American Express 2013 Annual Report Download - page 48

AMERICAN EXPRESS COMPANY
2013 FINANCIAL REVIEW
The Company analyzes a variety of scenarios to inform
management of potential impacts to earnings and economic value of
equity, which may occur given changes in interest rate curves using a
range of severities. As of December 31, 2013, the detrimental effect on
the Company’s annual net interest income of a hypothetical 100 basis
point increase in interest rates would be approximately $227 million.
To calculate this effect, the Company first measures the potential
change in net interest income over the following 12 months taking
into consideration anticipated future business growth and market-
based forward interest rates. The Company then measures the impact
of the assumed forward interest rate plus the 100 basis point increase
on the projected net interest income. This effect is primarily driven by
the volume of charge card receivables and loans deemed to be fixed-
rate and funded by variable-rate liabilities. As of December 31, 2013,
the percentage of worldwide charge card accounts receivable and
credit card loans that were deemed to be fixed rate was 67.6 percent,
or $77 billion, with the remaining 32.4 percent, or $37 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 $31 million. The Company currently
has approximately $36 billion of Prime-based, variable-rate U.S.
lending receivables and $31 billion of LIBOR-indexed debt, including
asset securitizations.
Foreign exchange risk is generated by Card Member cross-
currency charges, foreign subsidiary equity and foreign currency
earnings in units outside the U.S. 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 both December 31, 2013 and 2012, foreign currency
derivative instruments with total notional amounts of approximately
$27 billion 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.
The Company conducts scenario analysis to inform management
of potential impacts to earnings that may occur due to changes in
foreign exchange rates of various severities. 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, 2013. 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 $192 million as of
December 31, 2013. 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, 2013.
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 same
direction or in the same direction to the same degree, changes in the
cost, volume and mix of the Company’s hedging activities 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 Risk Committee of the Board of
Directors and the ALCO. Liquidity risk limits are approved by the
Risk Committee of the Board of Directors and the ERMC. 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
during a substantial weakening in economic conditions. 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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