Item 1. BUSINESS
Introduction
American Express Credit Corporation (Credco) was incorporated in Delaware in 1962 and was acquired by American Express Company (American Express) in December 1965. On January 1, 1983, Credco became a wholly-owned subsidiary of American Express Travel Related Services Company, Inc. (TRS), a wholly-owned subsidiary of American Express.
Credco is primarily engaged in the business of financing non-interest-bearing cardmember receivables arising from the use of the American Express® card, the American Express® Gold card, Platinum card®, Corporate card and other American Express cards issued in the United States, and in designated currencies outside the United States. Credco also purchases certain interest-bearing and discounted revolving loans and extended payment plan receivables comprised of American Express credit cards and Sign & Travel®, although interest-bearing and revolving loans are primarily funded by subsidiaries of TRS other than Credco. American Express charge cards and American Express credit cards are collectively referred to herein as the Card.
American Express Card Business
American Express is a world leader in providing charge and credit cards to consumers, small businesses and corporations. These cards include cards issued by American Express as well as cards issued by third-party banks and other institutions that are accepted on the American Express network. American Express’ various products and services are sold globally to diverse customer groups, including consumers, small businesses, middle-market companies, large corporations, and banking and financial institutions. As a merchant processor, TRS accepts and processes from each participating establishment the charges arising from cardmember purchases at a discount that is principally determined by the value that is delivered to the service establishment and generally includes a premium over other card networks. Value is delivered to the service establishment through higher spending cardmembers relative to competing card networks, the volume of spending by all cardmembers, marketing programs and the cardmembers’ insistence on using their cards when enrolled in rewards or other card loyalty programs. When establishing the discount rate, consideration is also given to a number of other factors, such as industry specific requirements, estimated charge volume and payment terms.
The charge card, which is marketed in the United States and many other countries and carries no preset spending limit, is primarily designed as a method of payment and not as a means of financing purchases of goods or services. Charges are approved based on a variety of factors including a cardmember’s account history, credit record and personal resources. Charge cards generally require payment by the cardmember of the full amount billed each month, and no finance charges are assessed. Charge card accounts that are past due are subject, in most cases, to a delinquency assessment and, if not brought to current status, may be cancelled. TRS and its licensees also offer a variety of revolving credit cards marketed in the United States and other countries. These cards have a range of payment terms, grace periods and rate and fee structures.
The American Express card businesses are subject to extensive regulations in the United States, as well as in foreign jurisdictions. In the United States, the business is subject to a number of federal laws and regulations, including:
the Equal Credit Opportunity Act (which generally prohibits discrimination in the granting and handling of credit);
the Fair Credit Reporting Act and the Fair and Accurate Credit Transactions Act (which, among other things, regulates use by creditors of consumer credit reports and credit prescreening practices and requires certain disclosures when an application for credit is rejected);
the Truth in Lending Act (TILA) (which, among other things, requires extensive disclosure of the terms upon which credit is granted), including the amendments to TILA that were adopted through the enactment of the Fair Credit and Charge Card Disclosure Act (which mandates certain disclosures on credit and charge card applications);
the Fair Credit Billing Act (which, among other things, regulates the manner in which billing inquiries are handled and specifies certain billing requirements); and
the Electronic Funds Transfer Act (which regulates disclosures and settlement of transactions for electronic funds transfers including those at ATMs).
Certain federal privacy-related laws and regulations govern the collection and use of customer information by financial institutions. Federal legislation also regulates abusive debt collection practices. In addition, a number of states, the European Union and many foreign countries have significant consumer credit protection, disclosure and privacy-related laws (in certain cases more stringent than the laws in the United States). The application of bankruptcy and debtor relief laws affect Credco to the extent that such laws result in amounts owed being classified as delinquent and/or written-off as uncollectible. Card issuers and card networks are subject to anti-money laundering and anti-terrorism legislation, including, in the United States, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA PATRIOT Act).
General Nature of Credco’s Business
Credco generally purchases certain cardmember receivables and cardmember loans arising from the use of the card throughout the world pursuant to agreements (the Receivables Agreements) with TRS and certain of its subsidiaries that issue the card (Card Issuers). Net income primarily depends on the volume of receivables arising from the use of the card purchased by Credco, the discount rates applicable thereto, the relationship of total discount to Credco’s interest expense and the collectibility of the receivables purchased. The average life and collectibility of accounts receivable generated by the use of the card are affected by factors such as general economic conditions, overall levels of consumer debt and the number of new cards issued.
Credco generally purchases cardmember receivables and loans without recourse. Amounts resulting from unauthorized charges (for example, those made with a lost or stolen card) are excluded from the definition of receivables and loans under the Receivables Agreements and are not eligible for purchase by Credco. If the unauthorized nature of the charge is discovered after purchase by Credco, the Card Issuer repurchases the charge from Credco.
Credco generally purchases non-interest and interest-bearing cardmember receivables at face amount less a specified discount, which is determined at the time of purchase based upon the nature of the receivables. The discount rate applicable to purchases of new receivables is negotiated to reflect the changes in money market interest rates or significant changes in the collectibility of the receivables. New groups of cardmember receivables are generally purchased net of reserve balances.
Cardmember loans, which include extended payment plan receivables, are primarily funded by subsidiaries of TRS other than Credco, although certain cardmember loans are purchased by Credco. These cardmember loans consist of certain interest-bearing and discounted extended payment plan receivables comprised of American Express credit card, Sign & Travel® and Extended Payment Option receivables.
As part of its receivables funding activities, Credco regularly reviews funding sources and strategies in international markets. Credco funds cardmember receivables and cardmember loans in Canada primarily through loans to Amex Bank of Canada, the card issuer and a wholly-owned subsidiary of TRS, rather than through the purchase of receivables without recourse. In Australia, the United Kingdom and Germany, Credco funds cardmember receivables and cardmember loans by acquiring such receivables and loans with recourse from the local card issuers, which are wholly-owned subsidiaries of TRS. These local funding
strategies result in Credco recording additional loans to affiliates. Beginning in 2007, Credco started a funding strategy in Mexico that will also result in additional loans to affiliates.
In conjunction with TRS’ securitization program, Credco, through its wholly-owned subsidiary, Credco Receivables Corporation (CRC), purchased participation interests from American Express Receivables Financing Corporation V LLC (RFC V), which is consolidated by TRS. The participation interests purchased represented the undivided interests in cardmember receivables transferred to the American Express Issuance Trust (AEIT) by TRS. TRS and its subsidiaries originated the receivables. AEIT is a non-qualifying special purpose entity that is consolidated by RFC V.
A subsidiary of TRS, as agent for Credco, underwrites the cardmember receivables and loans and thus establishes credit standards for cardmembers on Credco’s behalf. In addition, the subsidiary of TRS performs accounting, clerical and other services necessary to bill and collect all cardmember receivables and loans owned by Credco. The Receivables Agreements provide that, without prior written notice to Credco, the credit standards used to determine whether a card is to be issued to an applicant may not be materially reduced and that the policy as to the cancellation of cards for credit reasons may not be materially liberalized.
American Express, as the parent of TRS, has agreed with Credco that it will take all necessary steps to assure performance of certain TRS obligations under the Receivables Agreements between TRS and Credco. The Receivables Agreements may be terminated at any time by the parties thereto, generally upon little or no notice. The obligations of Credco are not guaranteed under the Receivables Agreements or otherwise by American Express or the Card Issuers.
Volume of Business
The following table shows the volume of all cardmember receivables and cardmember loans purchased by Credco during each of the years indicated, together with cardmember receivables and cardmember loans owned by Credco at the end of such years (billions):
The card business does not experience significant seasonal fluctuation, although card billed business tends to be moderately higher in the fourth quarter than in other quarters.
Cardmember Receivables
At December 31, 2007 and 2006, Credco owned $26.3 billion and $27.6 billion of cardmember receivables, respectively. Cardmember receivables represent amounts due from charge card customers and are recorded at the time they are purchased from the seller. Included in cardmember receivables are CRC’s purchases of the participation interests from RFC V in conjunction with TRS’ securitization program. At December 31, 2007 and 2006, CRC owned approximately $5.7 billion and $8.2 billion, respectively, of participation interests purchased from RFC V. During the fourth quarter of 2007, CRC sold back $2.0 billion, net of reserve, of gross seller’s interest in the charge cardmember receivables to RFC V. RFC V securitized $2.0 billion of charge cardmember receivables through the transfer of those assets to AEIT, which in turn issued notes to third-party investors collaterized by the transferred assets.
(1) Credco’s write-offs, net of recoveries, expressed as a percentage of the volume of cardmember receivables purchased by Credco in each of the years indicated.
(2) Represents the average life of cardmember receivables owned by Credco, based upon the ratio of the average amount of both billed and unbilled receivables owned by Credco at the end of each month, during the years indicated, to the volume of cardmember receivables purchased by Credco.
Cardmember receivables owned at December 31, 2007 decreased approximately $1.3 billion from December 31, 2006, as a result of lower consumer, small business and corporate cardmember receivables purchased during 2007, as well as the effect of changing certain international funding strategies which resulted in a shift in the mix of cardmember receivables and loans to affiliates. The cardmember receivables purchased during 2007 increased approximately 4 percent from the cardmember receivables purchased during 2006, due to overall business growth.
Cardmember Loans
At December 31, 2007 and 2006, Credco owned cardmember loans totaling $403 million and $356 million, respectively. These loans consist of certain interest-bearing and discounted extended payment plan receivables comprised principally of American Express credit card, Sign & Travel® and Extended Payment Option receivables. At December 31, 2007 and 2006, CRC did not own any participation interests in cardmember loans.
(1) Credco’s write-offs, net of recoveries, expressed as a percentage of the average amount of cardmember loans owned by Credco at the beginning of the year and at the end of each month in each of the years indicated.
The $47 million increase in Credco’s total owned cardmember loans in 2007 was primarily due to increased U.S. dollar denominated loan portfolios. The cardmember loans decrease of approximately 37 percent in 2006 from 2005, was primarily driven by Credco’s sale of certain Hong Kong, New Zealand and United States loan portfolios.
Loans to Affiliates
Credco’s loans to affiliates represent fixed and floating rate interest-bearing intercompany borrowings by other wholly-owned TRS subsidiaries and American Express.
The components of loans to affiliates at December 31, were as follows:
Changes to certain international funding strategies have resulted in the transfer of receivables with recourse to Credco from certain TRS subsidiaries. Prior to these funding strategy changes, Credco purchased the cardmember receivables without recourse and recorded the receivables as cardmember receivables. These funding strategy changes resulted in Credco recording additional loans to affiliates that are collateralized by approximately $8 billion of the underlying cardmember receivables transferred with recourse. In 2007, Credco started a similar funding strategy in Mexico that resulted in an increase in loans to affiliates. Beginning prospectively on September 30, 2007, certain cardmember receivables were reclassified to loans to affiliates. The remaining increase in loans to affiliates was due to overall business growth. These increases in loans to affiliates were offset in part by the decrease in the loan to TRS Parent of $531 million, which was repaid during the first quarter of 2007.
On February 26, 2008, Credco increased its loan to American Express International, Inc. by $323 million.
Sources of Funds
Credco’s business is financed by short-term borrowings consisting principally of commercial paper, borrowings under bank credit facilities in certain international markets, and issuances of U.S. and non-U.S. dollar long-term debt, as well as through operations and intercompany borrowings. The weighted average interest rates on an annual basis of all borrowings, after giving effect to commitment fees under lines of credit and the impact of interest rate swaps, during the following years were:
See Notes 4 and 5 to the Consolidated Financial Statements for additional information about Credco’s short-term and long-term debt, including lines of credit.
Foreign Operations
See Notes 1, 7 and 13 to the Consolidated Financial Statements for information about Credco’s foreign exchange translation and operations in different geographic regions.
Employees
At December 31, 2007, Credco had 23 employees.
Item 1A.
Item 1A. RISK FACTORS
This section highlights specific risks that could affect Credco and its businesses. You should carefully consider each of the following risks and all of the other information set forth in this Annual Report on Form 10-K. Based on the information currently known to Credco, we believe that the following information identifies the most significant risk factors affecting Credco. However, the risks and uncertainties Credco faces are not limited to those described below. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also adversely affect Credco’s business.
If any of the following risks and uncertainties develops into actual events or the circumstances described in the risks and uncertainties occur, these events or circumstances could have a material adverse effect on Credco’s business, financial condition or results of operations. These events could also have a negative effect on the trading price of Credco’s securities.
The risk management policies and procedures of Credco and the Card Issuers may not be effective.
Credco and the Card Issuers must effectively manage credit risk related to consumer debt, business loans, merchant bankruptcies, the rate of bankruptcies and other credit trends which can affect spending on card products, debt payments by individual and corporate customers and businesses that accept the Card Issuer’s products. Credit risk is the risk of loss from obligor or counterparty default. Credco and the Card Issuers are exposed to both consumer credit risk, principally from Cardmember receivables and institutional credit risk. While consumer credit risk is more closely linked to general economic conditions than borrower-specific events like institutional credit risk, both expose Credco and the Card Issuers to the risk of loss. Third parties may default on their obligations to Credco due to bankruptcy, lack of liquidity, operational failure or other reasons. Country, regional and political risks are components of credit risk. Rising delinquencies and rising rates of bankruptcy are often precursors of future write-offs and may require Credco to increase its reserves for losses. Higher write-off rates and an increase in the reserve for losses may adversely affect Credco’s results of operations and may increase its cost of funds.
Although Credco and the Card Issuers make estimates to provide for credit losses in their respective outstanding portfolios of loans and receivables, these estimates may not be accurate. In addition, the information that Credco and the Card Issuers use in managing credit risk may be inaccurate or incomplete. Although Credco and the Card Issuers regularly review their credit exposures to specific clients and counterparties and to specific industries, countries and regions that they believe may present credit concerns, default risk may arise from events or circumstances that are difficult to foresee or detect, such as fraud. Credco and the Card Issuers may also fail to receive full information with respect to the credit risks of their customers.
Credco must also effectively manage market risk to which it is exposed. Market risk represents the loss in value of portfolios and financial instruments due to adverse changes in market variables. Credco is exposed to market risk from interest rates in the Card business. Changes in the interest rates at which we borrow and lend money affect the value of our assets and liabilities. If the rate of interest we pay on our borrowings increases more than the rate of interest we earn on our loans to affiliates, our net income could fall. Credco
must also accurately estimate the fair value of the assets in its investment portfolio and, in particular, those investments that are not readily marketable.
Additionally, we must also effectively manage liquidity risk to which we are exposed. Liquidity risk is defined as the inability to access cash and equivalents needed to meet business requirements and satisfy our obligations. Liquidity risk is managed both at an aggregate Credco level and at American Express level in order to ensure that sufficient funding and contingent liquidity resources are available in a stress event. If we are unsuccessful in managing our liquidity risk, we may maintain too much liquidity, which can be costly and limit financial flexibility, or we may be too illiquid, which could result in financial distress during a liquidity event.
Finally, the Card Issuers must also manage the operational risks to which they are exposed. The Card Issuers consider operational risk to be the risk of not achieving their respective business objectives due to failed processes, people or information systems, or from the external environment, such as natural disasters. Operational risks include the risk that they may not comply with specific regulatory or legal requirements, exposing us to fines and/or penalties and possibly brand damage; employee error or intentional misconduct that results in a material financial misstatement; or a failure to monitor an outsourced partner’s compliance with a service level agreement, resulting in economic harm to us.
Although Credco and the Card Issuers have devoted significant resources to develop their risk management policies and procedures and expect to continue to do so in the future, their hedging strategies and other risk management techniques may not be fully effective. See Item 7A Quantitative and Qualitative Disclosures about Market Risk for a discussion of the policies and procedures Credco uses to identify, monitor and manage risks. Management of credit, market and operational risk requires, among other things, policies and procedures to record properly and verify a large number of transactions and events, and these policies and procedures may not be fully effective.
Credco is exposed to risks associated with fluctuations in foreign currency exchange rates and foreign exchange controls.
Credco generates a portion of its revenue from activities outside the United States, including by financing card receivables and loan receivables denominated in currencies other than the U.S. dollar. Revenues generated outside the United States or denominated in currencies other than the U.S. dollar are subject to unpredictable and indeterminate fluctuations if the values of other currencies change relative to the U.S. dollar. Credco’s risk management activities provide protection with respect to adverse changes in the value of only a limited number of currencies. Furthermore, Credco or the Card Issuers may become subject to exchange control regulations that might restrict or prohibit the conversion of their other revenue currencies into U.S. dollars. The occurrence of any of these events or circumstances could decrease revenues received from international operations and have a material adverse effect on their respective businesses.
Credco’s access to financing may be limited.
In general, the amount, type and cost of Credco’s funding, including financing from other financial institutions and the capital markets, directly impacts its expense in operating its business and growing its assets and therefore, can positively or negatively affect Credco’s financial results. A number of factors could make such financing more difficult, more expensive or unavailable on any terms both domestically and internationally (where funding transactions may be on terms more or less favorable than in the United States), including, but not limited to, financial results and losses, organizational changes, specific events that adversely impact Credco’s or the Card Issuers’ reputations, changes in the activities of the Card Issuers’ business partners, disruptions in the capital markets, specific events that adversely impact the financial services industry, counter-party availability, changes affecting Credco’s assets, Credco’s corporate and regulatory structure, interest rate fluctuations, rating agencies’ actions, general economic conditions and the
legal, regulatory, accounting and tax environments governing Credco’s funding transactions. Credco’s ability to raise funds is strongly affected by the general state of the United States and world economies, and may become increasingly difficult due to economic and other factors. Also, Credco competes for funding with other financial institutions, some of which are publicly funded. Competition from these institutions may increase Credco’s cost of funds.
Existing and proposed regulation in the areas of consumer privacy and data use and security could increase costs and decrease the number of charge and credit cards issued.
The Card Issuers are subject to regulations related to privacy and data use and security in the jurisdictions in which they do business, and they could be negatively impacted by these regulations. For example, in the United States, TRS, American Express Centurion Bank (Centurion Bank) and American Express Bank, FSB (FSB) are subject to the Federal Trade Commission’s information safeguards rule under the Gramm-Leach-Bliley Act. The rule requires that each financial institution develop, implement and maintain a written, comprehensive information security program containing safeguards that are appropriate to the financial institution’s size and complexity, the nature and scope of the financial institution’s activities, and the sensitivity of any customer information at issue. The heightened legislative and regulatory focus on data security, including requiring consumer notification in the event of a data breach, continues. In the United States, there are a number of bills pending in Congress and there have been several Congressional hearings to address these issues. Congress will likely consider data security/data breach legislation in 2008 that, if implemented, could affect the Card Issuers.
In addition, approximately 38 states, Puerto Rico and the District of Columbia have enacted security breach legislation, requiring varying levels of consumer notification in the event of a security breach, and several other states are considering similar legislation. In addition, several states are considering legislation requiring certain data security standards that could result in higher technology costs which may increase our costs. Regulation of privacy, data use and security in these and other jurisdictions may materially increase costs for issuing charge and credit cards and may decrease the number of cards issued, which could materially and adversely affect profitability. Failure to comply with the privacy and data use and security laws and regulations to which the Card Issuers are subject could result in fines, sanctions and damage to the Card Issuers’ global reputation and brand.
Credco and its subsidiaries are dependent on the Card Issuers that generate receivables.
Credco and its subsidiaries are dependent on the Card Issuers that generate receivables. Credco and American Express Overseas Credit Corporation Limited (AEOCC), a wholly-owned subsidiary of Credco, are parties to asset sale and purchase agreements relating to the purchase of receivables from the Card Issuers. These receivables agreements generally require that non-interest and interest-bearing receivables be purchased at discount rates that are negotiated and determined at the time of purchase based upon the nature of the receivables. Credco and AEOCC are dependent upon these contractual arrangements. Lower levels of cardmember receivables and loans generated by the Card Issuers from which Credco and AEOCC purchase receivables would result in a reduction in the level of finance operations and a reduction in revenues of Credco and AEOCC. American Express and TRS’ operations are independently subject to a variety of risk factors. The outstanding debt and other securities of Credco and AEOCC are not obligations of American Express, TRS or its other subsidiaries.
Global economic, political and other conditions may adversely affect trends in consumer spending and in travel.
Credco’s business depends heavily upon the overall level of spending using the American Express charge and credit cards, and we are not insulated from the effects of economic cycles. A sustained deterioration in general economic conditions, particularly in the United States or Europe, or increases in interest rates in key countries in which American Express operates, may adversely affect American Express’ financial
performance by reducing the number or average purchase amount of transactions involving American Express’ charge and credit cards and result in increasing delinquencies and credit losses. Political or economic instability in certain regions or countries could also affect American Express’ commercial or other lending activities, among other businesses, or result in restrictions on convertibility of certain currencies.
Terrorist attacks, natural disasters or other catastrophic events may have a negative effect on our business and infrastructure, including our information technology systems. Because we derive a portion of our revenues from American Express travel-related spending, our business will be sensitive to safety concerns, and thus may decline during periods in which travelers become concerned about safety issues or when travel might involve health-related risks.
Forward-looking Statements
Various statements have been made in this Annual Report on Form 10-K that may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may also be made in Credco’s other reports filed with or furnished to the SEC and in other documents. In addition, from time to time, Credco, through its management, may make oral forward-looking statements. Forward-looking statements are subject to risks and uncertainties, including those identified above and below, which could cause actual results to differ materially from such statements. The words “believe,” “expect,” “anticipate,” “optimistic,” “intend,” “plan,” “aim,” “will,” “may,” “should,” “could,” “would,” “likely” and similar expressions are intended to identify forward-looking statements. We caution you that the risk factors described above and below are not exclusive. There may also be other risks that we are unable to predict at this time that may cause actual results to differ materially from those in forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. Credco undertakes no obligation to update or revise any forward-looking statements.
Factors that could cause actual results to differ materially from Credco’s forward-looking statements include, but are not limited to:
credit trends and the rate of bankruptcies, which can affect spending on card products and debt payments by individual and corporate customers;
Credco’s ability to accurately estimate the provision for losses in Credco’s outstanding portfolio of cardmember receivables and loans;
fluctuations in foreign currency exchange rates;
negative changes in Credco’s credit ratings, which could result in decreased liquidity and higher borrowing costs;
the effect of fluctuating interest rates, which could affect Credco’s borrowing costs; and
the impact on American Express Company’s business resulting from continuing geopolitical uncertainty.
Item 1B.
Item 1B. UNRESOLVED STAFF COMMENTS
None.
Credco neither owns nor leases any material physical properties.
Item 3
Item 3
LEGAL PROCEEDINGS
There are no material pending legal proceedings to which Credco or its subsidiaries is a party or of which any of their property is the subject. Credco knows of no such proceedings being contemplated by government authorities or other parties.
Item 4.
Item 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Omitted pursuant to General Instruction I(2)(c) to Form 10-K.
PART II
Item 5.
Item 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
American Express, through its wholly-owned subsidiary, TRS, owns all of the outstanding common stock of Credco. Therefore, there is no market for Credco’s common stock.
Credco paid cash dividends of $750 million and $500 million to TRS in 2007 and 2006, respectively. On February 8, 2008, Credco paid a cash dividend of $125 million to TRS. For information about limitations on Credco’s ability to pay dividends, see Note 6 to the Consolidated Financial Statements.
Item 6.
Item 6. SELECTED FINANCIAL DATA
The following summary of certain consolidated financial information of Credco was derived from audited financial statements for the five years ended December 31:
Item 7.
Item 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
Critical Accounting Policies
American Express Credit Corporation’s (Credco) significant accounting policies are described in Note 1 to the Consolidated Financial Statements. The following provides information about critical accounting policies that are important to the Consolidated Financial Statements and that involve estimates requiring significant management assumptions and judgments about the effect of matters that are uncertain. These policies relate to reserves for cardmember losses.
Reserves for cardmember losses
Credco’s reserves for losses relating to cardmember receivables and loans represent management’s best estimate of the losses inherent in Credco’s outstanding portfolio of receivables and loans. Management’s evaluation process requires certain estimates and judgments. Reserves for these losses are primarily based upon models that analyze specific portfolio statistics, including average write-off rates, for various stages of receivable aging (i.e., current, 30 days, 60 days, 90 days) over a 24-month period and average bankruptcy and recovery rates. Also, to a lesser extent, these reserves reflect management’s judgment regarding overall reserve adequacy. Management considers whether to adjust reserves that are calculated by the analytic models based on other factors, such as the level of coverage and recent trends of past-due accounts, as well as leading economic and market indicators, such as the unemployment rate, the consumer confidence index, the purchasing manager’s index, bankruptcy filings and the legal and regulatory environment.
Receivables and loans are written-off when management deems amounts to be uncollectible, and is generally determined by the number of days past due. Cardmember receivables and loans are generally written-off when they are past due 360 and 180 days, respectively. To the extent historical credit experience is not indicative of future performance, actual loss experience could differ significantly from management’s judgments and expectations, resulting in either higher or lower future provisions for losses, as applicable. Receivables and loans in bankruptcy or owned by deceased individuals are written-off upon notification. As of December 31, 2007, if average write-off rates were five percent higher or lower, the reserve for losses would change by approximately $43 million. This sensitivity analysis does not represent management’s expectations of deterioration in write-offs but is provided as a hypothetical scenario to assess the sensitivity of the provision for cardmember losses to changes in key inputs.
The process for determining the reserve for cardmember losses requires a high degree of judgment. It is possible that others, given the same information, may at any point in time reach different reasonable conclusions.
Income Taxes
The taxable income of Credco is included in the consolidated U.S. federal income tax return of American Express. Under an agreement with TRS, taxes are recognized on a separate company basis. American Express is subject to the income tax laws of the U.S., its states and municipalities and those of the foreign jurisdictions in which American Express operates. These tax laws are complex, and the manner in which they apply to the taxpayer’s facts is sometimes open to interpretation. In establishing a provision for income tax expense, management must make judgments about the application of these inherently complex tax laws. Credco establishes a liability for unrecognized tax benefits, which are the differences between a tax position taken or expected to be taken in a tax return and the benefit recognized in the financial statements.
In establishing a liability for an unrecognized tax benefit, assumptions may be made in determining whether a tax position is more likely than not to be sustained upon examination by the taxing authority and also in determining the ultimate amount that is likely to be realized. A tax position is recognized when, based on
management’s judgment regarding the application of income tax laws, it is more likely than not that the tax position will be sustained upon examination. The amount of tax benefit recognized is based on management's assessment of the most likely outcome on ultimate settlement with the taxing authority. This measurement is based on many factors, including whether a tax dispute may be settled through negotiation with the taxing authority or is only subject to review in the courts. As new information becomes available, management evaluates its tax positions, and adjusts its unrecognized tax benefits, as appropriate.
If the tax benefit ultimately realized differs from the amount previously recognized in the income tax provision, Credco recognizes an adjustment to the provision.
Deferred tax assets and liabilities are determined based on the differences between the financial statement and tax bases of assets and liabilities using the enacted tax rates expected to be in effect for the years in which the differences are expected to reverse. A valuation allowance is established when management determines that it is more likely than not that all or some portion of the benefit of the deferred tax asset will not be realized.
Since deferred taxes measure the future tax effects of items recognized in the financial statements, certain estimates and assumptions are required to determine whether it is more likely than not that all or some portion of the benefit of a deferred tax asset will not be realized. In making this assessment, management analyzes and estimates the impact of future taxable income, reversing temporary differences and available tax planning strategies. These assessments are performed quarterly, taking into account any new information.
Should a change in facts or circumstances lead to a change in judgment about the ultimate realizability of a deferred tax asset, Credco records or adjusts the related valuation allowance in the period that the change in facts or circumstances occurs, along with a corresponding increase or decrease to the income tax provision.
Impact of Credit and Capital Market Environment
In December 2007, Credco began to feel the effects of the weakening U.S. economy as past-due and write-off rates for U.S. cardmembers increased. In the latter part of 2007, there was also significant volatility in the capital markets, particularly for the valuations of mortgage-backed and other asset-backed structured products as well as in the issuance cost and availability of short-term, asset-backed debt for certain issuers. In 2007, Credco did not hold any mortgage-backed and asset-backed securities in its investment portfolio.
U.S. cardmember receivables
While overall spending for U.S. cardmembers continued to be relatively strong and Credco benefited from a focus on the affluent sector of the market, Credco saw negative credit trends among U.S. consumers in the latter part of 2007, particularly in certain parts of the country most affected by the housing downturn as well as with U.S. small businesses. As a result, Credco recorded a $84 million credit-related charge in the fourth quarter comprised of additional provision for losses for U.S. cardmember receivables.
In managing risk on behalf of Credco, TRS’ objective is to protect its profitability, but also protect, to the extent it can, TRS’ ongoing relationship with the cardmember and their experience. With this in mind, the following actions have been taken by TRS across the U.S. cardmember portfolios:
TRS implemented a reduction of cardmember lines of credit for specific segments of the cardmember portfolio representing the greatest risk. These segments include cardmembers holding sub-prime mortgages and small businesses, in particular those operating in specific industries, such as mortgage companies, home builders and construction related businesses.
TRS adjusted its risk management models to reflect the higher probability of default that exists during a weaker economy, and in geographies that have been most impacted by home price declines.
To improve recoveries, TRS increased its staffing levels in credit and collection.
Investment Portfolio
Credco’s investment portfolio primarily supports its contingent liquidity plan. As a result, Credco generally holds its investments until their maturity. However, management may sell securities prior to maturity due to changes in Credco’s business goals, liquidity needs, and the market environment.
Credco reviews and evaluates its investments at least quarterly and more often as market conditions may require, to identify investments that have indications of other-than-temporary impairments. The determination of other-than-temporary impairments is a subjective process, requiring the use of assumptions and application of judgment. In addition to its impairment evaluation, Credco corroborates the prices provided by its pricing vendors to test the accuracy of the fair values.
Credco did not experience any defaults, event of defaults, or determine it would not receive timely contractual payments of interest and repayment of principal on any of its holdings in its investment portfolios in 2007.
At December 31, 2007, Credco owned approximately $3 billion of U.S. Treasury and government agency securities (Fannie Mae and Freddie Mac). The current credit market environment had a small positive impact on the values of U.S. Treasury and government agency securities.
Valuations of securities held within Credco’s investment portfolio will continue to be subject to changes in external market factors including default rates, rating agency actions, and the prices at which observable market transactions occur. Credco’s future results may be impacted by the valuation adjustments applied to these holdings.
Liquidity
As discussed in more detail below, Credco’s reliance on diverse sources of funding, with wide ranges of maturities, and its contingent liquidity strategy allow for the continued funding of business operations through difficult economic, financial market and business conditions when access to regular funding sources could become diminished or interrupted.
While the credit market environment that began to emerge in the second half of 2007 included disruptions in the capital markets, Credco had access to sufficient financing through its existing funding sources to meet its business needs in 2007. Disruptions in the financial markets to date have not resulted in a significant change of Credco’s debt funding mix. However, continued disruptions in 2008 in the financial markets could result in changes in the funding mix. Specifically, a potential lack of investor demand in sectors of the debt capital market, such as for long-term unsecured debt or commercial paper, could alter Credco’s funding mix. Credit ratings have a significant impact on the borrowing costs of Credco. There have been no changes in Credco’s credit ratings during 2007.
Consolidated Capital Resources and Liquidity
Credco is committed to maintaining cost-effective, well-diversified funding programs to support current and future asset growth in its global businesses. Credco’s funding plan is structured to meet expected and changing business needs to fund asset balances efficiently and cost-effectively. Credco relies on diverse sources to help ensure the availability of financing in unexpected periods of stress and to manage interest rate exposures. In addition to the funding plan described below, Credco has a contingent funding strategy to allow for the continued funding of business operations through difficult economic, financial market and business conditions when access to regular funding sources could become diminished or interrupted.
Financing Activities
Credco’s funding requirements are met primarily by the sale of commercial paper, the issuance of long-term notes, borrowings under long-term bank credit facilities in certain international markets and equity capital. Credco has readily sold the volume of commercial paper necessary to meet its funding needs as well as to cover the daily maturities of commercial paper issued. During 2007, Credco had uninterrupted access to the commercial paper and capital markets to fund its business operations.
The commercial paper market represents the primary source of short-term funding for Credco. Credco’s commercial paper, a widely recognized name among short-term investors, for the years ended December 31, 2007 and 2006, was as follows:
(1)
Credco currently manages the level of short-term debt outstanding such that its total back-up liquidity, including available bank credit facilities and term liquidity portfolio investment securities, is not less than 100 percent of net short-term debt. Net short-term debt, which consists of commercial paper and certain other short-term borrowings less cash and cash equivalents.
(2)
Based on the maximum available borrowings under bank credit facilities and term liquidity portfolio investment securities.
Long-term debt is raised through the offering of debt securities in the United States and international capital markets. Long-term debt is generally defined as any debt with an original maturity greater than 12 months. Credco continues to issue debt with a wide range of maturities to diversify the refinancing requirements in future periods.
In 2007, Credco issued $3.1 billion fixed and floating rate long-term debt with maturities ranging from two to five years.
Credco also has the ability to issue debt securities under shelf registrations filed with the Securities and Exchange Commission (SEC). The registration statement filed with the SEC is for an unspecified amount of debt securities to be issued from time to time. At December 31, 2007, Credco had $13.6 billion of debt securities outstanding, issued under the SEC registration statements.
Credco, TRS, AEOCC, Centurion Bank, and FSB have established a program for the issuance, outside the United States, of debt instruments to be listed on the Luxembourg Stock Exchange. As of December 31, 2007, the maximum aggregate principal amount of debt instruments outstanding at any one time under the program may not exceed $10.0 billion. The proceeds of these issuances were used for financing operations, including the purchase of receivables and the repayment of previously issued debt. At December 31, 2007, $4.0 billion was outstanding under this program, of which $2.7 billion was issued by Credco.
Credco established a program in Australia for the issuance from time to time of up to approximately $5.2 billion. During 2007, Credco issued approximately $174 million and $218 million of fixed rate and floating
rate notes, respectively, due in 2010. At December 31, 2007, approximately $4.4 billion was available for issuance under this program.
On November 30, 2007, the registration statement filed in Canada expired for the Canadian long-term note program. Therefore, at December 31, 2007 no securities were available for issuance under this program. At December 31, 2007, approximately $2.0 billion of debt securities was outstanding under this program. During the fourth quarter of 2007, American Express Canada Credit Corporation (Cancredco), a wholly-owned subsidiary of Credco, borrowed Canadian $300 million from the Bank of Montreal under a credit agreement guaranteed by Credco. The proceeds were used to pay the long-term notes under this program that were maturing.
On January 15, 2008, a new registration statement was filed in Canada, which was effective and available by February 15, 2008. The regulatory approval is for a base shelf prospectus for a long-term note program providing for the issuance from time to time, in Canada, of up to approximately Canadian $3.5 billion of notes by Cancredco. All notes issued under this shelf registration will be guaranteed by Credco.
Credco’s funding strategy is designed to maintain high and stable debt ratings from the major credit rating agencies, Moody’s, Standard & Poor’s, Fitch Ratings and DBRS. Maintenance of high and stable debt ratings is critical to ensuring Credco’s continuous access to the capital and credit markets. It also enables Credco to reduce its overall borrowing costs. At December 31, 2007, Credco’s debt ratings were as follows:
Rating agencies review factors such as capital adequacy with a view towards maintaining certain levels of capital, liquidity, business volumes, asset quality and economic market trends, among others, in assessing Credco’s and its subsidiaries’ appropriate ratings.
Credco actively manages the risk of liquidity and cost of funds resulting from Credco’s financing activities. A downgrade of Credco’s debt ratings would increase its borrowing costs. Management believes a decline in Credco’s long-term credit rating by two levels could result in Credco having to significantly reduce its commercial paper and other short-term borrowings. Remaining borrowing requirements would be addressed through other means such as the issuance of long-term debt and the sale of investment securities or drawing on existing credit lines. This would result in higher interest expense on Credco’s commercial paper and other debt, as well as higher fees related to unused lines of credit. Credco believes a two-level downgrade is highly unlikely due to its capital position and growth prospects.
Credco paid cash dividends of $750 million and $500 million to TRS in 2007 and 2006, respectively. On February 8, 2008, Credco paid a cash dividend of $125 million to TRS.
Contingent Liquidity Strategy
Credco seeks to ensure that it has adequate liquidity, that is cash and equivalents on hand, as well as access to cash and equivalents to continuously meet its business needs and satisfy its obligations. Liquidity is managed through the breadth of funding sources, as well as through the quality and liquidity of its funded assets.
Credco balances the trade-offs between having too much liquidity, which can be costly and limit financial flexibility, with having inadequate liquidity, which may result in financial distress during a liquidity event. Credco considers various factors in determining its liquidity needs, such as economic and financial market
conditions, seasonality in business operations, cost and availability of alternative liquidity sources, and credit rating agency considerations. In 2007, short-term debt including intercompany borrowings as a percentage of total debt increased to 47 percent at December 31, 2007, from 42 percent at December 31, 2006.
Credco has developed a contingent funding plan that enables it to meet its daily funding obligations when access to unsecured funds in the debt capital markets is impaired or unavailable. This plan is designed to ensure that Credco could continuously maintain normal business operations for a twelve-month period in which its access to unsecured funds is interrupted.
The contingent liquidity plan includes access to diverse sources of alternative liquidity funding that are available, mainly in the form of the liquidity portfolio, securitizations of cardmember receivables through RFC V and AEIT, loans through American Express affiliates, and bank credit facilities, to provide uninterrupted funding over a twelve-month period should access to unsecured debt sources become impaired. Credco estimates that, under a worst case liquidity crisis scenario, it has identified up to $6.1 billion in alternate funding sources available to cover cash needs over the first 60 days after a liquidity crisis has occurred.
Liquidity Investment Portfolio
During the normal course of business, funding activities may raise more proceeds than are necessary for immediate funding needs. These amounts are invested principally in high credit quality, highly liquid short-term instruments. In addition, Credco’s contingent funding plan includes access to a continuing liquidity portfolio in which proceeds raised from funding activities are invested in longer term, highly liquid instruments, such as U.S. Treasury securities and government sponsored entity debt. The invested amounts of the liquidity portfolio provide back-up liquidity, primarily for the commercial paper program. Instruments held within this portfolio will be of the highest credit quality and most liquid of investment instruments available. Credco can sell these securities or enter into sale/repurchase agreements to immediately raise cash proceeds to meet liquidity needs. At December 31, 2007, Credco held $3 billion of such securities under this program.
Credco entered into securities lending agreements in June 2006 with other financial institutions to enhance investment income. At December 31, 2007, the liquidity investment portfolio included approximately $970 million of investment securities loaned under these agreements.
From time to time, Credco may increase its liquidity portfolio in order to prefund maturing debt obligations when financial market conditions are favorable. These levels are monitored and adjusted when necessary to maintain short-term liquidity needs in response to seasonal or changing business conditions. The funding sources that would be relied upon depend on the exact nature of such a hypothetical liquidity crisis; nonetheless, Credco’s liquidity sources are designed with the goal of ensuring there is sufficient cash on hand to fund business operations over a twelve-month period regardless of whether the liquidity crisis was caused by an external, industry or Credco-specific event. The contingent funding plan also addresses operating flexibilities in quickly making these funding sources available to meet all financial obligations. The simulated liquidity crisis is defined as a sudden and unexpected event that temporarily impairs access to or makes unavailable funding in the unsecured debt markets.
Committed Bank Credit Facilities
Credco maintained committed bank credit facilities at December 31, 2007 as follows:
(a)
Committed lines supported by 37 financial institutions.
(b)
Included is $3.1 billion related to the Australian credit facility and $305 million related to the Canadian credit facility.
(c) Credco has the right to borrow a maximum amount of $11.6 billion with a commensurate maximum $1.2 billion reduction in the amount available to American Express.
The availability of the credit lines is subject to Credco’s compliance with certain financial covenants that require maintenance of a 1.25 ratio of combined earnings and fixed charges to fixed charges. The ratio of earnings to fixed charges for Credco was 1.38, 1.44 and 1.41 in 2007, 2006 and 2005, respectively. The ratio of earnings to fixed charges for American Express for 2007, 2006 and 2005 was 2.26, 2.60 and 2.64, respectively.
Committed bank credit facilities do not contain material adverse change clauses, which may preclude borrowing under the credit facilities. Additionally, the facilities may not be terminated should there be a change in Credco’s credit rating.
Results of Operations
Pretax income depends primarily on the volume of cardmember receivables and loans purchased, the discount factor used to determine purchase price, the relationship of the total discount to Credco’s interest expense and the collectibility of cardmember receivables and loans purchased.
Credco’s consolidated net income rose 16 percent to $720 million for the year ended December 31, 2007, as compared to the year ended December 31, 2006. The year-over-year increase was primarily due to an increase in discount revenue earned on purchased cardmember receivables and loans and an increase in interest income earned on loans to affiliates and investments, offset by an increase in interest expense to affiliates and others and provision for losses, net of recoveries and loan service fees.
The following table summarizes the changes attributable to the increase (decrease) in key revenue and expense accounts:
Discount Revenue Earned on Purchased Cardmember Receivables and Loans
Discount revenue increased 29 percent or $650 million to $2.9 billion for the year ended December 31, 2007, as compared to the same period in 2006. The year-over-year increase was primarily due to an increase in both discount rates and to a lesser extent volume of receivables purchased. Volume of receivables and loans purchased for the year ended December 31, 2007, was 4 percent higher than the same period a year ago; purchased volume does not include those cardmember receivables transferred with recourse to Credco and cardmember receivables and loans funded by loans to affiliates since these amounts are included in loans to affiliates rather than cardmember receivables. Discount rates, which vary over time due to changes in market interest rates or changes in the collectibility of cardmember receivables, increased an average of approximately 20 basis points compared to the year ended December 31, 2006.
Interest Income from Affiliates
Interest income from affiliates increased 24 percent or $127 million to $650 million for the year ended December 31, 2007, as compared to the year ended December 31, 2006. The year-over-year increase was primarily due to an increase in both the volume of loans to affiliates and the interest rates charged to affiliates. The average interest rate charged to affiliates during the year ended December 31, 2007, was 52 basis points higher than the average interest rate charged to affiliates in the same period a year ago, primarily due to greater floating rate interest-bearing borrowings with affiliates.
Interest Income from Investments
Interest income from investments increased 28 percent or $60 million to $278 million for the year ended December 31, 2007, as compared to the same period in the prior year. The year-over-year increase was due to the replacement of matured U.S. Treasury securities in 2006 primarily with higher yielding government sponsored entities securities. The average rate on the total investment portfolio increased 68 basis points for the year ended December 31, 2007, compared to the year ended December 31, 2006.
Provision for Losses, Net of Recoveries
The provision for losses, net of recoveries increased 43 percent or $253 million to $842 million for the year ended December 31, 2007, as compared to the year ended December 31, 2006. The increase in provision for losses was due to higher write-off and delinquency rates, increased loan volumes, and the charge for credit related trends. While overall cardmember spending continued to be relatively strong, Credco experienced some negative credit trends among U.S. consumers in the latter part of 2007. As a result, Credco recorded a $84 million credit-related charge in the fourth quarter.
Interest Expense and Interest Expense to Affiliates
Interest expense and interest expense to affiliates increased 26 percent and 30 percent, respectively, for the year ended December 31, 2007, as compared to the same period a year ago, due to an increase in both the levels of debt funding and higher effective cost of funds. The average interest rate on debt outstanding during the year ended December 31, 2007, was 54 basis points higher than the same period a year ago. The average interest rate due to affiliates during the year ended December 31, 2007, was 94 basis points higher than the same period a year ago, primarily due to the fact that a high proportion of the interest-bearing borrowings were at floating rate.
Service Fees to Affiliates
Credco pays fees to affiliates for the related servicing of the receivables purchased. Service fees to affiliates increased $99 million for the year ended December 31, 2007, as compared to the same period a year ago, due to an increase in servicing activities provided under service level agreements with affiliates.
Income Taxes
Credco’s effective tax rate for the years ended December 31, 2007, 2006 and 2005, was 7.3 percent, 13.2 percent and 10.8 percent, respectively. The effective tax rate was lower in 2007 as compared to 2006 primarily as a result of an increase in the benefits related to its ongoing funding activities outside the United States. These benefits are expected to continue in future periods. The effective tax rate was higher in 2006 compared to 2005 primarily as a result of a decrease in the proportion of foreign subsidiary pretax income to total pretax income.
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Credco’s risk management objective is to monitor and control risk exposures to earn returns commensurate with the appropriate level of risk assumed. In addition to business risk, Credco recognizes four fundamental sources of risk: credit risk, market risk, liquidity risk and operational risk. These risks, which are described below, are interrelated, and management has adopted well defined risk-taking principles to guide Credco’s business strategies and objectives. Credco views credit risk as a component of driving profitable growth. Market risk is hedged or managed within established parameters to sustain such earnings growth. Liquidity risk is managed through the diversification of funding sources, while operational risk arising from Credco’s business activities is carefully monitored to maintain it within acceptable limits.
Credco’s risk management oversight is performed through internal and independent oversight functions. Risk management governance at Credco begins with the American Express Board approved risk management policies and objectives and the American Express Board oversight of risk management parameters. Supporting the American Express Board in its oversight function are other risk management oversight committees, such as American Express’ Treasury Department and other asset and liability management committees. The American Express Enterprise Risk Management Committee (ERMC) supplements the risk management capabilities resident within American Express’ business segments by routinely reviewing key market, credit, operational and other risk concentrations across American Express and recommending action where appropriate. The ERMC recommends risk limits, promotes a rigorous understanding of risks across American Express, including Credco, and supports management in making risk-return decisions.
Credit Risk
TRS manages the overall credit risk exposure associated with the cardmember receivables and loans purchased by Credco. Credit risk is defined as the risk of loss from an obligor or counterparty default. Credco is exposed to credit risk through the cardmember receivables and cardmember loans it purchases generally without recourse, as well as through its participation interests. Since such a portfolio consists of millions of borrowers and individual exposures across multiple geographies, occupations, and social segments, its risk is substantially reduced through diversification. A loss distribution is characterized by a higher frequency but manageable severity that is more closely linked to general economic and legal conditions than by borrower-specific events. Receivable and loan purchase decisions and the related discount pricing are impacted by the overall credit risk considerations inherent in the cardmember receivables and cardmember loans.
Credit risk associated with Credco’s derivatives is limited to the risk that a derivative counterparty will not perform in accordance with the terms of the contract. To mitigate such risk, Credco’s counterparties are all required to be rated as investment grade. Additionally, Credco enters into master netting agreements with its counterparties wherever practical.
Market Risk Management Process
Market risk is the risk to earnings or value resulting from movements in market prices. Credco’s market risk consists primarily of interest rate risk and foreign exchange risk. Market risk exposures are monitored and managed by various risk committees, American Express’ Treasury Department as well as by management. Credco operates under American Express Board approved policies related to market risk management and the use of derivative financial instruments. With respect to derivative financial instruments, the value of such instruments is derived from an underlying variable or multiple variables, including commodity, equity, foreign exchange and interest rate indices or prices. These instruments enable end users to increase, reduce, or alter exposure to various market risks and, for that reason, are an integral component of Credco’s market risk and related asset liability management strategy and processes. See Note 7 for additional discussion of Credco’s derivative financial instruments.
Interest rate risk is generated by the funding of cardmember receivables and fixed rate cardmember loan purchases through longer term variable rate borrowings. Such assets and liabilities generally do not create naturally offsetting positions with respect to basis, re-pricing or maturity characteristics. By using derivative financial instruments, such as interest rate swaps, the interest rate profile can be adjusted to maintain and manage a desired profile. As of December 31, 2007 and 2006, the total notional amount of interest rate swaps was $8 billion and $6 billion, respectively. These derivatives generally qualify for hedge accounting. A portion of these derivatives outstanding as of December 31, 2007 extend to 2011.
In addition, foreign exchange risk is generated by cross-currency purchased cardmember receivables and cardmember loans, foreign currency denominated balance sheet exposures and foreign currency earnings in international units. Credco hedges this market exposure to the extent it is economically justified through various means including local market cross-currency funding and the use of derivative financial instruments, such as foreign exchange forward and cross-currency swap contracts, which can help “lock in” Credco’s exposure to specific currencies. As of December 31, 2007 and 2006, the total notional amount of foreign exchange derivatives was $32 million and $125 million, respectively. These derivatives generally do not qualify for hedge accounting.
The following discussion includes sensitivity analysis of interest rate and foreign currency risk and estimates the effects of hypothetical sudden and sustained changes in the applicable market conditions on the ensuing year’s earnings, based on year-end positions. The market changes, assumed to occur as of year-end, are a 100 basis point increase in market interest rates and a 10 percent strengthening of the U.S. dollar versus all other currencies. Computations of the prospective effects of hypothetical interest rate and foreign exchange rate changes are based on numerous assumptions, including relative levels of market interest rates and foreign exchange rates, as well as the levels of assets and liabilities. The hypothetical changes and assumptions will be different from what actually occurs in the future. Furthermore, the computations do not incorporate actions that management could take if the hypothetical market changes actually occur, including revising the discount rate applicable to purchases of new receivables. As a result, actual earnings consequences will differ from those quantified. The detrimental effect on Credco’s pretax earnings of a hypothetical 100 basis point increase in interest rates would be approximately $133 million based on the 2007 year-end positions. This effect, which is calculated using a static asset/liability gapping model, is primarily a function of the extent of variable rate funding of charge card and fixed rate lending products, to the degree that interest rate exposure is not managed by derivative financial instruments. From a foreign exchange risk perspective, based on the year-end 2007 and 2006 foreign exchange positions, the effect on Credco’s earnings of the hypothetical 10 percent strengthening of the U.S. dollar would be immaterial.
Liquidity Risk Management Process
Liquidity risk is defined as the inability to access cash and equivalents needed to meet business requirements and satisfy Credco’s obligations. Credco balances the trade-offs between maintaining too much liquidity, which can be costly and limit financial flexibility, with having inadequate liquidity, which may result in financial distress during a liquidity event. Liquidity risk is centrally managed by the Funding and Liquidity Committee of American Express, chaired by American Express’ Corporate Treasurer. American Express has developed a contingent funding plan that enables it to meet its daily cash obligations when access to unsecured funds in the debt capital markets is impaired or unavailable. This plan is designed to ensure that American Express and all of its main operating entities, including Credco, could continuously maintain business operations for a 12-month period in which its access to unsecured financing is interrupted. The hypothetical 12-month liquidity crisis is assumed to occur as a sudden and unexpected event that temporarily impairs access to or makes unavailable financing in the unsecured debt markets.
Liquidity risk is managed both at an aggregate American Express level and at the major legal entities, including Credco, in order to ensure that sufficient funding and contingent liquidity resources are available in the amount and in the location needed in a stress event. American Express’ Funding and Liquidity Committee manages the forecasts of American Express’ aggregate and subsidiary cash positions and
financing requirements, the funding plans designed to satisfy those requirements under normal conditions, establishes guidelines to identify the amount of contingent liquidity resources required, and monitors positions and determines any actions to be taken. Contingent liquidity planning also takes into account operating cash flexibilities.
Operational Risk Management Process
Credco defines operational risk as the risk of not achieving business objectives due to inadequate or failed processes, or information systems, human error or the external environment (e.g., natural disasters), including losses due to failures to comply with laws and regulations. Operational risk is inherent in all business activities and can impact an organization through direct or indirect financial loss, brand damage, customer dissatisfaction, or legal or regulatory penalties. Credco is committed to improving its ability to prioritize and manage operational risk through the delivery of a comprehensive operational risk program. American Express has developed a comprehensive program to identify, measure, monitor, and report inherent and emerging operational risks. However, day-to-day management of operational risk lies with Credco. Credco continues to enhance its operational risk management practices on an ongoing basis. The implementation of this operational risk program is expected to result in improved operational risk intelligence and a heightened level of preparedness to deal with operational risk events and conditions that may adversely impact Credco’s operations.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
1.
Financial Statements.
See Index to Financial Statements at page hereof.
2.
Supplementary Financial Information.
Selected quarterly financial data. See Note 14 to the Consolidated Financial Statements appearing herein.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
Item 9A(T).
Item 9A(T). CONTROLS AND PROCEDURES
Credco’s management, with the participation of Credco’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of Credco’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, Credco’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, Credco’s disclosure controls and procedures are effective.
There have not been any changes in Credco’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during Credco’s fourth fiscal quarter that have materially affected, or are reasonably likely to materially affect, Credco’s internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting
The management of Credco is responsible for establishing and maintaining adequate internal control over financial reporting. Credco’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America, and includes those policies and procedures that:
Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of Credco;
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of Credco are being made only in accordance with authorizations of management and directors of Credco; and
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of Credco’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Credco’s management assessed the effectiveness of Credco’s internal control over financial reporting as of December 31, 2007. In making this assessment, Credco’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Controls - Integrated Framework.
Based on management’s assessment and those criteria, management has concluded that, as of December 31, 2007, Credco’s internal control over financial reporting is effective.
This annual report does not include an attestation report of PricewaterhouseCoopers LLP, Credco’s registered public accounting firm, regarding internal control over financial reporting. Management’s report was not subject to attestation by Credco’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit Credco to provide only management’s report in this annual report.
Pursuant to Item 308T(a) of Regulation S-K, this Management’s Report on Internal Control Over Financial Reporting shall not be deemed to be filed for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of that section.
Item 9B.
Item 9B. OTHER INFORMATION
Not applicable.
PART III
Item 10.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Omitted pursuant to General Instruction I(2) (c) to Form 10-K.
Item 11.
Item 11. EXECUTIVE COMPENSATION
Omitted pursuant to General Instruction I(2) (c) to Form 10-K.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Omitted pursuant to General Instruction I(2) (c) to Form 10-K.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Omitted pursuant to General Instruction I(2) (c) to Form 10-K.
Item 14.
Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The Audit Committee of the Board of Directors of American Express Company has appointed PricewaterhouseCoopers LLP as the independent registered public accounting firm to audit the Consolidated Financial Statements of Credco for the year ended December 31, 2007.
Each year the Audit Committee reviews the accountants’ qualifications, performance and independence in accordance with regulatory requirements and guidelines. At least every ten years, the Audit Committee charter requires a detailed review of American Express’ accounting firm, which would include a comparison of resources available in other firms. The Committee conducted such a review in 2004, resulting in the appointment of PricewaterhouseCoopers LLP as the independent registered public accounting firm for Credco for the year beginning January 1, 2005.
Audit Fees
The aggregate fees billed or to be billed by PricewaterhouseCoopers LLP for professional services rendered for the audit of Credco’s Consolidated Financial Statements and services that were provided in connection with statutory and regulatory filings or engagements and other attest services were $263,500 and $258,275 for the years ended December 31, 2007 and 2006, respectively.
Audit-Related Fees
Credco was not billed by PricewaterhouseCoopers LLP for any fees for audit-related services for 2007 or 2006.
Tax Fees
Credco was not billed by PricewaterhouseCoopers LLP for any tax fees for 2007 or 2006.
All Other Fees
Credco was not billed by PricewaterhouseCoopers LLP for any other fees for 2007 or 2006.
Policy on Pre-Approval of Services Provided by Independent Registered Public Accountants
Pursuant to the requirements of the Sarbanes-Oxley Act of 2002, the terms of the engagement of Credco’s independent registered public accounting firm is subject to the specific pre-approval of the Audit Committee of American Express. All audit and permitted non-audit services to be performed by Credco’s independent registered public accounting firm require pre-approval by the Audit Committee in accordance with pre-approval procedures established by the Audit Committee. The procedures require all proposed engagements of Credco’s independent registered public accountants for services to Credco of any kind to be directed to the General Auditor of American Express and then submitted for approval to the Audit Committee of American Express prior to the beginning of any services.
Other Transactions with PricewaterhouseCoopers LLP
American Express has a number of business relationships with individual member firms of the worldwide PricewaterhouseCoopers LLP organization. American Express subsidiaries provide card and travel services to some of these firms and these firms pay fees to American Express
subsidiaries. These services are in the normal course of business and American Express provides them pursuant to arrangements that American Express offers to other similar clients.
PART IV
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
AMERICAN EXPRESS CREDIT CORPORATION
(Registrant)
Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities on the dates indicated.
AMERICAN EXPRESS CREDIT CORPORATION
COVERED BY REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
(Item 15