The American Express Credit Account Master Trust (the Trust) securitized $4 billion of loans in 1999 and $1 billion in 1998, through the public issuance of investor certificates. The securitized assets consist of loans arising in a portfolio of designated Optima Card, Optima Line of Credit and Sign & Travel/Special Purchase revolving credit accounts owned by American Express Centurion Bank (Centurion Bank), a wholly-owned subsidiary of TRS. At December 31, 1999 and 1998, TRS had a total of $7 billion and $3 billion, respectively, of Trust-related securitized loans, which are not on the Consolidated Balance Sheets. In February 2000, the Trust securitized an additional $1 billion of loans.
In addition, the American Express Master Trust (the Master Trust) securitizes Charge Card receivables generated under designated American Express Card, Gold Card and Platinum Card consumer accounts through the issuance of trust certificates. In 1998, the Master Trust issued $1 billion of Class A Fixed Rate Accounts Receivable Trust Certificates. In 1999 and 1998, $500 million and $300 million Class A Fixed Rate Accounts Receivable Trust Certificates, respectively, matured from the Charge Card securitization portfolio. At December 31, 1999 and 1998, TRS had securitized receivables of $3.45 billion and $3.95 billion, respectively, which are not on the Consolidated Balance Sheets.
In 1999, TRS issued and sold, exclusively outside the United States and to non-U.S. persons, $500 million 5.625% Fixed Rate Notes. These notes are listed on the Luxembourg Stock Exchange, and will mature in 2004.
In 1998, American Express Credit Corporation (Credco), a wholly-owned subsidiary of TRS, issued $150 million 1.125% Cash Exchangeable Notes due February 2003. These notes are exchangeable for an amount in cash which is linked to the price of the common stock of the company. Credco had entered into agreements to hedge fully its obligations. Credco exercised its option to call these notes in February 2000. Accordingly, the related hedging agreements were called at the same time.
TRS, primarily through Credco, maintained commercial paper outstanding of approximately $18.5 billion at an average interest rate of 5.6% and approximately $16.1 billion at an average interest rate of 5.3% at December 31, 1999 and 1998, respectively. Unused lines of credit of approximately $8.8 billion, which expire in increments from 2000 through 2002, were available at December 31, 1999 to support a portion of TRS’ commercial paper borrowings.
Borrowings under bank lines of credit totaled $1.5 billion and $1.6 billion at December 31, 1999 and 1998, respectively.
AMERICAN EXPRESS FINANCIAL ADVISORS
American Express Financial Advisors reported increases in net revenues of 17 percent and 16 percent and earnings of 14 percent and 16 percent for 1999 and 1998, respectively. Revenues and earnings in both years benefited primarily from higher fees due to growth in managed assets and strong product sales, particularly mutual funds, which set a record in both years.
Management and distribution fees rose 23 percent and 25 percent in 1999 and 1998, respectively; in both years, the increase was due to greater management fee revenue from higher managed and separate account assets. These assets increased due to strong market appreciation and positive net sales. Distribution fees also rose reflecting strong mutual fund sales and asset levels. The increase in investment income reflects growth in average investments. Other revenues rose from increased life insurance premiums and higher financial planning fees, as well as greater property-casualty insurance premiums in 1999. The provision for losses and benefits for annuities declined due to lower fixed annuities in force and accrual rates. The provisions for insurance and investment certificates rose in 1999 and 1998 reflecting higher in force levels. The increase in certificate provisions also reflects growth in the stock market certificate product, which is hedged by indexed options and resulted in a corresponding increase in investment income, with minimal effect on net income.
In January 2000, AEFA reached an agreement in principle to settle three class-action lawsuits related to the sales of insurance and annuity products. It is expected that the settlement will provide for approximately $215 million of benefits to more than two million class participants. Other operating 
expenses in the fourth quarter of 1999 include a $74 million (pretax) charge above reserves already established in prior periods in anticipation of a possible settlement. The agreement in principle to settle also provides for release by class members of all insurance and annuity market conduct claims dating back to 1985 and is subject to a number of contingencies including a definitive agreement and court approval.
Human resources expense rose in both years due to higher financial advisors’ compensation from growth in sales and asset levels and a greater number of employees to support business expansion. The increase in other operating expenses in both years includes higher data processing, technology, and advertising expenditures, and, in 1999, the charge related to the preliminary settlement of the three class-action lawsuits. The growth in human resources and other operating expenses was mitigated by reduced amortization of deferred acquisition costs for variable insurance and annuity products as a result of strong equity market performance during the year.
AEFA’s total assets and liabilities rose primarily due to growth in separate account assets as a result of market appreciation and positive net sales for both years. Investments comprised primarily corporate bonds and mortgage-backed securities, including $3.6 billion and $3.4 billion in below investment grade debt securities, and $4.0 billion and $3.8 billion in mortgage loans at December 31, 1999 and 1998, respectively. Investments are principally funded by sales of insurance and annuities and by reinvested income. Maturities of these investments are largely matched with the expected future payments of insurance and annuity obligations. Separate account assets, primarily investments carried at market value, are for the exclusive benefit of variable annuity and variable life insurance contract holders. AEFA earns investment management and administration fees from the related accounts.
AMERICAN EXPRESS BANK/TRAVELERS CHEQUE
American Express Bank/Travelers Cheque (AEB/TC) reported net income of $152 million in 1999, compared with $43 million a year ago. The 1998 results included a $138 million ($213 million pretax) credit loss provision related to AEB’s business in the Asia/Pacific region, particularly Indonesia. 1997 included approximately $62 million ($96 million pretax) of increased recognition of recoveries on abandoned property related to the Travelers Cheque business, which are included in Commissions, Fees and Other Revenues.
Net interest income in 1999 was essentially unchanged versus the prior year. Although the loan portfolio declined in 1999, last year included reversals of accrued interest on loans transferred to non-performing status in Indonesia. In 1998, net interest income was down due to smaller Corporate Banking revenues, primarily reflecting a lower overall loan portfolio and an increase in non-performing loans in Indonesia. 
These declines were partially negated by growth in deposits and loans in AEB’s two businesses oriented to individuals, Private Banking and Personal Financial Services (PFS). In 1999, TC investment income grew because of an increase in average investments. The decline in foreign exchange income in 1999 reflects lower foreign exchange revenues, primarily in Asia/Pacific, due to stabilization of currencies compared with 1998, when AEB posted strong trading results due to currency volatility. Commissions, fees and other revenues in 1999 includes growth in Private Banking and PFS. The decline in these revenues in 1998 reflects the economic downturn in Asia/Pacific.
Other operating expenses grew in 1999 primarily as a result of costs related to business building initiatives in Private Banking, PFS and TC, as well as reengineering costs incurred as AEB realigned business activities in certain countries.
AEB had approximately $5.1 billion outstanding in worldwide loans at December 31, 1999, down from $5.6 billion at December 31, 1998. The decline from the prior year was largely in the Asia/Pacific region; corporate and correspondent banking loans fell by $0.8 billion, as AEB focused on reducing exposures in these activities and emphasizing consumer and private banking loans, which rose by $0.5 billion in 1999, before the sale and securitization of $0.3 billion of consumer loans. Other banking activities, such as securities, unrealized gains on foreign exchange and derivatives contracts, various contingencies and market placements, added approximately $7.6 billion to AEB’s credit exposures at December 31, 1999 and December 31, 1998.
The 1998 reserve for credit losses includes a $213 million provision related to the Asia/Pacific region, net of write-offs during 1998. The reduction in this reserve in 1999 primarily reflects further write-offs against the provision established in 1998.
CORPORATE AND OTHER
Corporate and Other reported net expenses of $174 million, $84 million and $152 million in 1999, 1998 and 1997, respectively. 1998 results include income of $78 million after-tax ($106 million pretax) comprising a $39 million after-tax ($60 million pretax) gain from sales of common stock of First Data Corporation and a $39 million after-tax ($46 million pretax) preferred stock dividend based on earnings from Lehman Brothers. Excluding these items, Corporate and Other had net expenses of $162 million in 1998.
Results for 1999 include a $39 million after-tax ($46 million pretax) preferred stock dividend based on earnings from Lehman Brothers. 1998 and 1997 include a benefit due to an earnings payout from Travelers Inc., related to the 1993 sale of the Shearson Lehman Brothers Division. 1998 also reflects a benefit from the sale of securities and adjustment of valuation allowances related to certain corporate assets. The above items were offset by business building initiatives and costs related to the Y2K issue in each year.
OTHER REPORTING MATTERS
YEAR 2000
The company, to date, has not experienced any material systems failures related to the Year 2000 (Y2K) rollover. Our remediation plan for the Y2K issue is discussed in detail in the company’s 1998 Annual Report to Shareholders and 1999 10-Q reports. We will continue our Y2K monitoring and address any issues that may arise from internal systems or those of third parties. The company’s cumulative costs since inception of the Y2K initiative were $505 million through December 31, 1999 and are expected to be approximately $10 million in 2000. The majority of these costs are managed by and included in the Corporate and Other segment, as most remediation efforts are related to systems that are maintained by the American Express Technologies organization. Costs related to Y2K have not had a material adverse effect on the company’s results of operations or financial condition.
ACCOUNTING DEVELOPMENTS
As required by AICPA Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," the company capitalizes software costs rather than expensing them as incurred, which had been the company’s practice. For the year ended December 31, 1999, this amounted to a pretax benefit of $263 million (net
of amortization): $183 million related to TRS, $66 million related to AEFA and $14 million related to AEB/TC. This benefit was offset by increased investment spending and therefore had no material effect on net income.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which is effective January 1, 2001. This Statement establishes accounting and reporting standards for derivative instruments, including some embedded in other contracts, and hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities on the balance sheet and measure them at fair value. Changes in the fair value of a derivative will be recorded in income or directly to equity, depending on the instrument’s designated use. The ultimate financial effect of the new rule will be measured based on the derivatives in place at adoption and cannot be estimated at this time.
CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES
The company believes allocating capital to businesses with a return on risk-adjusted equity in excess of its cost of equity and sustained earnings growth in its core business will continue to build shareholder value.
The company’s philosophy is to retain enough earnings to help achieve its goals of earnings per share growth in the 12 to 15 percent range, on average and over time. To the extent earnings exceed investment opportunities, the company has returned excess capital to shareholders. As further described in Note 6 to the Consolidated Financial Statements, the company has undertaken a share repurchase program to offset new share issuances.
FINANCING ACTIVITIES
The company has procedures to transfer immediately short-term funds within the company to meet liquidity needs. These internal transfer mechanisms are subject to and comply with various contractual and regulatory constraints.
The parent company generally meets its short-term funding needs through an intercompany dividend policy and by the issuance of commercial paper. The Board of Directors has authorized a parent company commercial paper program that is supported by a $1.3 billion multi-purpose credit facility that expires in increments from 2000 through 2002. No borrowings have been made under this credit facility. There was no parent company commercial paper outstanding during 1999 or 1998.
Total parent company long-term debt outstanding was $1.1 billion at December 31, 1999 and 1998. At December 31, 1999 and 1998, the parent company had $2.1 billion of debt or equity securities available for issuance under shelf registrations filed with the Securities and Exchange Commission. In addition, TRS, Centurion Bank, Credco, American Express Overseas Credit Corporation Limited, a wholly-owned subsidiary of Credco, and AEB have established programs for the issuance, outside the United States, of debt instruments to be listed on the Luxembourg Stock Exchange. The maximum aggregate principal amount of debt instruments outstanding at any one time under the program will not exceed $3 billion. At December 31, 1999 and 1998, $1.6 billion and $1.1 billion of debt, respectively, has been issued under this program.
In 1998, American Express Company Capital Trust I, a wholly-owned subsidiary of the company, established as a Delaware statutory business trust (the Trust), completed a public offering of 20 million shares (carrying value of $500 million) of 7. 0% Cumulative Quarterly Income Preferred Shares Series I (liquidation preference of $25 per share). Proceeds of the issue, which represent the sole assets of the Trust, were invested in Junior Subordinated Debentures (the Debentures) issued by the company, due 2028. The company used the proceeds from the Debentures for general corporate purposes. See Note 5 to the Consolidated Financial Statements for further information.
RISK MANAGEMENT
Management establishes and oversees implementation of Board-approved policies covering the company’s funding, investments and use of derivative financial instruments and monitors aggregate risk exposures on an ongoing basis. The company’s objective is to realize returns commensurate with the level of risk assumed while achieving consistent earnings growth. Individual business segments are responsible for managing their respective exposures within the context of Board-approved policies. See Note 7 to the Consolidated Financial Statements for a discussion of the company’s use of derivatives.
The following sections include sensitivity analyses of three different tests of market risk and estimate the effects of hypothetical sudden and sustained changes in the applicable market conditions on the ensuing year’s earnings, based on year-end positions. The market changes, assumed to occur as of year end, are a 100 basis point increase in market interest rates, a 10% strengthening of the U.S. dollar versus all other currencies, and a 10% decline in the value of equity securities under management at AEFA. Computations of the prospective effects of hypothetical interest rate, foreign exchange rate and equity market changes are based on numerous assumptions, including relative levels of market interest rates, foreign exchange rates and equity prices, as well as the levels of assets and liabilities. The hypothetical changes and assumptions will be different from what actually occurs in the future. Furthermore, the computations do not incorporate actions that management could take if the hypothetical market changes actually occur. As a result, actual earnings consequences will differ from those quantified below.
TRS’ hedging policies are established, maintained and monitored by a central treasury function. TRS generally manages its exposures along product lines. A variety of interest rate and foreign exchange hedging strategies are employed to manage interest rate and foreign currency risks.
TRS funds its Charge Card receivables and Cardmember loans using both on-balance sheet funding sources, such as long-and short-term debt, medium-term notes, commercial paper and asset securitizations. Cardmember receivables are predominantly funded by Credco and its subsidiaries; funding for Cardmember loans is primarily through Centurion Bank. For its Charge Card and fixed rate lending products, interest rate exposure is managed through the issuance of long-and short-term debt and the use of interest rate swaps. During 1998, TRS targeted the funding mix for these products to be approximately 100 percent floating rate and purchased interest rate caps to limit the adverse effect of an interest rate increase on substantially all U.S. dollar funding costs. The majority of these caps matured during 1998. In early 1999, TRS entered into a series of interest rate swaps to convert a majority of its domestic funding from floating rate to fixed rate. During the second half of 1999 and in early 2000, TRS entered into additional swaps. The effect of these was to increase the amount of fixed rate funding. For the majority of its Cardmember loans, which are linked to a floating rate base and generally reprice each month, TRS uses floating rate funding and, to the extent necessary, interest rate swaps to achieve funding rates that reprice similarly with changes in the base rate of the underlying loans.
The detrimental effect on TRS pretax earnings of a hypothetical 100 basis point increase in interest rates would be approximately $123 million ($108 million related to the U.S. dollar) and $170 million ($155 million related to the U.S. dollar), based on 1999 and 1998 year-end positions, respectively. This effect is primarily due to the extent of variable rate funding of the Charge Card and fixed rate lending products. The reduction from 1998 to 1999 is primarily due to interest rate swaps purchased beginning in early 1999. Had the swaps entered into in early 1999 been in effect at December 31, 1998, the 1998 effect would have been substantially lower. Had the series of swaps entered into in early 2000 been in effect at December 31, 1999, the 1999 effect would also have been substantially lower.
TRS’ foreign exchange risk arising from cross-currency charges and balance sheet exposures is managed primarily by entering into agreements to buy and sell currencies on a spot or forward basis. In the latter parts of 1999 and 1998, foreign currency forward contracts were both sold (with notional amounts of $611 million and $569 million, respectively) and purchased (with notional amounts of $25 million and $34 million, respectively) to manage a majority of anticipated cash flows in major overseas markets for the subsequent year.
Based on the year-end 1999 and 1998 foreign exchange positions, but excluding the forward contracts managing the anticipated overseas cash flows for the subsequent year, the effect on TRS’ earnings of the hypothetical 10 percent strengthening of the U.S. dollar would be immaterial. With respect to the forward contracts related to anticipated cash flows for the subsequent year, the 10 percent strengthening would create hypothetical pretax gains of $53 million and $54 million related to the 1999 and 1998 year-end positions, respectively. Such gains, if any, would mitigate the negative effect of a stronger U.S. dollar on overseas earnings for the subsequent year.
AEFA’s owned investment securities are, for the most part, held by its life insurance and investment certificate subsidiaries, which primarily invest in long-term and intermediate-term fixed income securities to provide their clients with a competitive rate of return on their investments while minimizing risk. Investment in fixed income securities provides AEFA with a dependable and targeted margin between the interest rate earned on investments and the interest rate credited to clients’ accounts. AEFA does not invest in securities to generate trading profits for its own account.
AEFA’s life insurance and investment certificate subsidiaries’ investment committees regularly review models projecting different interest rate scenarios and their effect on the profitability of each subsidiary. The committees’ objectives are to structure their investment security portfolios based upon the type and behavior of the products in the liability portfolios to achieve targeted levels of profitability and to meet contractual obligations.
Rates credited to customers’ accounts are generally reset at shorter intervals than the maturity of underlying investments. Therefore, AEFA’s margins may be affected by changes in the general level of interest rates. Part of the committees’ strategies include the use of derivatives, such as interest rate caps, swaps and floors, for hedging purposes.
AEFA’s fees earned on the management of fixed income securities in variable annuities and mutual funds are generally based on the value of the portfolios. To manage the level of 1999 fee income, AEFA entered into a series of swaps in 1998 to mitigate the negative effect on fees that would result from an increase in interest rates.
The negative effect on AEFA’s pretax earnings of a 100 basis point increase in interest rates, which assumes repricings and customer behavior based on the application of proprietary models, to the book of business at December 31, 1999 and 1998, would be approximately $40 million and $55 million for 1999 and 1998, respectively.
AEFA’s fees earned on the management of equity securities in variable annuities and mutual funds are generally based on the value of the portfolios. To manage the level of fee income in 1999, AEFA entered into a series of stock index option transactions in 1998, to mitigate, for a substantial portion of the portfolios, the negative effect on fees that would result from a decline in the equity markets. In early 2000, AEFA entered into a series of stock index option transactions to mitigate this negative effect for 2000. In addition, AEFA writes and purchases index options to manage the margin related to certain investment certificate and annuity products that pay interest based upon the relative change in a major stock market index between the beginning and end of the product’s term. The negative effect on AEFA’s pretax earnings of a 10 percent decline in equity markets would be approximately $103 million and $72 million based on assets under management, certificate and annuity business in force, and index options as of December 31, 1999 and 1998, respectively. Had the series of stock index option transactions entered into in early 2000 been in effect at December 31, 1999, the 1999 effect would have been substantially lower.
AEB/TC employs a variety of on- and off-balance sheet financial instruments in managing its exposure to fluctuations in interest and currency rates. Derivative instruments consist principally of foreign exchange spot and forward contracts, interest rate swaps, foreign currency options and forward rate agreements. Generally, they are used to manage specific on-balance sheet interest rate and foreign exchange exposures related to deposits and long-term debt, equity, loans and securities holdings.
The negative effect of the 100 basis point increase in interest rates on AEB/TC’s pretax earnings would be $9 million as of December 31, 1999 and negligible as of December 31, 1998. The effect on earnings of the 10 percent strengthening of the U.S. dollar would be negligible and, with respect to translation exposure of foreign operations, would result in a $8 million and $14 million pretax charge against equity as of December 31, 1999 and 1998, respectively.
AEB utilizes foreign exchange and interest rate products to meet the needs of its customers. Customer positions are usually, but not always, offset. They are evaluated in terms of AEB’s overall interest rate or foreign exchange exposure. AEB also takes limited proprietary positions. Potential daily exposure from trading activities is calculated using a Value at Risk methodology. This model employs a parametric technique using a correlation matrix based on historical data. The Value at Risk measure uses a 99 percent confidence interval to estimate potential trading losses over a one-day period. During 1999 and 1998, the Value at Risk for AEB was less than $3 million.
Asset/liability and market risk management at AEB are supervised by the Asset and Liability Committee, which comprises senior business managers of AEB. It meets monthly and monitors: (i) liquidity, (ii) capital exposure, (iii) capital adequacy, (iv) market risk and (v) investment portfolios. The committee evaluates current market conditions and determines AEB’s tactics within risk limits approved by AEB’s Board of Directors. AEB’s treasury, risk management and global trading management issue policies and control procedures and delegate risk limits throughout AEB’s regional trading centers.
AEB’s overall credit policies are approved by the Finance and Credit Policy Committee of AEB’s Board of Directors. Credit lines are based on a tiered approval ladder, with levels of authority delegated to each country, geographic area, AEB’s senior management and AEB’s Board of Directors. Approval authorities are based on factors such as type of borrower, nature of transaction, collateral, and overall risk rating. AEB controls the credit risk arising from derivative transactions through the same procedures. The Credit Audit department reviews all significant exposures periodically. Risk of all foreign exchange and derivative transactions is reviewed by AEB on a regular basis.
TRS’ net revenues on a managed basis rose 13 percent and 9 percent in 1999 and 1998, respectively, compared with the previous year. In both years, TRS’ net revenues benefited from growth in worldwide billed business, Cardmember loans outstanding and higher travel commissions and fees. 1998 results also reflect wider interest margins. In both 1999 and 1998, growth in billed business was due to higher average spending per Basic Cardmember and growth in average cards outstanding. Greater average spending per Basic Cardmember resulted from several factors, including the benefits of rewards programs and expanded merchant coverage. The increase in U.S. cards during 1999 reflects a greater level of consumer and small business services card acquisition activities, as well as the successful launch of new products, including Blue and co-branded Costco cards. The international increase in both 1999 and 1998 includes growth in proprietary products, as well as the addition of a substantial number of new network cards over the past two years.
Discount revenue rose 10 percent in 1999 and 8 percent in 1998 as a result of higher worldwide billed business, which increased despite (i) a general tightening of corporate travel and entertainment expenses which began in the latter half of 1998 and (ii) the company’s decision to withdraw from the U.S. Government Card business in the fourth quarter of 1998, which caused the cancellation of 1.6 million U.S. Government cards, representing approximately $3.5 billion in annualized spending. The 1999 growth in billed business is primarily the result of increases in retail and "everyday spend" categories.
TRS securitizes loans and receivables in the normal course of its business. The above statements of income and related discussion present TRS results on a managed basis, as if there had been no securitization transactions. The effect of securitizations is to remove the securitized loans and receivables from TRS’ balance sheet. TRS continues to service the accounts and receives a fee for doing so. On a GAAP basis, each new loan securitization results in a reduction in a previously established reserve for losses and the recognition of the present value of the future net cash flows related to the securitized loans. The ongoing effect of loan securitizations is that TRS no longer recognizes net finance charge revenue and provisions for losses on securitized loans. Rather, TRS receives servicing revenue and any excess of net finance charge revenue, after write-offs and servicing costs, on the securitized loans. These amounts are recorded in other revenues. Charge Card securitizations result in a reduction of interest expense and provisions for losses, and recognition of servicing revenues, which is offset by discount expense on the securitized receivables.
