Bruised AmEx Returns to Roots Article

By ROBIN SIDEL American Express Co., after outclassing its rivals for the past 50 years, is looking uncomfortably like just another credit-card company. AmEx is reeling from late payments and defaults by customers it aggressively wooed before the U.S. economy tumbled into recession. Its sterling reputation for customer service is under attack from longtime clients. Even cardholders with plenty of money are putting away their plastic, pushing shares of the New York company to a 12-year low. "If we had known this was coming, we would have ratcheted back some of our investment and put tighter guardrails on our credit decisions," says Alfred Kelly, the company's president. In an attempt to mitigate the damage, AmEx is retreating from an ill-timed expansion of its credit-card business. The company is now going back to its roots as a charge-card issuer to well-heeled Americans who can pay off their balance every month. It also is getting tough on many of the same customers it courted when times were good. The course reversal is causing problems of its own. Last fall, AmEx slashed a line of credit for David Sewell's small business to $10,200 from $80,000. Mr. Sewell, who owns an online computer-accessory store in Provo, Utah, had been an AmEx cardholder for 15 years, but he only signed up for a business line of credit in 2004. In January, that line was canceled altogether when AmEx abolished the program. "It has tarnished my view of American Express," says Mr. Sewell. AmEx declined to discuss his case, but in a letter to Mr. Sewell, the company cited a number of factors that contributed to the decision to reduce his credit line, including a late payment to a vendor and a high debt level. AmEx's stumbles have fueled speculation that it could be vulnerable to a takeover, though most potential buyers are too bogged down in their own messes to seek a deal. Instead, executives are likely to spend years wrestling with the painful consequences of their push to get AmEx cardholders to spend more just before the housing bubble burst. AmEx recently reported that defaults on its securitized loans, or loans that are bundled and sold to investors, rose to about 8.3% in January, up from 7% in December and from a trough of about 2% in January 2006. Overall January defaults are likely to be even worse, because those figures don't include small-business customers and some of AmEx's newest cardholders. Kenneth Chenault, AmEx chairman and chief executive, acknowledges that the company flooded customers with too much credit, and that taking some of it away now could anger people. Once the current crisis passes, though, the company's return to its traditional strategy of focusing on charge cards for the wealthy will pay off, Mr. Chenault predicts. "The fundamentals of this company still feel strong to me," he says. Indeed, AmEx was profitable in the fourth quarter even as the nation's banking industry recorded a $26.2 billion loss for the period. And the company says it has been able to maintain the rates it charges merchants for each transaction. Misery is mounting for all credit-card issuers as the U.S. economy sinks and more consumers fall behind on their bills. Bank of America Corp. and J.P. Morgan Chase & Co. had net losses in their credit-card operations during the fourth quarter. In January, late payments on credit cards hit a record high, according to Fitch Ratings. By year end, Fitch estimates that credit-card defaults, or balances that credit-card companies write off as uncollectible, will surpass the previous record of 7.7% recorded by the Federal Deposit Insurance Corp. in the first quarter of 2002, and approach 9%. Defaults hit a record low of 1.37% in the first quarter of 1984 and hovered well under 5% during the recent boom years, according to the FDIC. Card companies also are being bruised by consumers who are leery about spending. That means lower interest payments and transaction fees generated by swiping plastic. According to the Commerce Department, consumer spending fell 1% in December, the fifth monthly decline in a row. Spending on AmEx cards tumbled 10% in the fourth quarter, with no improvement since then, the company says. Recessions have been part of AmEx's history ever since it began issuing personal charge cards on purple paper in 1958. Until the current mess, though, AmEx limited its exposure to economic downturns with its carefully cultivated exclusivity. While other card companies issued revolving cards that let customers carry a balance from month to month, AmEx historically kept its attention focused on charge cards. Unlike credit-cards users, charge-card customers must pay off their balance in full each month, so they tend to be among the more affluent. AmEx's penchant for the elite is on display at its headquarters in lower Manhattan, where a column on an executive floor is sheathed in cards embossed with the names of famous AmEx customers such as Dwight Eisenhower and Ella Fitzgerald ("cardmember since 1961"). According to the company, Lyndon Johnson got an AmEx card while he was in the White House. Available by invitation only, the company's black Centurion card is reserved for people who charge more than $250,000 a year. The AmEx card trounces rivals Visa Inc. and MasterCard Inc. in the market for corporate cards. Its Membership Rewards loyalty program provides scores of offers for customers. Many of AmEx's current woes began with a gradual shift in strategy begun around 2003, as Mr. Chenault and other top executives sought to transform one of the world's most exclusive brands into a product that could be used more broadly. AmEx has issued credit cards since the late 1990s, but that business was fairly small. Most of those credit cards were co-branded with outside companies such as Delta Air Lines Inc. and Costco Wholesale Corp., from whom customers could earn reward points when they use their cards. The first big AmEx branded credit card was called Blue. Introduced in 1999, Blue had a unique clear plastic design, carried no annual fee and was pitched to existing charge-card holders and new and younger customers. Loan volume generated by the Blue card grew 40% from mid-2001 to mid-2003, representing 19% of AmEx's lending business. Mr. Kelly, the AmEx executive in charge of the company's U.S. card business, said at the time that the credit quality of the Blue cardholders was strong. AmEx wasn't lowering its standards to attract new customers, he assured investors. Despite Blue's impressive growth, AmEx still had less than $40 billion in U.S. credit-card loans outstanding in 2003, compared with $118 billion at MBNA Corp., a Wilmington, Del., issuer best known for cards bearing the logos of sports teams and colleges. MBNA was later acquired by Bank of America. As consumers began using plastic for more small purchases at supermarkets, gas stations and restaurants, AmEx executives decided they wanted a bigger piece of the action. In 2003, total annual use of plastic in the U.S. to buy retail goods and services exceeded cash and checks for the first time. AmEx revved up its push into the credit-card business, rolling out new cards that allowed customers to carry a balance from month-to-month. That thrust the company into frenzied competition against scores of card issuers and bank-owned debit cards, which were catching on with young consumers. Targeting Newlyweds From 2003 to 2005, AmEx developed a new generation of credit cards for younger consumers whom it described as "pre-affluent," including a line aimed at single urban professionals called the "IN" card. Other credit cards were targeted at newlyweds (the "Nest") and engaged couples (the "Knot"). "We saw a window to invest, which we seized," says Mr. Kelly, one of several top AmEx executives who pushed the strategy. People familiar with AmEx's credit-decision policies say the company didn't entirely stray from its affluent customer base when it barreled into credit cards. Unlike other lenders now in trouble, the company didn't load up on subprime customers or expand into mortgages. The problem: While card-issuing banks make a big chunk of their profits by charging interest, AmEx relies just as heavily on fees it gets from processing each transaction. Each time someone swipes his AmEx card, AmEx collects a fee from the merchant. Its business model, therefore, is based on convincing people to pile on purchases. As it expanded its customer base, the company doled out more and more credit to its new cardholders. And when customers didn't spend up to their limit, AmEx gave them even more credit to encourage spending. "The timing was incredibly bad," says John Williams, an analyst at Macquarie Research in New York who worked in AmEx's finance department between 2003 and 2006. He has been a harsh critic of AmEx since he started covering the company in September, recommending that investors sell the stock. AmEx charge-card customers routinely were encouraged to apply for Blue credit cards. The company pitched a business credit-line product to small-business owners who already were using its cards. Customers who exceeded their credit limits often could get them increased with a single telephone call. "We felt they had the capacity to spend more," Mr. Kelly says. The company estimates that about 35% of its customers have both an AmEx charge card and an AmEx credit card. By the summer of 2007, AmEx had accrued nearly $70 billion in credit-card loans, or about double the amount they had in 2002. Early Warning Signs Soon, Mr. Chenault, who took over in 2001, was starting to worry. In a regular review of AmEx's financial data in December 2007, he noticed that spending had dropped off sharply. He dialed the CEO of a luxury retailer. "Are you seeing what we're seeing?" he asked. The other CEO confirmed the downturn in spending, he recalls. The situation got worse as the housing market tumbled last year. AmEx customers are heavily concentrated along the U.S. coasts, making the company more exposed to California and Florida, which have been battered by plunging home prices and foreclosures. Credit cards opened in 2005 and 2006 became some of the company's worst performers because, says AmEx, it didn't have enough of a history with those customers to accurately assess how they would respond to an economic downturn. In addition, the company says this downturn has hit affluent customers faster and harder than previous ones. Scrambling to limit the financial damage, AmEx has canceled some newer credit cards that didn't catch on with younger consumers. It is now offering some Blue and Optima cardholders a $300 gift card if they pay off their balances and cancel their accounts. Last summer, the company began reducing credit lines for people who live in states hardest hit by the housing slump even if they hadn't shown any signs of being in financial distress. AmEx also began reducing credit lines or canceling the cards of people who worked in industries that are among the most vulnerable to the financial crisis, such as financial services and real estate. In October, AmEx infuriated thousands of customers by reducing their credit limits based on where they shopped and the lenders that held their mortgages. The reason: Other AmEx customers who frequented the same companies were having trouble making payments on their cards, according to the company. AFP/Getty ImagesAt the same time, AmEx is trying to recruit more affluent charge-card customers; half of its recent monthly direct-mail efforts have been tied to those cards, compared with 16% last year. But for some of the people who are seeing their credit lines reduced, the insult is enough to drive them away entirely. "I've always told everyone that AmEx was the best credit-card company out there," says Bill Jenkins, who recently canceled two of his AmEx cards after the company imposed spending limits on the card he uses for his auto-parts business in Virginia -- then wouldn't budge when he complained. AmEx wouldn't comment on Mr. Jenkins's case. AmEx says the number of customer defections is modest, adding that it is working hard to calm unhappy customers. And while the company is trying to slash costs by cutting 7,000 jobs, or nearly 10% of its work force, customer-service operations haven't been affected, the company says. Still, says Mr. Chenault, AmEx customers are "a group that is not used to getting bad news. To call someone who has never imagined they would go through this experience is not easy." Write to Robin Sidel at robin.sidel@wsj.com