American Express 2006 Annual Report Download - page 53

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2006 fi nancial review
american express company
CONSUMER CREDIT RISK
Consumer credit risk arises principally from the
Company’s portfolio of consumer and small business
charge cards, credit cards, lines of credit, and loans. Since
such portfolio consists of millions of borrowers across
multiple geographies, occupations, and social segments,
its risk is substantially reduced through diversification.
In addition, the Company benefits from the fact that
the credit profile of its cardmembers is better than that
of its many competitors, which is a combined result of
the brand positioning, underwriting, and customer
management policies, premium customer servicing, and
product reward features. The level of consumer credit
risk losses is more driven by general economic and legal
conditions than by borrower-specific events.
Consumer credit risk is managed within a highly
organized structure of policies covering all facets of
credit extension, including prospecting, approvals,
authorizations, line management, collections, and fraud
prevention. The policies ensure consistent application
of credit management principles and standardized
reporting of asset quality and loss recognition. Moreover,
consumer credit risk management is supported by
sophisticated proprietary scoring and decision-making
models.
Credit underwriting decisions are made based on
sophisticated evaluation of product economics and
customer behavior predictions. The Company has
developed unique decision logic for each customer
interaction, including prospect targeting, new accounts,
line assignment, balance transfer, cross sell, and
account management. Each decision has benefited from
sophisticated modeling capability that uses the most up-
to-date proprietary information on customers, including
payment history, purchase data, as well as insights from
data feeds from credit bureaus.
In addition to the impact of improved risk
management processes, the Company’s overall consumer
credit performance has also benefited from the shifting
mix of the portfolio towards products that reward the
customer for spending. Rewards attract higher spending
from premium customers, which in turn leads to lower
credit loss rates.
While consumer credit r isk indicators have cont inued
to show steady progress, the Company’s objective of
driving profitable growth may be accomplished by the
launch of new products or of existing products in new
markets, which may exhibit higher loss rates.
INSTITUTIONAL CREDIT RISK
Institutional credit risk arises principally within the
Company’s corporate card, establishment services,
network services, and international banking businesses.
Unlike consumer credit risk, institutional credit risk
is characterized by a lower loss frequency but higher
severity. It is affected both by general economic conditions
and by borrower-specific events. The Company’s senior
risk officers recognize that the absence of large losses
in any given year or over several years is not necessarily
representative of the risk of institutional portfolios, given
the infrequency of loss events in such portfolios.
Under the governance of the Institutional Risk
Management Committee (IRMC), the credit officers
of each business unit make investment decisions in
core risk capabilities, ensure proper implementation of
the underwriting standards and contractual rights of
risk mitigation, monitor risk exposures, and determine
risk mitigation actions. The IRMC formally reviews
large institutional exposures to ensure compliance with
ERMC guidelines and procedures. At the same time,
the IR MC prov ides continuous guidance to business unit
risk teams to optimize risk-adjusted returns on capital.
A company-wide risk rating utility and a specialized
airline risk group provide independent risk assessment of
institutional obligors.
MARKET RISK MANAGEMENT PROCESS
Market risk is the risk to earnings or value resulting
from movements in market prices. The Company’s non-
trading related market risk consists of:
• Interest rate risk in its card, insurance, and certificate
businesses; and
• Foreign exchange risk in its international operations.
Market risk is centrally managed by the corporate
treasurer, who also acts as the Vice Chairman of the
ERMC. Within each business, market risk exposures
are monitored and managed by various asset/liability
committees, guided by Board-approved policies
covering derivative financial instruments, funding and
investments. Derivative financial instruments derive
their value from an underlying variable or multiple
variables, including commodity, equity, foreign
exchange, and interest rate indices or prices. These
instruments enable end users to increase, reduce or alter
exposure to various market risks and, for that reason,
are an integral component of the Company’s market
risk and related asset/liability management strategy
and processes. Use of derivative financial instruments
is incorporated into the discussion below as well as
Note 10 to the Consolidated Financial Statements.
Market exposure is a byproduct of the delivery of
products and services to cardmembers. Interest rate
risk is generated by funding cardmember charges and
fixed-rate loans with variable rate borrowings. These