage to delinquencies will remain as long as credit remains under pressure?

I'm not sure whether that was one question or five questions, but -- so I think there is the seasoning that takes place really takes place amongst 12 through 36 in large measure.

So I don't think in the near-term we're going to see any radical change in the seasoning impact.

Because we have been fortunate in that we have been able to add significant new customers to the franchise, which is what our intent is as we strive to drive spend and take share in the marketplace.

And so and even today based on the investments that we're making in the business, we are continuing to bring on card members.

So I don't think we will see the seasoning impact have any quick change in the next six to 12 months.

As you know, we're having more of an impact of that seasoning on our business than our competitors are because they have not grown at the same rate that we have.

In terms of billed business and the impact that we saw in May and June, we think it is the impact of the economy.

We look across all products.

We look across all tenures.

We look across all FICO scores.

And, as Ken was saying, what we're seeing is people with very good FICO scores who have been long tenured customers are just being more cautious in this environment.

And so we're seeing a slowdown in spend really across the board, and that is really what caused us to think that it is the economy.

Plus, I think you have seen from all of our competitors they have been impacted in the same manner in the second quarter.

Moving to your last question, in terms of what we put out for reserves, reserves that we set up for as a combination of what we're seeing in write-off rates, what we're seeing in roll rates, what we're also sensing is happening in the economy and certainly in June we saw unemployment jump dramatically.

Consumer confidence is down.

So setting reserve really contemplates all those things in assessing the inherent risk in the portfolio.

So I think we will continue to keep what we consider to be appropriate levels of reservess as long as we continue to see a slowdown in the economy.

If the economy were to get worse from here, we would see additions to reserves.

And when the economy improves, we will take those reserves down in a prudent fashion.

Brad Ball, Citigroup.

Just a point of clarification on the chart on page 20, is that using the old method of computing the write-off rate, including accrued interest and fees, or is that the new method you are talking about excluding those?

I would think that is the old method including interest and fees.

And so in terms of thinking about the magnitude of the impact that you're experiencing relative to your industry peers, I think you just acknowledged that you are seeing a faster acceleration in lost dollar amounts and lost rates relative to your much higher growth versus peers over the last couple of years.

Is that correct?

I would not call it acceleration.

I think we're being impacted the same way everybody is being impacted.

Certainly if we decided to bring on fewer customers historically, then lost rates in those periods and lost rates in these periods would be lower.

The way we view it is the life of the customer.

So to the extent we can bring on customers that have good economics over their life with us, we want to bring those customers on to the books.

To the extent there is a slowdown, to the extent we have more customers, we're going to have higher write-offs that provision in the short-term, but our focus is not the short-term.

Our focus is the medium to long-term, and we think that those investments to bring in those customers were good decisions.

I think what is important is, and it is obviously understandable given the economic environment and the credit situation, if we were managing the business just for '08, there would be a different set of strategies and tactics that you would put in place.

But I think what we have been able to demonstrate is, as I look at our overall book of business, I think we have got the best-in-class customers on our books.

And I believe that positions us very well from a multiyear standpoint, and we take the current economic environment, very, very seriously.

But what I would emphasize is that we're balancing those risks against what we see as very strong opportunities from a multiyear basis.

And as we look through history and we look at the last two downturns and that is why I have made this point that competitively I think we are far stronger and I think the quality of our customer base is very strong and as I said is best-in-class, I think we are positioning ourselves so that we have multiple year growth with attractive economics going forward.

And I think that is the point.

We could, in fact, limit the credit exposure by not growing at all.

And what I would submit is that the economic trade-offs that we have made have been good trade-offs over a multiple-year period.

And that has really been the philosophy that we have used to manage our business.

And just as a follow-up, roughly speaking if you look at your '06 and '07 vintage loan receivables, what proportion of those are MR customers?

So I would say that a very high percentage of customers are either MR customers or on another product with our rewards -- (multiple speakers)

Like Starwood or --?

Delta, Costco -- that is a rewards-based product.

So when you say -- are we talking 90%, 100%?

Yes, I would say it is over 90% in the volume.

Because I think what is important is, that the quality of accounts that we have added in recent years is as strong as our traditional cardmembers.

So I think that is an important point that I would emphasize.

Clearly we have grown, but we have not grown as a result of lowering the quality of our accounts.

In fact, the quality of accounts is a strong as our traditional cardmembers.

Howard Shapiro, Fox-Pitt Kelton.

I have just a question on how you model future credit losses and kind of the degree of confidence in your modeling.

Given just the changes we're seeing in consumer behavior and the fact that we're seeing, for example, a nationwide decline in home values and we don't know what that means for consumer behavior, how confident are you in your modeling?

Can you talk about how often you review it and the feedback mechanism and how often you would incorporate that into new assumptions?

Okay.

So, as you know, we are using historical data to inform our view of the future, and we look at both the absolute level of performance today, as well as the trends over the last several months.

And we look at what we're seeing in roll rates once things are in delinquency to assess what percentage will ultimately go to write-off, which helps inform us in terms of where our reserves should be.

What we have assumed is that the roll rates that we see today will worsen somewhat over the balance of the year.

And so I have high confidence in our ability to model what will happen, assuming that that is exactly what happens.

It is slightly worse.

Now, as you know if next month or over the next few months, things get significantly worse then we will build that into the model, but it will cause write-offs to be higher in the balance of the year.

So, quite frankly, the inverse is true.

If customer behavior improves, then it will be better.

So we use all the information at our disposal, and we look at not only what is happening in write-offs and roll rates but what is happening in spend to help inform our view of what is going to happen over the balance of the year.

So I feel good about our ability to forecast the next six months.

Once you get beyond that, it becomes a lot more difficult.

And I would just really cover one example that you use, which is multiple mortgages.

That is just an example of where we have been able to incorporate a change from what we saw historically.

And the reality is that we're looking at a whole set of drivers where we have a constant feedback loop to understand what has a change in causing the credit performance.

And that is something that we are very, very focused on, and it really is a constant feedback loop that we had.

And we have demonstrated that we can act on that I think very, very quickly and feed that into our overall system.

Mike Taiano, Sandler O'Neill.

Just looking at your slide on page 18 on the roll rates, the dip in May in both the top and bottom slide, is it fair to assume that maybe some of that was attributable to the tax rebate checks?

It was hard to say definitively.

That certainly could have an impact.

I would say that sometimes there is movement month-to-month, and we try not to react too dramatically just to a week's information or a month's information.

Because, as you can see from these charts, it can bounce back.

But May could have been impacted by the rebate checks.

It is hard to assess.

Our focus was that it looked like at least for the 30-day past-due to write-off, May seemed to be something of an aberration compared to the trend.

But I would just say the tax rebates to Dan's point is we don't really have any evidence on credit or spending that we're seeing an impact.

And if you look at the overall profile of our customer base, my personal view would be I don't think there was much impact.

But I cannot say that for certain, but when I look at the profile of our customer base, I don't think that would have much of an impact.

Okay.

And then just on your comments on the multiple mortgages attribute, can you maybe clarify why would that have been a positive attribute in the past, and how quickly have you made that change in your underwriting model?

I mean it is -- the comment is just based on historical performance.

Historically folks that had multiple mortgages appeared to be people who had the capacity to handle those mortgages, continue to be financially balanced and continue to spend and make payments on our products.

That is just a historical fact.

What we've started to see is that in this environment, probably heavily impacted by the drop in housing prices, that the inverse is starting to happen.

That as a group people who have multiple mortgages are starting to perform less well than folks who do not have multiple mortgages.

So, as we started to see that, we started to build that into our credit decisioning so that our models are as up-to-date as possible and help us to make the best decisions.

And I think on the multiple mortgage issue, the reality is an example you had historically a highly creditworthy customer who had very good credit scores.

The issue is from a multiple mortgage if they have a sharp valuation decline, some of them are caught in the middle.

And that -- you may not -- you would not see that upfront in modeling that some one's credit score was different.

This was a group that I would say intuitively would stand to reason that in a range of environments highly creditworthy they have multiple mortgages.

And then that they had a price decline on one or two of those properties.

That is going to have an impact.

And by any modeling that you have done, they looked like and acted and performed and paid as very, very good customers.

And so that is why I point to the example, but I think the logic of it, which was borne out by their performance over a multiple year period, was that these were highly creditworthy people who, in fact, performed well.

And have you seen the more pronounced change in the areas most affected by the home price depreciation in California and Florida?

Yes, absolutely.

That was true in the first quarter and continues to be true this quarter.

Eric Wasserstrom, UBS.

Just to get back to the roll rate analysis, I mean the roll rate obviously is an important tool in determining the number of current people going bad that will ultimately go through default.

But do you have a view about incremental incidents of loss which will not be reflected there?

Well, I mean this is historical data.

So if the question is, how many people who are in current today will ultimately go past-due and then ultimately write-off, we use the historical data that we have.

And, as I said, we increased it above the current level to reflect our view of the economy.

But if you have any -- whether that is going to worsen or improve, I think will be very much driven by the economy that we see in the US.

Right.

So just to be clear then, there is not -- and I guess I'm trying to determine whether there is an expectation that things will or will not get worse and whether that is baked into this future loss expectation?

So our reserve anticipates higher write-offs in the third and fourth quarter and anticipates that the roll rates will get somewhat worse.

Okay.

If I could just ask a follow-up on slide 20, do you have any commentary on the slope of the recent vintages and how much that differential versus some of the older vintages relates to the seasoning issue versus changing in underwriting?

Yes, I mean that is clearly a key question.

I think the reason that we included these multiple years is that from the very early origination years of '01 and '02, you can see the normal seasoning take place.

But, as you can see, it is having an impact on the '03, '04, '05 vintages which are very strong vintages.

So it causes us to conclude that the impact that we're seeing in '07 and '06 is being driven by the economy as opposed to that group was less creditworthy than the groups in the earlier years.

Okay.

I guess, Dan, I'm having difficulty reconciling that, though, with the severity of the slope on the '06 and '07.

It would seem to suggest that they are following the same pattern but seem to be more fully loaded curves?

Well, I think the folks in the 12 to 36 month are probably the most vulnerable group because they are in the height of the curve.

And so to think that the height of the curve is where you are going to have the greatest impact to me is a very logical assumption to make.

But I think you are seeing some of the other curves move up by 100 basis points or more on each plot point, and I think you have to look at all the data that we have available.

If you look at slide 21, here clearly you can see that using FICO scores as an indicator that we not only did not drop FICO scores, but we actually increased the quality of customers just looking at FICO scores.

So I think the plot point you are seeing for '06 is reflecting the fact that they are in the height of the curve, and therefore, they are being more impacted.

But we still think that will be a large group of customers within that origination year will be terrific customers long-term.

Yes, the other point again as we keep on emphasizing, we don't use the FICO scores from a modeling standpoint but to categorize where we've come out.

Now given this example in our blue card portfolio, which is the largest 12% in '01, we are 750 and above FICO scores.

At the end of 2006, 46% were 750 and above.

So just go back to the quality of customer that we have been bringing in, obviously there is an impact from a seasoning standpoint and an impact on the economic environment overall.

But I do not believe it is an issue that we have lowered the criteria for new customers.

And the last point I would make is that when you look at the earlier curves for customers who came in in '01 through '04,they were going through that difficult seasoning period when the economy was very strong.

And so naturally you would expect them to be lower than the current curves.

Moshe Orenbuch, Credit Suisse.

I was just wondering given your comment that the reserves are kind of anticipating a deterioration of losses, I noticed and you expressed them as a percentage of the delinquencies, your ratio of charge-offs to delinquencies kind of doubled over the last year.

It went from 135 or 137% up to 175%.

And as you kind of look at the global owned charge-offs, they are running in the second quarter kind of 30% at an annual rate ahead of the reserve, and you are saying you're expecting them to go up.

So I guess I wanted to understand, how anticipatory that is and what we should expect for the reserve if, in fact, charge-offs increase in the third and fourth quarters?

So usually -- I mean we show owned and managed statistics.

Generally we have looked more often to the managed statistics when I think about the health of the overall franchise.

Over the recent last three years, when the economy was strong, the coverage ratio of delinquencies has been in the 95 to 100 range.

We have taken them off to 135% on a owned basis, 144% on a managed basis, which are I think at the levels we had when we're back in the last slowdown.

We actually feel very comfortable that we have an appropriate level of reserves based on what we have seen to date and anticipating that it will be somewhat worse going forward.

How many months of charge-offs do you expect to keep in the reserve?

Well, we don't use loans coverage of write-offs.

It is one of the statistics that we obviously look at.

So currently we would have over 12 months of write-off coverage in our book.

And even assuming that write-offs increased the way that our models say, even after that if you looked out to December, we would have over 10 months of coverage.

I guess I'm having trouble with that since the current annualized charge-off rate is in excess of the reserve on both an owned and a managed basis.

So I'm not sure exactly what the rate you are referring to is.

Well, there is $827 million of write-offs on the owned worldwide portfolio and $2.6 billion of reserves.

So 800 times 4 is $3.2 billion, $3.3 billion.

Okay.

So --

And the ending balance, the reserve is 2.6.

Yes, I think so.

We do months coverage, right?

You're just looking -- first again, I would recommend we do it on a managed basis, and you have to go back.

That number is write-offs in one month, so I guess that is a quarter.

So you actually kind of have to track back over the last three quarters --

So you are saying it is historical, not perspective?

Yes, it is historical.

I think we have got time for one more question.

Tom?

Scott Valentin, FBR Capital Markets.

Just a question on the discount rate.

Historically you have kind of (inaudible) that due to everyday spend categories as pressure, slow but modest pressure, over time on a discount rate.

I was wondering given the comments regarding moving away from discretionary and more towards nondiscretionary spend, if you expect the discount rate pressure to accelerate?

So I think without any pricing actions on our part based on the growth in everyday spend, we would expect the discount rate to drop by 2 or 3 basis points a year.

However, we have been very successful with certain categories of merchants to go back to them and demonstrate the value that we bring to them and actually have been able to increase price.

And, as a result of that, we have either last year I think we stayed pretty flat.

This year we have seen a very modest reduction in discount rates.

So we will continue I think to see growth in everyday spend, which will put pressure on the discount rate.

But I think we will also continue to look at when it is appropriate based on the value we bring to increase certain categories.

Yes.

I would also say that given some of the reward programs and marketing programs that we have created, the reality is there are a number of merchants in a range of categories who want to build business.

And the point is while we have seen declines, as I talked about, in some of our more affluent customers, their loyalty to our product and the use of the product has continued.

And so I think that what is incumbent upon us, which we have been successful on this over the last several years, is to continue to increase the value that we can provide merchants and to use what is clearly a pretty challenging economic time to reenforce our value and to bring more business to merchants.

And so while no one likes being in this situation, I think that it is an opportunity for us to continue to demonstrate the value that we're providing merchants and to have that cardmember assistance and loyalty, which I think is still continuing despite the fact that people are lowering their level of spending.

When they are spending, we want them obviously using our products and services.

Okay.

So we want to thank everyone for joining the call this afternoon.

As usual, we will be available for follow-up questions for a portion of this evening and certainly tomorrow and over the coming days.

And once again, thanks very much for joining us, and we will look forward to talking with you soon.

The one point I would make is there is an analyst meeting coming up in early August, and I think as we indicated in the invite, there will be further discussion by Al Kelly and Ed Gilligan around our businesses and the trends and the like and look forward to seeing many of you there as well.

Thanks very much.

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