American

Express

Financial Institutions

Professor Matthews

December 11, 2002

by:

Miriam McDonough

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Table of Contents

Industry Trends. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 1-2

American Express . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 2-3

Ratio Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 3-7

Risk Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 7-10

Recommendation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 10-11

Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 12

Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Exhibit A

Ratio Comparisons. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Exhibit B

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Industry Trends

Focusing mainly on the trends of the financial industry in 2001, it is easy to see

that it was a hard year across the board. With the weakening economy, the high default

risk, the horrific terrorist attacks and the corporate scandals, the financial industry

suffered many times over during late 2000 and throughout 2001. And the recovery did

not begin there. It is hard to predict when the economy will turn around, and it is even

harder to correctly predict.

The weakening economy caused consumer spending to slowdown drastically. It

was no longer the booming, bull market. Rather, consumers were faced with challenging

times and they reacted accordingly. This negatively affected many industries, including

the financial industry. There were also high rates of default on both the consumer and

institution sides. But nothing could prepare the industry for the terrorist attacks and the

consequences that would follow.

The market was already performing extremely poorly when the attacks on

September 11, 2001 occurred. Domestic and foreign faith in America receded.

Numerous industries were hit hard, and the financial industry was no exception.

And as if matters could not get worse, corporations started losing the faith of the

consumers through scandals and accounting problems. It was no longer a question of

who is the best, but rather a question of who can you trust? It seemed to consumers that

no one in the financial industry possessed the integrity that was previously believed to be

present. But after surviving the hard times, it now seems that there is a future, even a

bright future, for the financial industry. Still, after so many predictions, it seems as

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though no one will know when the bull market will occur until it is experienced, and until

then, the financial industry will have to survive the bad weather.

American Express

American Express began serving its customers in 1850 and has been building a

strong, well-known name ever since. It provides services throughout the world such as

travel-related services, financial advisory services and international banking services.

The company offers products such as financial planning, brokerage services, mutual

funds, insurance and other investment strategies. American Express’s main subsidiary,

American Express Travel Related Services Company, Inc. (TRS), also provides a wide

variety of products and services to consumers worldwide.

Due to the weakening economy, the depressed equity markets, the high default

rates, the sudden slowdown in spending by consumers, and the terrorist attacks on

September 11, 2001, American Express faced one of its most challenging years in its

corporate history in 2001. American Express was forced to examine and reevaluate its

business model and business processes. In 2002 and the years to follow, American

Express has plans to transform its business, while still maintaining the high quality of

services and products that it has provided to consumers for over 150 years. American

Express is striving to become less dependent on its revenues to reach its targeted

earnings, working to reengineer its business model, and making every effort to reduce its

expenses.

In order to cope with the economy and still remain one of the competitive forces

in the industry, American Express has developed a plan with three main objectives:

strengthen its business model, lower its risk profile, and invest in key growth

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opportunities. American Express is focusing on strengthening the performance of their

businesses and providing greater flexibility. This will enable the company to become less

dependent on an unpredictable economic environment to deliver growth in earnings. In

an attempt to lower the company’s exposure to risk, American Express has evaluated and

rebalanced their portfolios risk to reward profile. They have sold or reduced their

exposure in certain investments and repositioned their portfolio toward lower risk

investments. They plan to create a portfolio that is more similar to that of the industry’s

average. American Express, like many other companies in its industry, must find

opportunities for future growth. They have found that the three main opportunities and

successes that are present for American Express are: expanding the card business in

international markets, growing the card business in the US, and growing the retail

financial services worldwide.

Although American Express did not meet its financial goals for 2001, the

company is developing and executing plans that will enable them to better face

challenges such as the ones that occurred in 2001. American Express has been in

business for over 150 years and they have been providing quality service and products

since their opening. By restructuring their businesses and searching for ways to better

serve their customers, American Express will survive these trying times and certainly

come out on top.

Ratio Analysis

Performing a ratio analysis, I am able to look at the value of American Express

Company and in some cases compare it to that of the industry. By calculating and

analyzing ratios from five different areas such as profitability, liquidity, efficiency, debt

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management, and market value, I am able to see that American Express has suffered in a

number of different categories. But despite American Express Company’s great losses,

analysis also shows that there is a strong possibility of a healthy and prosperous future in

store for American Express.

Looking at profitability ratios, specifically the profit margin, I found that

American Express Company’s profitability has declined significantly from 2000 to 2001.

The profit margin indicates the rate of profit from sales and revenues. During 1999 and

2000, American Express had a relatively high profit margin, but decreased from 11.8% to

5.8% between 2000 and 2001, and is significantly lower than the industry that is currently

at 8.9%. This shows that 2001 was a very hard year American Express. Other aspects

that measure profitability for a company are return on assets and return on equity. Both

of these measurements support the profit margin indication that American Express’s

profitability has drastically decreased from 2000 to 2001. The ROE shows how

profitable a company is in comparison with the industry. From 2000 to 2001 the ROE

dropped from 24 to 10.9, while the industry average rose to 25.63. This shows that the

return on equity for American Express is 135% less than the industry average, indicating

that the profit level of American Express is 135% less then the other companies in the

financial services industry. The ROA indicates what earnings were generated from

invested capital. The ROA for American Express is currently half or .91 less than the

industry that is 1.81; while in 1999 and 2000 the ROA for American Express was very

close with the industry average. This is also showing, like the ROE, that there is an

enormous gap between the profits of other companies in the financial services industry

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and American Express. The profitability ratios show that American Express is literally

half as profitable or less than half as profitable as its competitors.

Using the current ratio, which is one of the liquidity ratios, the ability of

American Express to meet it daily operating expenses and short-term obligations can be

measured. The current ratio for American Express has increased from 1999 to 2001

by .27. This shows that the company has been meeting its obligations faster and more

efficiently. In other words, the company has become more liquid. The quick ratio for

American Express is the same as its current ratio because the company does not hold any

inventory. The quick ratio is a measure of how fast a company’s assets can be turned into

cash. It also measures a company’s financial strength. Because it has grown by more

than .2, the quick ratio indicates that the strength of American Express is growing.

Although the financial services industry does not provide averages for liquidity ratios, it

is assumed that a number between one and two is acceptable, and as always, if it is

moving in an optimal direction, it is favorable.

Efficiency ratios are used to evaluate the overhead structure of a financial

institution. These ratios measure how efficient and therefore how profitable a company

is. The total asset turnover has increased very slightly between 1999 and 2001 from .14

to .15. Although this is still .05 less than the industry (which is currently at .2), it does

show that the efficiency and profitability of American Express is moving in a positive

direction. Another measure of efficiency is receivables turnover. This ratio portrays

American Express moving in a negative direction. The financial service industry does

not provide an industry average for the receivables turnover ratio, but by looking at the

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numbers from 1999 to 2001, it is seen that the return per dollar has been decreasing,

which indicates a decrease in profits.

Analyzing debt management ratios, I looked at the debt/equity ratio and the

performance of American Express in relation to the industry. The debt/equity ratio

measures a company’s financial leverage, i.e. how much debt and how much equity a

company uses to finance its assets. A higher ratio indicates an aggressive investment in

assets using debt. American Express has been increasing its debt usage but is still

enormously behind the industry average. This could and is having a very strong affect on

profits. The total debt ratio is also used in measuring management specifically risk

management. Like the debt/equity ratio, the total debt ratio indicates how much a

company finances its assets using debt and in return measures a company’s risk.

American Express’s total debt ratio has been slightly decreasing and therefore shows

again that the company does not use much debt to finance its assets and therefore has a

very low risk rating.

Finally I looked at market value ratios. In contrast with the profitability, liquidity,

efficiency, and debt management ratios, the market value ratios paint a brighter picture

for American Express’s future. For instance, the P/E ratio for American Express is

extremely high. It has grown from 24.8 in 2000 to 41.5 in 2001, which is a 67.3%

increase, and it is 71.5% higher than the industry average. This could mean big things for

the future of American Express. The high P/E ratio most likely means high projected

earnings in the upcoming years. The book value per share ratio shows that the book

value of American Express’s stock has been increasing since 1999, when it was $7.52.

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Currently it is at $9.04, which is still below the market average, but again, is moving in a

positive direction. (See Exhibit A and Exhibit B)

Risk Management

American Express’s objective is to monitor and control risk

exposures to earn returns commensurate with the level of risk

assumed.

Management establishes and oversees implementation of Board-

approved policies covering the company’s funding, investments and

the use of derivative financial instruments. The company’s treasury

department, along with various asset and liability committees in the

businesses, is responsible for managing financial market risk

exposures within the context of Board-approved policies.

In the second half of 2001, the company established the

Corporate Risk Management Committee (CRMC) to supplement the risk

management capabilities resident within its business segments by

routinely reviewing key market, credit and other risk concentrations

across the company and recommending corrective action where

appropriate. The CRMC promotes a rigorous understanding of risks

across the company and supports senior management in making risk-

return decisions.

Management considers the risk of liquidity and cost of funds from

the company’s market related activities. Management believes a

decline in the company’s long-term credit rating by two levels could

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result in the company having to significantly reduce its commercial

paper and other short-term market borrowings and replace them, in

part, by taking down existing credit lines. Remaining borrowing

requirements would be addressed through other means such as

additional securitizations and sale or repurchase of investment

securities. This would result in higher interest expense on the

company’s commercial paper and other debt, as well as higher fees

related to unused lines of credit. The company believes a two level

downgrade is unlikely due to its capital position and growth prospects.

American Express Travel Related Service’s (TRS) hedging policies

are established, maintained and monitored by the company’s treasury

department. TRS generally manages its exposures along product lines.

A variety of interest rate and foreign exchange hedging strategies are

employed to manage interest rate and foreign currency risks. TRS

funds its Charge Card receivables and Cardmember loans using various

funding sources, such as long- and short-term debt, medium-term

notes, commercial paper and asset securitizations. Cardmember

receivables are predominantly funded by Credco and its subsidiaries;

funding for Cardmember loans is primarily through Centurion Bank. For

its Charge Card and fixed rate lending products, interest rate exposure

is managed through the issuance of long and short term debt, the use

of interest rate swaps and, to a lesser extent, caps. During 2001, TRS

continued its strategy by augmenting its portfolio of interest rate

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swaps that convert its domestic funding from floating rate to fixed

rate. TRS regularly reviews its strategy and may modify it. For the

majority profits Cardmember loans, which are linked to a floating rate

base and generally repriced each month, TRS uses floating rate

funding. The detrimental effect on TRS pretax earnings of a

hypothetical 100 basis point increase in interest rates would be

approximately $48 million ($31 million related to the U.S. dollar) and

$80 million ($61 million related to the U.S. dollar), based on 2001 and

2000 year-end positions, respectively. This effect is primarily a function

of the extent of variable rate funding of Charge Card and fixed rate

lending products, to the degree that interest rate exposure is not

managed by derivative financial instruments.

With respect to the managed portion of that interest rate

exposure, a substantial amount of the $296 million of the company’s

net after-tax unrealized losses recorded in other comprehensive

income on the consolidated balance sheet at December 31, 2001

represents the fair value of the related derivative financial instruments.

These losses will be recognized in earnings during the terms of those

derivatives contracts at the same time that the company realizes the

benefits of lower market rates of interest on its funding of Charge Card

and fixed rate lending products. Notwithstanding the unrealized losses,

the company expects a year-over-year benefit from lower interest

rates in 2002 that is in excess of $400 million.

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TRS’ foreign exchange risk arising from cross-currency charges

and balance sheet exposures is managed primarily by entering into

agreements to buy and sell currencies on a spot or forward basis.

Additionally, in the latter parts of 2001 and 2000, foreign currency

forward sales and, in the latter part of 2000, foreign currency forward

purchases were contracted to manage a portion of anticipated cash

flows from operations in major overseas markets for the subsequent

year. In early 2002, the company entered into additional forward

contracts covering a substantial portion of the remaining cash flows

from operations.

American Express utilizes foreign exchange and interest rate

products to meet the needs of its customers. Customer positions are

usually, but not always, offset. They are evaluated in terms of overall

interest rate or foreign exchange exposure. American Express also

takes limited proprietary positions. Potential daily exposure from

trading activities is calculated using a Value at Risk methodology. This

model employs a parametric technique using a correlation matrix

based on historical data. The Value at Risk measure uses a 99%

confidence interval to estimate potential trading losses over a one-day

period. On December 31, 2001 and 2000, the Value at Risk for

American Express was less than $1 million. (American Express Annual

Report 2001)

Recommendation

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After examining American Express’s 2001 Annual Report, its historical profile,

the industry trends, its ratio comparisons, and its future plans, I have decided on a hold

recommendation.

The 2001 Annual Report for American Express paints a bleak picture. With

revenues low and goals not meet, it is easy to see that 2001 was not a good year. But

then viewing the historical profile, I see that American Express is a strong name that is

known worldwide with a reputation for high quality. It is a company that is a competitive

force in the financial industry that has proven year after year to be one of the best. The

industry trends show that almost all other companies in the industry faced many of the

same challenges in 2001 as American Express and that the circumstances of 2001 forced

many companies to reevaluate what direction their company was headed. The ratio

comparisons predict two possible futures for American Express, but taking into

consideration the economic factors of 2001 and looking at the industry averages, I believe

it is very viable that American Express is moving in a positive direction and will be ready

to grasp growth opportunities when the economy turns around.

American Express has designed and implemented various strategies to reengineer

and improve its overall company. It looks to a bright future and plans on taking full

advantage of opportunities that will provide success in an ever changing market. I

recommend a hold and anticipate a buy in the not so distant future.

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Bibliography

www.americanexpress.com

www.finance.yahoo.com

www.multexinvestor.com

www.moneycentral.com

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www.sec.gov

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