American Express 2006 Annual Report Download - page 43

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2006 fi nancial review
american express company
Interest expense in 2006 and 2005 increased 34
percent and 13 percent to $1.2 billion and $920 million,
respectively, reflecting a higher effective cost of funds
and increased debt funding levels in support of growth
in receivables.
Other expenses in 2006 decreased 1 percent to $1.3
billion compared to 2005 due to the reclassification
of certain card acquisition-related costs, beginning
prospectively July 1, 2006, from other expenses to a
reduction in net card fees, and the 2006 gains on the
sales of the Company’s card and merchant-related
activities in Brazil, Malaysia, and Indonesia as well as
the investment in EAB. The decrease was partially
offset by the September 11, 2001-related insurance
settlement in 2005 and higher volume and technology-
related costs in 2006.
The effective tax rate was 30 percent in 2006
compared to 24 percent in 2005 and 30 percent in
2004. The effective tax rate in 2006 as compared to
2005 reflected higher tax expense related to uncertainty
regarding the Company’s ability to obtain tax benefits
for certain expenses attributable to foreign subsidiaries,
a relatively high effective tax rate due to the impact of
foreign exchange translation on the gain on the sale of
the Company’s investment in EAB, and a relatively low
effective tax rate benefit on the credit losses in Taiwan.
These items were offset by the favorable impacts of a
relatively low effective rate on the sale of the Company’s
card and merchant-related activities in Brazil resulting
principally from the difference between the applicable
Brazil tax rate and the higher U.S. statutory rate, a net
interest receivable from the IRS, finalization of the
2005 U.S. federal tax return, and an adjustment of 2006
estimated state taxes. The effective tax rate was lower
in 2005 as compared to 2004 as the 2005 rate reflected
benefits of $239 million resulting from the resolution
of previous years’ tax items and the finalization of state
tax returns.
(Loss) income from discontinued operations, net of
tax, was $(22) million, $513 million, and $830 million
in 2006, 2005, and 2004, respectively. Included in
2006 is a $22 million after-tax loss related to the sale
of the Company’s international banking activities in
Brazil. Income from discontinued operations, net of
tax, decreased 38 percent in 2005 from 2004 due to
spin-off related costs of $127 million after-tax, partially
offset by a $63 million net after-tax gain on certain
dispositions, primarily TBS. Additionally, 2005 results
from discontinued operations are included through
September 30, 2005, the date on which the spin-off of
Ameriprise and certain dispositions (primarily TBS)
occurred, whereas 2004 included a full year of results
from these discontinued operations. The discontinued
operations generated revenues of $9 million, $5.8 billion,
and $7.2 billion for 2006, 2005, and 2004, respectively.
Going forward, the Company recognizes the need
to respond to increased competitive pressures within
the marketplace and challenges within the economic
environment. In particular, as compared to 2005, the
Company economically hedged a smaller percentage
of its expected interest rate exposure in 2006, and is
substantially less economically hedged for 2007 and
beyond. This decrease along with higher interest
rates and higher volume-related borrowings resulted
in higher funding costs in 2006 as compared with
2005. The Company expects higher funding costs
to continue in 2007, due to an expected increase in
higher-cost floating rate borrowings relative to fixed-
rate funding that matured in 2006. In addition, the
Company expects that results in 2007 will not reflect
the same benefit to its write-off rate that resulted from
the change in U.S. bankruptcy laws in 2005, and that
favorably impacted results in 2006. The Company is
focused on meeting these and other challenges in 2007
and beyond by investing in growth opportunities, by
focusing on reengineering activities to control operating
expense growth, by efficiently allocating capital, and
by controlling discretionary expenses, including lower
levels of marketing and promotion expenses.
CONSOLIDATED CAPITAL RESOURCES
AND LIQUIDITY
CAPITAL STRATEGY
The Company generates equity capital primarily through
net income to fund current needs and future business
growth and to maintain a targeted debt rating. Equity
capital generated in excess of these needs is returned to
shareholders through dividends and the share repurchase
program. The maintenance of a solid equity capital base
provides the Company with a strong and stable debt
rating and uninterrupted access to diversified sources
of financing to fund asset growth. In addition, the
Company has a contingency funding plan to help ensure
adequate sources of financing in difficult economic or
market environments and, in certain circumstances, for
other adverse events affecting the Company.
The Company believes allocating capital to growing
businesses with a return on risk-adjusted equity in excess
of its cost of capital will generate shareholder value. The
Company retains sufficient earnings and other capital
generated to satisfy growth objectives and, to the extent
capital exceeds business needs, returns excess capital to
shareholders. The Company was able during 2006 to