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. Both American Express and TRS are bank holding companies.
Credco is engaged in the business of financing non-interest-earning 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 certain countries outside the United States. Credco also finances certain interest-earning and discounted revolving loans generated by cardmember spending on American Express credit cards issued in non-U.S. markets, although interest-earning 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 global service company that provides customers with access to products, insights and experiences that enrich lives and build business success. American Express’ principal products and services are charge and credit payment card products and travel-related services offered to consumers and businesses around the world.
American Express’ products and services are sold globally to diverse customer groups, including consumers, small businesses, middle-market companies, and large corporations. As a merchant processor, TRS accepts and processes from each participating establishment the charges arising from cardmember purchases. TRS charges a fee, the “merchant discount,” to the merchant that reflects the value that is delivered to the merchant and the investments made in providing that value. Value is delivered to the merchant in a variety of ways, including through higher spending cardmembers relative to users of cards issued on competing card networks, marketing expertise and programs, information services, fraud prevention services, and other investments that enhance the value propositions associated with acceptance of the card. When establishing the merchant 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 generally 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 current spending patterns, payment history, credit record and financial resources. Charge cards generally require payment by the cardmember of the full amount billed each month, and no finance charges are assessed on the balance. 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. The no preset spending limit and pay-in-full nature of these products attract high-spending cardmembers. In addition to charge cards, TRS and its subsidiaries and 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.
Some of the statements in this report constitute forward-looking statements. You can identify forward-looking statements by words such as “believe,” “expect,” “anticipate,” “optimistic,” “intend,” “plan,” “aim,” “will,” “may,” “should,” “could,” “would,” “likely,” “estimate,” “predict,” “potential,” “continue,” or other similar expressions. We discuss certain factors that affect our business and operations and that may cause our actual results to differ materially from these forward-looking statements under “Item 1A.
Item 1A. RISK FACTORS
Based on the information currently known, Credco believes that the matters discussed below identify the most significant risk factors affecting Credco. However, the risks and uncertainties that Credco faces are not limited to those described below. Additional risks and uncertainties not presently known to Credco or that Credco currently believes to be immaterial may also adversely affect Credco’s business and the trading price of its securities.
Adverse capital and credit market conditions may significantly affect Credco’s ability to meet liquidity needs, access to capital and cost of capital.
The global money and capital markets, while demonstrating generally improved conditions, remain susceptible to volatility and disruption, which could negatively impact market liquidity conditions.
Credco relies on liquidity to pay operating expenses, interest on debt and dividends on capital stock and to repay maturing liabilities. Without sufficient liquidity, Credco could be forced to limit its business growth or curtail operations. The principal sources of Credco’s liquidity are payments from cardmembers, cash and cash equivalents, debt instruments such as unsecured medium- and long-term notes and assets that could be sold to TRS for securitizations, and long-term committed bank borrowing facilities in certain non-U.S. markets, as well as access to additional liquidity in the form of cash and readily marketable securities held by certain affiliates through intercompany loan agreements.
Credco’s ability to obtain financing in the debt capital markets for unsecured term debt and asset securitization is dependent on investor demand. Notwithstanding Credco’s solid financial position, Credco is not immune from pressures experienced broadly across the financial markets. The fragility of the credit markets and the current economic and regulatory environment have impacted financial services companies. Although the market for Credco’s unsecured term debt has improved, there is no assurance that the markets will be open in the future. For example, recent concerns regarding U.S. debt and budget matters and the sovereign debt crisis in Europe have caused uncertainty in financial markets. Although the U.S. debt limit was increased, a failure to raise the U.S. debt limit and/or a further downgrade of U.S. debt ratings in the future could, in addition to causing economic and financial market disruptions, materially adversely affect Credco’s ability to access capital markets on favorable terms, as well as have other material adverse effects on the operation of our business and our financial results and condition. The impact of the sovereign debt crisis in Europe on financial institutions in Europe and globally could also have an adverse impact on the capital markets generally. Credco also would have less flexibility in accessing the commercial paper market as a short-term funding vehicle in the event of a downgrading in its short-term debt rating and volatility in the commercial paper market generally.
In the event that current sources of liquidity, including internal sources, do not satisfy Credco’s needs, it could be required to seek additional financing. The availability of additional financing will depend on a variety of factors such as market conditions, the general availability of credit, the overall availability of credit to the financial services industry, new regulatory restrictions and requirements, Credco’s debt credit ratings (which were downgraded in April 2009 by two of the major rating agencies) and credit capacity, as well as the possibility that lenders could develop a negative perception of Credco’s long- or short-term financial prospects if it incurs large credit losses or if the level of its business activity decreases due to an economic downturn or due to perceived operational risk. Similarly, Credco’s access to funds may be impaired if regulatory authorities or rating agencies take negative actions against Credco.
While American Express and Credco have experienced positive credit trends since the latter half of 2009, if the performance of Credco’s charge card and credit card receivables were to weaken through increasing delinquencies and write-offs, Credco’s long-term and short-term debt ratings could be downgraded and its access to capital could be materially adversely affected and its cost of capital could increase.
Disruptions, uncertainty or volatility in the capital and credit markets may also limit Credco’s access to capital required to operate its business. Such market conditions may limit its ability to replace, in a timely manner, maturing liabilities and access the capital necessary to grow its business. As such, Credco may be forced to delay raising capital, or bear an unattractive cost to raise capital, which could decrease profitability and significantly reduce financial flexibility.
If levels of market disruption and volatility worsen, there can be no assurance that Credco will not experience an adverse effect. This may have a material impact on Credco’s ability to access capital and on its business, financial condition and results of operations.
Difficult conditions in the global capital markets and the economy generally may materially and adversely affect Credco’s business and results of operations.
Credco’s results of operations are materially affected by conditions in the global capital markets and the economy in general, both in the United States and elsewhere around the world.
Ongoing concerns over the availability and cost of credit, the mortgage and real estate markets, elevated levels of unemployment and geopolitical issues continue to impact global economies and markets. In addition, the impact of the perceived creditworthiness of the U.S. government and the current crisis in Europe with respect to the ability of certain European Union countries to continue to service their sovereign debt obligations could adversely affect the U.S. and global financial markets and economic conditions. This environment and the uncertain expectations for an economic recovery have had, and may continue to have, an adverse effect on Credco, in part because it is very dependent upon consumer and business behavior. A prolonged period of slow economic growth or a deterioration in economic conditions could change customer behaviors further. Credco’s revenue growth is likely to decline in such circumstances and, in certain instances, revenues may decrease, and its profit margins could erode. In addition, in the event of extreme prolonged market adversity, such as the global credit crisis and economic slowdown, Credco could incur significant losses.
Factors such as consumer spending, business investment, government spending, interest rates, tax rates, fuel and other energy costs, the volatility and strength of the capital markets and inflation all affect the business and economic environment and, ultimately, Credco’s profitability. An economic downturn characterized by higher unemployment, lower family income, lower corporate earnings, lower business investment and lower consumer spending is likely to materially and adversely affect Credco’s business, results of operations and financial condition. Furthermore, the factors discussed above may cause Credco’s earnings, credit metrics and margins to fluctuate and diverge from expectations of analysts and investors, who may have differing assumptions regarding their impact on Credco’s business.
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 Credco’s business and infrastructure, including its information technology systems. Because Credco derives a portion of its revenues from travel-related spending, its business will be sensitive to safety concerns, and thus is likely to decline during periods in which travelers become concerned about safety issues or when travel might involve health-related risks.
If the conditions described above (or similar ones) were to persist or worsen, Credco could experience continuing or increased adverse effects on its results of operations and financial condition.
The impairment of other financial institutions could adversely affect Credco.
Credco’s ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial services institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. Credco routinely executes transactions with counterparties in the financial services industry, including commercial banks, investment banks and insurance companies. Defaults or non-performance by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by one or more of Credco’s counterparties, which, in turn, could have a material adverse effect on Credco’s results of operations and financial condition.
Any downgrade in Credco’s credit ratings could increase the cost of its funding from and restrict Credco’s access to the capital markets and have a material adverse effect on Credco’s results of operations and financial condition.
Although Credco’s long-term debt is currently rated investment grade by the major rating agencies, the ratings of its debt were downgraded during the second quarter of 2009 by Moody’s Investors Services (Moody’s) and Standard & Poors (S&P). The rating agencies regularly evaluate Credco, and their ratings of Credco’s long-term and short-term debt are based on a number of factors, including Credco’s financial strength, as well as factors not entirely within Credco’s control, including conditions affecting the financial services industry generally and the wider state of the economy. There can be no assurance that Credco will maintain its current credit ratings. Failure to maintain those ratings could, among other things, limit Credco’s access to the capital markets and adversely affect the cost and other terms upon which Credco is able to obtain funding and increase Credco’s cost of capital.
Credco cannot predict what actions rating agencies may take. As with other companies in the financial services industry, Credco’s ratings could be downgraded at any time and without any notice by any of the rating agencies.
Adverse currency fluctuations, foreign exchange controls and continued concerns regarding the European debt crisis could decrease revenue Credco receives from its international operations.
During 2011, over 56 percent of Credco’s revenue was generated from activities outside the United States. Credco is exposed to foreign exchange risk from its international operations, and some of the revenue it generates outside the United States is subject to unpredictable and indeterminate fluctuations if the values of other currencies change relative to the U.S. dollar. Resulting exchange gains and losses are included in Credco’s net income. Furthermore, Credco may become subject to exchange control regulations that might restrict or prohibit the conversion of Credco’s other revenue currencies into U.S. dollars. The occurrence of any of these events or circumstances could decrease the revenues Credco receives from its international operations and have a material adverse effect on Credco’s business.
Concerns persist regarding the ability of certain European countries to continue to service their sovereign debt obligations, the overall stability of the euro and the suitability of the euro as a single currency given the diverse economic and political circumstances in individual Eurozone countries. These concerns may cause the value of the euro to fluctuate more widely than in the past and could lead to the re-introduction of individual currencies in one or more Eurozone countries, or, in more extreme circumstances, the possible dissolution of the euro currency entirely. If there is a significant devaluation of the euro and Credco is unable to hedge its foreign exchange exposure to the euro, the value of its euro-denominated net monetary assets and liabilities would be correspondingly reduced when translated into U.S. dollars for inclusion in Credco’s financial statements. The re-introduction of individual currencies would require the card issuers to reconfigure their billing and other systems to reflect individual currencies in place of the euro. Implementing such changes could be costly and failures in the currency reconfiguration could cause disruptions in Credco’s normal business operations. In addition, foreign currency derivative instruments to hedge Credco’s market exposure to re-introduced currencies may not be immediately available or may not be available on terms that are acceptable to us.
The potential developments regarding Europe and the euro, or market perceptions concerning these and related issues, could continue to have an adverse impact on consumer and business behavior in Europe and globally, which could have a material adverse effect on Credco’s business, financial condition and results of operations. As discussed above, concerns over the effect of this financial crisis on financial institutions in Europe and globally could have an adverse impact on the capital markets generally.
The risk management policies and procedures of Credco and the card issuers may not be effective.
Credco’s risk management framework seeks to mitigate risk and appropriately balance risk and return. We have established policies and procedures intended to identify, monitor and manage the types of risk to which we are subject, including credit risk, market risk, liquidity risk, operational risk and reputational risk. Management of our risks in some cases depends upon the use of analytical and/or forecasting models. If the models we use to mitigate these risks are inadequate, we may incur increased losses. In addition, there may be risks that exist, or that develop in the future, that we have not appropriately anticipated, identified or mitigated.
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. 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, Credco’s risk management techniques and hedging strategies may not be fully effective. In addition, as regulations and markets in which we operate continue to evolve, our risk management framework may not always keep sufficient pace with those changes. If our risk management framework does not effectively identify or mitigate our risks, we could suffer unexpected losses or reputational harm that could materially adversely affect us.
Credco must effectively manage credit risk related to consumer debt, business loans, merchant bankruptcies, the rate of bankruptcies, and other credit trends that can affect spending on card products, debt payments by individual and corporate customers and businesses that accept American Express card products.
Credit risk is the risk of loss from obligor or counterparty default. Credco is exposed to both consumer credit risk and institutional credit risk through the cardmember receivables and cardmember loans it purchases generally without recourse as well as through its participation interests. 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. Credco’s ability to assess creditworthiness may be impaired if the criteria or models we use to manage our credit risk become less predictive of future losses, which could cause Credco’s losses to rise and have a negative impact on Credco’s results of operations. Rising delinquencies and rising rates of bankruptcy are often precursors of future write-offs and may require Credco to increase its reserve for losses. Although delinquencies and charge-offs declined significantly in 2011, we believe we are experiencing historical lows in these rates and they are likely to increase. In addition, if economic conditions do not improve, these rates may increase more than expected. Higher write-off rates and an increase in Credco’s reserve for losses adversely affect Credco’s profitability and may increase Credco’s cost of funds. In addition, Credco’s ability to recover amounts due on receivables that it has previously written off may be adversely affected.
Although Credco and the card issuers make estimates to provide for credit losses in their respective outstanding portfolio of loans and receivables, these estimates may not be accurate. In addition, the information Credco and the card issuers use in managing their credit risk may be inaccurate or incomplete. Although Credco regularly reviews its
and the card issuers’ credit exposure to specific clients and counterparties and to specific industries, countries and regions that Credco and the card issuers 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 customers. Increased credit risk, whether resulting from underestimating the credit losses inherent in our portfolio of loans and receivables, deteriorating economic conditions or otherwise, could require us to increase our provision for losses and could have a material adverse effect on our results of operations and financial condition.
Credco must also effectively manage the 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 primarily exposed to market risk from the impact of interest rate movements on its borrowings and interest-earning assets. If the rate of interest Credco pays on its borrowings increases, this will lead to Credco increasing the discount rate at which it offers to purchase receivables in order to achieve the minimum required 1.25 fixed charge coverage ratio. To the extent this increased price is not acceptable to the seller, the amount of receivables purchased may decline, which would result in a lower net income to Credco.
Additionally, Credco must also effectively manage liquidity risk to which it is exposed. Liquidity risk is defined as the inability to access cash and equivalents needed to meet business requirements and satisfy Credco’s obligations. If Credco is unsuccessful in managing its liquidity risk, it may maintain too much liquidity, which can be costly and limit financial flexibility, or it may be too illiquid, which could result in financial distress during a liquidity event. For additional information regarding Credco’s management of liquidity risk, see “Adverse capital and credit market conditions may significantly affect Credco’s ability to meet liquidity needs, access to capital and cost of capital” above.
Finally, Credco must also manage the operational risks to which it is exposed. Credco considers operational risk to be the risk of not achieving business objectives due to inadequate or failed processes or information systems, human error, or the external environment (i.e., such as natural disasters), including losses due to failure to comply with laws and regulations. Operational risks include the risk that Credco may not comply with specific regulatory or legal requirements, exposing Credco to fines and/or penalties and possibly brand damage; employee error or intentional misconduct that results in a material financial misstatement; a failure to monitor an outsource partner’s compliance with a service level agreement; or a failure to adequately monitor and control access to data in our systems we grant to third-party service providers.
Credco is an indirect wholly-owned subsidiary of American Express and therefore subject to strategic decisions of American Express and affected by American Express’ performance.
Credco is fundamentally affected by its relationship with American Express. As an indirect wholly-owned subsidiary of American Express, Credco is managed by officers and employees of American Express and Credco is subject to a wide range of possible strategic decisions that American Express may make from time to time. Those strategic decisions could include the level and types of financing Credco provides to support the business of American Express and its other subsidiaries and the level and types of transactional or other support made available to Credco by American Express. In addition, circumstances affecting American Express can significantly affect Credco. For example, Credco’s debt ratings are closely tied to those of American Express, and when rating agencies take actions regarding American Express’ ratings, they may take the same actions with respect to Credco’s ratings. Significant changes in American Express’ strategy or its relationship with Credco or material adverse changes in the performance of American Express or its other subsidiaries could have a material adverse effect on Credco. The outstanding debt and other securities of Credco are not obligations of American Express, TRS or other American Express subsidiaries.
Credco is an indirect wholly-owned subsidiary of American Express and any arrangements or agreements between the two entities may have different terms than would have been negotiated by independent, unrelated parties.
Credco is an indirect wholly-owned subsidiary of American Express. As a result, the arrangements and agreements between Credco and its subsidiaries, on the one hand, and American Express and its other subsidiaries, principally the card issuers, on the other hand, may have different terms and provisions than would have been negotiated by independent, unrelated parties. The principal agreements between the parties are the receivables purchase agreements between Credco, on the one hand, and each of the Banks and TRS, on the other hand. Credco or its subsidiaries are also parties to agreements with card issuers in various international markets for the purchase or transfer with recourse of card receivables and for unsecured loans to card issuers. The agreements between Credco and the card issuers provide that the parties intend that the transactions thereunder be conducted on an arm’s length basis and that, for example, the price at which receivables are sold to Credco or its subsidiaries be at fair market value (including consideration of changes in interest rates or significant changes in collectibility). While there can be no assurance that the terms of these arrangements are the same as would be negotiated between independent, unrelated parties, Credco and its subsidiaries are prohibited, under the terms of the indenture governing Credco’s senior debt securities, from engaging in transactions with any other American Express entities (such as the card issuers) on a basis that is materially less favorable to Credco or its subsidiaries than would be the case if the transaction were with an unrelated third party.
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 its subsidiaries are parties to receivables purchase agreements with the card issuers. These receivables agreements generally require that non-interest and interest-earning 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 its subsidiaries are dependent upon these contractual arrangements. Lower levels of cardmember receivables and loans generated by the card issuers from which Credco and its subsidiaries purchase receivables would result in a reduction in the level of finance operations and a reduction in the revenues and net income of Credco and its subsidiaries.
In October 2008, Credco and each of the Banks mutually agreed to amend their respective receivables purchase agreements to allow the Banks flexibility, from time to time, to sell receivables to Credco or to retain the receivables and fund them from their own sources. However, the amended agreements require the Banks to sell either all or none of their charge card receivables to Credco at any given time. The Banks, therefore, may not direct receivables with particular risk characteristics for sale to Credco. The amendments have led to a material reduction in Credco’s purchases of receivables from the Banks and could result in increased volatility in the volume of Credco’s purchases of receivables from time to time. This in turn could increase the volatility of Credco’s operating metrics that are volume-driven, including discount revenue, interest expense and net income.
The Credit Card Accountability Responsibility and Disclosure Act of 2009 will significantly impact Credco’s business practices and could have a material adverse effect on Credco’s results of operations.
The CARD Act required American Express to make fundamental changes to many of American Express’ business practices, including marketing, underwriting, pricing and billing. Among other things, the CARD Act prohibits an issuer from increasing the annual percentage rate (APR) on outstanding balances (with limited exceptions), requires additional account disclosures, provides consumers with the right to opt out of significant changes to account terms, and restricts penalty fees and charges that may be imposed by an issuer.
In addition, the CARD Act requires issuers to periodically reevaluate APR increases to determine if a decrease is appropriate. The obligation to periodically reevaluate APR increases commenced in February 2011 and is ongoing, and it is uncertain how these provisions will be interpreted by the Consumer Financial Protection Bureau.
American Express has made changes to Card product terms and practices that are designed to comply with, and mitigate the impact of, the changes required by the CARD Act; however, there is no assurance that such changes will continue to be successful. The long-term impact of the CARD Act on American Express’ business practices and revenues will depend upon a number of factors, including its ability to successfully implement its business strategies, consumer behavior and the actions of American Express’ competitors, which are difficult to predict at this time. In the event the CARD Act constrains American Express’ ability to respond to economic, market and other conditions, it could have a material adverse effect on American Express’ results of operations. This, in turn, may also directly impact Credco’s results of operations.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Reform Act) may have a significant adverse impact on Credco’s business, results of operations and financial condition.
In July 2010, President Obama signed into law the Dodd-Frank Reform Act. The Dodd-Frank Reform Act, as well as regulations promulgated thereunder, could have a significant adverse impact on American Express’ business, results of operations and financial condition by, for example, requiring American Express to change its business practices, requiring American Express to comply with more stringent capital, liquidity and leverage ratio requirements, limiting American Express’ ability to pursue business opportunities, imposing additional costs on American Express (including increased compliance costs and increased costs of funding raised through the issuance of asset-backed securities), limiting the fees American Express can charge for services and impacting the value of American Express’ assets.
The Dodd-Frank Reform Act has resulted in increased scrutiny and oversight of consumer financial services and products, primarily through the establishment of the Consumer Financial Protection Bureau (CFPB) within the Federal Reserve. The CFPB has broad rulemaking and enforcement authority over providers of credit, savings and payment services and products and authority to prevent “unfair, deceptive or abusive” practices. The CFPB has the authority to write regulations under federal consumer financial protection laws, and enforce those laws against and examine large financial institutions like American Express, Centurion Bank and American Express Bank FSB for compliance. It is also authorized to collect fines and provide consumer restitution in the event of violations, engage in consumer financial education, track consumer complaints, request data and promote the availability of financial services to underserved consumers and communities. Following a review by the Federal Deposit Insurance Corporation (FDIC) and the Utah Department of Financial Institutions (DFI) of Centurion Bank’s card practices for compliance with certain consumer protection laws and regulations, and the FDIC’s providing the CFPB with information the FDIC considered relevant and obtained by it in the course of its review, the FDIC notified Centurion Bank that it plans to take formal enforcement action against it, and it appears likely the CFPB and the DFI will take some type of action against Centurion Bank as well. Changes by Centurion Bank to its card practices in response to regulatory concerns and enforcement or other action by the FDIC, the CFPB or the DFI, which may include civil money penalties and require additional refund obligations to cardmembers, could adversely affect American Express’ operations and results.
Depending on how the CFPB functions and its areas of focus, it could have a material adverse impact on American Express’ businesses. In addition to increasing card issuers’ compliance costs and potentially delaying American Express’ ability to respond to marketplace changes, this could result in requirements to alter American Express’ products and services that would make its products less attractive to consumers and impair its ability to offer them profitably. The impact this new regulatory regime will have on American Express’ business is uncertain at this time.
Many provisions of the Dodd-Frank Reform Act, including numerous provisions not described above, require the adoption of rules to implement. In addition, the Dodd-Frank Reform Act mandates multiple studies, which could result in additional legislation or regulatory action. Therefore, the ultimate consequences of the Dodd-Frank Reform Act and its implementing regulations on American Express’ and Credco’s business, results of operations and financial condition remain uncertain.
Ongoing legal proceedings regarding American Express Company’s non-discrimination policies could require changes to those policies that could result in a material loss of revenue or increased expenses, substantial monetary judgments and/or damage to American Express’ global reputation and brand.
The U.S. Department of Justice (DOJ), along with certain states attorneys general have brought an action against American Express, MasterCard International Incorporated (MasterCard) and Visa, Inc. (Visa), alleging a violation of Section 1 of the Sherman Antitrust Act. The complaint alleges that the defendants’ policies prohibiting merchants from steering a customer to use another network’s card, another type of card or another method of payment (“anti-steering” and “non-discrimination” rules) violate the antitrust laws. The complaint alleges that the defendants participate in two distinct markets, a “General Purpose Card network services market,” and a “General Purpose Card network services market for merchants in travel and entertainment (T&E) businesses.” The complaint contends that each of the defendants has market power in the alleged two markets. The complaint seeks a judgment permanently enjoining the defendants from enforcing their anti-steering and non-discrimination rules. The complaint does not seek monetary damages. Concurrent with the filing of the complaint, the plaintiffs and Visa and MasterCard announced they had reached an agreement settling the complaint against them by agreeing to modifications in their rules prohibiting merchants that accept their cards from steering customers to use another network’s card, another type of card or another method of payment.
An adverse outcome in any of these proceedings against American Express could materially and adversely impact the profitability of American Express, require it to change its policies in a way that could expose American Express’ card products to steering or other forms of discrimination at the point of sale, threaten the imposition of substantial
monetary damages and/or damage American Express’ global reputation and brand. Even if American Express were not required to change its policies, changes in policies agreed to by Visa and MasterCard pursuant to their settlement agreement with the DOJ and state attorneys general, or other changes to their policies or practices as a result of the proceedings brought by merchants against them, could subject American Express to market pressures that force it to make certain changes to its own policies and practices, which could materially and adversely impact American Express’ profitability and affect Credco’s business of funding American Express card receivables and revolving loans.
Other Reporting Matters
Accounting Developments
Refer to the Recently Issued Accounting Standards section of Note 1 to the Consolidated Financial Statements.
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 Securities and Exchange Commission (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. Credco cautions you that the risk factors described above and other factors described below are not exclusive. There may also be other risks that Credco is 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, which will depend in part on the economic environment, including, among other things, the housing market and the rates of bankruptcies, which can affect spending on card products and debt payments by individual and corporate customers;
• the effectiveness of Credco’s risk management policies and procedures, including Credco’s ability to accurately estimate the provisions for losses in Credco’s outstanding portfolio of cardmember receivables and loans, and operational risk;
• fluctuations in foreign currency exchange rates;
• negative changes in Credco’s credit ratings, which could result in decreased liquidity and higher borrowing costs;
• changes in laws or government regulations affecting American Express’ business, including the potential impact of regulations adopted by federal bank regulators relating to certain credit and charge card practices, the impact of the CARD Act, and the impact of the Dodd-Frank Reform Act, which is subject to further extensive rulemaking, the implications of which are not fully known at this time;
• the effect of fluctuating interest rates, which could affect Credco’s borrowing costs;
• the impact on American Express’ business resulting from continuing geopolitical uncertainty;
• the impact on American Express’ business that could result from litigation such as class actions or proceedings brought by governmental and regulatory agencies (including the lawsuit filed against American Express by the DOJ and certain state attorneys general);
• Credco’s ability to satisfy its liquidity needs and execute on its funding plans, which will depend on, among other things, Credco’s future business growth, the impact of global economic, political and other events on market capacity, Credco’s credit ratings, demand for securities offered by Credco, performance by Credco’s counterparties under its bank credit facilities and other lending facilities, and regulatory changes; and
• Credco’s results of operations being adversely impacted by various proposals to reform the taxation of income earned by U.S. companies’ international business operations and by other legislative action or inaction, including the potential failure of the United States Congress to renew legislation regarding the active financing exception to Subpart F of the Internal Revenue Code.
Item 1B.
Item 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
Item 2.
Item 2. PROPERTIES
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.
Item 4.
Item 4. MINE SAFETY DISCLOSURES
Not applicable.
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 $865 million and $260 million to TRS in 2011 and 2010, respectively. For information about limitations on Credco’s ability to pay dividends, refer to 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 years ended December 31:
Item 7.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING ESTIMATES
Refer to Note 1 to the Consolidated Financial Statements for a summary of Credco’s significant accounting policies referenced, as applicable, to other financial statement footnotes. Certain of Credco’s accounting policies that require significant management assumptions and judgments are set forth below.
RESERVES FOR CARDMEMBER LOSSES
Reserves for cardmember losses represent management’s best estimate of losses inherent in Credco’s outstanding portfolio of cardmember loans and receivables as of the balance sheet date.
In estimating losses management uses statistical models that take into account several factors, including loss migration rates, historical losses and recoveries, portfolio specific risk indicators, current risk management initiatives and concentration of credit risk. In establishing the reserves, management also considers other external environmental factors such as leading economic and market indicators such as unemployment rates, home prices and Gross Domestic Product.
The process of determining the reserve for cardmember losses requires a high degree of judgment. To the extent historical credit experience updated for external environmental trends is not indicative of future performance, actual losses could differ significantly from management’s judgments and expectations, resulting in either higher or lower future provisions for losses.
As of December 31, 2011, an increase (decrease) in write-offs equivalent to 20 basis points of cardmember loans and receivables balances at such date would increase (decrease) the provision for cardmember losses by approximately $26 million. This sensitivity analysis does not represent management’s expectations for write-offs but is provided as a hypothetical scenario to assess the sensitivity of the provision for cardmember losses.
FAIR VALUE MEASUREMENT
Credco holds derivative instruments that are carried at fair value on the Consolidated Balance Sheets. Management makes assumptions and judgments when estimating the fair values of these financial instruments. Credco’s primary derivative instruments are interest rate swaps, foreign currency forward agreements and cross-currency swaps.
In accordance with fair value measurement and disclosure guidance, the objective of a fair value measurement is to determine the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). The disclosure guidance establishes a three-level hierarchy of inputs to valuation techniques used to measure fair value. The fair value hierarchy gives the highest priority to the measurement of fair value based on unadjusted quoted prices in active markets for identical assets or liabilities (Level 1), followed by the measurement of fair value based on pricing models with significant observable inputs (Level 2), with the lowest priority given to the measurement of fair value based on pricing models with significant unobservable inputs (Level 3). Credco does not have any Level 3 assets. Refer to Note 2 in the Consolidated Financial Statements.
The fair value of Credco’s derivative instruments is estimated by using either a third-party valuation service that uses proprietary pricing models, or by internal pricing models, where the inputs to those models are readily observable from actively quoted markets. Credco reaffirms its understanding of the valuation techniques used by its pricing services at least annually.
To mitigate derivative instrument credit risk, counterparties are required to be pre-approved and rated as investment grade. In addition, Credco manages certain counterparty credit risks by exchanging collateral under executed credit support agreements. Based on the assessment of credit risk of Credco’s derivative counterparties, Credco does not have derivative positions that warrant credit valuation adjustments.
In the measurement of fair value for Credco’s derivative instruments, although the underlying inputs used in the pricing models are readily observable from actively quoted markets, the pricing models do entail a certain amount of subjectivity and, therefore, differing judgments in how the underlying inputs are modeled could result in different estimates of fair value.
INCOME TAXES
As a member of the consolidated federal income tax return of American Express, Credco is subject to the income tax laws of the United States, its states and municipalities and those of the foreign jurisdictions in which Credco 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, Credco must make judgments about the application of inherently complex tax laws.
Unrecognized Tax Benefits
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, and the extent to which, a tax position should be sustained. A tax position is recognized only when it is more likely than not to be sustained upon examination by the relevant taxing authority based on its technical merits. The amount of tax benefit recognized is the largest benefit that management believes is more likely than not to be realized on ultimate settlement. As new information becomes available, Credco evaluates its tax positions, and adjusts its unrecognized tax benefits, as appropriate.
Tax benefits ultimately realized can differ from amounts previously recognized due to uncertainties, with any such differences generally impacting the provision for income tax expense.
Deferred Tax Asset Realization
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.
Since deferred taxes measure the future tax effects of items recognized in the Consolidated 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.
Changes in facts or circumstances can lead to changes in the ultimate realization of deferred tax assets due to uncertainties.
Consolidated Capital Resources and Liquidity
Credco’s balance sheet management objectives are to maintain:
• A broad, deep and diverse set of funding sources to finance its assets and meet operating requirements; and
• Liquidity programs that enable Credco to continuously meet expected future financing obligations and business requirements for at least a 12-month period, even in the event it is unable to continue to raise new funds under its traditional funding programs.
Funding Strategy
American Express has in place an enterprise-wide Funding Policy. The principal funding objective is to maintain broad and well-diversified funding sources to allow American Express, including Credco, to meet its maturing obligations, cost-effectively finance current and future asset growth, as well as to maintain a strong liquidity profile. The diversity of funding sources by type of debt instrument, by maturity and by investor base, among other factors, provides additional insulation from the impact of disruptions, or from any one type of debt, maturity, or investor. The mix of Credco’s funding in any period will seek to achieve cost-efficiency consistent with both maintaining diversified sources and achieving its liquidity objectives. Credco’s funding strategy and activities are integrated into its asset-liability management activities.
Credco, like many financial services companies, has historically relied on the debt capital markets to fulfill a substantial amount of its funding needs. It has a variety of funding sources available to access the debt capital markets, including senior unsecured debentures and commercial paper. One of the principal tenets of Credco’s funding strategy is to issue debt with a wide range of maturities to distribute its refinancing requirements across future periods. Credco continues to assess its funding needs and investor demand and could change the mix of its existing sources as well as add new sources to its funding mix. Credco’s funding plan is subject to various risks and uncertainties, such as the disruption of financial markets or market capacity and demand for securities offered by Credco as well as any regulatory changes or changes in its long-term or short-term credit ratings. Many of these risks and uncertainties are beyond Credco’s control.
Credco’s funding strategy for 2012 is to raise funds to meet short-term borrowings outstanding, which includes seasonal and other working capital needs and changes in receivables and other asset balances, while seeking to maintain access to a sufficient amount of its own and its affiliates’ cash and readily-marketable securities that are easily convertible to cash, in order to meet the scheduled maturities of all long-term funding obligations for a 12-month period. Credco has $1.6 billion of unsecured long-term debt that will mature during the next 12 months.
Credco’s funding strategy is designed, among other things, to maintain appropriate and stable unsecured debt ratings from the major credit rating agencies, including Moody’s, S&P, Fitch Ratings (Fitch) and Dominion Bond Rating Service (DBRS). Such ratings help to support Credco’s access to cost-effective unsecured funding as part of its overall financing programs.
Credco’s short-term ratings, long-term ratings and outlook as disclosed by the four major credit rating agencies are as follows:
Downgrades in Credco’s unsecured debt ratings could result in higher funding costs, as well as higher fees related to borrowings under its unused lines of credit. Declines in credit ratings could also reduce Credco’s borrowing capacity in the unsecured debt and commercial paper markets. The overall level of the funding provided by Credco to other American Express affiliates, is impacted by a variety of factors, among them Credco’s ratings. To the extent Credco is subject to a higher cost of funds, whether due to an adverse ratings action or otherwise, the affiliates could continue to use, or could increase their use of, alternative sources of funding for their receivables that offer better pricing. Downgrades to certain of Credco’s unsecured debt ratings in the last several years have not materially impacted Credco’s borrowing costs or resulted in a reduction in its borrowing capacity.
Short-term Funding Programs
Credco’s issuance and sale of commercial paper is utilized for working capital needs. The amount of short-term borrowings issued in the future will depend on Credco’s funding strategy, its needs and market conditions. Credco’s commercial paper outstandings were stable throughout 2011. As of both December 31, 2011 and 2010, Credco had $0.6 billion of commercial paper outstanding. The average commercial paper outstanding was $0.6 billion and $0.9 billion for the years ended December 31, 2011 and 2010, respectively.
Credco’s total back-up liquidity coverage, which includes its undrawn committed bank facilities, was 62 percent and over 100 percent of net short-term borrowings, including short-term debt to affiliates, as of December 31, 2011 and 2010, respectively. The undrawn committed bank credit facilities were $2.9 billion and $5.7 billion as of December 31, 2011 and 2010, respectively.
In 2008, the Federal Reserve Board established the Commercial Paper Funding Facility (CPFF), which provided three months of liquidity to U.S. issuers of commercial paper through a special purpose vehicle. The CPFF program expired on February 1, 2010. The expiration of the CPFF program has not had, and under current market conditions Credco does not expect the expiration to have, any material impact on Credco’s business or funding positions. However, if extreme levels of volatility and disruptions in capital markets reemerge, the lack of government supported liquidity programs, such as CPFF, could negatively impact Credco’s funding capabilities.
The following table presents selected statistics regarding Credco’s commercial paper balances outstanding as of:
(a) Based on monthly averaging.
Long-term Debt Programs
Long-term debt is raised through the offering of debt securities in the United States and capital markets outside the United States. Long-term debt is generally defined as any debt with an original maturity greater than 12 months.
Credco had the following long-term debt outstanding as of December 31:
Refer to Note 5 to the Consolidated Financial Statements for further details on total year-end interest rates on debt and maturities.
Credco has the ability to issue debt securities under shelf registrations filed with SEC. The latest shelf registration statement filed with the SEC is for an unspecified amount of debt securities to be issued. As of December 31, 2011 and 2010, Credco had $12.3 billion and $10.5 billion of debt securities outstanding, respectively, issued under the SEC registration statement.
Credco has established a program for the issuance of debt instruments outside the United States, which is listed on the Luxembourg Stock Exchange. The prospectus for this program expired in January 2012 and was subsequently renewed in February 2012. It allows for a maximum aggregate principal amount of debt instruments outstanding at any one time of $50 billion. During 2011, no notes were issued under this program. As of December 31, 2011 and 2010, $1.7 billion and $2.6 billion, respectively, were outstanding under this program, of which $1.7 billion and $2.1 billion, respectively, were issued by Credco.
Credco has also established a program in Australia for the issuance of debt securities of up to approximately $6.1 billion. During 2011, no notes were issued under this program. As of December 31, 2011 and 2010, approximately $6.1 billion and $5.6 billion, respectively, of notes were available for issuance under this program and the outstanding notes were nil and $456 million, respectively.
As of December 31, 2011, one of Credco’s wholly-owned subsidiaries maintained a shelf registration in Canada for a medium-term note program providing for the issuance, when necessary of up to approximately $3.4 billion of notes by American Express Canada Credit Corporation (AECCC), an indirect wholly-owned subsidiary of Credco. All notes issued by AECCC under this shelf registration are guaranteed by Credco. As of December 31, 2011 and 2010, AECCC had $2.2 billion and $1.8 billion, respectively, outstanding under this program. The financial results of AECCC are included in the consolidated financial results of Credco.
Credco’s 2011 issuances were as follows:
(a) Canadian Dealer Offered Rate.
The covenants of debt instruments issued by Credco impose the requirement that Credco maintain a minimum consolidated net worth of $50 million, which limits the amount of dividends Credco could pay to its parent. As of December 31, 2011, management believes Credco is in compliance with all restrictive covenants contained in its debt agreements. During 2011 and 2010, Credco paid $865 million and $260 million, respectively, of cash dividends to TRS. There are no significant restrictions on the ability of Credco to obtain funds from its subsidiaries by dividend or loan. Additionally, there are no limitations on the amount of debt that can be issued by Credco, provided it maintains the minimum required fixed charge coverage ratio of 1.25.
Liquidity Strategy
General principles and the overall framework for managing liquidity risk across American Express on an enterprise-wide basis are set out in American Express’ Liquidity Risk Policy. The liquidity objective is to maintain access to a diverse set of cash, readily-marketable securities and contingent sources of liquidity, such that American Express and its subsidiaries, including Credco, can continuously meet their business requirements and expected future financing obligations for at least a 12-month period, even in the event they are unable to raise new funds under their regular funding programs.
Credco manages this objective by regularly accessing capital through its various funding programs, as well as by maintaining a variety of contingent sources of cash and financing, such as access to securitizations of cardmember receivables through sales of receivables to TRS for securitization by RFC V and AEIT, as well as committed bank facilities.
Credco incurs and accepts liquidity risk arising in the normal course of its activities. The liquidity risks that American Express, including Credco, is exposed to can arise from a variety of sources, and thus the enterprise-wide liquidity management strategy includes a variety of parameters, assessments and guidelines, including but not limited to:
• Maintaining a diversified set of funding sources (refer to Funding Strategy section for more detail);
• Maintaining unencumbered liquid assets and off-balance sheet liquidity sources; and
• Projecting cash inflows and outflows from a variety of sources and under a variety of scenarios.
Credco’s current liquidity target is to maintain adequate liquidity in the form of cash, as well as access to additional liquidity through intercompany borrowing arrangements, to satisfy all maturing funding obligations for a period of 12 months, while continuing to maintain access to significant additional contingency liquidity sources. As of December 31, 2011, Credco had $1.6 billion of unsecured long-term debt that will mature within 12 months.
As of December 31, 2011, Credco had cash and cash equivalents of approximately $480 million. In addition to its actual holdings of cash and cash equivalents, Credco maintains access to additional liquidity, in the form of cash and cash equivalents held by certain affiliates, through intercompany loan agreements.
The yield Credco receives on its cash and cash equivalents is generally less than the interest expense on the sources of funding for these balances. Thus, Credco incurs interest costs on these amounts. The level of net interest costs will be dependent on the amount of its cash and cash equivalents, as well as the difference between its cost of funding these amounts and their investment yields.
Committed Bank Credit Facilities
Credco maintained the following committed syndicated bank credit facilities as of December 31, 2011:
(a) Credco has the right to borrow a maximum amount of $7.5 billion with a commensurate maximum $0.8 billion reduction in the amount available to American Express.
Credco’s remaining committed bank credit facilities expire as follows:
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 earnings to fixed charges. The ratio of earnings to fixed charges for Credco and American Express was as follows:
Committed bank credit facilities do not contain material adverse change clauses that might otherwise preclude borrowing under the credit facilities. The facilities may not be terminated should there be a change in Credco’s credit rating.
In consideration of all its funding sources as described above, Credco believes it would have access to liquidity to satisfy all maturing long-term funding obligations for at least a 12-month period in the event that access to the secured and unsecured fixed income capital markets is completely interrupted for that length of time. These events are not considered likely to occur.
Results of Operations
Pretax income depends primarily on the volume of cardmember receivables and loans purchased, the discount factor used to determine purchase price, interest earned, interest expense and collectibility of cardmember receivables and loans purchased.
Credco’s consolidated net income increased $49 million or 14 percent to $397 million for the year ended December 31, 2011, as compared to $348 million for the year ended December 31, 2010. The year-over-year increase is due principally to lower provision for losses, higher benefit in other, net expenses and income tax benefit, partially offset mainly by higher interest expense.
The following table summarizes the changes attributable to the increase (decrease) in key revenue and expense accounts as of December 31:
Discount revenue earned on purchased cardmember receivables and loans
Discount revenue decreased $8 million or 2 percent to $435 million for 2011, as compared to $443 million in 2010, due to a decrease in discount rates, partially offset by an increase in the volume of cardmember receivables purchased. Discount rates, which vary over time due to changes in market interest rates or changes in the collectibility of cardmember receivables, decreased an average of 3 basis points to 0.25 percent in 2011 from 0.28 percent in 2010. Volume of cardmember receivables and loans purchased in 2011 increased 8 percent to $171 billion in 2011 from $159 billion in 2010, primarily due to increased cardmember spending.
Interest income from affiliates
Interest income from affiliates increased $39 million or 8 percent to $505 million in 2011, as compared to $466 million in 2010. The average loan balances with affiliates were $11.2 billion and $10.2 billion for the years ended December 31, 2011 and 2010, respectively. The annual interest rate charged to affiliates decreased 7 basis points to 4.51 percent for 2011 from 4.58 percent for 2010.
Interest income from investments
Interest income from investments decreased $26 million or 81 percent to $6 million for 2011, as compared to $32 million for 2010. The decrease was driven by the maturity of the available-for-sale securities in 2010 and the decrease in interest rates. The average investment balance, including time deposits, was $0.3 billion and $1.8 billion for the years ended December 31, 2011 and 2010, respectively. The effective annual interest rate on investments decreased 12 basis points to 1.69 percent for 2011 from 1.81 percent for 2010.
Finance revenue
Finance revenue decreased $1 million or 3 percent to $38 million during 2011 as compared to $39 million for 2010. The year-over-year decrease was driven by a decrease in average loan balance, partially offset by an increase in average interest rates.
Provisions for losses
The provisions for losses decreased $48 million or 38 percent to $80 million for 2011, as compared to $128 million for 2010. The decrease was primarily driven by a change in accounting estimate for certain charge card products and overall improved credit metrics across all portfolios.
Interest expense
Interest expense increased $113 million or 19 percent to $695 million for 2011 as compared to $582 million for 2010, due to an increase in the effective annual interest rates on long-term debt and by forward points gain of $43 million, which was recorded in interest expense for the first six months in 2010. Effective in the third quarter of 2010, forward points gain is recorded in other, net expenses.
Interest expense to affiliates
Interest expense to affiliates decreased $4 million or 25 percent to $12 million for 2011, as compared to $16 million for 2010, due to a decrease in both average debt outstanding and interest rates. The effective annual interest rate on average debt due to affiliates as of December 31, 2011 decreased 5 basis points to 0.27 percent in 2011 from 0.32 percent in 2010. In addition, average debt outstanding to affiliates decreased by 12 percent to $4.5 billion for 2011 from $5.1 billion for 2010.
Other, net expenses
The benefit recorded in other, net expenses increased $81 million to a benefit of $152 million in 2011 from a benefit of $71 million in 2010. The increase was primarily due to the reclassification of the forward points gain, which was recorded in interest expense for the first six months of 2010. The other, net expenses in 2011 includes an additional impact of forward points gain of $85 million as well as an additional favorable impact related to hedge ineffectiveness gain of $7 million, as compared to a gain of $10 million in 2010 as a result of recoveries from the investment in the Reserve Primary Fund.
Service fees to affiliates
Certain affiliates do not explicitly charge Credco a servicing fee for the servicing of receivables purchased. Instead Credco receives a lower discount rate on the receivables sold to Credco than would be the case if servicing fees were charged. If a servicing fee had been charged by these affiliates from which Credco purchases receivables, servicing fees to affiliates would have been higher by approximately $127 million and $120 million for the years ended December 31, 2011 and 2010, respectively. Correspondingly, discount revenue would have increased by approximately the same amounts in these periods.
Income taxes
Credco’s effective tax rate for the years ended December 31, 2011 and 2010 was (13.8) percent and (7.4) percent, respectively. Each of the periods reflects recurring permanent tax benefits in relation to the level of pretax income. Credco’s effective tax rate reflects the favorable impact of the tax benefit related to its ongoing funding activities outside the United States. The availability of this benefit in future years is largely dependent on the continued extension by Congress of a provision of the United States Internal Revenue Code. Refer to “Forward-Looking Statements” for further discussion of this provision.
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Credco’s risk management objective is to identify, monitor and appropriately control its risk exposures. Credco’s risk management oversight is performed through internal and independent oversight functions. Risk management governance at Credco begins with the American Express Board’s Audit and Risk Committee approved American Express Enterprise-wide Risk Management Policy (Policy), which defines risk management objectives, risk appetite, risk limits and escalation triggers, and establishes the internal governance structure for managing risk. The Policy focuses on the risks that are most important to American Express and Credco - credit risk, operational risk, market risk and reputational risk. The Audit and Risk Committee of the American Express Board also approves the risk policies governing the areas of individual credit risk, institutional credit risk, market risk, liquidity risk, operational risk, asset/liability management and capital management, as well as the policy governing the launch of new products and services. Internal management committees, including the Enterprise-wide Risk Management Committee (ERMC), chaired by the American Express Chief Risk Officer, and the Asset-Liability Committee (ALCO), chaired by the American Express Chief Financial Officer, are responsible for implementing policies for managing these risks across American Express, including Credco.
Credit Risk Management Process
Credit risk is defined as the risk of loss due to obligor or counterparty default or changes in the credit quality of a security. TRS manages the overall credit risk exposure associated with the cardmember receivables and loans purchased by Credco. 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 in cardmember receivables. Since Credco’s portfolio consists of millions of borrowers and individual exposures across multiple geographies, occupations, and social segments, its risk is 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 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 exposure is primarily generated by:
• Interest rate risk in its funding activities; and
• Foreign exchange risk in its operations outside the United States.
General principles and the overall framework for managing market risk across American Express and its subsidiaries, including Credco, are defined in the Market Risk and Asset Liability Management Policies, which are the responsibility of the ALCO. Market risk limits and escalation triggers within those policies are approved by the ALCO and by the ERMC. Market risk is centrally monitored for compliance with policy and limits by the Market Risk Committee, which reports into the ALCO and is chaired by the Chief Market Risk Officer of American Express. Market risk management is also guided by policies covering the use of derivative financial instruments, funding and liquidity and investments.
Derivative financial instruments derive their value from an underlying variable or multiple variables, including interest rate, foreign exchange, and equity 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 American Express’ market risk management. Credco does not engage in derivative financial instruments for trading purposes. Use of derivative financial instruments is incorporated into the discussion below as well as Note 7 to Credco’s Consolidated Financial Statements.
Interest rate risk arises through the funding of cardmember receivables and fixed-rate cardmember loans purchased with variable-rate borrowings. Interest rate exposure within Credco’s charge card and fixed-rate lending products is managed by varying the proportion of total funding provided by variable-rate debt compared to fixed-rate debt. In addition, interest rate swaps are used from time to time to effectively convert fixed-rate debt to variable-rate or to convert variable-rate debt to fixed-rate. Credco may change the mix between variable-rate and fixed-rate funding based on changes in business volumes and mix, among other factors.
Credco regularly reviews its interest rate exposure profile and may modify it. Interest rate derivatives, primarily interest rate swaps, with notional amounts of approximately $12 billion and $10 billion were outstanding as of December 31, 2011 and 2010, respectively. These derivatives generally qualify for hedge accounting. A portion of the interest rate derivatives outstanding as of December 31, 2011 extends to 2015.
Given the nature of Credco’s business model, where Credco includes its costs of funding in the calculation of the discount at which Credco offers to purchase receivables, and where such discount is determined to maintain Credco’s required minimum fixed charge coverage ratio of 1.25, there would be minimal detrimental effect on Credco’s pretax earnings of a hypothetical 100 basis point increase in interest rates.
Foreign exchange risk is generated by funding foreign currency cardmember receivables and loans in U.S. dollars and by foreign subsidiary equity and foreign currency earnings in units outside the United States. Credco hedges this market exposure to the extent it is economically justified through various means, including foreign currency funding and the use of derivative financial instruments such as foreign exchange forwards and cross-currency swap contracts, which can help “lock in” the value of Credco’s exposure to specific currencies.
As of December 31, 2011 and 2010, foreign currency hedge instruments with total notional amounts of approximately $9 billion and $7 billion, respectively, were outstanding. Derivative hedging activities related to balance sheet exposures and foreign currency earnings generally do not qualify for hedge accounting; however, derivative hedging activities related to translation exposure of foreign subsidiary equity generally do.
With respect to foreign currency balance sheet exposures, including related foreign exchange forward contracts and swaps outstanding, the effect on Credco’s earnings of a hypothetical 10 percent change in the value of the U.S. dollar would be immaterial as of December 31, 2011.
Funding and Liquidity Risk Management Process
Liquidity risk is defined as the inability of Credco to meet its ongoing financial and business obligations as they become due at a reasonable cost. General principles and the overall framework for managing liquidity risk across American Express are defined in the Liquidity Risk Policy, approved by the ALCO and the Audit and Risk Committee of the American Express Board. Liquidity risk is centrally managed by the Funding and Liquidity Committee, which reports into the ALCO. 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. American Express has developed a liquidity plan that enables it to meet its daily cash obligations when access to both unsecured and secured funds in the debt capital markets is impaired or unavailable. This plan is designed to ensure that Credco and all of its main operating entities could continuously meet their maturing funding obligations for a 12-month period if access to all capital markets is interrupted.
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 liquidity resources are available in the amount and in the location needed in a stress event. The Funding and Liquidity Committee reviews the forecasts of American Express aggregate and Credco cash positions and financing requirements and approves the funding plans designed to satisfy those requirements under normal conditions, establishes guidelines to identify the amount of liquidity resources required, and monitors positions and determines any actions to be taken. Liquidity planning also takes into account operating cash flexibilities.
Operational Risk Management Process
Operational risk is 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.
The general principles and the overall framework for managing operational risk across American Express are defined in the Operational Risk Policy approved by the Audit and Risk Committee of the American Express Board of Directors. The Operational Risk Management Committee (ORMC) provides governance for the operational risk framework.
In order to appropriately measure and manage operational risk, American Express has developed a comprehensive operational risk model. This model requires the assessment of operational risk events (i.e., what occurred or could have occurred) to determine root causes, (i.e., why did it occur or could have occurred), impacts and accountability for risk mitigation. Any impacts are assessed from a financial, brand, regulatory and legal perspective. The operational risk model also assesses the frequency and likelihood that events may occur again so that the appropriate mitigation steps may be taken.
The operational risk framework also includes the entity risk self-assessment, in which senior leaders identify key operational risks in a business unit or support group and determine preparedness to respond should these risks occur. Top risks are tracked to ensure that the appropriate monitoring or mitigation is in place. The day-to-day management of operational risk lies with Credco.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
1. Financial Statements.
See Index to Financial Statements at page hereof.
2. Supplementary Financial Information.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
Item 9A.
Item 9A. 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 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 and designed to ensure that the information required to be disclosed in Credco’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the requisite time periods specified in the applicable rules and forms, and that it is accumulated and communicated to Credco’s management, including Credco’s principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
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 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 GAAP 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 GAAP, 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, 2011. 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 Control - Integrated Framework.
Based on management’s assessment and those criteria, management has concluded that, as of December 31, 2011, Credco’s internal control over financial reporting is effective.
Item 9B.
Item 9B. OTHER INFORMATION
Not applicable.
PART III
Item 10.
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
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, AND DIRECTOR INDEPENDENCE
Omitted pursuant to General Instruction I(2) (c) to Form 10-K.
Item 14.
Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The Audit and Risk 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, 2011.
Each year the Audit and Risk Committee reviews the accountants’ qualifications, performance and independence in accordance with regulatory requirements and guidelines. At least every ten years, the Audit and Risk Committee charter requires 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 $672,260 and $678,032 for the years ended December 31, 2011 and 2010, respectively.
Audit-Related Fees
Credco was not billed by PricewaterhouseCoopers LLP for any fees for audit-related services for 2011 or 2010.
Tax Fees
Credco was not billed by PricewaterhouseCoopers LLP for any tax fees for 2011 or 2010.
All Other Fees
Credco was not billed by PricewaterhouseCoopers LLP for any other fees for 2011 or 2010.
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 are subject to the specific pre-approval of the Audit and Risk 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 such Audit and Risk Committee in accordance with pre-approval procedures established by such Committee. All such services provided by
Credco’s independent registered public accounting firm have been pre-approved in accordance with these procedures. The procedures require all proposed engagements of Credco’s independent registered public accounting firm 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 and Risk Committee of American Express prior to the beginning of any services.
Other Transactions with PricewaterhouseCoopers
American Express has a number of business relationships with individual member firms of the worldwide PricewaterhouseCoopers 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
Item 15.
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
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)
Date: March 15, 2012
By
/s/ David L. Yowan
David L. Yowan
Chief Executive Officer
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 and on the dates indicated.
(Item 15 (a))
COVERED BY REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
AMERICAN EXPRESS CREDIT CORPORATION
All other schedules are omitted since the required information is not present or because the information required is included in the Consolidated Financial Statements or notes thereto.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholder of
American Express Credit Corporation
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of American Express Credit Corporation and its subsidiaries (the “Company”) at December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in the Note 9 to the consolidated financial statements, the Company has entered into significant related party transactions with its affiliates.
/s/ PricewaterhouseCoopers LLP
New York, New York
March 15, 2012
CONSOLIDATED STATEMENTS OF INCOME
AMERICAN EXPRESS CREDIT CORPORATION
See Notes to Consolidated Financial Statements.
CONSOLIDATED BALANCE SHEETS
AMERICAN EXPRESS CREDIT CORPORATION
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
AMERICAN EXPRESS CREDIT CORPORATION
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF SHAREHOLDER’S EQUITY
AMERICAN EXPRESS CREDIT CORPORATION
See Notes to Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
Note 1 - Summary of Significant Accounting Policies
Basis of Presentation
American Express Credit Corporation (Credco), together with its subsidiaries, is a wholly-owned subsidiary of American Express Travel Related Services Company, Inc. (TRS), which is a wholly-owned subsidiary of American Express Company (American Express). American Express charge cards and American Express credit cards are collectively referred to herein as the card.
Credco is engaged in the business of financing non-interest-earning 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 certain countries outside the United States. Credco also finances certain interest-bearing and discounted revolving loans generated by cardmember spending on American Express credit cards issued in non-U.S. markets, although interest-bearing and revolving loans are primarily funded by subsidiaries of TRS other than Credco.
Credco executes material transactions with its affiliates. The agreements between Credco and its affiliates provide that the parties intend that the transactions thereunder be conducted on an arm’s length basis; however, there can be no assurance that the terms of these arrangements are the same as would be negotiated between independent, unrelated parties.
American Express provides Credco with financial support with respect to maintenance of its minimum overall 1.25 fixed charge coverage ratio, which is achieved by charging appropriate discount rates on the purchases of receivables Credco makes from, and the interest rates on the loans Credco provides to, TRS and other American Express subsidiaries. Each monthly period, the discount and interest rates are determined to generate income for Credco that is sufficient to maintain its minimum fixed charge coverage ratio.
Principles of Consolidation
The Consolidated Financial Statements of Credco are prepared in conformity with U.S. generally accepted accounting principles (GAAP). All significant intercompany transactions are eliminated.
Credco consolidates all entities in which it holds a “controlling financial interest.” For voting interest entities, Credco is considered to hold a controlling financial interest when Credco is able to exercise control over the investees’ operating and financial decisions. For variable interest entities (VIEs), Credco is considered to hold a controlling financial interest when it is determined to be the primary beneficiary. A primary beneficiary is a party that has both: (1) the power to direct the activities of a VIE that most significantly impact that entity’s economic performance, and (2) the obligation to absorb losses, or the right to receive benefits, from the VIE that could potentially be significant to the VIE. The determination of whether an entity is a VIE is based on the amount and characteristics of the entity’s equity.
Foreign Currency
Assets and liabilities denominated in foreign currencies are translated into U.S. dollars based upon exchange rates prevailing at the end of each year. The resulting translation adjustments, along with any related qualifying hedge and tax effects, are included in accumulated other comprehensive (loss) income (AOCI), a component of shareholder’s equity. Translation adjustments, including qualifying hedge and tax effects, are reclassified to earnings upon the sale or substantial liquidation of investments in foreign operations. Revenues and expenses are translated at the average month-end exchange rates during the year. Gains and losses related to transactions in a currency other than the functional currency, including operations outside the United States where the functional currency is the U.S. dollar, are reported net in Credco’s Consolidated Statements of Income, in interest expense or other, net expense, depending on the nature of the activity. Net foreign currency transaction gains amounted to approximately $137 million, $93 million and $34 million in 2011, 2010 and 2009, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
Amounts Based on Estimates and Assumptions
Accounting estimates are an integral part of the Consolidated Financial Statements. These estimates are based, in part, on management’s assumptions concerning future events. Among the more significant assumptions are those that relate to reserves for cardmember losses relating to cardmember receivables and loans, fair value measurement and income taxes. These accounting estimates reflect the best judgment of management, but actual results could differ.
Discount Revenue Earned from Purchased Cardmember Receivables and Loans
Credco earns discount revenue from purchasing cardmember receivables and loans at a discount to par value. The discount is deferred and recognized as revenue over the period that the receivables are estimated to be outstanding. Estimates are based on the recent historical average life of cardmember receivables.
Interest Income from Affiliates
Interest income from affiliates is earned on interest-bearing loans made by Credco to affiliates. Interest income is accrued primarily using the average daily balance method on loans owned and is recognized based on the outstanding loan principal amount and interest rates specified in the agreements until the outstanding loan balance is paid.
Interest Income from Investments
Interest income for Credco’s performing fixed-income securities is accrued as earned using the effective interest method, which adjusts the yield for security premiums and discounts, fees and other payments, so that a constant rate of return is recognized on the security’s outstanding balance. These amounts are recognized until such time as a security is in default or when it is likely that future interest payments will not be made as scheduled.
Finance Revenue
Cardmember lending finance revenues are assessed using the average daily balance method for loans owned and are recognized based upon the loan principal amount outstanding in accordance with the terms of the applicable account agreement until the outstanding balance is paid or written off.
Interest Expense
Interest expense includes interest incurred primarily to fund cardmember receivables and loans, general corporate purposes, and liquidity needs, and is recognized as incurred.
Cash and Cash Equivalents
Cash and cash equivalents include cash and amounts due from banks, interest-earning bank balances, and other highly liquid investments with original maturities of 90 days or less.
Other Significant Accounting Policies
The following table identifies Credco’s other significant accounting policies, along with the Note and page where a detailed description of each policy can be found.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
Recently Issued Accounting Standards
The Financial Accounting Standards Board recently issued Accounting Standards Update (ASU) No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This standard requires entities to report components of comprehensive income in either a continuous statement of comprehensive income or two separate but consecutive statements. This standard will not impact Credco’s financial position or results of operations. Credco will begin reporting components of other comprehensive income in a separate statement following the Consolidated Statement of Income beginning in the quarter ending March 31, 2012.
Note 2 - Fair Values
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date, and is based on Credco’s principal or most advantageous market for the specific asset or liability.
GAAP provides for a three-level hierarchy of inputs to valuation techniques used to measure fair value, defined as follows:
•
Level 1 - Inputs that are quoted prices (unadjusted) for identical assets or liabilities in active markets.
•
Level 2 - Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability, including:
-
Quoted prices for similar assets or liabilities in active markets
-
Quoted prices for identical or similar assets or liabilities in markets that are not active
-
Inputs other than quoted prices that are observable for the asset or liability
-
Inputs that are derived principally from or corroborated by observable market data by correlation or other means
•
Level 3 - Inputs that are unobservable and reflect Credco’s own assumptions about the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances (e.g., internally derived assumptions surrounding the timing and amount of expected cash flows).
Financial Assets and Financial Liabilities Carried at Fair Value
The following table summarizes Credco’s financial assets and financial liabilities measured at fair value on a recurring basis, categorized by GAAP’s valuation hierarchy (as described in the preceding paragraphs), as of December 31:
(a) Refer to Note 7 for the fair values of derivative assets and liabilities on a further disaggregated basis as well as the netting of both (i) cash collateral received or posted under credit support agreements and (ii) derivative assets and derivative liabilities under master netting agreements. These balances have been presented gross in the table above.
Credco did not measure any financial instruments at fair value using significantly unobservable inputs (Level 3) during the years ended December 31, 2011 and 2010.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
GAAP requires disclosure of the estimated fair value of all financial instruments. A financial instrument is defined as cash, evidence of an ownership in an entity, or a contract between two entities to deliver cash or another financial instrument or to exchange other financial instruments. The disclosure requirements for the fair value of financial instruments exclude leases, equity method investments, affiliate investments, pension and benefit obligations, insurance contracts and all non-financial instruments.
Valuation Techniques Used in Measuring Fair Value
For the financial assets and liabilities measured at fair value on a recurring basis (categorized in the valuation hierarchy table above), Credco applies the following valuation techniques to measure fair value:
Derivative Financial Instruments
The fair value of Credco’s derivative financial instruments, which could be assets or liabilities on the Consolidated Balance Sheets, is estimated by a third-party valuation service that uses proprietary pricing models or by internal pricing models where the inputs to those models are readily observable from actively quoted markets. The pricing models used are consistently applied and reflect the contractual terms of the derivatives, including the period of maturity, and market-based parameters such as interest rates, foreign exchange rates, equity indices or prices, and volatility. Credco reaffirms its understanding of the valuation techniques used by its pricing services at least annually.
Credit valuation adjustments are necessary when the market parameters, such as a benchmark curve, used to value derivatives are not indicative of the credit quality of Credco or its counterparties. Credco considers the counterparty credit risk by applying an observable forecasted default rate to the current exposure. Refer to Note 7 for additional fair value information.
Financial Assets and Financial Liabilities Carried at Other Than Fair Value
The following table discloses the estimated fair value for Credco’s financial assets and financial liabilities that are not carried at fair value, as of December 31:
The fair values of these financial instruments are estimates based upon the market conditions and perceived risks as of December 31, 2011 and 2010, and require management judgment. These figures may not be indicative of their future fair values. The fair value of Credco cannot be reliably estimated by aggregating the amounts presented.
The following methods were used to determine estimated fair values:
Financial Assets for Which Carrying Values Equal or Approximate Fair Value
Financial assets for which carrying values equal or approximate fair value include cash and cash equivalents, cardmember receivables, cardmember loans, due from affiliates, accrued interest and certain other assets. For these assets, the carrying values approximate fair value because they are short term in duration or variable rate in nature.
Financial Assets Carried at Other Than Fair Value
Loans to affiliates
Loans to affiliates are recorded at historical cost on the Consolidated Balance Sheets. Fair value is estimated based on either the fair value of the underlying collateral or the terms implicit in the loan agreements as compared with current market terms for similar loans.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
Financial Liabilities for Which Carrying Values Equal or Approximate Fair Value
Financial liabilities for which carrying values equal or approximate fair value include short-term debt, short-term debt to affiliates, accrued interest and certain other liabilities for which the carrying values approximate fair value because they are either short term in duration, have no defined maturity or have an underlying interest rate that is variable.
Financial Liabilities Carried at Other Than Fair Value
Long-term debt
Long-term debt is recorded at historical issuance cost on the Consolidated Balance Sheets adjusted for the impact of fair value hedge accounting on certain fixed-rate notes. Fair value is estimated using either quoted market prices or discounted cash flows based on Credco’s current borrowing rates for similar types of borrowings.
Note 3 - Cardmember Receivables and Loans
American Express’ charge and lending payment card products result in the generation of cardmember receivables (from charge payment products) and cardmember loans (from lending payment products) described below.
Cardmember Receivables
Cardmember receivables represent amounts due from customers of American Express and certain of its affiliates’ charge payment products. For American Express, the cardmember receivables are recorded at the time a cardmember enters into a point-of-sale transaction with a merchant. Each charge card transaction is authorized based on its likely economics reflecting a cardmember’s most recent credit information and spend patterns. Global limits are established to limit the maximum exposure for American Express from high risk and some high spend charge cardmembers, and accounts of high risk, out of pattern charge cardmembers can be monitored even if they are current. Charge card customers generally must pay the full amount billed each month.
Credco records these cardmember receivables at the time they are purchased from TRS and certain of its subsidiaries that issue the card (card issuers). Cardmember receivable balances are presented on the Consolidated Balance Sheets, net of reserves for losses (refer to Note 4). Cardmember receivables also include participation interests purchased from an affiliate. Participation interests in cardmember receivables represent undivided interests in the cash flows of the non-interest-earning cardmember receivables. In conjunction with TRS’ securitization program, Credco, through its wholly-owned subsidiary, Credco Receivables Corporation (CRC), purchases participation interests from American Express Receivables Financing Corporation V LLC (RFC V), a wholly-owned subsidiary of TRS that receives an undivided, pro rata interest in cardmember receivables transferred to the American Express Issuance Trust (AEIT) by TRS. AEIT is a special purpose entity that is consolidated by RFC V. As of December 31, 2011 and 2010, CRC owned approximately $3.0 billion and $3.7 billion, respectively, of participation interests in cardmember receivables purchased without recourse from RFC V.
Cardmember receivables as of December 31, 2011 and 2010 consisted of:
(a) International is comprised of consumer and small business services.
(b) Cardmember receivables modified in a troubled debt restructuring (TDR) program were immaterial.
Cardmember Loans
Cardmember loans represent amounts due from customers of American Express and certain of its affiliates’ lending payment products. For American Express, these cardmember loans are recorded at the time a cardmember enters into a point-of-sale transaction with a merchant or when a charge card customer enters into an extended payment arrangement with American Express. American Express’ lending portfolios primarily include revolving loans to cardmembers obtained through either credit card accounts or the lending on
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
charge feature of their charge card accounts. These loans have a range of terms such as credit limits, interest rates, fees and payment structures, which can be adjusted over time based on new information about cardmembers and in accordance with applicable regulations and the respective product’s terms and conditions. Cardmembers holding revolving loans are typically required to make monthly payments greater than or equal to certain pre-established amounts. The amounts that cardmembers choose to revolve are subject to finance charges. When cardmembers fall behind their required payments, their accounts are monitored.
Credco records these cardmember loans at the time they are purchased from TRS and certain of its affiliates. Cardmember loans are presented on the Consolidated Balance Sheets, net of reserves for losses and include accrued interest and fees receivable. Credco’s policy generally is to cease accruing for interest receivable on a cardmember loan at the time the account is written off. Credco establishes reserves for interest that Credco believes will not be collected.
Cardmember loans, consisting of loans in the International Card Services portfolio, as of December 31, 2011 and 2010 were as follows:
(a) Cardmember loans modified in a troubled debt restructuring (TDR) program were immaterial.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
Cardmember Receivables and Cardmember Loans Aging
Generally a cardmember account is considered past due if payment is not received within 30 days after the billing statement date. The following table represents the aging of cardmember receivables and cardmember loans as of December 31, 2011 and 2010:
(a) For cardmember receivables in International and Global Commercial Services, delinquency data is tracked based on days past billing status rather than days past due. A cardmember account is considered 90 days past billing if payment has not been received within 90 days of the cardmember’s billing statement date. In addition, if collection procedures are initiated on an account prior to the account becoming 90 days past billing the associated cardmember receivable balance is considered 90 days past billing. These amounts are shown above as 90+ Days Past Due for presentation purposes.
(b) Historically, data for periods prior to 90 days past billing are not available due to system constraints. Therefore, it has not been utilized for risk management purposes. The balances that are current to 89 days past due can be derived as the difference between the Total and the 90+ Days Past Due balances.
(c) Cardmember loans over 90 days past due continue to accrue interest.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
Credit Quality Indicators for Cardmember Receivables and Cardmember Loans
The following table presents the key credit quality indicators for the years ended December 31:
(a) Credco’s write-offs, net of recoveries, represent the amount of cardmember receivables or cardmember loans owned by Credco that are written off, expressed as a percentage of the average cardmember receivables or cardmember loans balances during the period.
(b) Credco’s write-offs, net of recoveries, represent the amount of cardmember receivables owned by Credco that are written off, expressed as a percentage of the volume of cardmember receivables purchased by Credco during the period.
(c) Effective January 1, 2010, American Express revised the time period in which past due cardmember receivables in International Card Services and Global Commercial Services are written off to when they are 180 days past due or earlier, consistent with applicable bank regulatory guidance and the write-off methodology adopted for U.S. Consumer and Small Business receivables. Previously, receivables were written off when they were 360 days past billing or earlier. Therefore, the net write-offs for the first quarter of 2010 include net write-offs resulting from this write-off methodology change, which increased the net loss ratios and decreased the 90 days past billing metrics for these segments, but did not have a significant impact on provisions for losses.
Refer to Note 4 for other factors, including external environmental factors, that management considers as part of its evaluation of reserves for losses.
Note 4 - Reserves for Losses
Reserves for Losses - Cardmember Receivables and Loans
Reserves for losses relating to cardmember receivables and loans represent management’s best estimate of the losses inherent in Credco’s outstanding portfolios. Credco’s total provisions for losses were $80 million, $128 million and $214 million for the years ended December 31, 2011, 2010 and 2009, respectively. Management’s evaluation process requires certain estimates and judgments.
Reserves for these losses are primarily based upon statistical models that analyze portfolio performance and reflect management’s judgment regarding overall reserve adequacy. The models take into account several factors, including loss migration rates and average losses and recoveries over an appropriate historical period. Management considers whether to adjust the models for specific factors such as increased risk in certain portfolios, impact of risk management initiatives on portfolio performance and concentration of credit risk based on factors such as vintage, industry or geographic regions. In addition, management may increase or decrease the reserves for losses on cardmember loans for other external environmental factors including leading economic and market indicators such as the unemployment rate, home price indices, Gross Domestic Product (GDP), non-farm payrolls, personal consumption expenditures index, consumer confidence index, bankruptcy filings and the legal and regulatory environment. Generally, due to the short-term nature of cardmember receivables, the impact of additional external factors on the losses inherent within the cardmember receivable portfolio is not significant. As part of this evaluation process, management also considers various reserve coverage metrics, such as reserves as a percentage of past due amounts, reserves as a percentage of cardmember receivables or loans and net write-off coverage.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
Cardmember loans and receivables balances are written off when management deems amounts to be uncollectible, which is generally determined by the number of days past due and is typically no later than 180 days. Cardmember loans and receivables in bankruptcy or owed by deceased individuals are written off upon notification. Recoveries are recognized on a cash basis.
Changes in Cardmember Receivables Reserve for Losses
The following table presents changes in the cardmember receivables reserve for losses for the years ended December 31:
(a) Represents loss provisions for cardmember receivables resulting from authorized transactions.
(b) Primarily represents reserve balances applicable to participation interests in cardmember receivables purchased from an affiliate. Participation interests in cardmember receivables purchased from an affiliate totaled $2.7 billion, $3.6 billion and $1.8 billion for the years ended December 31, 2011, 2010 and 2009, respectively.
(c) Cardmember receivables net write-offs include recoveries of $95 million, $111 million and $67 million for the years ended December 31, 2011, 2010 and 2009, respectively.
(d) Primarily relates to reserves for losses attributable to participation interests in cardmember receivables sold to an affiliate. Participation interests in cardmember receivables sold to an affiliate totaled $3.3 billion, $2.7 billion and $2.3 billion for the years ended December 31, 2011, 2010 and 2009, respectively.
(e) Volume of receivables purchased was $168 billion, $157 billion and $115 billion for the years ended December 31, 2011, 2010 and 2009, respectively.
Changes in Cardmember Loans Reserve for Losses
The following table presents changes in the cardmember loans reserve for losses for the years ended December 31:
(a) Represents (benefits)/loss provisions for cardmember loans resulting from authorized transactions.
(b) Cardmember loans net write-offs include recoveries of $7 million, $8 million and $8 million for 2011, 2010 and 2009, respectively.
(c) These amounts include foreign currency translation adjustments.
(d) Volume of loans purchased were $3 billion, $2 billion and $3 billion for the years ended December 31, 2011, 2010 and 2009, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
Note 5 - Debt
Short-Term Debt
Credco’s short-term debt outstanding (excluding short-term debt to affiliates), defined as borrowings with original maturities of less than one year, as of December 31 were as follows:
(a) For floating rate debt issuances, the stated interest rates are based on the floating rates in effect as of December 31, 2011 and 2010, respectively. These rates may not be an indication of future interest rates.
Credco paid interest on short-term debt and obligations of $1 million, $1 million and $30 million for the years ended December 31, 2011, 2010 and 2009, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
Long-Term Debt
Credco’s long-term debt outstanding, defined as debt with original maturities of one year or greater, as of December 31 was as follows:
(a) The outstanding balances include (i) unamortized discount and premium, (ii) the impact of movements in exchange rates on foreign currency denominated debt, and (iii) the impact of fair value hedge accounting on certain fixed-rate notes that have been swapped to floating rate through the use of interest swaps. Under fair value hedge accounting the outstanding balances on these fixed-rate notes are adjusted to reflect the impact of changes in fair value due to changes in interest rates. Refer to Note 7 for more details on Credco’s treatment of fair value hedges.
(b) For floating-rate debt issuances, the stated and effective interest rates are based on the floating rates in effect as of December 31, 2011 and 2010, respectively. These rates are not indicative of future interest rates.
(c) Effective interest rates are only presented when swaps are in place to hedge the underlying debt.
Aggregate annual maturities of long-term debt obligations (based on final maturity dates) as of December 2011 were as follows:
Credco paid interest on long-term debt obligations and corresponding interest rate swaps of $0.7 billion, $0.6 billion and $0.6 billion for the years ended December 31, 2011, 2010 and 2009, respectively.
As of December 31, 2011 and 2010, Credco maintained total bank lines of credit of $7.5 billion and $9.8 billion, respectively. Of these amounts, $2.9 billion and $5.7 billion were undrawn as of December 31, 2011 and 2010, respectively, and supported commercial paper borrowings and contingent funding needs. American Express had the right to draw up to $0.8 billion on these undrawn lines of credit as of both December 31, 2011 and 2010, respectively, which would have resulted in a corresponding reduction of the amount available to Credco. The drawn amounts under these bank lines are classified as long-term debt on the accompanying Consolidated Balance Sheets. Credco paid $13.6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
million and $6.4 million in fees to maintain these lines for the years ended December 31, 2011 and 2010, respectively. The availability of these credit lines is subject to compliance with certain financial covenants, including the maintenance of a 1.25 ratio of earnings to fixed charges. As of December 31, 2011, Credco’s ratio of earnings to fixed charges was 1.49.
The committed bank credit facilities do not contain material adverse change clauses that would preclude borrowing under the credit facilities. Additionally, the facilities may not be terminated should there be a change in Credco’s credit ratings.
Note 6 - Restrictions as to Dividends and Limitations on Indebtedness
The debt instruments issued by Credco impose the requirement that Credco maintain a minimum consolidated net worth of $50 million, which limits the amount of dividends Credco could pay to its parent. There are no limitations on the amount of debt that can be issued by Credco, provided it maintains the minimum fixed charge coverage ratio of 1.25.
Note 7 - Derivatives and Hedging Activities
Credco uses derivative financial instruments (derivatives) to manage exposure to various market risks. Derivatives derive their value from an underlying variable or multiple variables, including interest rate and foreign exchange rate. 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 management. Credco does not engage in derivatives for trading purposes.
Market risk is the risk to earnings or value resulting from movements in market prices. Credco’s market risk exposure is primarily generated by:
• Interest rate risk in its funding activities; and
• Foreign exchange risk in its operations outside the United States.
American Express centrally monitors market risks using market risk limits and escalation triggers as defined in its market risk policy.
Interest rate exposure within Credco’s charge card and fixed-rate lending products is managed by varying the proportion of total funding provided by short-term and variable-rate debt compared to fixed-rate debt. In addition, interest rate swaps are used from time to time to economically convert fixed-rate debt obligations to variable-rate obligations or to convert variable-rate debt obligations to fixed-rate obligations. Credco may change the mix between variable-rate and fixed-rate funding based on changes in business volumes and mix, among other factors.
Foreign exchange risk is generated by (i) funding foreign currency cardmember receivables and loans with U.S. dollars and (ii) foreign subsidiary equity and foreign currency earnings in entities outside the United States. Credco hedges this market exposure to the extent it is economically justified through various means, including the use of derivatives such as foreign exchange forwards and cross-currency swap contracts, which can help “lock-in” the value of Credco’s exposure to specific currencies. Exposures from foreign subsidiary equity in Credco’s entities outside the United States are hedged through various means, including the use of foreign currency debt and foreign exchange forwards executed either by Credco or TRS.
Derivatives may give rise to counterparty credit risk, which is the risk that a derivative counterparty will default on, or otherwise be unable to perform pursuant to, an uncollateralized derivative exposure. Credco manages this risk by considering the current exposure, which is the replacement cost of contracts on the measurement date, as well as estimating the maximum potential value of the contracts over the next 12 months, considering such factors as the volatility of the underlying or reference index. To mitigate derivative credit risk, counterparties are required to be pre-approved and rated as investment grade. Counterparty risk exposures are centrally monitored and American Express takes risk mitigation actions, when necessary. Additionally, in order to mitigate the bilateral counterparty credit risk associated with derivatives, Credco has in certain instances entered into master netting agreements with its derivative counterparties that provide a right of offset for certain exposures between the parties. To further mitigate bilateral counterparty credit risk, Credco exercises its rights under executed credit support agreements with certain of its derivative counterparties. These agreements require that, in the event the fair value change in the net derivatives position between the two parties exceeds certain dollar thresholds, the party in the net liability position posts collateral to its counterparty.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
In relation to Credco’s credit risk, under the terms of the derivative agreements it has with its various counterparties, Credco is not required to either immediately settle any outstanding liability balances or post collateral upon the occurrence of a specified credit risk-related event.
Credco’s derivatives are carried at fair value on the Consolidated Balance Sheets. The accounting for changes in fair value depends on the instruments’ intended use and the resulting hedge designation, if any, as discussed below. Refer to Note 2 for a description of Credco’s methodology for determining the fair value of its derivatives.
The following table summarizes the total fair value, excluding interest accruals, of derivative assets and liabilities as of December 31:
(a) As permitted under GAAP, balances represent the netting of cash collateral received and posted under credit support agreements, and the netting of derivative assets and derivative liabilities under master netting agreements.
Derivative Financial Instruments that Qualify for Hedge Accounting
Derivatives executed for hedge accounting purposes are documented and designated as such when Credco enters into the contracts. In accordance with its risk management policies, Credco structures its hedges with very similar terms to the hedged items. Credco formally assesses, at inception of the hedge accounting relationship and on a quarterly basis, whether derivatives designated as hedges are highly effective in offsetting the fair value or cash flows of the hedged items. These assessments usually are made through the application of a regression analysis method. If it is determined that a derivative is not highly effective as a hedge, Credco will discontinue the application of hedge accounting.
Fair Value Hedges
A fair value hedge involves a derivative designated to hedge Credco’s exposure to future changes in the fair value of an asset or a liability, or an identified portion thereof that is attributable to a particular risk. Credco is exposed to interest rate risk associated with its fixed-rate long-term debt. Credco uses interest rate swaps to economically convert certain fixed-rate long-term debt obligations to floating-rate obligations at the time of issuance. As of December 31, 2011 and 2010, Credco hedged $11.6 billion and $8.9 billion, respectively, of its fixed-rate debt to floating-rate debt using interest rate swaps.
To the extent the fair value hedge is effective, the gain or loss on the hedging instrument offsets the loss or gain on the hedged item attributable to the hedged risk. Any difference between the changes in the fair value of the derivative and the hedged item is referred to as hedge ineffectiveness and is reflected in earnings as a component of other, net expenses. Hedge ineffectiveness may be caused by differences between the debt’s interest coupon and the benchmark rates, which are primarily due to credit spreads at inception of the hedging relationship that are not reflected in the
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
valuation of the interest rate swap. Furthermore, hedge ineffectiveness may be caused by changes in the relationship between 3-month LIBOR and 1-month LIBOR rates, as these so-called basis spreads may impact the valuation of the interest rate swap without causing an offsetting impact in the value of the hedged debt. If a fair value hedge is de-designated or no longer considered to be effective, changes in fair value of the derivative continue to be recorded through earnings but the hedged asset or liability is no longer adjusted for changes in fair value due to changes in interest rates. The existing basis adjustment of the hedged asset or liability is then amortized or accreted as an adjustment to yield over the remaining life of that asset or liability.
The following table summarizes the impact on the Consolidated Statements of Income associated with Credco’s hedges of fixed-rate long-term debt for the years ended December 31:
Credco also recognized a net reduction in interest expense on long-term debt and other of $257 million, $259 million and $206 million for the years ended December 31, 2011, 2010 and 2009, respectively, primarily related to the net settlements (interest accruals) on Credco’s interest rate derivatives designated as fair value hedges.
Cash Flow Hedges
A cash flow hedge involves a derivative designated to hedge Credco’s exposure to variable future cash flows attributable to a particular risk. Such exposures may relate to either an existing recognized asset or liability, or a forecasted transaction. Credco hedges existing long-term variable-rate debt, the rollover of short-term borrowings and the anticipated forecasted issuance of additional funding through the use of derivatives, primarily interest rate swaps. These derivative instruments economically convert floating-rate debt obligations to fixed-rate obligations for the duration of the instrument. As of December 31, 2011 and 2010, Credco hedged $0.3 billion and $0.8 billion, respectively, of its floating-rate debt using interest rate swaps.
For derivatives designated as cash flow hedges, the effective portion of the gain or loss on the derivatives is recorded in AOCI and reclassified into earnings when the hedged cash flows are recognized in earnings. The amount that is reclassified into earnings is presented in the Consolidated Statements of Income in the same line item in which the hedged instrument or transaction is recognized, primarily in interest expense. Any ineffective portion of the gain or loss on the derivatives is reported as a component of other, net expenses. If a cash flow hedge is de-designated or terminated prior to maturity, the amount previously recorded in AOCI is recognized into earnings over the period that the hedged item impacts earnings. If a hedge relationship is discontinued because it is probable that the forecasted transaction will not occur according to the original strategy, any related amounts previously recorded in AOCI are recognized into earnings immediately.
In the normal course of business, as the hedged cash flows are recognized into earnings, Credco expects to reclassify $1 million of net pretax losses on derivatives from AOCI into earnings during the next 12 months.
Net Investment Hedges
A net investment hedge is used to hedge future changes in currency exposure of a net investment in a foreign operation. Credco primarily designates foreign currency derivatives, typically foreign exchange forwards, and on occasion foreign currency denominated debt, as hedges of net investments in certain foreign operations. These instruments reduce exposure to changes in currency exchange rates on Credco’s investments in non-U.S. subsidiaries. The effective portion of the gain or loss on net investment hedges is recorded in AOCI as part of the cumulative translation adjustment. Any ineffective portion of the gain or loss on net investment hedges is recognized in other, net expenses during the period of change. No ineffectiveness or other amounts were reclassified from AOCI into income for the years ended December 31, 2011, 2010 and 2009, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
The following table summarizes the impact of cash flow hedges and net investment hedges on the Consolidated Statements of Income for the years ended December 31:
(a) During the years ended December 31, 2011 and 2010, there were no forecasted transactions that were considered no longer probable to occur.
Derivatives Not Designated as Hedges
Credco has derivatives that act as economic hedges but are not designated as such for hedge accounting purposes. Foreign currency transactions and non-U.S. dollar cash flow exposures from time to time may be partially or fully economically hedged through foreign currency contracts, primarily foreign exchange forwards, options, and cross-currency swaps. These hedges generally mature within one year. Foreign currency contracts involve the purchase and sale of a designated currency at an agreed upon rate for settlement on a specified date. The changes in the fair value of the derivatives effectively offset the related foreign exchange gains or losses on the underlying balance sheet exposures. From time to time, Credco may enter into interest rate swaps to specifically manage funding costs related to American Express’ proprietary card business.
For derivatives that are not designated as hedges, changes in fair value are reported in current period earnings.
The following table summarizes the impact of derivatives not designated as hedges on the Consolidated Statements of Income for the years ended December 31:
Note 8 - Variable Interest Entity
Credco has established a VIE, American Express Canada Credit Corporation (AECCC), used primarily to loan funds to affiliates. AECCC has a shelf registration in Canada for a medium-term note program providing for the issuance of notes by AECCC. All notes issued under this program are fully guaranteed by Credco. These medium-term note issuances are the primary source of financing loans to the Canadian affiliate. Credco is considered the primary beneficiary of the entity and owns all of the outstanding voting interests and therefore, consolidates the entity in accordance with accounting guidance governing consolidation of VIEs. Total assets as of both December 31, 2011 and 2010 were $2.4 billion and were eliminated in consolidation. Total liabilities as of both December 31, 2011 and 2010 were $2.3 billion and were primarily recorded in long-term debt. As of December 31, 2011 and 2010, $74 million and $501 million, respectively, of liabilities were eliminated in consolidation. The assets of the VIE are not used solely to settle the obligations of the VIE. The note holders of the VIE have recourse to Credco.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
Note 9 - Transactions with Affiliates
As described below, Credco executes material transactions with its affiliates. The agreements between Credco and its affiliates provide that the parties intend that the transactions thereunder be conducted on an arm’s length basis, however, there can be no assurance that the terms of these arrangements are the same as would be negotiated between independent parties.
In 2011, 2010 and 2009, Credco purchased cardmember receivables and loans without recourse from TRS and certain of its subsidiaries totaling approximately $174 billion, $163 billion and $120 billion, respectively. In 2011, 2010 and 2009, Credco sold cardmember receivables and participating interests to affiliates totaling $3.3 billion, $2.7 billion and $2.3 billion, respectively. The receivables agreements require TRS and its subsidiaries to perform accounting, clerical and other services necessary to bill and collect all cardmember receivables and loans owned by Credco. Since settlements under the agreements occur monthly, an amount due from, or payable to, such affiliates may arise at the end of each month.
As of December 31, 2011 and 2010, CRC owned approximately $3.0 billion and $3.7 billion, respectively, of participation interests purchased from RFC V.
Other transactions with American Express and its subsidiaries as of or for the years ended December 31 were as follows:
(a) Fees paid to affiliates for related servicing of receivables purchased.
Credco’s loans to affiliates represent fixed- and floating-rate interest-bearing intercompany borrowings by other wholly-owned TRS subsidiaries and American Express. Revenue earned from cardmember receivables with recourse and cardmember receivables and loans funded by loans to affiliates is recorded as interest income from affiliates in the Consolidated Statements of Income. As of December 31, 2011 and 2010, no significant amount of loss reserves has been recorded and no loans are 30 days or more past due.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
Components of loans to affiliates as of December 31 were as follows:
(a) As of December 31, 2011, Credco had $11.4 billion of outstanding loans to affiliates, of which approximately $7.5 billion are collateralized by the underlying cardmember receivables transferred with recourse and the remaining $3.9 billion are uncollateralized loans primarily with affiliated banks. As of December 31, 2010, Credco had $11.0 billion of outstanding loans to affiliates, of which approximately $7.6 billion are collateralized by the underlying cardmember receivables transferred with recourse and the remaining $3.4 billion are uncollateralized loans primarily with affiliated banks.
Due to/from affiliates relate primarily to a timing difference resulting from the purchase of cardmember receivables net of remittances from TRS, as well as from operating activities.
Components of short-term debt to affiliates as of December 31 were as follows:
Short-term debt to affiliates consists primarily of master note agreements for which there is no stated term. Credco does not expect any changes to its short-term funding strategies with affiliates.
Service Fees to Affiliates
Certain affiliates do not explicitly charge Credco a servicing fee for the servicing of receivables purchased. Instead Credco receives a lower discount rate on the receivables sold to Credco than would be the case if servicing fees were charged. If a servicing fee had been charged by these affiliates from which Credco purchases receivables, servicing fees to affiliates would have been higher by approximately $127 million, $120 million and $126 million for the years ended December 31, 2011, 2010 and 2009, respectively. Correspondingly, discount revenue would have increased by approximately the same amounts in these periods.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
Note 10 - Significant Credit Concentrations
Concentrations of credit risk exist when changes in economic, industry or geographic factors similarly affect groups of counterparties whose aggregate credit exposure is material in relation to Credco’s total credit exposure. Credco’s primary credit exposure, cardmember receivables and loans and loans to affiliates, is diversified among TRS affiliated companies that operate in diverse industries, economic sectors and geographic regions.
The following table details Credco’s credit exposure by category as of December 31:
(a) Individuals primarily include cardmember loans and receivables.
(b) Financial institutions primarily include debt obligations of banks, broker-dealers, insurance companies and savings and loan associations.
(c) All other primarily includes cardmember receivables from other corporate institutions.
(d) Certain distinctions between categories require management judgment.
As of December 31, 2011 and 2010, Credco’s most significant concentration of credit risk was primarily with cardmember receivables and loans. Credco purchased cardmember receivables and loans from TRS and certain of its subsidiaries. TRS generally advances these amounts on an unsecured basis. However, TRS reviews each potential customer’s credit application and evaluates the applicant’s financial history and ability and willingness to repay. TRS also considers, on behalf of Credco, credit performance by customer tenure, industry and geographic location in managing credit exposure.
The following table details Credco’s cardmember receivables and loans exposure in the United States and outside the United States as of December 31:
The remainder of Credco’s on-balance sheet exposure includes cash and cash equivalents, loans to affiliates, due from affiliates and deferred charges and other assets. The majority of these balances is primarily outside the United States.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
Note 11 - Changes in Accumulated Other Comprehensive (Loss) Income
AOCI is a balance sheet item in the Shareholder’s Equity section of Credco’s Consolidated Balance Sheets. It is comprised of items that have not been recognized in earnings but may be recognized in earnings in the future when certain events occur. Changes in each component of AOCI for the three years ended December 31 were as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
The following table shows the tax impact for the three years ended December 31 for the changes in each component of accumulated other comprehensive (loss) income:
(a) Results for all years include recurring permanent tax benefits in relation to the level of pretax income. Expenses in the United States are attracting a 35 percent statutory benefit whereas foreign earnings are taxed at lower rates and are indefinitely reinvested. Credco’s effective tax rate reflects the favorable impact of the tax benefit related to its ongoing funding activities outside the United States. The availability of this benefit in future years is largely dependent on the continued extension by Congress of a provision of the United States Internal Revenue Code.
Credco records a deferred income tax (benefit) provision when there are differences between assets and liabilities measured for financial reporting and for income tax return purposes. These temporary differences result in taxable or deductible amounts in future years and are measured using the tax rates and laws that will be in effect when such 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 assets will not be realized.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
The significant components of deferred tax assets and liabilities as of December 31 are reflected in the following table:
Accumulated earnings of certain non-U.S. subsidiaries, which totaled approximately $3.7 billion as of December 31, 2011, are intended to be permanently reinvested outside the United States. Credco does not provide for federal income taxes on foreign earnings intended to be permanently reinvested outside the United States. Accordingly, federal taxes, which would have aggregated approximately $1.3 billion, have not been provided on those earnings.
Credco is subject to the income tax laws of the United States and 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. Given these inherent complexities, Credco must make judgments in assessing the likelihood that a tax position will be sustained upon examination by the taxing authorities based on the technical merits of the tax position. A tax position is recognized only 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 benefit recognized for financial reporting purposes is based on management’s best judgment of the largest amount of benefit that is more likely than not to be realized on ultimate settlement with the taxing authority given the facts, circumstances and information available at the reporting date. Credco adjusts the level of unrecognized tax benefits when there is new information available to assess the likelihood of the outcome.
American Express is subject to examination by the Internal Revenue Service (IRS) and tax authorities in other countries and states in which American Express has significant business operations. The tax years under examination and open for examination vary by jurisdiction. The IRS has completed its field examination of American Express’ federal tax returns for years through 2004, and in April 2011, unagreed issues for 1997 through 2004 were resolved at IRS Appeals. Additional refund claims for those years continue to be reviewed by the IRS. In addition, American Express is currently under examination by the IRS for the years 2005 through 2007.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
The following table presents changes in unrecognized tax benefits:
Included in the $737 million, $528 million and $100 million of unrecognized tax benefits as of December 31, 2011, 2010 and 2009 respectively, are approximately $106 million, $108 million and $85 million, respectively, that, if recognized, would favorably affect the effective tax rate in a future period.
Credco believes it is reasonably possible that the unrecognized tax benefits could decrease within the next 12 months by as much as $625 million principally as a result of potential resolutions with taxing authorities. Of the $625 million of unrecognized tax benefits, approximately $615 million relates to amounts recorded to equity that, if recognized, would not impact the effective rate. With respect to the remaining $10 million, it is not possible to quantify the impact a change may have on the effective tax rate and net income due to the inherent complexities and the number of tax years open for examination in multiple jurisdictions. Resolution of the prior years’ items that comprise this remaining amount could have an impact on the effective tax rate and on net income, either favorably (principally as a result of settlements that are less than the liability for unrecognized tax benefits) or unfavorably (if such settlements exceed the liability for unrecognized tax benefits).
Interest and penalties relating to unrecognized tax benefits are reported in the income tax provision. During the years ended December 31, 2011, 2010 and 2009, Credco recognized approximately $4 million, $(2) million and $11 million, respectively, of interest and penalties. Credco has approximately $35 million and $25 million accrued for the payment of interest and penalties as of December 31, 2011 and 2010, respectively.
Current federal taxes due to/from affiliates included current federal taxes payable to TRS of $105 million as of December 31, 2011, and current federal taxes receivable from TRS of $3 million as of December 31, 2010.
Income taxes refunded to Credco during 2011 and 2010, including taxes refunded by TRS, were $67 million and $156 million, respectively.
Note 13 - Geographic Regions
GAAP governing the disclosures about segments of an enterprise and related information requires public companies to report certain financial information about significant revenue-producing segments of the business for which such information is available and utilized by the chief operating decision maker. Credco is principally engaged in the business of financing the cardmember receivables and loans of its affiliates. Management makes operating decisions and assesses performance based on an ongoing review of these financing activities which constitute Credco’s only operating segment for financial reporting purposes.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS CREDIT CORPORATION
The following presents Credco’s revenues and pretax income in different geographic regions:
(a) The data in the table above is, in part, based upon internal allocations which require management’s judgment.
Note 14 - Quarterly Financial Data (Unaudited)
Quarterly financial information for the years ended December 31 are summarized as follows:
EXHIBIT INDEX
Pursuant to Item 601 of Regulation S-K
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* These interactive data files are furnished and deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
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