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Friday, November 14, 2008

Welcome to Bank of AmEx

On Nov. 11, 2008, American Express Co. won approval from Federal Reserve banking regulators to become a commercial bank. The fourth largest U.S. credit card issuer said it is taking steps to cut borrowing costs and give it access to government funds. Regulators said they approved its application because of the "unusual and exigent circumstances" currently shaking up financial markets.

This move opens the door for AmEx to accept deposits and permanently access financing from the Fed.

The Fed approved the application for AmEx and its subsidiary American Express Travel Related Services Co. Inc. to become bank holding companies. The Fed's approval for AmEx was similar to the decision it made in September to transform the country's two biggest investment banks, Goldman Sachs Group Inc. and Morgan Stanley, into bank holding companies. AmEx can now issue bonds that are government guaranteed through the end of June 2012.

Sliding profits

In its third-quarter 2008 filing with the Security and Exchange Commission, AmEx said its profits fell 24 percent, and it expected chargebacks in its credit card portfolio to continue climbing through the fourth quarter of 2008 and into 2009. "The transformation of AmEx into a commercial bank opens it up to an infusion of funds," said Red Gillen, an Analyst with consulting firm Celent LLC. "You can't let AmEx fail is basically what the Fed is saying."

The increased funding opportunities through government programs, including a potential $3.5 billion investment, could be a huge boost to AmEx since its primary sources of funding have nearly disappeared amid the ongoing credit crunch.

Sung Won Sohn, an Economist at the Smith School of Business at California State University Channel Islands, said AmEx expects to greatly expand its resources and avoid the fate of other companies that depended heavily on commercial loans to continue operations. "As a bank holding company, they will have a lot more flexibility," Sohn said.

Capital access

AmEx Chairman and Chief Executive Officer Kenneth Chenault said the company should gain greater access to the "capital on offer" with Federal Reserve oversight. "Given the continued volatility in the financial markets, we want to be best positioned to take advantage of the various programs the federal government has introduced to support U.S. financial institutions," Chenault said.

Industry analysts said the primary concern about AmEx is not funding, but consumer credit losses. The funding pressures are adding to the credit pressures the company is facing. Default rates among its credit card clients in the United States almost doubled in the third quarter of 2008.

The road ahead

However, investors caution that becoming a bank will not solve all of AmEx's difficulties. "There is a lot of competition for deposits now, and pricing for deposits is still high," said Blake Howells, Director of Equity Research at Portland, Ore.-based Becker Capital Management Inc.

Some investors believe AmEx's decision indicates the company's executives foresee serious problems ahead.

Scott Valetin of investment banking group FBR Capital Markets Corp. said the conversion to a bank holding company is "the prudent action, but it evidences the significant funding stress we believe AmEx is experiencing. The company is still likely to rely heavily on the securitization market for funding in the future, since AmEx lacks a branch presence to more rapidly increase its deposit base." end of article

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