Why Amex Wooed Warren BuffettLeah Nathans Spiro
During an American Express Co. finance committee meeting in mid-July, James D. Robinson III, AmEx's chairman and chief executive, started talking with John J. "Jack" Byrne, a fellow board member and head of Fund American Cos., formerly Fireman's Fund Insurance Co. The two spoke about a topic much on Robinson's mind: his plan to raise equity for the credit-card giant. Suddenly Byrne had a brainstorm. What about calling his close friend Warren E. Buffett? Byrne knew him from his days running Geico Corp., an early Buffett investment. Robinson gave the O. K. Recalls Buffett: "I told Jack that I would be interested, and he had Jim Robinson call me." Barely a week later, Buffett shelled out $300 million for a private issue of AmEx convertible preferred stock.
Securing the imprimatur of the legendary Omaha investor was a great image play for AmEx. Buffett's name conjures up images of brilliant investments in unbeatable franchises such as Coca-Cola Co. and Washington Post Co.
Yet AmEx needed Buffett's money much more than his name. Until recently, the company's financial strength was unassailable. Now AmEx is engaged in a far-ranging campaign to bolster its capital base. The main reason: continuing write-offs at its ailing brokerage unit, Shearson Lehman Brothers Inc. AmEx is feeling the strain of Shearson's balance sheet, which is very thinly capitalized. The broker's tangible net worth is on the rise, but at $627 million, quite skimpy compared with its assets of $66.5 billion. Further, AmEx has helped fund Shearson's problems with earnings from its once-robust card division, and those earnings are now slowing.
Despite Robinson's efforts to improve AmEx's capital position, Standard & Poor's Corp. in July downgraded AmEx senior debt from AA to AA-, almost certainly an embarrassment for the proud chairman. Now analysts suggest that AmEx is moving aggressively to avoid a further downgrade. Robinson acknowledges that rating agencies have tightened their standards for financial institutions. "We're a double-A credit, and we could say AmEx doesn't need capital," says Robinson. "Given the fact the name of our business is `promises to pay,' we felt it was time to increase our strength rather than sit with the hand we had."
POSTING LOSSES. Robinson's capital-bolstering campaign began last summer. It has included everything from paying some employee bonuses in stock, which raises equity, to methodically selling off a number of assets on AmEx's balance sheet. This way, AmEx is generating more equity to support fewer assets. One plan is to securitize, or bundle into securities, as much as $1 billion in credit and charge-card receivables so they can be sold to investors. This year alone, AmEx could reduce its assets by some $3 billion, estimates Guy Moszkowski, an analyst with Sanford C. Bernstein & Co. "I think that will allow them to retain their rating without issuing more equity for the time being."
Most of the asset sales have been at Shearson. Despite Shearson's strong operating results in the first half of 1991, it is still posting losses from one-time write-offs. Robinson points outthat between its peak in 1989 and June, 1991, Shearson's assets have shrunk by $25 billion, to $66.5 billion.Shearson is also working to improve the quality of its assets. It has already jettisoned $1 billion in junk bonds. Shearson Lehman Mortgage Corp. is for sale. This company services mortgages, and its sale could shrink AmEx's assets by $800 million. AmEx is disposing of $500 million in British home mortgages owned by Shearson's Boston Co. unit. And AmEx may securitize and sell some of its $4.1 billion portfolio of Boston's jumbo home mortgages made to affluent individuals.
In years past, AmEx was able to subsidize Shearson's persistent financial difficulties with profits from American Express Travel Related Services Co., the card division, and still have cash to spare. Those days are over. AmEx's cards are facing mounting pressure from rival cards and merchants who are demanding cuts in the fees they pay to AmEx. "TRS has momentum, but it is not robust enough to replenish AmEx's coffers," says Richard Schmidt, an analyst at Standard & Poor's.
In the third quarter, AmEx plans to securitize and sell off as much as $1 billion in TRS's $22 billion in Optima, green, or gold credit and charge-card receivables. While the technique is old hat in the banking industry, AmEx has always remained above the fray. Says one investment banker, referring to all the administrative paperwork involved: "It's a pain in the rear. You don't do it unless you have to."
BAD-LOAN PLAGUE. Asset disposals will permit AmEx to minimize further equity sales, which could anger shareholders, whose stakes would be diluted. Last February, AmEx began paying bonuses to some Shearson employees in stock. Over five years, that and other measures, such as making contributions in stock to various employee benefit plans, will save $600 million through the issuance of 25 million new shares, 5% of the total outstanding.
AmEx's deal with Buffett was also designed to avoid shareholder unrest. Robinson insisted on limiting Buffett's ability to profit on the stock's appreciation. And he turned down Buffett's offer to up his investment to $500 million. "Jimmy, to his credit, wanted to minimize the number of shares he was going to sell," Buffett says. "I admire him for that."
Bernstein's Moszkowski doesn't expect AmEx to issue more equity, unless "Shearson's exposures required a lot more reserves." Analysts worry about $1.8 billion in Balcor Co. assets. The commercial real estate unit, backed with just $200 million in reserves, has been plagued by bad loans. It has been shifted from Shearson's books onto AmEx's, and it is being slowly liquidated.
Still on Shearson's books is a $500 million bridge loan to Prime Computer Inc. And though Shearson took a $144 million write-off in the second quarter for its stake in First Capital Holdings Corp., whose insurance units were seized by state regulators, the broker still faces an unknown litigation tab from lawsuits by disgruntled Shearson customers. Considering the enormous problems that Shearson continues to cause AmEx, some analysts believe that the credit-card giant may eventually decide to dump it. AmEx denies any such plans.AmEx's current travails are a big change from its earlier days, when Robinson was hailed as a daring and innovative empire-builder. He admits that was a lot more fun than shrinking AmEx's balance sheet. But he is confronting his current tasks philosophically. "Do I look forward to calmer days? Absolutely," says Robinson. Given the scope of AmEx's financial pressures, those days may not be around the corner.