Financial Services Hitting the Credit Limit

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 reappraisal 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.

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CREDIT: TIME Graphic by Steve Hart

CAPTION: AMERICAN EXPRESS STOCK PRICE, monthly closings