On July 22, 2010, American Express Company (AXP) reported its second-quarter income from continuing operations of $1.0 billion or 84 cents per share, ahead of the Zacks Consensus Estimate of 78 cents. The significant surge in earnings for American Express was attributable to increased usage of cards with lesser defaults, as consumers resumed their spending, a level similar to the pre-recession period.

American Express’ card members’ spending increased 16% year-over-year. The increase came from corporate cards, cards issued by its bank partners and premium co-branded cards.

Results in the year-ago quarter were $0.6 billion or 27 cents, excluding a deduction of $0.2 billion or 18 cents per share from a repurchase of preferred shares from the U.S. government. The results also exclude a loss of $5.0 million from discontinued operations. However, the results from discontinued operations were nil during the reported quarter.

Behind the Headlines

American Express posted total revenues, net of interest expenses, of $6.9 billion, up 13% year-over-year as opposed to $6.1 billion, primarily as a result of the consolidation of securitized card member loans and related debt onto the balance sheet in the first quarter of 2010.

Additionally, the increase in revenues was supported by higher spending by card members, offset by a smaller loan portfolio and lower yields on both the securitized and non-securitized portions of the portfolio.

Net interest income climbed 60% to $1.2 billion in the reported quarter as opposed to $0.7 billion in the year-ago quarter. However, over the last several quarters, American Express has generated lower interest income on account of lesser borrowing by card members and rising payment of their outstanding debt.

Provisions for losses were $0.7 billion, down 59% from $1.6 billion in the prior-year quarter. The year-over-year decrease in provisions for losses was driven primarily by continued improvement in credit quality on the charge and credit card portfolios.

Total expenses of American Express mounted to $4.6 billion in the second quarter of 2010, up 13% year-over-year from $4.1 billion, reflecting growth of investment in business building initiatives along with higher rewards costs.

Segment Results

U.S. Card Services reported a net income of $0.5 billion, substantially up from a loss of $0.2 billion incurred in the prior-year quarter. Total revenues, net of interest expenses increased 27% year-over-year to $3.6 billion from $2.9 billion.

International Card Services’ net income came in at $0.2 billion, from $78.0 million in the year-ago quarter. Total revenues net of interest expenses were $1.1 billion, almost flat from the year-ago quarter.

Global Commercial Services’ net income came in at $0.1 billion, compared to $67.0 million in the prior-year quarter. Total revenues net of interest expense increased 9% year-over-year to $1.1 billion, from $1.0 billion.

Global Network & Merchant Services reported a net income of $0.3 billion, up 13% year-over-year from $0.2 billion in the prior-year quarter. Total revenues net of interest expense increased 17% year-over-year to $1.1 billion from $1.0 billion.

Corporate & Other reported net expenses of $51.0 million compared with a net income of $0.1 billion a year ago. The results for both periods reflected an income of $0.2 billion ($0.1 billion after-tax) for Visa Inc. (V) and Mastercard Incorporated (MA) settlements, while the year-ago results also included a $0.2 billion ($0.1 billion after-tax) gain on the sale of a portion of the company’s equity holding in Industrial and Commercial Bank of China.

Evaluation of Capital and Profitability Ratios

As on June 30, 2010, American Express’ return on average equity (ROE) was 23.5%, up from 13.2% in the year-ago quarter. Return on average common equity (ROCE) was 23.2%, up from 12% in the year-ago quarter.

As of June 30, 2010, American Express’ cash held was $21.0 billion. While total assets were $144.0 billion as of June 30, 2010, total shareholders’ equity of American Express was recorded at $15.0 billion.

Following a moderation in the rate of decline over the last few quarters, we noticed a decent improvement in American Express’ billed business in the U.S. and beyond since fourth quarter of 2009. Additionally, with some early signs of economic recovery, we note that the monthly comparisons of card members spending volume have improved.

Comparison with Competitors

Rival card company Capital One Financial Corporation (COF) also reported its second quarter results concurrent with American Express’ earnings on July 22, 2010. Capital One’s second-quarter income from continuing operations were $1.78 per share, substantially better than the Zacks Consensus Estimate of 88 cents. This also compares unfavorably with a loss of 64 cents in the year-ago period.

Another competitor, Discover Financial Services (DFS) also reported a second quarter profit from continuing operations of 33 cents per share on June 24, well ahead of the Zacks Consensus Estimate of 11 cents. Discover reported a loss of 31 cents in the year-ago quarter.

Other competitors of American Express, such as Visa, will report its third quarter earnings on July 28, 2010, and Mastercard will report its second quarter earnings on August 3, 2010.

Our Take

After suffering large credit losses in 2008, American Express is one card company which has pulled itself out of the recession more quickly than its rivals, owing to its creditworthy customers. Besides, there has been an impressive recovery in credit trends, with increased card spending over the last few quarters.

However, we remain concerned about the challenging regulatory economy and the impact of new regulations facing the card industry. We fear that the new regulations under the CARD Act of 2009 are expected to make American Express’ credit cards costlier and will in turn result in lower interest income and loan fee income.

The quantitative Zacks #3 Rank for American Express denotes a short-term Hold rating, indicating no clear directional pressure on the shares over the near term.

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