美國運通 (AXP) 2010 Q3 法說會逐字稿

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  • Operator

  • Ladies and gentlemen, thank you for standing by.

  • Welcome to the American Express third-quarter 2010 earnings release conference call.

  • At this time, all participants are in a listen-only mode.

  • (Operator Instructions).

  • As a reminder, this conference is being recorded.

  • I would now like to turn the conference over to our host, Mr.

  • Ron Stovall.

  • Please go ahead, sir.

  • Ron Stovall - SVP IR

  • Thank you very much, Cathy, and welcome.

  • We appreciate all of you for joining us today in the call.

  • As usual, it's my job 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 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 the forward-looking statements included in 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 2009 10-K report and 2010 first- and second-quarter 10-Q reports, all already on file with the Securities and Exchange Commission, in the third-quarter 2010 earnings release and earnings supplement, as well as the presentation slides, all of which are now posted on our website at IR.AmericanExpress.com.

  • We have provided information that describes certain non-GAAP financial measures used by the Company and the comparable GAAP financial information.

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

  • Today's discussion will be structured differently than recent calls.

  • We will begin with our Chairman and Chief Executive Officer, Ken Chenault, who will provide some perspective on the evolving regulatory environment surrounding the payments industry and the DOJ's antitrust lawsuit against the Company.

  • Then Dan Henry, Executive Vice President and Chief Financial Officer, will review some key points related to the quarter's earnings through the series of slides included with the earnings document and provide some summary -- or brief 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.

  • Ken Chenault - Chairman, CEO

  • Good afternoon and thank you all for joining our call today.

  • As Ron said, given the news that hit this month about the DOJ lawsuit, we are going to break from our norm on today's conference call.

  • So, before turning things over to Dan to cover the third quarter, I'm going to spend a few minutes sharing my views on the various regulatory and legislative changes that have occurred over the last two years, including the DOJ lawsuit.

  • I'm going to discuss the issues raised by all of these changes, not just for our Company, but for the payments industry overall.

  • First, I want to assure you that we're taking the DOJ lawsuit very seriously.

  • However, a number of the changes we are currently seeing are likely to have far greater impact on industry growth, pricing, consumer behavior, and merchant relationships than the DOJ suit alone.

  • The lawsuit, after all, is about steering between credit products.

  • Merchants are already allowed to offer a discount or incentive for customers who pay by cash, check, or debit card, but few do.

  • For bank-issued credit products, there is some rate differential between products.

  • For example, for Visa credit products, the difference between their high and low interchange rates is approximately 90 basis points.

  • That's $0.90 on a $100 purchase.

  • All things being equal, it seems questionable whether merchants would disrupt the transaction at the point of sale and risk a potential loss of customer goodwill for the sake of a relatively small differential.

  • For me, the core issue of the lawsuit is a simple one.

  • It's about consumer choice and the right of a customer to select the card they want to use at the point of sale.

  • Now I don't believe the government or the merchant should be making this choice.

  • This choice should belong to the customer.

  • And I also believe that we, as a Company like American Express, should have the right to negotiate freely with our merchants on the terms of our contract.

  • Our contract requires the welcome acceptance of our card products and our customers at the point of sale.

  • And I don't believe that government intervention in this matter or in any legal commercial negotiation will lead to a positive outcome.

  • Finally, I disagree strongly with the DOJ's assertion that we have market power, that merchants are forced to accept our products.

  • This is not the case, and I believe it's one of the many reasons why we'll win this suit.

  • In terms of merchant acceptance, we are the smallest network, smaller even than Discover, who is not a party to this suit.

  • In the DOJ's own antitrust case against Visa and MasterCard several years ago, they explicitly stated, and the courts agreed, that we did not have market power.

  • Merchants chose to accept AMEX because they understand the value we bring them -- higher spending customers, our superior service, and our marketing expertise to help them expand their business.

  • Our actions in the marketplace are all about competition, not coercion.

  • Now as I said earlier, while we certainly take this lawsuit seriously, it's also essential to put into perspective and, in fact, connect the dots against all the changes across the payments and card industry in recent years.

  • Just over the last two years, we've seen the Card Act, the Dodd-Frank Bill, we've seen Durbin on interchange regarding debit, and new regulatory limits on overlimit fees.

  • Now, this regulation and the legislation has clearly been the most significant in the history of the card industry.

  • Each clearly reflects the political environment and a turn back towards regulation rather than competition in the banking, financial services, and card industry.

  • And while they share a common starting point, each one is likely to have a different impact on the market, on the consumer, and on different players in the industry.

  • For example, among other impacts, the Card Act has changed how some consumer products are priced.

  • On one side, it has simplified terms, conditions, and made disclosure more transparent.

  • It has insulated some consumers from higher interest rates and fees if they fall behind on payments.

  • And it forced some issuers to stop practices that were misleading or, at best, very hard for customers to understand.

  • Now on the other side, it may cause some lenders to limit access to credit to all but the most financially-secure borrowers.

  • It may increase the overall cost of borrowing from some banks as they offset their inability to charge higher rates for riskier customers.

  • It's made the traditional mass-market credit card business less attractive.

  • It's caused some issuers to reorient their sights on the premium sector.

  • And it may cause others to scale back investments in the card business, perhaps significantly.

  • Now we've noted before that because of our spend-based model, we're less impacted by the Card Act than our bank-issuing peers.

  • For example, while we did have a significant impact within our yield because of the Act, we've worked to mitigate it through our repricing activities over recent quarters.

  • The financial impact on many issuing banks from the Card Act is substantially greater, and therefore harder to mitigate.

  • And during the second-quarter earnings cycle, a number of our issuing peers disclosed that after mitigation, they would have net income losses of several hundred million dollars as a result of the Card Act.

  • The Dodd-Frank Act, which included Durbin and the creation of the Consumer Financial Protection Bureau, coupled with the Reg E changes to overdraft practices, are likely to have an equally broad impact on issuing banks.

  • The Consumer Financial Protection Bureau will represent continued uncertainty until its approach and regulatory program are clarified, and the combined effects of Durbin and Reg E are easier to see.

  • So on the one side, it's eliminated high, frequent, overdraft charges to consumers, Reg E.

  • It's eliminated the practice of processing high ticket debit transactions out of sequence in order to generate multiple overdraft fees.

  • It may provide merchants a lower interchange and/or transaction fee for debit and certain prepaid cards, and it's given consumers the choice of whether to accept and pay for overdraft protection.

  • On the other side, it's made the debit card business much less attractive to banks.

  • If banks do end up imposing monthly debit or transaction fees, consumers may shift back to credit or charge products, and it may lead some banks to impose higher fees or rates elsewhere in retail banking to compensate for lost debit revenue.

  • But there are certainly competitive consequences to an action like that, and it has the potential to cause a scaleback or elimination of rewards programs that are tied to debit products.

  • So what we have here is bank issuers are seeing their debit economics squeezed from two sides -- lower interchange rates and lower revenues from overdraft fees.

  • Their previous public disclosures on these changes again projected loss revenue in the billions of dollars.

  • Our charge and credit products do compete with debit.

  • So the Durbin pricing adjustments will impact competition among payment products.

  • However, whether and to what extent that competition will affect our pricing and revenues will depend on the specific government guidelines and the reaction of consumers to steering.

  • Depending on the Fed's reasonable and proportional debit study comes out, there is the potential for a 50 to 100 basis points reduction in debit interchange fees from current levels.

  • This could increase the gap between debit and credit rates to approximately 150 to 200 basis points.

  • With this potential benefit, some merchants may try to steer their customers towards debit, but given this rate differential, it's possible they could fund some discount or incentive to encourage customers to switch to debit.

  • But there is still a question of whether the amount will be significant enough for merchants to disrupt the sales process and risk a potential loss of customer goodwill.

  • Now, the DOJ case on the surface addresses some of the same issues as Durbin.

  • The terms of its settlement deal with Visa and MasterCard would allow merchants to steer consumers to a lower-priced credit or debit product.

  • For example, if a consumer pulls out a Visa Rewards product, the merchant has the right to ask a customer to switch to a Visa or MasterCard credit product with a lower rate.

  • The merchant could offer the consumer an incentive for them to switch or they could just ask.

  • Now as I mentioned earlier, the gap between a higher-cost Visa and a lower-cost Visa is about 90 basis points.

  • And for context, the AMEX average rate is about 25 basis points higher than Visa and MasterCard's average for credit products, or about $0.25 on a $100 transaction.

  • Assuming these differentials remain constant, steering between credit products does not offer a lot of marginal economics for merchants, particularly when weighed against the potential alienation of good customers and the operational difficulties in implementing these actions at the point of sale.

  • The irony here is that if the DOJ's case against us were successful and merchants did engage in steering, it is far more likely for merchants to steer customers to Visa and MasterCard and away from us, thereby making the two dominant players in the industry even more dominant and harming competition.

  • This is why we must defend and win this case, and we will.

  • So in my view, as far as the DOJ settlement is concerned, it offers a remedy that could push more business to the two largest networks and, if it is put into effect, could push consumers to lower-value cards that offer minimal protections, fewer benefits, limited customer service, scaled-back rewards, and, potentially, higher interest rates.

  • So for the card industry, over the last two years the impact of the legislative, regulatory, and DOJ actions can be summarized like this.

  • The Card Act will have the biggest impact on issuers who have relied heavily on interest income from basic revolving credit products, issuers who relied heavily on backend and penalty fees, and issuers that targeted less creditworthy borrowers.

  • Durbin will have the biggest impact on debit card issuers and potentially on merchants steering to debit from other payment products.

  • Now the DOJ impact is yet to be determined.

  • But it is more likely to have a smaller dollar impact on the industry than the Card Act or Durbin.

  • Now going forward, I believe the traditional lend-centric models most bank issuers rely on will need to be refashioned.

  • Some issuers will focus on low-cost, no-frills products.

  • Others will focus on full-service, high-value alternatives, and this segmentation among issuers is already underway.

  • Going forward, I believe debit-based models will look much different and debit products will likely cost more for consumers to use, while offering fewer rewards.

  • But I also believe that despite all the changes, there are some constants.

  • First, that many consumers and merchants will continue to place a premium on superior value and service, and second, that regardless of the industry, merchants, while they will always want a lower price, want high-spending customers and value from the payment networks they choose to accept.

  • Merchants know how important it is to treat customers well at the checkout counter, particularly in a slow-growth economy, and successful merchants will be reluctant to risk losing the goodwill of their customers absent a real economic upside for them.

  • So while everyone will need to adapt to a new regulatory environment, long-term success within payments will continue to depend on several factors -- treating customers well, providing superior service, providing value in return for a fair price, innovation is going to be critical, and obviously keeping expenses in line.

  • Superior service and value will continue to earn a premium price from card members and merchants.

  • And I believe that we can compete very successfully as a network of choice for high-spending card members.

  • Our strong recent performance has shown that we have been successful in each of these areas, and I remain highly confident in our ability to compete and win in the future.

  • So with that, let me now turn things over to Dan to go into detail on our third-quarter results.

  • Dan Henry - EVP, CFO

  • Thanks, Ken.

  • So I will use our slide package and start with slide two, summary of financial performance.

  • So total revenues were up 17%, but the more appropriate line to look at is the managed total revenue line, which was up 5%.

  • That compares with being down 1% in the second quarter.

  • Income is $1.093 billion, and it's the second quarter in a row that we've had income over $1 billion.

  • EPS is at $0.90, a significant improvement from last year.

  • And ROE is now 26%.

  • Moving to slide three, metric performance, billed business had 14% growth, and this is a continuation of the strong growth that we saw in both the first and second quarter.

  • Cards in force, proprietary cards were flat with last year.

  • GNS cards increased 3%, so total cards are up 1%.

  • Average spending also has continued to be strong with growth of 15%.

  • Loans on a managed basis decreased 6%, based on our actions and customer deleveraging.

  • Now this is down less than what we saw in the first and second quarter.

  • Travel sales increased 21%, driven by airline spending, which was up 20%, as we saw both higher average price and higher number of transactions, both in consumer and corporate.

  • Looking at slide four, worldwide billed business, so the bars on this chart reflect the amount of billed business each month.

  • The lines represent the growth rate both on a reported and an FX basis.

  • So monthly billed business has been at $58 billion or more since March.

  • The third quarter, we had growth of 14% despite more difficult growovers as billings were improving last year.

  • Now, billings month to date in October are growing at about the same rate as we saw in the third quarter.

  • Moving to slide five, which is billed business by segment, you can see that we had strong billed business growth across all businesses.

  • Each segment had double-digit growth, both on a reported and an FX-adjusted basis.

  • GNS continues to have the strongest growth, but global commercial services, or GCS, needs to grow at above-average rates.

  • Again this quarter, it appears that we will gain share in the U.S.

  • as growth in our spending by our customers is notably above the growth we see in our competitors' spending.

  • Slide six, billed business growth by region, so here again we see strong performance in all regions, particularly JPAA, which is Asia and Australia.

  • All regions had double-digit growth on an FX-adjusted basis, so we can see that the growth in business is really very broad-based, both by business and by geography.

  • Moving to slide seven, so this is spending by product for U.S.

  • consumer and small business, and you can see here spending by product over the past five quarters.

  • Billed business growth continues to be strongest in charge and co-brand products, consistent with our strategy and investments in premium lending and charge.

  • Moving to slide eight, so this is lending billed business and managed loan growth; the solid line is loan growth -- is billed business and the dotted line is loans on a managed basis.

  • So loan balances are no longer tracking closely with the increase in spending on lending products, as you can see on the chart.

  • Due in part to our actions and part to consumer deleveraging, our actions have included line management reductions, fewer prop lending acquisitions, and significant reductions in balance transfer, and card members have changed their behavior as they are transacting more and revolving less.

  • If you look at our lending trust paydown rates, in September of 2009 paydown was 25.2%, and in September of 2010 it was 29.28%, an increase of over 400 basis points.

  • So next is slide nine, and this is our net interest yield for USCS, looking at managed loans.

  • As we've discussed in prior quarters, the impact of the Card Act within yield is significant.

  • However, we have worked to mitigate it through repricing.

  • And you can see on the chart the increase in yield from the fourth quarter of 2008 to the first quarter of 2009.

  • We expect yield to migrate back to the historical range of yields in the high 8%s or 9%, and you can see that this is taking place in the second and third quarter of this year.

  • Moving to slide 10, which is revenue performance, discount revenue is up 13%, driven by 14% growth in billed business, partially offset by faster growth in GNS billed business and higher contra revenues, including higher cashback rewards and corporate incentive payments.

  • The average discount rate was 2.56%, up two basis points from last year and flat with the second quarter.

  • The increase compared to last year reflects certain pricing initiatives.

  • Going forward, we will likely see an erosion in the average discount rate over time.

  • Card fees continue to hold, and we're basically flat with last year.

  • Net interest income should be looked at on a managed basis, so we are down 16% through the combination of loans being down 6% and the decrease in yield from 10.2% last year to 9.5% in the third quarter of this year.

  • Now, those are worldwide numbers.

  • The numbers on the prior slide were for USCS.

  • Travel commissions and fees reflect the higher travel sales that we saw earlier.

  • Other revenues, up 13% on a reported basis, and that reflects the fact that we have fees on loans that were previously securitized.

  • If you look at it on a managed basis, we're up 4%, and that's being driven by higher foreign currency conversion revenue and higher GNS partner-related revenues.

  • Overall, we're up 5%, and while that's not robust, it compares very favorably to the revenue growth that we saw earlier in the year.

  • Now moving to slide 11, charge card provision improved over $50 million based on improved metrics and lower reserve requirements.

  • If we look at card member loans or lending provision, it has improved dramatically by over $700 million on a GAAP basis, as you can see on the slide.

  • On a managed basis, it's actually $1.2 billion better.

  • And this is due to significantly improved write-off rates, which result in lower write-off dollars in the quarter, and improved 30-day past-due levels that translate into lower reserve requirements.

  • Reserves decreased by $548 million in the third quarter, compared to the second quarter.

  • Slide 12, expense performance.

  • Marketing promotion is up significantly in the third quarter, compared to last year, and up from $208 million in the second quarter of this year.

  • This is consistent with what we've said.

  • As credit improved, we indicated we would drop some to the bottom line and invest to drive business momentum.

  • Next is rewards.

  • Now here, if we exclude the benefit in the third quarter of 2009 related to a policy change related to accounts that were 30 days past due, rewards expense increased in line with spending.

  • Salaries and benefits increased 7%.

  • This reflects merit increases, higher benefit costs, and higher compensation -- incentive compensation on an employee base that is basically flat with last year.

  • Other operating expense includes, in last year, a benefit related to adjustment in how we accounted for our net investment in foreign subsidiaries.

  • Absent that, it increased 17%, reflecting higher technology-related expense, higher T&E, and investments in new business initiatives.

  • Now, income taxes are higher, and that is due in part to higher income and part to the fact that we have a higher tax rate.

  • In this quarter, it's 33%.

  • In the third quarter of last year, it was 30%.

  • And that really reflects the level of pretax income relative to the recurring permanent differences that we have.

  • So when income was lower, those permanent differences have a larger impact, and as income increases, it has less of an impact.

  • So, a 33% rate is a reasonably normalized rate for our business.

  • Moving to slide 13, marketing and promotion expense, as I've mentioned, marketing and promotion is above historic levels, as you can see on this chart.

  • We have elevated spending levels across U.S.

  • consumer and small business, international consumer, and the merchant and network businesses.

  • Within USCS, it's primarily charge and premium co-brand acquisition.

  • In international consumer, it's primarily acquisition and spend stimulation.

  • In the merchant business, it's spending on perceptions of coverage and brand communication, and in GNS, it's contractual payments driven by higher billings.

  • Moving to slide 14, operating expense, so operating expense growth was 12%.

  • Now some portion of that is investments to drive growth in our business, and that is above 12%.

  • And a portion is not driving revenues, and that's below the 12%.

  • Here we can see that we have significantly higher levels of spending on technology development that supports business growth -- new business initiatives including Loyalty Edge, Revolution Money, and Business Insights, as well as GNS partner investments and higher levels of salesforce, while below the dotted line, we are controlling non-revenue-generating OpEx.

  • Moving to slide 14, now this is charge card reserve coverage.

  • Now while charge card credit metrics are improving, we have maintained appropriate levels of reserves across the U.S.

  • card, international card, and global commercial services, as you can see from the reserve coverage ratios on this page.

  • On page -- slide 16, here we're looking at managed lending net write-off rates.

  • And here you can see that managed lending write-off rates have improved dramatically over the last four quarters in both the U.S.

  • and international.

  • In the U.S.

  • in the third quarter, the write-off rate was 5.2%, a 100 basis-point improvement from the second quarter and 370 basis points' improvement compared to last year.

  • Our metric performance is substantially better than the industry.

  • Next, slide 17.

  • So this is the managed lending 30-day past due chart.

  • So, again, lending and 30-day past due also continues to improve, both in the U.S.

  • and internationally.

  • These improvements will prove to be beneficial to us as we move forward.

  • Next is slide 18, and here we're providing information for USCS lending related to roll rates and bankruptcy filings.

  • So the current month write-off is a function of the current to 30-day past-due roll rate five months ago.

  • So the green triangles in the upper-left chart is the write-off rate in -- three triangles in the upper left lead to the write-off rate in the third quarter of this year.

  • And you can see that they are lower than the three triangles just before that.

  • So, all else being equal, you would expect write-offs in the third quarter to be lower than the second quarter, which is what we've seen.

  • You'll also see that the three triangles following the three dots are lower.

  • So all else being equal, we could see fourth-quarter write-offs being lower than the third quarter.

  • You'll also note the 30-day past-due to write-off, the bottom left chart, is improving slightly.

  • Now, bankruptcies on the right -- if you took an average of the three quarters in 2010, you can see that they are slightly lower than what we saw in 2009, and this is the number of filings.

  • Two other things to consider is the dollar amount of each filing, and they have been lower this year than in 2009, and the other is the percentage of filings that we've already written off, and that percentage is higher than we saw last year.

  • So, all in all, bankruptcy losses are lower than last year.

  • Now I'd remind you that these are uncertain economic times, and what the write-off rate in the fourth quarter will be will depend on the 30-day past due to write-off percentage, bankruptcies, and recoveries -- what they actually are.

  • Moving to slide 19, so this is our lending reserve levels, and it reflects the activity in the third quarter of last year and this year, and you can see that the dollar write-offs have improved significantly.

  • So if you look at the chart and look at 2009, write-offs were $850 million.

  • This year, they were $810 million, but that includes both the previously securitized and those that were on balance sheet.

  • If we looked at this on an apples-to-apples basis, you'd have to add the write-offs related to the securitized receivables last year.

  • They were about $500 million.

  • So the actual comparison is about $1.350 billion, compared to the $810 million that we had this year.

  • So the reserve level we have reflects our credit performance and the inherent risk in the portfolio, and you can see that we have reduced lending reserves by $550 million.

  • Next, on slide 20, we look at lending reserve coverage.

  • And as you saw on the prior slides, credit metrics have been improving, and we have reduced reserves based on our methodology.

  • However, we continue to be cautious in setting reserves as the economic environment remains uneven and unemployment remains stubbornly high.

  • Here, you can see the reserve coverage ratios in the U.S.

  • and on a worldwide basis.

  • Our reserve coverage reflects the uncertainty that we see in the environment.

  • So next is our capital ratios.

  • And so, while the capital requirements, what they'll actually be, is still evolving, our capital position and ratios remain strong, particularly Tier 1 Common, and you can see that it has increased from 10.7% in the second quarter to 11.7% in the third quarter.

  • Now one other thing that I would note is that it's our plan in the fourth quarter to repurchase shares approximately equal to the 15 million shares that we issued under employee programs over the past four quarters in the fourth quarter of this year.

  • So, moving to slide 22, this is our liquidity snapshot.

  • We continue to hold excess cash and marketable securities to meet the next month of funding requirements.

  • Now, the higher-than-normal level of excess cash is due to the funding maturities in the fourth quarter and the anticipated seasonal increase in the balance sheet associated with higher holiday spending in the fourth quarter.

  • Now looking at slide 23, this is our retail deposits.

  • Now as accounts receivable and loan balances remained relatively consistent with the second-quarter level, we did not have demands for higher funding levels.

  • So this quarter, we focused on reducing brokerage CDs and continuing to grow direct personal savings CDs and high-yield savings deposits.

  • So, with that, let me conclude with a few final comments.

  • Results for the quarter reflect the continuation of the positive business trends evident during the first half of this year.

  • Spending growth remains strong across all our business segments.

  • In fact, on FX-adjusted basis, this was the strongest quarter ever in terms of dollars spent.

  • We also continue to see further improvement in credit trends.

  • Some of this is due to our strategic and risk-related actions, some reflecting the post-recession behavior of consumers.

  • Even through these trends have contributed to a divergence between consumer spending and borrowing levels, the net effect is a lower risk profile for the Company as charge and co-brand spending are the main driver of our volumes and receivable trends.

  • Managed revenue growth of 5% improved versus prior quarters and outpaced our large industry competitors, as strong card member volumes more than offset the impact of lower loan balances and yields.

  • Importantly, our strong billings growth, improving credit trends, and well-controlled operating expense provided an ability to invest in the business at significant levels, while also generating strong earnings.

  • Some of these investments are driving metrics and improving revenue comparisons near term, but others are focusing on the medium- to long-term success of the Company.

  • Challenges clearly remain in the U.S.

  • and many other key markets.

  • Job creation remains weak.

  • Consumer confidence is volatile.

  • Consumer behavior is uncertain, and regulatory and legislative initiatives are changing aspects of the business going forward.

  • While we are currently investing at historically high levels, these factors have us approaching the future investments and spending commitments with caution.

  • But the bottom line is that our strong competitive position is yielding high-quality results, as spending on our network continues to increase well above industry average and our credit performance remains best among major card issuers.

  • This gives us confidence that our investments and differentiated business model are appropriately positioned to manage through our challenges, capitalize on the opportunities in front of us, and continue to win in the marketplace.

  • Thanks for listening.

  • Ken and I are now ready to take questions.

  • Operator

  • (Operator Instructions).

  • Craig Maurer, CLSA Limited.

  • Craig Maurer - Analyst

  • A couple of things.

  • First, I was wondering what changed in the quarter for you from the prior conference calls.

  • In the last call, if I remember correctly, you'd indicated that marketing spend had peaked in the second quarter.

  • So, what were you seeing in the environment?

  • Secondly, regarding the other expenses, the $251 million, I was hoping you could go into a little more detail there because it's up dramatically off the prior quarter and the quarter before that.

  • And I'm wondering if there's any type of one-time spending in that number.

  • Thanks.

  • Dan Henry - EVP, CFO

  • I think last quarter we had $802 million, which is probably the peak that we had seen at that juncture, but as we've said, as credit improved, we were going to continue to invest.

  • And so, credit continued to improve, billed business continued to be very strong, and so we actually elevated marketing spend to a somewhat higher that you saw in this quarter, and what you see in operating expense, as what we've said and the reason I think we provide the new bubble chart that we've had for a couple of quarters, is that investments are not solely marketing and promotion.

  • Certainly, marketing and promotion is one aspect of our investments in terms of acquiring customers and stimulating spending with existing customers, but investments also include bringing on the right capabilities, having the right talent to move forward with our new business initiatives, and it also includes investing in higher salesforce for both our merchant business and our commercial business.

  • So I think the increase that you're seeing in operating expense is a reflection of that.

  • So as long as we have strength in the business, we'll continue to invest at higher levels.

  • Ken Chenault - Chairman, CEO

  • I would say given the momentum that we're seeing in a range of businesses, and the opportunity that we have to invest, we obviously want to continue that, moving aggressively.

  • Dan Henry - EVP, CFO

  • So I think this is part of what we've talked about, I think, for some time, which is really the flexibility that we have in our business model.

  • While we have this strong performance in spending by our customers and the improvement that we're seeing in credit, we're going to flex up and invest at a higher level.

  • As those diminish, we'll flex back down our investment to more traditional levels, but I think we've demonstrated that in 2009 we can flex down, but where we have the opportunity we can also flex up.

  • So we went to take some of that and improve the bottom line.

  • I think you saw a significant improvement in the bottom line.

  • But we also want to invest to drive business momentum going forward.

  • Craig Maurer - Analyst

  • Understood, but when I think about the run rate, my question is more along the lines of -- are -- is a lot of that going into the $251 million one time to build capabilities, and you'll see that investment slow down again.

  • That is what I'm getting at.

  • Dan Henry - EVP, CFO

  • Yes, okay.

  • So I think that when we get back to a more normal state as it relates to provision, I think you'll see marketing spend back more to where we were, say, in the 2005 to 2007 timeframe, and I think you'll see operating expense not grow at the levels that it's growing today.

  • It may be not the level that we had back in 2007 because I think the nature of our business is changing somewhat, and you can see that we are investing in businesses that are more fee related and that generally will be driven by operating expense.

  • But we will continue to be focused on having the right margins in PTI.

  • So, that's something we'll focus on going forward.

  • Craig Maurer - Analyst

  • Okay.

  • And with Ken in the room, Ken, I was wondering if you could give us your thoughts on PCF's suit to try to block the Durbin amendment?

  • Ken Chenault - Chairman, CEO

  • Frankly, I have not studied that closely, so I really can't shed a lot of light on that at all.

  • Obviously, debit is an important piece of business to them.

  • They are very focused on it, but that's not something I frankly have spent a lot of time on.

  • Operator

  • Ken Bruce, BofA Merrill Lynch.

  • Ken Bruce - Analyst

  • Thank you and good evening.

  • First, very impressive quarter.

  • Second, understanding the answer that you just gave to Craig, I'd like to ask maybe a bigger picture question as it relates to how you see the credit card market and the charge card market evolving, with obviously a lot of competition focused on the high end.

  • If you think that some of these costs, in particular, rewards, are going to be, in essence, at a higher run rate going forward, though, despite your interest in maybe pulling back at some point in the future that you don't have quite as much flexibility, if you could give me any kind of sense as to how you're thinking about that, any early thoughts about competitor moves as they begin to target the affluent market again.

  • Ken Chenault - Chairman, CEO

  • I think, first, if we just step back a little bit is, one, it is not new news that we've had a number of competitors, literally over the past 20 years, on the premium segment.

  • And the reality is that I think that certainly rewards are important.

  • It's important to have a diversified rewards program.

  • And it's clear that our competitors and ourselves are investing more in those capabilities, but at the end of the day, what we've been able to demonstrate is that we're getting very good returns from those investments.

  • It's less clear, given the difference between a lend-centric and a spend-centric model, if our competitors in fact will enjoy the same types of economics, but we've proven that we can impact those levers.

  • The third piece that I think is very important is, if we just look at the backdrop of the last 18 months and look at the disproportionate growth that we've been able to generate against our competitors, when in fact some of our competitors have dramatically increased their marketing and advertising spending, it does not seem to have had a damaging impact.

  • In fact, quite the contrary.

  • We have accelerated our growth and our market share improvement.

  • The last piece that I think I would emphasize very strongly is that we have, in fact, made investments.

  • We have concentrated on improving our service quality and our capability of service both online and off-line.

  • It is easy to replicate a feature on a card product.

  • It is much harder to deliver consistently high-quality service, and if I go back to the J.D.

  • Power award, frankly -- and I won't name names, but if you take a look at the list of issuers and those who were saying that they're focused on the premium market, some of them, in fact, are in fifth and sixth and seventh place, and we, in fact, have won for four years in a row.

  • So one of the things is we clearly understand the causality of segmenting our customer service and providing it.

  • So, I think it's a focus.

  • Certainly, rewards are important, features are important, service is important, but the momentum that we have generated over the last year and the fact that that momentum is increasing, so that gives me a lot of confidence going into the premium segment.

  • But as I said earlier when I was going through some of the trade-offs, I really do believe that someone who has a lend-centric model, which is most of the traditional bank card issuers, are going to have to substantially reconfigure their business models to compete effectively going forward because they have the impact, some of them, of debit.

  • They had the impact of the changes in pricing and they've got to find some of the formulas that will allow them to really come up with a premium value proposition that resonates with the consumer.

  • Dan Henry - EVP, CFO

  • So the only thing I'd add to that is that part of putting a value proposition in the marketplace that consumers want to use, and we are seeing them use our product, part of that is having a valuable rewards proposition.

  • And so, going forward, it's likely that you will see that rewards as a percentage of revenues will be slightly higher than we may have seen in the past, and we recognize that and that means that we need to be very focused on operating expense efficiency, which we are, and a combination of all those things again, I think, will provide economics that are very attractive.

  • Ken Chenault - Chairman, CEO

  • Yes.

  • The only other point I would make, because you really do have to connect the dots on all that is going on, that as you improve the value proposition of your premium products, in fact the value proposition to the merchant improves because the merchant wants to generate more spend, and they're going to get that from those customers that carry premium products and that will spend more.

  • And that's why our average spend is four times that of Visa and MasterCard.

  • So, I think what's very critical is you've got to look at what we call this virtuous circle, that you've got to have an improved value proposition that customers really want, and obviously then get those customers who will spend more so that their value proposition at merchants is enhanced.

  • And in these economic times, we are finding that to be incredibly valuable.

  • Ken Bruce - Analyst

  • Great.

  • Points well taken.

  • Could you reiterate -- you had mentioned, Dan, the momentum coming into the fourth quarter was equally strong from a growth perspective.

  • And also, do you have any thoughts as to maybe whether credit has the capacity to trend well below the historical norm, which it seems like you're getting there very quickly, if you think that we're actually going to be looking at a sustained period of very low credit losses, given the nature of the underwriting over the last few years, please.

  • Dan Henry - EVP, CFO

  • What I indicated is billed business month to date in October growth rate was similar to the growth rate that we saw in the third quarter.

  • Now in terms of credit, I think we're all keenly aware that our credit has improved at a far more rapid pace than the industry.

  • And I think where it will settle out will obviously in each period depend in part on the economy, but I think it will be impacted by the strategies that we've put in place where we're focusing on charge and premium lending.

  • So, to the extent that's our focus going forward, I think it's reasonable to have an expectation that it could be somewhat lower on average and over time than what we may have seen before when we participated more broadly in the lending space.

  • Operator

  • Betsy Graseck, Morgan Stanley.

  • Betsy Graseck - Analyst

  • Thanks so much.

  • Good evening.

  • Question on international.

  • I wonder if you could give us some color as to what kind of investments you are making in the non-U.S.

  • space.

  • It seems like one of the opportunities, and I guess I'm wondering if you have anything in the works to expand your presence overseas.

  • Dan Henry - EVP, CFO

  • Right, so we believe that there is opportunity for strong growth outside the U.S..

  • We are actually increasing slightly the allocation of investments to more globally outside the U.S..

  • Ken Chenault.

  • And that has been the case over the last several years.

  • Dan Henry - EVP, CFO

  • And so, we're focused really on two things.

  • What are the right acquisitions that we should make in our proprietary markets?

  • How can we fairly further stimulate our current customers?

  • And then, quite frankly, how can we kind of optimize internationally between what we do on a proprietary basis and what we do with GNS partners?

  • And that has been our focus, and is going to continue to be our focus as we go forward.

  • Ken Chenault - Chairman, CEO

  • Yes, the other point I would make is that we're making substantial investments across our payments business -- our global merchant services business -- to bring on more merchants.

  • That's something that we have invested in outside the U.S.

  • as well as the U.S..

  • And the other point that I would make is that our GNS business not only helps us acquire card and acquire spending, but also allows us to expand our merchant coverage.

  • So, we have been very pleased, I think, as you saw from the numbers, in international, the growth that we are generating, and in fact, the innovation that's taking place in those markets, so that -- the priorities that we had listed for growth, international remains one of our top priorities.

  • Betsy Graseck - Analyst

  • Okay, yes, because when people just look at the simple charts of merchant acceptance, it looks like there's a gap and that you need to spend some investment dollars on filling that, and --

  • Ken Chenault - Chairman, CEO

  • Yes, and that is exactly what we're doing.

  • As you went through some of those bubble charts from Dan, the reality is that in the operating expense line, we are expanding our salesforce and we have expanded that -- our salesforce in the international markets for coverage.

  • So you've got to look at two ways that we're doing that.

  • One is we are increasing our proprietary salesforce, and then in the bank partnership deals that we're doing, in a number of those deals we're also able to get our partner to expand merchant acceptance.

  • So that's something that we're very focused on, and obviously you will see the impact of that over the next several quarters.

  • So, it's not something you're going to see in 30 days, but you'll see it over the next several quarters.

  • Betsy Graseck - Analyst

  • And so, a dollar invested in the U.S.

  • versus a dollar invested in the non-U.S.

  • markets, which one has the faster growth rate or profitability associated with it?

  • Dan Henry - EVP, CFO

  • So, I think it depends on the investment, so I don't think there is a blanket statement that international is better than U.S..

  • I think it's really depending on what the product is and what the nature of the investment is.

  • And as we've said, we've tried to concentrate some of our investments about things that give us a near-term return, and others are more focused on the medium to long term.

  • But even the near-term investments, when you take a salesperson on, you need to train them, they need to get seasoned, and so all of these things that we do when we evaluate investments, we're not evaluating -- what's the benefit three quarters from now.

  • We are really evaluating what's the value that's created over the life of either the salesperson, the merchant, the card member that we are acquiring, and that's how we evaluate investments.

  • Ken Chenault - Chairman, CEO

  • Yes, I'd just like to emphasize, you've really got to separate out what I'd call the card acquisition investments from the salesforce investments because they have a longer tail.

  • But the impact of those investments, as we have seen over the years in middle market and large corporate, have been substantial, even though it is a longer tail.

  • And the other point that I would make is, as a result of consolidating the card businesses under Ed Gilligan, we're able to more quickly make portfolio acquisition changes of how we're going to allocate those dollars across markets and across products that has really helped us in a major way.

  • Operator

  • Mike Taiano, Sandler O'Neill & Partners.

  • Mike Taiano - Analyst

  • I just wanted to make sure I understood on the regulatory challenges, and I know obviously they're all challenges, but you're making the case that the Durbin amendment, because of the differential between credit products and debit products, as well as cash and check, is a bigger threat than the DOJ case because of the smaller differential between you and Visa MasterCard.

  • Ken Chenault - Chairman, CEO

  • Look, the point I'm making is that if you go through debit and -- just don't listen to me.

  • In fact, as you go through the pronouncements from a range of banks, what they're saying is that their revenues are being impacted by billions of dollars.

  • Because you have this double-whammy squeeze going on is you have the squeeze going on on the issuing side and what the features are going to be, and then you have the issue of the potential of a lower interchange rate.

  • So, one, at the end of the day, we're not in the debit card business.

  • But the point is that if you review the earnings releases and the statements that I've read from major banks, they are the ones saying that debit will not be as profitable, that they, in fact -- some have said on an individual basis that they're going to lose billions of dollars in revenues.

  • Now, the point for us that I think is critical, while it's hard to speculate on what the individual impact will be on us, the reality is -- what's not new news is that we know that merchants don't have to accept our products and we have to earn a premium rate every day by providing them with premium value.

  • And as I said earlier, what we have seen, particularly in this environment, is that merchants value spending and that our average spending is three to four times the size of Visa and MasterCard.

  • And they also value, which we are increasingly doing -- we are providing them with information, insights, marketing help, and all of which we think helped tremendously, because we are seeing it, that it helps with the acceptance of the card, but it also is providing us revenues in some of the particular services that we provide.

  • So I think at the end of the day, premium value is at the core of what we do with merchants, and at the end of the day, we face a very competitive marketplace in terms of merchant pricing, I might add, not just in the U.S., but all over the world, but I think what we've demonstrated very strongly in a very tough economy is that we've continued to succeed and grow because of our ability to compete on value, and I have no doubt that that will continue to be the case in the U.S..

  • Mike Taiano - Analyst

  • Thanks, and then just one other question.

  • I saw you guys took up the fee on your Starwood co-brand card this quarter.

  • Was that fairly broad-based with other co-brand products as well and would that have been reflected in this quarter?

  • Dan Henry - EVP, CFO

  • I think what's important, and this is where innovation comes in, if you're a premium value provider, you've got to innovate.

  • And so, what you saw in the Starwood product is we refreshed that product and added some attractive features that increased the value, and at the end of the day, you can't call yourself a premium provider if you're not consistently adding premium value, and so that's what we did on Starwood, and we believe that we're going to get fair value for that product and we think that the increase is very, very fair related to the value.

  • But that is a fundamental principle when you're in the premium value business is that you have to innovate, and we will continue to innovate and when we innovate and when we increase our value, if you're really a premium provider, then you should be able to charge a premium price.

  • Operator

  • Sanjay Sakhrani, Keefe, Bruyette & Woods.

  • Sanjay Sakhrani - Analyst

  • I just had a couple of questions for Ken, based on his commentary.

  • First was, just -- in your conversations with the top merchants, do you believe those merchants would steer customers from credit to debit?

  • And then, secondly, was wondering if you guys have had continued dialogue with the DOJ and if it were possible to come up with some kind of agreement before going to trial.

  • Thank you.

  • And one other question for Dan, just if you could elaborate on the net interest yield trends going forward, I'd appreciate that.

  • Thank you.

  • Ken Chenault - Chairman, CEO

  • Look, I think I'd say, Sanjay, the same point that I made before.

  • The reality is that we have continued to provide substantial value to our merchants, and the spread certainly between credit and debit is larger.

  • However, there is not much evidence that merchants are taking the risk of steering customers.

  • And I think that's a very important point, and what is critical to emphasize is that merchants have had the right to steer from credit to debit.

  • They can do that now.

  • And I think that what is very important is that merchants recognize that what you don't want to do is alienate your good and best customers, and fortunately, we have good, high-spending premium customers.

  • That's the last group that, frankly, you want to alienate.

  • So, we have not seen much evidence of that happening.

  • Dan Henry - EVP, CFO

  • So, to go to your second question, Sanjay, if you look at slide eight, slide nine rather, you can see that back in the third and fourth quarter of 2008, we were at 8.9% yield.

  • We put in pricing changes which were intended to mitigate the impact of the Card Act.

  • So you can see in the first quarter of 2009 that that popped up and through 2009 kind of stayed in the high 9%s, maybe 10%.

  • Now that the Card Act is taking effect, you can see that it's migrating back down, and we would expect that it's going to migrate back down over time to something in the high 8%s or 9% range, and that would be very much in line with what our expectations were.

  • Ken Chenault - Chairman, CEO

  • Sanjay, I just wanted to come back to one point on steering that's worthwhile emphasizing and is critical.

  • Is unlike Visa and MasterCard, merchants are not compelled to accept us.

  • We have to prove that every day.

  • And I think that is a very, very important point, that we've got to sell value to merchants.

  • Merchants are under no obligation to accept us, and what's important for us is we've got to demonstrate that value, and that's why we have to individually negotiate with each merchant to demonstrate that value.

  • The point is that I think we have demonstrated over the years, and certainly over the recent years particularly, how we've come out of the downturn in the billings that we are generating, that merchants are strongly seeing that value.

  • Dan Henry - EVP, CFO

  • So one other thing I just mentioned, as an add-on to what I said about yield, and that's -- our expectations will go back to historical levels.

  • But the one caveat to that is the extent customer behavior changes, then that could potentially impact that.

  • Sanjay Sakhrani - Analyst

  • Okay.

  • And then, just on the DOJ question I had?

  • Ken Chenault - Chairman, CEO

  • You know, look, the reality is -- I'm not going to go through legal strategy.

  • What I've said is we think we have a very strong case.

  • We are going to defend ourselves.

  • We think that the DOJ case is a weak case for all the reasons that we have outlined.

  • And that's the position we're taking.

  • Operator

  • Drew Dampier, Meredith Whitney Advisory Group LLC.

  • Drew Dampier - Analyst

  • On a percentage basis, your travel commissions and fees jumped fairly dramatically.

  • Could you just clarify if that line includes your travelers cheques and prepay business, and what the main driver of that year-over-year growth was?

  • Dan Henry - EVP, CFO

  • So, travel sales does not include prepaid or the travelers cheque business.

  • I mean, the growth that we saw in travel sales, which was both in consumer and corporate, I think is a function of really the resilience that we're seeing in our total customer base.

  • And I think it's also being heavily driven by airlines, where we are seeing both an increase in price and the number of transactions.

  • So I think -- probably that's the largest driver of increase in travel sales.

  • Operator

  • Bob Napoli, Piper Jaffray & Co..

  • Bob Napoli - Analyst

  • Just on your repurchase, I was wondering if you had to get any certain approvals for that, and if you intend to continue to repurchase.

  • And then, a question on the lawsuit as well.

  • Has any other government around the globe attempted to litigate against private contracts, individual contracts, anything similar to this lawsuit?

  • I mean, I think in other markets that have regulated interchange, they haven't attempted to regulate your discount fee to -- maybe a little color on that would be helpful.

  • Dan Henry - EVP, CFO

  • Okay, so I'll take the first question.

  • So the question is do we need to have conversations with the regulators before we do repurchases?

  • And the answer to that question is yes.

  • At the moment, what they've given us the go-ahead on is to the extent we've issued shares related to our employee programs and it really covers what those issuances were over the last four quarters.

  • I think what we've seen in repurchases and financial services to date, for ourselves and others, is really related to employee plan issuances.

  • Certainly as we go forward, we intend to have conversations with regulators on what our plans would be in terms of repurchases going forward, and we'll probably start those discussions within the next month or so.

  • Ken Chenault - Chairman, CEO

  • Bob, in answer to your question, what I would say is, in at least everything I know and in all the markets where actions have been taken in place relative to the interchange rate, they have all been directed to Visa and MasterCard because they're the dominant payment networks.

  • So, that's been the focus.

  • So, you know, it's a question that I would really put to them because they really have been the subject of the focus, not us.

  • Bob Napoli - Analyst

  • Okay.

  • And then, just one quick question on the international.

  • The revenue growth in international was lower than the spend growth -- like revenue growth.

  • I think the discount fee growth in the mid-single digits and spend in the mid-double digits, or is the discount fee coming down international, or why the gap between revenue growth and spend growth?

  • Dan Henry - EVP, CFO

  • Yes, I think one aspect of that might be FX is affecting the growth rate as it relates to revenues.

  • I don't think there's any markedly different trend in discount rates internationally compared to what we're seeing in the U.S..

  • Operator

  • David Hochstim, Buckingham Research Group.

  • David Hochstim - Analyst

  • A couple things.

  • I wonder, Ken, could you talk about whether you think there is any significance to the fact that the Justice Department didn't pursue a change in surcharging rules at this point?

  • Ken Chenault - Chairman, CEO

  • You know, I can't really comment what their intent is or what their strategies are.

  • So, it's -- I couldn't really make any informed response to that.

  • David Hochstim - Analyst

  • Then, is there any other color you could share with us about the conversations you've had with merchants since the lawsuit was announced, aside from --

  • Ken Chenault - Chairman, CEO

  • Yes, I mean, at the end of the day, what I would say is the conversations have been very constructive and very supportive, and the only thing I will say is at least we've also heard from different people in the media who have talked to merchants and have not been able to identify a merchant who is saying that they are going to steer as a result of what the DOJ is doing.

  • And very frankly, exactly the points that I've made -- the reality is people are saying there is no surprise that you charge a higher price.

  • This is not new news.

  • You give us a lot of value, and we like the business that you generate, so very frankly, the conversations have been pleasant, constructive, supportive.

  • David Hochstim - Analyst

  • And then, just wondering if you could explain what happened with total and basic cards in the U.S.

  • this quarter.

  • They're down about 900,000.

  • They were up last quarter.

  • Is there some anniversary of free promotion or something that's --

  • Dan Henry - EVP, CFO

  • No, it really has to do with a change that we made as it relates to certain GNS cards.

  • We had an issuance with a large partner and included all the cards that had been issued.

  • Now, some of those cards, to the extent they're only used in store, don't really generate revenues for us.

  • So we made the decision that we should not be including those cards.

  • So that is actually the fact that is driving the reductions in card members.

  • David Hochstim - Analyst

  • Was it Macy's cards or some (multiple speakers)

  • Ken Chenault - Chairman, CEO

  • No, not Macy's.

  • Dan Henry - EVP, CFO

  • No, it was not Macy's.

  • But we think it's a better reflection of the cards.

  • They're actually generating revenues for us.

  • So it was really a one-time change in policy that drove that.

  • (Multiple speakers).

  • It was 1.6 million cards that we actually backed out related to that.

  • David Hochstim - Analyst

  • So if we wanted to have an apples-to-apples comparison with Q2, we'd take the same 1.6 million out of Q2?

  • Dan Henry - EVP, CFO

  • That would be correct.

  • David Hochstim - Analyst

  • Okay, and then, just lastly, on slide 18 where you have 30-days past due to write-off, there was a nice decline in July, and then a little bit of an uptick in August and September.

  • Can you explain what happened?

  • Dan Henry - EVP, CFO

  • Yes, so that's just a processing [glyph] we shouldn't focus on.

  • In fact, that goes back -- if you took it back to the beginning, it relates to last February, and we were actually in the process of just adopting UDAP and had to change some of the cycle cuts.

  • In addition to that, February is just a shorter month.

  • So what happened is more items fell into the first roll rate that made, therefore, the denominator in this calculation higher, but in the end, it rolled down to the same amount of write-offs.

  • So, that's why you had that little bit of a dip, so it's not an indication of a change from a credit perspective.

  • It was just the mechanics that took place in the systems in February.

  • Operator

  • Bill Carcache, Macquarie Research Equities.

  • Bill Carcache - Analyst

  • I have a couple of questions.

  • First question for Ken.

  • Ken, just for the sake of argument, let's assume for a second that you're not found to have market power.

  • So as you think about managing the business going forward, is market power something that you need to be conscious of, so that you don't ultimately achieve it for obvious negative regulatory consequences or is market power just something that you don't think will ever really be a concern, given you're focused on the premium customer segment?

  • And therefore, that would be something that would make market power not something that would ever be a concern.

  • Could you just share some of your thoughts around that?

  • Ken Chenault - Chairman, CEO

  • Here's my view.

  • I am a growth-oriented guy.

  • I want to grow, and at the end of the day, if I grow to a substantial level under the legal definition of market power, and I have market power, I don't have a problem with that.

  • So, our focus is on growing the business.

  • We think we have a range of opportunities across payments and services to grow, and what I've said to our management team and our employees is I want us to be a growth company, even in a slow growth environment.

  • And, so, the reality is we are now the smallest.

  • And so, what I'd separate out is where we are today.

  • And there are obviously the legal issues with that.

  • But I think we are very comfortable in a world where I have to prove that we provide value to our customers every day, and at the end of the day, my objective is growth, profitable growth.

  • Bill Carcache - Analyst

  • Okay, that's very helpful.

  • Thank you.

  • One other question, on your fee-based initiatives.

  • Can you give us a sense of whether -- it seems like all of these things that you mentioned earlier, or the Card Act there have been, the DOJ sued, Reg E, all of these things, the impact on the pool of profits around cards is clear.

  • But to what extent are the fee revenues that you would generate from your network in these fee-based initiatives not impacted by that?

  • Is that fair to think about it that way or would those potentially be exposed?

  • Ken Chenault - Chairman, CEO

  • No, I think it's fair to think about it that way.

  • The reality is, obviously we cross-sell services to customers, so if we couldn't acquire card or we couldn't retain cards, that would have an impact.

  • But at the end of the day, if you look at our fee services strategy, we are offering fee services to our card customers, we are offering fee services to merchants, we are offering fee services to non-card members, and so I think we have a lot of options.

  • And the other point that I would make is with our enterprise growth group under Dan Schulman, we'll be talking with you in the weeks and months to come about the growth opportunities there, and I would say that the vast majority of those growth opportunities are not related to impacts from the Card Act.

  • All that said, I want to reinforce even in the Card Act, we had a fundamental difference because of our spend-centric model against a lend-centric model that we're less reliant on spread revenue and back-end fees.

  • That is a major difference in our model, and why I think we've been able to navigate through those changes in a way that has put us in a better competitive position than the traditional bank card issuers.

  • Operator

  • Jason Arnold, RBC Capital Markets.

  • Jason Arnold - Analyst

  • Thanks, Ken, for your comments on the regulatory front, very insightful.

  • One market where you've seen regulatory impact on your business from a steering or surcharge perspective already is Australia, and while I know your business is growing and you've been taking share in that market, I'm curious if there's any way to quantify the impact you've seen here in this market as measured on a discount fee or perhaps ROE perspective?

  • Ken Chenault - Chairman, CEO

  • I think the only points that we would make there, and obviously we've been very clear that those -- that the two markets are different, and we certainly did see a lowering of our discount rate.

  • That was clear.

  • But because of the fact, and this is the point that we have emphasized, because we have the most diversified business model, payments business model, in the world, we had other business and revenue and economic levers that we could pull, and so that's why we are in a situation where Australia is generating good growth and good financials.

  • Now I would add, that didn't happen overnight.

  • We had to adjust to those changes, but I think what we were able to demonstrate is that we were able to adjust and actually create not only a viable business, but in fact a very well-performing business that has gained profitable market share over the last several years.

  • Jason Arnold - Analyst

  • Terrific.

  • And then, just one quick one for Dan.

  • I was just wondering if you could talk about where the care and re-aging programs stand, and the size of the loans outstanding here?

  • Dan Henry - EVP, CFO

  • So, the caring program continues in place.

  • Still a very difficult environment.

  • It hasn't grown in size substantially, nor has it really declined in size.

  • As we've said with respect to those customers, we're very conscious of how they're performing, so we understand the economics related to them.

  • In total, it's not a very large program.

  • So I would say it's on an equal footing to where it's been over the last couple of quarters.

  • Operator

  • John Stilmar, SunTrust Robinson Humphrey.

  • John Stilmar - Analyst

  • Ken, to dovetail on the last question with regards to Australia, I believe that in Australia with the right to surcharge, one of the dynamics that's been happening is Visa and MasterCard -- or the merchants are allowed to apply a surcharge differently to American Express versus Visa and MasterCard.

  • But over the time since the implementation of Australia's rules, the surcharge differential has been narrowing, and other than the qualitative that it's been narrowing that we've heard from you in the past, is there any sort of numerical evidence that you can share with us that shows that American Express has taken on Visa and MasterCard with regards to parity at the point of sale with merchants?

  • Ken Chenault - Chairman, CEO

  • No, I think -- here's the point.

  • The reality is that even with surcharging, our fundamental positioning is the same, that we provide substantial incremental value and plus business to merchants.

  • So, we have been successful in, in fact, pushing back surcharging.

  • That was one of the points that I was implying is when it first happened, it certainly took some time for us to adjust, but what we were very encouraged and we saw a very tangible results is that we, in fact, were able to successfully reduce substantially the level of surcharging that was taking place because we were able to not only convince, but demonstrate, the plus value that we were bringing to the merchant, so the merchant no longer saw the value of surcharging.

  • So the reality is, it exists still in some places, but it has been substantially reduced, and again, as we look at our share of billings, our market share has increased, which is concrete proof that obviously we've been able to successfully deal with surcharging.

  • So, it goes back to this fundamental point that the premium value positioning and premium value in your cards and premium value for your merchant really does work in the marketplace.

  • John Stilmar - Analyst

  • Is there any numerical evidence that you can -- or some more disclosure that you can see say in terms of the pace of that improvement and how it occurred, other than sort of what we can glean from the governmental releases that they (multiple speakers)

  • Ken Chenault - Chairman, CEO

  • You know, what I would say -- frankly, the government releases the data.

  • The data shows conclusively that we have gained substantial share in Australia over the last several years.

  • So, it's not our data.

  • It is the government's data that demonstrates that we've grown share.

  • And our earnings have improved, and so it's profitable market share growth, but what it also points out is the diversity of our business model in that we have a consumer card business, we have a corporate card business, both large corporate and middle market, we have a GNS business, and we have been able to pull the levers of those different businesses to create a business model that in fact has worked very well.

  • John Stilmar - Analyst

  • Thank you.

  • And Dan, just a quick point on revisiting -- I'm not sure I got the question of the jump in other expense this quarter.

  • Is that temporary?

  • Should we think about that?

  • What was the driver there and how should we think about that going forward?

  • Dan Henry - EVP, CFO

  • So the jump in operating expense in part is being driven by investments.

  • So when we are increasing investments, we're not only increasing them in the marketing and promotion line, we're also making investments that get reflected in operating expense.

  • So, technology spending to support growth in our products.

  • Initiatives such as investing in Revolution Money or Business Insight or Loyalty Edge, or growing our salesforce.

  • Those are all things that are running through operating expense.

  • And just like marketing and promotion, those are at elevated levels.

  • When we get to the point where credit isn't throwing off as much in terms of reserve releases, we'll bring those more back to normal levels, but investment levels that are sufficiently healthy to enable us to sustain business growth going forward.

  • Ken Chenault - Chairman, CEO

  • The other point I would make is, again, because we talked about the salesforce expansion, but as we said in the earnings release, the investments that we've concentrated on, for example, charge card and co-brand, are paying off.

  • We are generating those results, and you see them in the quality of cards that we've been able to perform.

  • If you go back to the analyst meeting in August, we actually took you through the increase that we were seeing in spending from the new cards that we were bringing on, not just compared to 2009 but compared to previous years.

  • And so, what you're really seeing is a partial redirection of our payment strategy where we're focused on more select segments for lending.

  • We are concentrating on premium lending, and charge cards, frankly, has become more of a product for the times.

  • Consumers are becoming more disciplined.

  • They are becoming more careful, and at the end of the day, the services, the rewards that we have on those charge card products is very appealing to a number of segments.

  • So there, you are seeing relatively quick payback from the investments that we've made over the last year.

  • Ron Stovall - SVP IR

  • Operator, I think we have time for one more question, please.

  • Operator

  • Brad Ball, Evercore Asset Management.

  • Brad Ball - Analyst

  • Thanks.

  • The last question.

  • I wonder if you could comment on the proportion of your spending that is currently in T&E and what the trends have been of late?

  • Is that still coming down as it has over several years?

  • And the reason I ask is, Ken, is it possible that you would have different merchants, sort of a tiering of merchants, react to their new powers differently?

  • Maybe higher-end merchants, luxury sales merchants, more likely to not steer discount, and lower-end merchants sort of more motivated to do the steering.

  • How do you see that?

  • Ken Chenault - Chairman, CEO

  • I think the reality is we've continued to see the T&E related volume categories expand, and so non-T&E in the U.S.

  • is approximately 72% of our U.S.

  • billed business.

  • Dan Henry - EVP, CFO

  • So, you're right.

  • Over time, we've really transitioned from kind of two-thirds T&E to really more than two-thirds non-T&E.

  • In the near term, just in the very short term now, the bounceback but we've seen is really across all categories.

  • It's all segments, it's all geographies.

  • So T&E is bouncing back along with other spending in this very short term.

  • Ken Chenault - Chairman, CEO

  • Right.

  • And I think, Brad, it really represents a strategy.

  • Frankly, if you go back to 2000, we in fact talked about the fact that we were going to focus on non-T&E, and very frankly, even in our commercial card business, that is one of the priority areas and we've had -- that where we've also invested in this year -- where we have been very pleased with the progress that our non-T&E spending has increased.

  • And frankly, what that makes for is a more balanced model, so as we go through different economic times, we don't have the reliance on some of the T&E categories that we had historically, so that, frankly, gives us more balance and puts us, I think, in a more stable situation where we are less reliant on non-T&E categories.

  • So I think what's important to understand is that non-T&E is very key to the success we've had in both our billings growth, but also our business mix.

  • So I think that is a very good thing.

  • Brad Ball - Analyst

  • And in terms of the merchants potentially tiering?

  • Ken Chenault - Chairman, CEO

  • Excuse me?

  • Brad Ball - Analyst

  • The question of whether different merchants would be more likely to steer than others?

  • So, higher end, less likely?

  • Ken Chenault - Chairman, CEO

  • Again, I go back to that the reality is that all merchants, as we go through the categories, are not just high-end merchants.

  • And what they're really doing is they're focused on taking care of customers at the point of sale.

  • I would go back to what Dan said, which is that we're seeing growth across all merchant categories, all merchant categories, small, medium, and large, and I would go back to the other point that our conversations that we've had recently with a range of merchant categories have been very positive and constructive and supportive conversations.

  • So, the point to focus on is that what we want to deliver to our merchants, irrespective of size and category, is high-spending customers.

  • That's really our focus.

  • And we are providing that value, and the proof of it is in our disproportionate growth rates relative to the rest of the credit card industry.

  • Brad Ball - Analyst

  • Got it.

  • Great, thanks.

  • Ron Stovall - SVP IR

  • Cathy, I think that's going to be the end of the call.

  • If you could just alert people to the availability of the tape -- the replay.

  • Operator

  • Certainly.

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  • (Operator Instructions).

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