American Express Customers Slow Their Spending

American Express (AXP +1.85%) had a banner year in 2018, driving spending and lending growth by signing up new cardholders and grabbing a greater share of its cardholders' spending and borrowing needs.

But the story in the fourth quarter was one of slowing growth. Though cardholders used their cards to spend about 8% more on a currency-adjusted basis in the fourth quarter, that was down from the double-digit growth in billed business that investors had become accustomed to seeing for the bulk of 2018.

Check out the latest American Express earnings call transcript.

American Express' fourth quarter: By the numbers

AmEx wouldn't be a financial company without messy tax-related items affecting its headline numbers. Both the fourth quarter of 2017 and 2018 had some one-time oddities relating to the Tax Cuts and Jobs Act, as well as other tax items, that make year-over-year comparisons a little more difficult.

Image source: American Express.

Just for perspective, consider that American Express' tax rate under generally accepted accounting principles (GAAP) was negative 9.8% in the fourth quarter of 2018 versus 167.1% in the fourth quarter of 2017. In other words, on a GAAP basis, it incurred negative tax expenses in the fourth quarter of 2018 and taxes in excess of its pre-tax income in the same period of 2017.

Companies keep two sets of books, one for investors, and one for Uncle Sam. They don't always play nicely with each other.

The adjusted diluted EPS figure shown in the table below excludes impacts resulting from prior years' tax audits, tax charges (and later adjustments) related to the Tax Cuts and Jobs Act, and changes in tax accounting for some expenses, as calculated and reported by American Express. In other words, it removes all the oddball items in each quarter to present a more accurate comparison.

Data source: American Express.

What happened at American Express this quarter?

American Express competes in everything from credit cards to loans to small businesses all around the world. But its earnings reports can be boiled down to just a handful of needle-moving components. Here's what really mattered in AmEx's fourth-quarter results:

• Billed business increased, albeit at a slower rate. Coming into the fourth quarter, American Express' billed business -- spending volume on AmEx cards, in other words -- was growing at a breakneck pace for a bank its size. But growth decelerated in the fourth quarter, as total billed business grew roughly 6% year over year, down slightly from 8% year-over-year growth in the third quarter. When adjusted for currency fluctuation, total billed business grew about 8% year over year, down from growth of roughly 10% in the sequential quarter. Management attributed the slowdown in growth to a tough comparison from elevated spending in the fourth quarter of 2017.
• Credit remains exceptional. American Express built a business on high-income households and creditworthy corporate customers, which is reflected in net write-off rates that are consistently lower than the industry average. This quarter, its net write-off rate stood at 2.4%, down from 2.5% sequentially and up slightly from 2.2% in the year-ago period. Loans 30-plus days past due increased to 1.4% of loans, up slightly from 1.3% in both the sequential quarter and the fourth quarter of 2017.
• The company is setting more money aside for losses. The card issuer provisioned $954 million for losses in the fourth quarter, up 14% from the year-ago period. Reserves for loan losses now stand at 2.6% of worldwide card loans, up from 2.5% in the sequential quarter and 2.3% a year ago. In prepared remarks on the conference call, management said it expected "modest" increases in net write-off rates as new accounts season over the course of 2019.
• It issued more cards, and added more places to use them. American Express added more than 12 million new cards for the full year 2018. Continuing on a multiyear effort to bridge the gap between its acceptance rates and those of market leaders Visa and Mastercard, AmEx said it added more than 1 million new locations to its network for the second year in a row.

What management had to say, and a look ahead

With its fourth-quarter earnings report behind it, American Express rolled out guidance for 2019, calling for an 8% to 10% increase in revenue and diluted earnings per share in the range of $7.85 to $8.35.

When asked by an analyst to give background information about assumptions that went into its guidance for the year ahead, CFO Jeff Campbell provided some more information for investors.

On its revenue guidance, Campbell said: "The couple of revenue headwinds we've been talking about for a while are you're lapping the Hilton portfolio and you're getting a little moderation in our net interest yield. But we feel really good about our ability to sustain strong revenue growth."

The Hilton portfolio refers to a portfolio of cards it acquired from Citi in 2018. On last quarter's call, management said that portfolio had added about 1.2 percentage points of revenue growth in 2018 versus prior-year periods. It's not particularly large, but the "free" tailwind of revenue from an acquired book of business will no longer help in year-over-year comparisons in 2019. 

As for net interest yield, which increased modestly in 2018, the difference is truly a rounding error to revenue growth, given that net interest income earned from lending only makes up about 20% of revenue in the first place.

As for its EPS guidance, Campbell had this to say: "So, in a world where 2019 turns out to look something like 2018 in terms of the economy, you should expect this to be at the mid-to-upper end of the range, and the lower end of the range is there when you think about things happening in the equity markets, government is shut down right now -- a little bit of uncertainty. So sure, if the economy weakens a little bit, that's what the lower end of the range is for."

Fourth-quarter earnings reports from many banks revealed a similar tone of cautious optimism about the health of the economy, balanced by the reality that the current credit cycle and economic expansion are very long in the tooth.