TIME: Almanac 1993/TIME Almanac 1993.iso/time/102191/1021200.000

Text File | 1992-08-28 | 11.0 KB | 229 lines

                                                                                BUSINESS, Page 72

FINANCIAL SERVICES

Hitting the Credit Limit


No longer good as gold, American Express struggles to recover
from painful attempts to diversify and a slump in card fortunes

By THOMAS MCCARROLL


    In the race to create vast financial supermarkets,
American Express was among the first in line. Backed by a
blue-chip image and the clout of its ubiquitous green charge
cards, the Manhattan-based conglomerate went on a spending spree
in which it acquired brokerage firms, insurance companies and
a real estate business in an ambitious bid to offer a grocery
list of investment services under one roof.

    Initially, the strategy produced one success after
another, contributing to American Express's almost mythic
reputation for savviness and invincibility. But a recent chain
of misfortunes, miscues and poor managerial decisions is
prompting a re appraisal of Amex's sterling reputation.
Acquisitions that looked like masterstrokes only a few years ago
are now facing criticism; the managerial decision-making process
that was once considered fine-tuned and flawless is suddenly
being second-guessed; businesses that were thought to be
impervious to economic downturns have proved to be vulnerable
after all. In short, American Express is showing that it has
chinks in its armor.

    The latest shock is the poor performance of one of Amex's
youngest and most vaunted products: the Optima card. Launched
four years ago as Amex's response to Visa and MasterCard, the
revolving-charge card was perceived as a winner. But the company
announced earlier this month that Optima (total card members:
more than 3 million) had suffered much higher defaults than
expected. The result: $155 million in Optima write-offs during
the third quarter, which will produce a loss -- the first one
ever -- of $50 million to $75 million for the company's Travel
Related Services division.

    Moreover, the company disclosed last week that it is
conducting an internal investigation to see whether Optima
executives, either at its operations office in Jacksonville or
at Manhattan headquarters, falsified records to hide the true
degree of card-holder defaults. The Federal Deposit Insurance
Corp. is probing the matter as well, because the American
Express Centurion Bank, which issues Optima, filed incorrect
documents with federal regulators as a result of the apparent
cover-up. Amex investors, who suffered from a sharp drop in the
company's stock when the Optima trouble came to light, have
filed a class-action lawsuit claiming that the company
misrepresented the card's performance.

    With Optima, Amex had planned to cash in on a part of the
card business the company had always disdained: revolving
credit. Amex had issued only charge cards, which had to be paid
in full each month. But Visa and MasterCard had successfully
turned credit cards into a consumer lending vehicle, and were
gaining a huge share of the total charge volume at the expense
of Amex's green, gold and platinum cards. (Visa has 257 million
cards worldwide vs. 163 million for MasterCard and 37 million
for Amex.) So American Express decided to counterattack with a
credit card it would offer only to its existing customers, who
were presumably good credit risks.

    Unlike its competitors, however, Amex had woefully little
experience in running a revolving-credit operation. Optima
managers lacked the subtle nuances of knowing when to close bad
accounts and start collecting. As a result, in the second
quarter Optima's charge-off rate on accounts unpaid after 180
days was 8%, or about twice the average for similar cards. Says
Alex (Pete) Hart, president of MasterCard: "American Express
painfully discovered that the revolving-credit business is a
different animal."

    Many Amex customers, though accustomed to paying in full
each month, proved much less disciplined in their approach to
the Optima card. "We thought we had better demographics and
experience with our customers," says James Robinson, Amex's
chairman, who defended the company's assumptions. "Either our
hypothesis was wrong or we didn't manage it right." But Robinson
believes that external factors, most notably the current
recession, hit Amex's clientele especially hard. "We had models
for dealing with tough times but not for a white-collar
recession. The model wasn't tested for hurricanes."

    Optima's troubles could hardly come at a worse time for
its credit-card division, which has enjoyed uninterrupted
growth ever since the green card was launched 33 years ago. That
all changed this year with the drastic slowdown in consumer
spending and travel that was prompted by the recession and the
gulf war. Charge volume, which had been growing at more than 10%
annually during the past two years, is expected to decline this
year.

    Adding to the card division's headaches have been a series
of revolts by disgruntled merchants demanding that the company
lower the rate it imposes for handling customer transactions.
Traditionally, American Express has charged merchants a premium
-- as high as 4.25% for most retailers, about twice what Visa
and MasterCard charge. In justifying its rate, Amex contends
that its customers tend to be bigger spenders than bank-card
holders. But as Visa and MasterCard have become more
competitive in the prestige-card market, merchants have lost
patience with Amex's higher premium.

    The most notable rebellion occurred in Boston, where
several restaurants threatened to drop American Express unless
it would renegotiate its rates. American Express refused, but
quietly offered a standing discount for merchants who submit
their receipts electronically. The company fears that if it
gives in to one group, that could start a stampede by others
demanding rate discounts. Amex's biggest fear is that airlines
and hotels, which account for 45% of its merchant-fee income,
will ask for renegotiated deals.

    To control the damage, Robinson put bearlike Amex
president Harvey Golub in direct charge of the Travel Related
Services division, which includes card operations. Golub, known
for his expertise on the ski slopes and in the kitchen, had been
boss of one of Amex's few star performers, IDS Financial
Services. To cut losses in the credit-card business, Golub plans
a top-to-bottom overhaul at a cost of $110 million, which will
include laying off 1,700 workers. Among other goals, Golub plans
to boost the growth of Amex cards in force. Among the possible
incentives: waiving the $55 annual renewal fee for its
green-card holders.

    The problems in Amex's core business come after a long
string of mishaps in its diversified pursuits. The chief money
drain has been its Shearson Lehman Bros. investment arm, which
suffered mightily from its $962 million takeover of ailing and
scandal-ridden E.F. Hutton in 1988. Shearson is just now
starting to show signs of recovery from Wall Street's postcrash
slump. Amex had hoped to flee the securities business, but after
failing to find a buyer for Shearson, Amex injected $1 billion
in capital to restructure the firm.

    Shearson took a direct hit in its real estate business, as
did many financial firms. Shearson's Balcor subsidiary suffered
$200 million in loan losses, and was liquidated by the company
in 1990. Amex had done even worse in the insurance business
after buying Fireman's Fund, which suffered heavy underwriting
losses. In 1986 Amex sold the company, but only after pumping
more than $400 million into the business. American Express
suffered both scandal and loss at its Boston Co. unit, a
money-management firm that was discovered to have improperly
overstated its 1988 earnings by $30 million.

    The company seems increasingly wary about its forays
beyond financial services, which in the past included
illustrious but money-hungry start-ups like MTV. Amex may be
preparing to recapitalize or sell off its ventures in magazine
publishing, which it entered in 1968. The company has discussed
selling part or all of its publications, which include New York
Woman and L.A. Style, to an investment group controlled by
buyout artist Henry Kravis.

    While Amex's financial troubles could largely be chalked
up as honest mistakes or twists of fate, one episode revealed
a darker side of the corporate culture. In 1989 Amex managers
admitted conducting a public smear campaign against Edmond
Safra, a wealthy financier who had sold a bank to American
Express in 1983. After he departed to start a competing bank,
American Express officials began spreading the word that Safra
was caught up with money launderers and drug traffickers.

    Why did so many things go wrong for American Express in
such a short time? Analysts who follow the company say much of
the same hubris and lack of managerial controls responsible for
the Optima scandal may also be the cause of past disasters. The
company's failed foray into cable TV, critics say, was an
example of an unwise management decision to find synergy where
none existed. The company may have lost sight of its limits,
says analyst Daniel Murray of Argus Research. "If you invented
your own private money, you might be a little arrogant too."

    The Optima affair, with its whiff of a cover-up, raises
many unsettling questions about what top executives knew, and
when. Robinson, for instance, concedes that he wasn't made aware
of the problems at Optima until a month or so ago, a point that
raised eyebrows throughout the industry. Says a high-ranking
executive at a rival credit-card company: "I heard rumors about
Optima's losses a year ago. Something's wrong when competitors
knew before American Express senior executives did. If James
Robinson didn't know, he should have."

    Amex is now learning a humbling lesson. Earlier this year
the company's weakened financial condition forced it to search
for outside capital. Warren Buffett, the Omaha-based
billionaire who serves as interim caretaker at Salomon Brothers,
stepped in with a $300 million investment. The company has also
recognized that its managers have to adjust to an economic
slowdown that may last for the better part of the 1990s. Says
Robinson: "Management has to be able to deal with good times and
bad. It's easier in good times, but we can't always operate in
an environment that's friendly."

    Robinson strongly denies that the company ever set out to
be all things to all people, to become a true financial
supermarket. Amex has always seen itself as more of a niche
player, an upscale specialist. But Robinson concedes that his
financial empire might have overreached in its scope. "This has
been a time of tremendous turmoil and change," he says. "We've
had problems along the way, but we've gone and fixed them."
Robinson may not have fully repaired Amex just yet, but the
company seems to have finally come to grips with the likelihood
that the current decade will be a time of brutal competition and
less-than-platinum expectations.