Ladies and gentlemen, thank you for standing by, and welcome to the American Express second quarter 2012 earnings call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session with instructions being given at that time. If you should require assistance during the call, please press star then zero. As a reminder, this call is being recorded. I would now like to turn the conference over to your host, Rick Petrino. Please go ahead.
Thank you. Welcome. We appreciate all of you joining us for today's call. The discussion today contains certain forward-looking statements about the company's future financial performance and business prospects, which are subject to risks and uncertainties and speak only as of today. The words believe, expect, anticipate, estimate, optimistic, intend, plan, aim, will, should, could, likely, and similar expressions are intended to identify forward-looking statements. Factors that could cause actual results to differ materially from these forward-looking statements, including the company's financial and other goals, are set forth within today's earnings press release and earnings supplement, which were filed in an 8-K report and in the company's 2011 10-K and Q1 2012 10-Q report, already on file with the Securities and Exchange Commission.
In the second quarter 2012 earnings release and earnings supplement, as well as the presentation slides, all of which are now posted on our website at ir.americanexpress.com, we have provided information that describes certain non-GAAP financial measures used by the company and the comparable GAAP financial information. We encourage you to review that information in conjunction with today's discussion. Today's discussion will begin with Dan Henry, Executive Vice President and Chief Financial Officer, who will review some key points related to the quarter's earnings through the series of slides included with the earnings documents distributed and provide some brief summary comments. Once Dan completes his remarks, we will move to Q&A. With that, let me turn the discussion over to Dan.
Okay. Thanks, Rick. I'll start on slide two. Total revenues net of interest expense came in at $7,965,000,000. That's an increase of 5% compared to last year. On an FX adjusted basis, it's an increase of 7%. Income from continuing operations was $1,339,000,000. That's an increase of 3%. EPS from continuing operations came in at $1.15. That's 7% increase compared to last year. The difference in growth rate between EPS and income from continuing operations are the share buybacks that we've been doing. If you go two lines down, you can see that the diluted shares outstanding are down 4% compared to the second quarter of 2011. Return on equity came in at 27%. Moving to slide three, these are our second quarter 2012 metrics. Billed business comes in at $221.6 billion. That's 7% higher on a reported basis and 9% higher on an FX adjusted basis.
Throughout, you'll see that FX is having a larger impact on reported results than normal because of the strength of the US dollar. If we were to look back at billed business growth just to see a trend, if you went back to the second quarter of 2011 on an FX adjusted basis, we had growth of 15% in billed business. That moved to 13% in the third quarter of last year, 11% in the fourth quarter. It ticked up to 13% in the first quarter of this year. However, it had the benefit of leap year and came in at 12.6, so rounded up. I view that more similar to the fourth quarter at 11%. In this quarter, we're at 9%, so we are seeing a slowing in the growth rates over really the last four quarters.
Cards in force are up to 100 million, up 6% from last year. GNS cards are growing at 15%, and proprietary cards are growing at 2%. We again see good growth in basic card member spending, which illustrates the high level of customer engagement that we have. Card member loans are $61 billion. That compares with $60.1 billion in the first quarter of this year and 4% growth compared to the second quarter of 2011. Worldwide travel sales increased 3% on an FX adjusted basis. Moving to slide four, this is billed business growth by segment, FX adjusted. Each business really had a similar slowing in billed business growth for the quarter. Each decreased about 3% or 4%, really broad-based slowing in the growth rate. GNS continues to be the highest growth rate at 13%.
If we move to slide five, this is billed business growth by region, again, FX adjusted. Here again, you can see that each region has a similar slowing in the billed business growth rate. It ranges from a decline of 2%-4%, and again, is broad-based. As you'd expect, EMEA has the lowest growth rate, but still had positive growth at 4%. Just a little information for countries within EMEA. Germany had a growth of 5%, U.K. grew at 4%, Italy was flat with last year, and Spain decreased 5%. JAPA continues to be the highest growth region. Moving to slide six. This is just providing some information on billed business in international currencies. We're providing this because of the impact that foreign exchange is having on the reported numbers. Just to take you through the slide.
Obviously these are several of our major countries that we operate in. The first information there, looking at the euro, for instance, the 5%-7% is the approximate range of billed business in the euro compared to total billed business. For Australia, it's 5%-6%. If you go down to the next line, this is really the year-over-year change in the foreign currency compared to the U.S. dollar. In the second quarter of 2012, the strength of the U.S. dollar drove a 2% reduction in our billed business growth rate. As you know, in periods of a strengthening U.S. dollar, volume metrics and revenue growth rates are negatively impacted when translated back into U.S. dollars. While inversely, expense growth rates benefit from the strengthening of the U.S. dollar.
As we have estimated in our 2011 annual report, the adverse impact on pre-tax income of a hypothetical 10% strengthening of the U.S. dollar, related to overseas operations for 12 months, would be about $175 million. That's an annual amount if there was a 10% impact. As you can see for the numbers on this slide, the impact is, in aggregate, less than 10%. In general, it's our policy to hedge the P&L one quarter out. Slide seven. This is lending billed business, which is the solid line, the growth rate in lending billed business. The dotted line is the growth rate in managed loans. We still have a gap. We have a growth rate of lending billed business being higher at 9% compared to managed loans, which is growing at 4%, but the gap continues to narrow.
Now, paydown increased quite a bit in 2009 and 2010, but has stabilized in recent quarters. In the second quarter, the trust paydown rate was 31.5%, and that's well above industry average. As I'll speak to in a few minutes, our credit is behaving very well on loans. Moving to slide eight. This is revenue performance. Total revenues grew at 5%. It's not on this slide, but on an FX-adjusted basis, it grew at 7%. Starting with discount revenue, it grew at 5%, and this reflects 7% billed business growth, offset by higher contra-revenues, including corporate incentive payments and higher cash rebates. Average discount rate on the second quarter of this year was 2.54%, which is flat with the second quarter of 2011. Although over time, we still expect the average discount rate to decrease slightly due to pricing incentives and mix change.
If we look at the next three revenue lines, net card fees, travel commissions and fees, and other commissions and fees, on a reported basis, they're basically flat. On an FX-adjusted basis, they are growing at between 3% and 4%. If we look at other revenues, that increased 21%, and that includes a $30 million gain on the sale of a portion of our ICBC investment, a favorable revision in the estimate of the liability for uncashed traveler's checks in international markets, and higher royalty payments from our GNS partners. Looking at net interest income, it increased 4%, and that's driven by 4% growth in loans, and our net yield is the same this year as it was in the second quarter of 2011, resulting in 4% net interest income growth. Moving to slide nine. This is provision for losses. Credit continues to perform very well.
However, provision increased 29% as lending reserve releases are well below what we saw in the second quarter of 2011. In charge card, we had higher write-off dollars in the second quarter of this year compared to last year, and that was offset by higher reserve releases In the second quarter of this year than last year, although these are much smaller amounts than what we see in lending. The net of that is that the charge card provision is flat, as you can see on this chart. Now, in lending, we had lower write-offs in the second quarter of this year. The write-offs this year were $370 million compared to $511 last year. Write-offs are $140 million lower in this period, that would drive provision down.
We had lower reserve releases, as you can see on the chart, and therefore the benefit of reserve releases were about $230 million less than last year. As a result, the lending provision is $100 million higher than we had in the second quarter of 2011. Moving to slide 10. These are charge card credit metrics. As you can see on the left, the U.S. consumer and small business group had higher write-off rates in the second quarter of 2011 at 2%, compared to 1.5% in the second quarter of last year. That's why in the prior chart we had higher write-off dollars in charge card. I will note that the 2% is lower than the 2.3% in write-offs that we saw in the first quarter of this year. International consumer and global corporate products, the right chart.
You can see that credit continues to perform very well. All these metrics are at historically low levels. Next, I'll take you to slide 11. These are lending credit metrics. On the left, you can see that the write-off rate decreased from 3.1% in the second quarter of 2011 to 2.2% in the second quarter of this year. It's also down 10 basis points from 2.3% in the first quarter. In the second quarter of this year, if you looked at it by month, in April the write-off rate was 2.4%, in May it was 2.2%, and in June it was 2.0%, so we have an improving trend in the quarter. If you look at the right side, this is 30 days past due, and this is also improving.
It improved from 1.6% in the second quarter of last year to 1.4% in the first quarter of this year and 1.3% this quarter. I just remind you that our objective is not to have the lowest possible write-off rate, but achieve the best economic gain when we make investments. These metrics are at historic low levels and represent best-in-class credit metrics in the industry. Slide 12. This is lending reserve coverage. You can see that both the U.S. card and worldwide reserves as a percentage of loans continue to come down as the write-off rates and the 30-day past due rates improve. The percentage now for U.S. card is 2.6%, and worldwide is 2.5%. Reserves as a percentage of past due are similar this quarter to the percentages that we had in the first quarter of this year.
That's true for the principal months coverage as well. For those people who can hear the thunder in the background, if you're not in New York, it's a big lightning and thunderstorm here. The reserves we think are appropriate, based on the credit models that we use to set reserves. Moving to slide 13. This is expense performance. Here you can see that total expenses increased 2%. On an FX adjusted basis, which is not on the slide, would have increased 4%. If you exclude the Visa MasterCard settlement payments of $220 million that we received in the second quarter of 2011, and which was zero this quarter, total expenses would have decreased by 2%. I'll cover each of the individual line items on this slide and subsequent slides.
I would point out that the effective tax rate this quarter of 29% reflects the realization of certain foreign tax credits this year, and the 27% in the second quarter of 2011 reflects the impact of favorable resolution of certain prior year tax items. A normal tax rate for us would be in the low 30s. Looking at slide 14, this is marketing and promotion. On the prior slide, we saw that in the second quarter of this year, marketing and promotion was $773 million, and that's down 3% from $795 million in the second quarter of 2011. It is up from $631 million in the first quarter of this year. We have said that our target for marketing promotion generally is to be around 9% of revenues so that we can drive growth.
In the first quarter, when marketing and promotion was only 8.3% of revenues, we said we had a plan for full-year marketing promotion to be approximately 9%. In this quarter, we increased marketing and promotion to 9.7% of revenues, and we are continuing to invest in the business at healthy levels to drive growth. This puts us on track to achieve our plan of approximately 9% for marketing to be 9% for the full year of revenues. If we move to slide 15, now we're covering card member rewards expense. Card member rewards expense for this quarter was $1.463 billion, and that's down 9% from $1.613 billion in the second quarter of 2011. The blue section of this bar represents MR points earned in the current period and co-brand expense.
I remind you that for co-brand products, the co-brand partner has the obligation to deliver the reward. We pay the co-brand partner each month for the amount we expense and have no balance sheet liability. On the other hand, we are responsible for delivering the rewards earned under the Membership Rewards program and had a balance sheet reserve of approximately $5 billion at the end of 2011. The green section of the bar represents Membership Rewards expense related to points earned in previous periods due to an increase in the estimate of the ultimate redemption rate or a change in the estimate of the weighted average cost per point. The green section in the second quarter of 2011 represents an increase in the ultimate redemption rate based on customer behavior and an increase in the weighted average cost per point in the second quarter of 2011.
You can see that there is no green section in the second quarter of 2012, as we had a modest increase in the ultimate redemption rate in the second quarter of this year, much lower than the increase in the second quarter of 2011. This quarter is much closer to historical levels of an increase in the ultimate redemption rate in a quarter. We did have an increase and that created an expense in the quarter, but it was offset by a reduction in the weighted average cost per point in this quarter, which reduces expense in the quarter, and the two items net to approximately zero. Slide 16, operating expense performance, we have been very focused on this area.
On a reported basis, total operating expense increased 10% in the quarter, if you exclude the Visa, MasterCard litigation settlement proceeds that are included in the second quarter of last year but are zero this year, it would have been a growth of 2%. Salaries and benefits decreased 4% compared to last year, that reflects the fact that in the second quarter of 2011, we had a $48 million re-engineering charge, in this quarter of 2012, we had the favorable impact of foreign exchange. Our total employee count was approximately 64,000 and is relatively consistent with the prior year and last quarter. If we look at professional services, it's lower by 5% as last year had higher levels of technology costs. If we look at occupancy and equipment, it's up 14%, this reflects higher data processing costs related to software licenses and some higher rent.
If we look at adjusted other net of $422 million in the second quarter of 2012, it increased significantly from $92 million in the second quarter of 2011, primarily reflecting the Visa, MasterCard settlement payment received in 2011. In addition, the increase includes accruals for refunds to customers as well as investment impairments. As to the customer refunds, we are discussing matters with our U.S. banking regulators, including those mentioned in the 10-K. Based on those conversations and our own ongoing internal reviews, we've made some changes to our card practices at our two banking subsidiaries, Centurion Bank and FSB. The expense for these items is largely reflected in adjusted net other in this quarter. Moving to slide 17. This is eight quarters of information on operating expense levels, and we are at operating expense levels that we believe will enable us to drive business growth.
Going forward, we will continue to implement our plans to contain operating expenditures. As you can see, operating expense was similar in the second quarter of this year compared to the first quarter. I'm not making a forecast here, if operating expense stays at the current level, the growth rate for the full year, adjusted for the Visa, MasterCard settlement proceeds, would be in the low single digits. There's no change to our objective of growing operating expense more slowly than revenue growth over the next two to three years. Slide 18. This is expense flexibility over time, this slide shows adjusted expenses as a percentage of revenues, adjusted expenses excludes credit provision. On the left side, you can see five years of history, on the right side, the past five quarters.
Both the first quarter and the second quarter of 2011 show improvement compared to the quarters in 2011. While the second quarter rounds to 71%, it is slightly lower than in the first quarter. Over time, we expect this rate to migrate back towards historical levels in two ways. First, through top-line revenue growth, second, through expense flexibility, which includes our plans to contain operating expense growth. Moving to slide 19, these are our capital ratios. Our Tier 1 capital ratio at the end of 2011, it's not on the slide, was 12.3%. It increased to 13.4% in the first quarter of this year, as share repurchases did not start until mid-March after the Fed completed their review of our capital distribution plan. In the second quarter, we built capital with $1.3 billion of net income and $200 million related to employee plans.
As planned, we made capital distributions of $2 billion, 1.8 in share repurchases, and $200 million in dividends, resulting in Tier 1 common moving to 2.8%. The Tier 1 common ratio of 2.8% puts us in a strong capital position and well above required benchmarks. Moving to slide 20, this is total payout ratios. The left side, you can see the ratios for the last five years, and on the right, for the past four quarters. In the first quarter of 2012, as I just mentioned, we didn't start share repurchases until mid-March, we only repurchased $200 million in the first quarter of this year. The capital distribution plan allows for $4 billion in share repurchases in 2012, and we repurchased $1.8 billion in the second quarter to bring our year-to-date repurchases to $2 billion. Half of the allowed repurchases at the midpoint of the year.
Slide 21 is our liquidity snapshot. We continue to hold excess cash and marketable securities to meet the next 12 months of funding maturities. We have $16 billion in excess cash and marketable securities, and the next 12 months of maturities is $15 billion. Moving to Slide 22, this is U.S. retail deposits. As we had limited cash needs in the second quarter, and we issued $2.5 billion in unsecured debt and asset-backed securitizations, we allowed deposits to decrease in the quarter by $1.7 billion. We remain committed to increase direct deposits over time. With that, let me conclude with a few final comments. Given the uncertain environment, we feel positive about our financial performance in the second quarter, including our ability to continue to grow earnings in the absence of settlement proceeds and with lower reserve releases.
Spending growth remained relatively strong, albeit at a slower pace than recent quarters, we continued to grow faster than most of our large issuing competitors, despite a more difficult prior year comparison. We also saw average loans continue to grow modestly year-over-year, with net yields comparable to the prior year, leading to 4% growth in net interest income. At the same time, lending loss rates improved to new all-time lows. Despite very strong credit performance, provision expense increased as lending reserve releases were significantly lower this year than last year. Our revenue growth of 5% or 7% on an FX-adjusted basis reflects the benefits of our strength-centric model and stands in contrast to many other issuers who still face year-over-year revenue declines. In the quarter, total expenses were well controlled at only 2% growth or 4% on an FX-adjusted basis.
We are still investing in the business, these investments are driving higher average spending and growth in the card base while continuing to build capabilities for the future. Marketing promotion, though down slightly year-over-year, represent 9.7% of revenues, up from 8.3% last quarter. We are continuing to move forward with our plans to grow operating expenses more slowly than revenues over the next two to three years. We also wanted to remind you that starting in the third quarter, the impact on operating expense growth rates of losing the Visa MasterCard settlement proceeds will decline significantly. Our capital strength was also on display this quarter as we were able to elevate our year-to-date payout ratio to 83% while maintaining very strong capital ratios.
Looking ahead, we recognize that our business is not immune to the economic environment, but we continue to believe that our business model is well-positioned for the challenges ahead. Thanks for listening, we are now going to take questions.
Thank you. Ladies and gentlemen, if you do wish to ask a question, please press star then one on your phone keypad. If you're using a speakerphone, please pick up your handset before pressing the numbers. Once again, if you have a question or comment, please press star one at this time. Our first question comes from the line of Craig Maurer with CLSA. Please go ahead.
Yeah. Good evening, guys. Thanks. Wanted to inquire about performance on billed business so far in July. Also, if you could comment on, just looking at domestic billed business, seasonality would dictate growth, linked quarter and around the 10% range. We are a little off from that this quarter. I was wondering if you could discuss any possible specific places where it might have weakened, or if it was just general. Thanks.
Yeah. I think we're not going to comment on July to date numbers. I would say, though, that in the second quarter, the growth rate that we saw in June was very comparable to the growth rate that we saw in May. In terms of categories, I would say that we probably saw slower growth in T&E categories than we saw in other categories. Really the change in growth rates that we saw, as I illustrated on the slides, was really across all of our business lines and really across all geographies. I would say it was pretty broad-based.
If I can ask one follow-up regarding the top line. You had mentioned incentive payments as an offset in discount revenue. We've heard that from you guys a couple times now. Is there any way that we could think about modeling that, and is it worth our time to figure out how to model that as an offset to pure discount revenue?
Modeling always assumes that the future will be the same as the past, if you use historical information. We have had over the last several quarters higher levels of incentive payments. Those are based on new agreements with many of our large corporate clients. That is a business that has very high levels of profitability for us. Despite the higher level of incentive payments, sometimes which are triggered by new agreements, sometimes triggered by corporate customers just spending at higher levels. Again, we think they are effectively worthwhile investments because it is a business with very good profitability.
Okay.
The levels that we have from period to period will kind of depend on the growth in their spending and when contracts are renewed.
Okay. Thank you.
Next we'll go to the line of Ryan Nash with Goldman Sachs. Please go ahead.
Hey, Dan. A follow-up on the prior question. In terms of the spend volumes, are you seeing any changes in terms of spending patterns both here and internationally, whether it's moves from discretionary to non-discretionary? Were there any changes throughout the quarter?
Yeah. I don't know that there was a big shift between discretionary and non-discretionary. I guess I would just point out that last year in the second quarter, we grew 15%. I don't know that any of our competitors grew at that level. To the extent you have that kind of growth when you come to the next year, it's just a higher challenge in terms of growth rates. Given those higher comparables, I think our growth rates remain healthy and are reflective of the fact that the investments that we've made over the past couple of years continue to pay off.
Okay. Then on the capital. You've now repurchased $2 billion for the year, and I'm guessing some of this quarter was a catch-up from last quarter. How do we think about for over the next three quarters, given what your CCAR allotment is? I know you've talked in the past about having some say for acquisitions, but it seems like we've been pretty quiet on that front. Just want to think about how we should think about the path over the next two to three quarters. Second, now that we've gotten the NPR from the regulators, any sense of what the all-in Basel III capital levels look like? Thanks.
As you say, for the balance of the year, we have approval based on our submission to buy back $2 billion more through the end of the year. We could afford to do modest levels of acquisitions and still buy back $2 billion more. If we had acquisitions at higher levels, we would moderate the buybacks accordingly, which is, I think, very consistent with what we've said our plan would be as we go through the course of this year. Really no change there. In terms of new Basel information, what I remind you of is that we have our ratios calculated under Basel I, right? We are still in the process of developing what they would be under Basel II, we don't have that information yet.
The impact in this quarter of going from Basel I to Basel III is approximately 30 basis points. It varies from quarter to quarter, but has generally been in this kind of 20-80 basis points range, depending on the quarter. This quarter was about 30 basis points.
Okay. Thank you.
Thank you. Our next question is coming from the line of Don Fandetti with Citigroup. Please go ahead.
Hi, Dan. I wonder if you could talk a little bit about post the MOU merchant settlement. If you can kind of remind us what you allow in terms of surcharging and what the potential impact might be going forward.
Okay. I think as most people know, we were not party to that litigation. That lawsuit was filed against Visa and MasterCard, and they control about 70% or 80% of the market. Fundamental legal differences between us and Visa, MasterCard, is that they have market power. The courts have recognized this and determined that they used that power improperly. American Express does not have market power. We continue to believe that there's no merit to the separate merchant cases that we are involved in, and we believe that we have strong legal defenses. As it relates to surcharging is not consumer-friendly. The terms and conditions within the settlement agreement that deal with surcharging are very complicated. Given that complexity, we think it's too early to know what the impact of the rule changes might actually have in the marketplaces.
We obviously will monitor the situation and respond appropriately. Now, we've seen different reactions in different international markets where surcharging is allowed by law. In Australia, some merchants have introduced surcharging. It was first allowed there back in 2003, and we've been able to respond effectively and continue to operate successfully. In contrast, in the U.K., we've seen very little evidence of merchants surcharging, and that was first allowed by the Thatcher government many years ago. The other thing I'd point out, and you should keep in mind, is that in the U.S., there are 10 states that have laws that prohibit surcharging, and these states represent about 50% of our U.S. billings volume. The Visa, MasterCard rule change doesn't change the terms of our contracts with merchants.
We do not prevent merchants from surcharging, we do continue to require parity treatment so that our card members are not discriminated against at point of sale. By parity treatment, I mean that if an American Express card member is surcharged 100 basis points, any other credit card that is presented would be surcharged the same 100 basis points.
Okay. Thank you.
Next we'll go to the line of Ken Bruce with Bank of America Merrill Lynch. Please go ahead.
Thanks. Good afternoon. You pointed out in your earlier remarks that the total cards in force have been growing quite a bit more in the network partner area. I believe you stated 15% versus 2% proprietary.
Right.
Can you dimensionalize maybe the differences in the customer base for a network partner card versus a proprietary card, what you expect in terms of spend on a partner card versus a proprietary card? Anything that would let us maybe better forecast the overall growth in that line?
GNS partners, when we speak to them, their products are targeted to their more affluent customers. That's really the design of the product. It's designed to encourage spending to their more affluent customers. Now, I would say that the average spend within GNS, our partner customers, is lower than the average spend in proprietary American Express cards. We see the GNS business as a terrific business for us in that it brings more Card Members into merchants, so it makes the American Express network more relevant in more markets. Often these are customers that we would not be able to reach other than through the GNS partner relationships. Today, GNS has grown over the years to be an important contributor to income.
While the dollar profit that we earn on each dollar of GNS billed business is lower than what we earn on a dollar of proprietary billed business, it requires very little capital. The returns are good. The other thing I'd point out is that many of the GNS partnerships operate in both some markets are developed markets and some are developing markets. You need to take that into consideration as well. Net, we think it is a good business overall in terms of the contribution it makes.
Just as a follow-up, I guess we just need to think about how that's going to impact the discount revenues versus overall spend. If I remember correctly, the network cards are mostly on a credit card platform versus a charge card platform. Is that correct?
Their products and our products run on our network, right? The cards that the GNS partners issue are often credit cards. That's the difference. They don't run on a different network. It's the American Express network.
Okay. Maybe just if I could get one last one. On the refunds that you took the charge on for in the quarter, can you expand on that at all? We've seen some other peers that have taken similar charges. I guess I'd just like to better understand what those refunds are.
Yeah. These relate to certain changes that we've made in our card practices. The changes generally relate to items around either pricing, disclosure, or collections. That gives you a little bit more flavor in terms of the changes we're making that led to the refunds that we're making to customers.
Okay. Thank you.
Thank you. Our next question comes from the line of Scott Valentine with FBR Capital Markets. Please go ahead.
Good evening, and thanks for taking my question. Just as you pointed out, billed business during the quarter slowed across the board and across all platforms. Just wondering, you also reiterated the desire to kind of continue to generate positive operating leverage. Just curious how much flexibility there is if we assume a further slowdown in billed business, given the global economic outlook, how much room there is to still continue to cut costs or accelerate the decline in costs?
Yeah. I think when we talk about our desire to contain operating expense, it's really a long-term view. It's not just related to this quarter or next quarter or related to a potential slowdown. I think it's really a desire to create operating leverage so that expenses are growing at an appropriate level that enable us to have the investment dollars that we desire so that we can drive business over the long term and achieve our financial targets on average and over time. The whole notion of operating leverage is really designed as a long-term objective, and not necessarily related to a short-term slowdown. We also could react if there was a severe short-term slowdown, the way we have historically when there's been a recession. I would think of those as really two different types of focuses on operating expense.
Okay. Assuming a modest slowdown in billed business growth, you'd still expect to generate operating leverage?
It's our goal to continue to generate operating leverage from where we are today, yes.
Just as a follow-up, you mentioned before M&A. If you do anything that's, I guess, not large, you still have room to do buyback as well. You haven't done anything recently, where are you seeing the opportunities and where are you focused on M&A?
I think M&A, we would focus on what I describe as kind of bolt-on acquisitions, not very large acquisitions. They would be to enable us to achieve our strategic business objectives, and/or be in something that's a very close adjacency. Loyalty Partner is a good example of that, where they had a coalition loyalty platform primarily in Germany, but in several other countries. We have a significant amount of loyalty experience, and we have global reach, and we thought that was a very good combination. We'll generally be in areas that would generate fee business going forward. Those would be the general parameters of what we're endeavoring to achieve.
Okay. Thank you very much.
Thank you. Our next question comes from Chris Brendler with Stifel Nicolaus. Please go ahead.
Hi. Thanks. Good afternoon. I just wanted to get a little more color, if you can, Dan, on the spending trends. I believe you said that June levels were similar to May levels, and it's a little bit early to get into July. Just looking at the June and May, I guess I was under the impression that your last public update in June, I think it was guided to 9%-10% billed business growth through May. I'm just trying to reconcile how it slowed all the way down to 7% with just the month of June, if June was within line with May. Do I have those numbers right?
I think you have the numbers right. The 9-10 that related to April and May were FX-adjusted.
Okay. Right in line, got it.
The comparable number is 9% for the quarter.
Got it. Right in line. Okay. The second question would be, on the expense side, just getting a little more color on the HR costs, salaries and benefits line. It's the first time we've had a negative growth rate there since 2009. I think you did call out the re-engineering, but even if I adjust for re-engineering, it's still down on a year-over-year basis versus up 7+% in the first quarter. Anything else that helped cut costs this quarter on the personnel side? Was there lower bonus accruals that go along with the slower spending or anything else that was one-time in nature that helped the OpEx growth slow so much on the personnel line?
Yeah. I think if you back out the re-engineering, you kind of get close to flat. Really we were helped, as all the expense lines were, by FX. If you look at total, I don't know what it is exactly on salaries and benefits, but on the total expenses took the growth rate from two up to four. If you had a similar relationship on salaries and benefits, it would be about 2%, which is in the realm of what you would expect if you have a constant employee base. What we had in this quarter was similar to what we had in the second quarter of last year in terms of total number of employees.
Okay. One final one on the spending side again. Some of those growth rates you gave us for some of the countries within the Eurozone, any color you can give us on how much those have changed and how much of a slowdown you're seeing in countries like Spain or Italy or Germany?
Yeah. I think we gave last quarter similar numbers, I would venture to say that the countries in Southern Europe, if I remember correctly. Let's see. I actually have some data here. Let's see. I would say each of the countries decreased by 2 or 3%, not much different than what we're seeing overall. Spain decreased a little bit more than that compared to last quarter. I think we said Spain was up 2% in the first quarter of this year. Not wide variation other than Spain. Basically, the same kind of trends that we're seeing across the world.
Great. Thanks so much for the color.
Next we'll go to the line of Bill Carcache with Nomura. Please go ahead.
Thanks. Good evening. Dan, I believe you've said that in the past that you think the 12% range is conservatively the Tier 1 Common level that you see Amex operating at, given the uncertainty surrounding Basel II. 12% seems kind of high to me, but I wonder if you can just give us some updated thoughts there in terms of what the right Tier 1 Common ratio is that we should be thinking about as your target level going forward.
Initially, when we were coming out of the recession, we said we wanted to be at least 10% or 11%. I think over the course of the past couple of years, we've had good capital generation. Really in 2011, we kind of increased from that 11% range up to the 12% range because in our submission to the Fed in January of 2011, we only asked for $2.3 billion of buybacks on the assumption that we were going to use half of the capital generated to do acquisitions, which would mean we'd do $2 billion in acquisitions. In fact, that year we only did $1 billion. We effectively wound up as a result of that of retaining another $1 billion. That took us from 11% up to 12%.
I think we've taken artificially high in the first quarter because we couldn't do share buybacks in the first quarter of 2012 until our plan was approved. That was in the middle of March. I'd expect to see us to trend back towards where we were at the beginning of this year, which was 12.3%. We think our submission was appropriate in terms of the levels of buybacks that we requested. The fact that the Fed approved that level, I think is a demonstration of our financial strength and flexibility. This will evolve over time, and next year we'll probably get better insight in terms of where we want to be. As we move forward with the work that we're doing on Basel II, which we may not have better insights until we get to 2014.
When we get those better insights, we'll have a better sense of where we want this to settle in. Now, the other thing I think that's important is not just the raw number that your Tier 1 common ratio is. If you look at the stress test and see where your ratio is after that stress, may start to become even more important. Certainly, if you look at the data from this year, you can see that based on the stress test that the Fed decided the assumptions on, we had very limited drop in where the Tier 1 common was in that stress, which was different than many others. I think people will start to look at that, and that'll be something that we'll have to consider when we ultimately set where we decide to hold Tier 1 common ratio.
Okay. As a follow-up, can you talk about what happened with the Bluebird product at Walmart? If you could just give a little bit more color there. I believe you guys have talked about converging all of your prepaid offerings under one platform. I believe that was the Serve platform. Can you update us on where we are on that and whether Bluebird had anything to do with that convergence? Thanks.
We do have a plan to move our reloadable prepaid product onto the Serve platform within the next couple of quarters. That doesn't have anything to do with Bluebird, but it is an excellent use of the Serve platform for a business that we think will be growing and a business where we think we have a very good product in the marketplace compared to the competitions. As it relates to Bluebird, American Express and Walmart have a great partnership. Our work together on Bluebird has moved to a new phase, and we continue to test different points of distribution and marketing messages, while also collecting and analyzing feedback for customers who took part in our pilot. At this time, it wouldn't make sense to speak about any future plans with Bluebird, but we appreciate your interest around the Bluebird project.
Okay. Thank you.
Next we'll go to the line of Moshe Orenbuch with Credit Suisse. Please go ahead.
Do you got any specific plans to reduce the cost per point, and how to think about that as we go forward?
I think the cost per point is something that we're focused on just in terms of the offerings that we put into the program are designed to create value for our customers. We have over 100 different options within the program that are part of what make it an excellent program. Certainly as we think about adding customers and options, we do think about the overall cost to us. It's a balance between value to our customers who participate in the Membership Rewards program and the cost of the program in terms of the overall economics of the products that we offer. For years, we've been focused on the cost per point and endeavor to manage it. We'll continue to do that as we go forward. In this period, it was really not a result of changing the offerings within the program.
It was really driven by customer behavior and a change in mix. In this quarter, we just had a shift in mix, really away from the amount that was being redeemed for airlines compared to what we had had in prior quarters. That's what drove the weighted average cost per point down in this given period.
I know you said before that you don't strive for the lowest loss rate, but rather kind of an economic answer. Could you talk a little bit about why you've got kind of 50, 60 basis point increase in charge card losses in the first half of this year versus first half of last year?
Yeah. Our strategy is to focus on growing spend products. Those would be charge cards as well as premium lending cards. As we strove to grow the charge business, to see write-off rates go up a bit is perfectly fine with us as long as we're attracting customer groups that have good long-term economics. As you know, when you bring in a lending customer, sometimes it takes 12 to 24 months before the portfolio seasons because people can make minimum payments. In charge card, on the other hand, it's a pay-in-full product, you see it a lot more quickly. I think that's part of what drove the increase that we saw through the first quarter.
On the other hand, we continue to get focused on what's taking place within our portfolio, I think that focus is what enabled the write-off rate actually to come down in the second quarter.
Compared to the first
The first. Still all in, these are very low write-off rates, and if we can drive the right economics and acquire the right customers, having write-off rates being higher than where they are today are perfectly fine.
Great. Just one last very quick thing, and that is, the ancillary products that you mentioned, are those sold through a third party, or do you sell them directly?
Which ancillary products, sorry?
The ones that you were talking about having customer rebates for.
I don't know the specific answer to that question. I know we have been focusing on them, and I suspect that at least a portion of them, I think, are sold through our proprietary process. I don't have a specific split between what's proprietary and what might be with third parties.
Okay. Thanks very much.
Thank you. Next, we'll go to the line of Mike Taiano with Kelsey Advisory Group. Please go ahead.
Hi, Dan. Thanks. I just wanted to make sure that I understood the answer on the surcharging question. As I understand it, so if Visa and MasterCard were to charge, let's just say, 2%, or merchants were to charge 2% on a Visa MasterCard transaction, your rules would not allow merchants to charge a higher amount than that, even if your cost of acceptance to the merchant is higher?
Our provision does not prohibit surcharging. Requires that the surcharging be on a parity basis so that our card members are not discriminated against at the point of sale. If someone was charging 2% to our customers, our contracts would require that any other credit card that's presented would be required to have the same surcharge.
Okay, they would have to charge MasterCard or Visa cardholders the same as they're charging you and not vice versa?
Well, our contracts cover our card members, right? The Visa and MasterCard rules cover theirs. If a merchant has a contract with us, it requires that our card members be charged on parity, as I just described, and that other credit cards that are presented would have to have the same surcharge.
Okay. Got it. Just one follow-up on, I saw you guys are adopting the EMV standards. Was just curious what you think that impact will be if there's additional cost that you'll have to incur next year on that.
We're going to start issuing cards that have EMV enabled. We will convert cards over a multi-year period. The cost of doing that will not be in one or two quarters, but will be over a several-year period.
Okay. Thanks very much.
Next, we'll go to the line of Bob Napoli with William Blair. Please go ahead.
Thank you. Good afternoon. Good evening. Just a comment on the long-term growth model, revenue and earnings growth model, if you can. Obviously, your targets are at least 8% revenue growth and 12%-15% earnings growth. I think Ken suggested looking at 2010 as kind of a base. As we look forward to 2013 and 2014, it doesn't seem like the economic trajectory is going to change all that much from here. It certainly doesn't feel like it today. Do you feel good about being able to hit those targets? You're blowing out your return on equity target pretty significantly, but can you hit the revenue and EPS? Do you feel confident in those targets?
On average and over time, I would think about a 10-year cycle, not a three or four-year cycle. Clearly, in times where economic growth is slow, you would expect to have slower billed business growth in those periods than when you had a robust period. When we say on average and over time, I think we look at it an extended cycle. Over that cycle, I think we're confident that we can achieve those levels, we can achieve our financial targets.
On spend growth, you had Continental. How much of an effect has Continental switch to United had on your billed business?
We had a fair number of initiatives in place last year when the Continental contract expired. We actually were very pleased in terms of what we were able to achieve in terms of retaining customers through those initiatives at the end of the day. What I would point out is, I don't have any specific data on how many customers we may have lost. What I would say is over the past year, we have Continue to build share in the U.S. In total, we've continued to be successful in the marketplace when you look at the overall population of people who are using credit and charge cards. At the end of the day, that's our aim, is to be successful in terms of financial results and continuing to be able to compete successfully in the marketplace.
Okay. Just a last question on Serve, if I could. If you could give some update. American Express has invested at least several hundred million dollars to date in Serve. I know that we haven't seen as many new relationships being announced recently, when can we get some information on how successful Serve is being? It seems, looking at your numbers and the growth of fee income, it really still seems to be pretty irrelevant, it's hard to forecast any benefit from that significant investment that you've been making over these last several years.
Yeah. I think last year was the year we wanted to sign agreements with other businesses that would put Serve in the path of their customers. This year, it's all about getting customers onto the network, that's what we're focused on. That's our focus. Now, in terms of Serve, we are seeing some successful uses of Serve. Certainly by putting our reloadable products on Serve. If we didn't have that platform, our ability to issue the product would've been hampered. We have also entered into an agreement in China with LianLian, where the basis of that is that LianLian is going to use the Serve platform as part of their mobile top-up process. We are seeing spots we're able to use it. I don't think we're at the point yet where we would release financial information.
We continue to make progress against the objectives that we have set for ourselves.
I guess as that relates to your fee income targets, it seems like you're still quite a ways away from hitting your targets on fee income seems like you need to make acquisitions. Isn't it to grow that are you disappointed with the level of fee income growth that you've been able to generate given your aggressive target?
Yeah. Our target is to exit, I think, 2014 at a $3 billion run rate. Last year, we had $1.3 billion in fee income. We continue to make progress in the fee area and against that target. For the operator, I would say I'll take one last question.
Okay, thank you. That would be from Brad Ball with Evercore. Please go ahead.
Hi, Dan. What was the amount of the accrual for refunds in the quarter, had you accrued any in prior quarters?
We did have an accrual back in the fourth quarter, which we mentioned at that time. As it relates to the accruals in this quarter, we don't plan to disclose the exact dollar amount. We felt that the cost in this quarter were important enough to mention, but not large enough to qualify.
The adjusted other rose by $110 million year-over-year. Is most of that driven by this accrual?
I would say that there were two items that contributed to it. It was this accrual as well as investment impairments that drove it. Those are the two big items that are in the increase.
Okay. Separately, you continue to show spending on lending products that are growing faster than your overall loan growth. At the same time, you've got historically strong credit quality. I'm just wondering, when will you start pushing a little harder on loan growth and driving up your net charge-off ratio to a more economically reasonable level down to 2.2%? It just seems too low to drive the kind of returns and spending volume growth that you have the potential to get here.
Right. We have never had a target to grow loans. I don't anticipate that we will in the future. Our focus is to make investments that have good economic returns over time. They're currently focused on charge card as well as premium lending. To the extent customers want to have the ability to lend and we have the right credit quality, then we want to put investments up against both charge and premium lending. To the extent we're successful, we may see loan growth increase. We don't have any specific targets for loan growth. We really target our investments for the greatest economic return over time.
What would you say is a normalized net charge-off rate?
A normalized charge-off rate. That's what we're going to have to wait and see. Over the past 10 years, it was about 4.5%. I feel pretty confident, not going too much out on a limb, that it will be less than that going forward. Exactly where it will go from here will be very dependent on both our strategy as well as customer behavior at the end of the day.
Okay. Thank you.
All right. Thanks everybody for joining the call, and have a good evening.
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