American Express 2012 Annual Report Download - page 42

AMERICAN EXPRESS COMPANY
2012 FINANCIAL REVIEW
percentage of worldwide charge card accounts receivable and
credit card loans that were deemed to be fixed rate was 67.5
percent, or $74 billion, with the remaining 32.5 percent, or $36
billion, deemed to be variable rate.
The Company is also subject to market risk from changes in
the relationship between the benchmark Prime rate that
determines the yield on its variable-rate lending receivables and
the benchmark LIBOR rate that determines the effective interest
cost on a significant portion of its outstanding debt. Differences
in the rate of change of these two indices, commonly referred to
as basis risk, would impact the Company’s variable-rate U.S.
lending net interest margins because the Company borrows at
rates based on LIBOR but lends to its customers based on the
Prime rate. The detrimental effect on the Company’s net interest
income of a hypothetical 10 basis point decrease in the spread
between Prime and one-month LIBOR over the next 12 months
is estimated to be $34 million. The Company currently has
approximately $35 billion of Prime-based, variable-rate U.S.
lending receivables and $34 billion of LIBOR-indexed debt,
including asset securitizations.
Foreign exchange risk is generated by cardmember cross-
currency charges, foreign subsidiary equity and foreign currency
earnings in units outside the United States. The Company’s
foreign exchange risk is managed primarily by entering into
agreements to buy and sell currencies on a spot basis or by
hedging this market exposure to the extent it is economically
justified through various means, including the use of derivative
financial instruments such as foreign exchange forward and
cross-currency swap contracts, which can help “lock in” the
value of the Company’s exposure to specific currencies.
As of December 31, 2012 and 2011, foreign currency derivative
instruments with total notional amounts of approximately $27
billion and $23 billion, respectively, were outstanding. Derivative
hedging activities related to cross-currency charges, balance sheet
exposures and foreign currency earnings generally do not qualify
for hedge accounting; however, derivative hedging activities
related to translation exposure of foreign subsidiary equity
generally do.
With respect to cross-currency charges and balance sheet
exposures, including related foreign exchange forward contracts
outstanding, the effect on the Company’s earnings of a
hypothetical 10 percent change in the value of the U.S. dollar
would be immaterial as of December 31, 2012. With respect to
earnings denominated in foreign currencies, the adverse impact
on pretax income of a hypothetical 10 percent strengthening of
the U.S. dollar related to anticipated overseas operating results
for the next 12 months would be approximately $187 million as
of December 31, 2012. With respect to translation exposure of
foreign subsidiary equity, including related foreign exchange
forward contracts outstanding, a hypothetical 10 percent
strengthening in the U.S. dollar would result in an immaterial
reduction in equity as of December 31, 2012.
The actual impact of interest rate and foreign exchange rate
changes will depend on, among other factors, the timing of rate
changes, the extent to which different rates do not move in the
samedirectionorinthesamedirectiontothesamedegree,and
changes in the volume and mix of the Company’s businesses.
FUNDING & LIQUIDITY RISK MANAGEMENT
PROCESS
Liquidity risk is defined as the inability of the Company to meet
its ongoing financial and business obligations as they become
due at a reasonable cost. General principles and the overall
framework for managing liquidity risk across the Company are
defined in the Liquidity Risk Policy approved by the ALCO and
Audit, Risk and Compliance Committee of the Board. Liquidity
risk is centrally managed by the Funding and Liquidity
Committee, which reports into the ALCO. The Company
manages liquidity risk by maintaining access to a diverse set of
cash, readily-marketable securities and contingent sources of
liquidity, such that the Company can continuously meet its
business requirements and expected future financing obligations
for at least a 12-month period, even in the event it is unable to
raise new funds under its regular funding programs. The
Company balances the trade-offs between maintaining too much
liquidity, which can be costly and limit financial flexibility, and
having inadequate liquidity, which may result in financial
distress during a liquidity event.
Liquidity risk is managed both at an aggregate Company level
and at the major legal entities in order to ensure that sufficient
funding and liquidity resources are available in the amount and
in the location needed in a stress event. The Funding and
Liquidity Committee reviews the forecasts of the Company’s
aggregate and subsidiary cash positions and financing
requirements, approves the funding plans designed to satisfy
those requirements under normal conditions, establishes
guidelines to identify the amount of liquidity resources required
and monitors positions and determines any actions to be taken.
Liquidity planning also takes into account operating cash
flexibilities.
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