UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 30 OF THE INVESTMENT COMPANY ACT OF 1940
AND SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________to ________
Commission File No. 2-23772
American Express Certificate Company
(Exact name of registrant as specified in its charter)
Delaware 41-6009975
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
52 AXP Financial Center
Minneapolis, Minnesota 55474
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (612) 671-3131
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
------------------------------------ ----------------------------
None None
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes __X__ No _____
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. _____
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes _____ No __X__
As of December 31, 2004, there were no voting shares held by non-affiliates
of the registrant. Common shares of the registrant outstanding at March 14, 2005
were 150,000.
Documents Incorporated By Reference
None
The registrant meets the conditions set forth in General Instructions I (1)(a)
and (b) of Form 10-K and is therefore filing this Form with the reduced
disclosure format.
TABLE OF CONTENTS
Form 10-K
Item Number
Page
PART I
1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . 1 - 7
2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . 7
3. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . 7
4. Submission of Matters to a Vote of Security Holders. . . . . 8
PART II
5. Market for the Registrant's Common Stock and Related
Stockholder Matters. . . . . . . . . . . . . . . . . . . . . 8
6. Selected Financial Data. . . . . . . . . . . . . . . . . . . 8
. . . . . . . . . . . .
7. Management's Discussion and Analysis of Financial Condition
and Results of Operation . . . . . . . . . . . . . . . . . . 9-14
7A. Quantitative and Qualitative Disclosures About Market Risk. 14
8. Financial Statements and Supplementary Data. . . . . . . . . 14
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure . . . . . . . . . . . . . . . . . . 15
9A. Controls and Procedures. . . . . . . . . . . . . . . . . . . 15
PART III
14. Principal Accountant Fees and Services . . . . . . . . . . . 15 - 16
PART IV
15. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . 17 - 18
Index to Financial Statements. . . . . . . . . . . . . . . . F-1
Exhibit Index. . . . . . . . . . . . . . . . . . . . . . . . E-1 - E-4
PART I
ITEM 1. BUSINESS
American Express Certificate Company (AECC) is incorporated under the laws of
Delaware. AECC's principal executive offices are located at 52 AXP Financial
Center, Minneapolis, Minnesota 55474, and its telephone number is (612)
671-3131. American Express Financial Corporation (AEFC), a Delaware corporation
located at 200 AXP Financial Center, Minneapolis, Minnesota 55474, owns 100
percent of the outstanding voting securities of AECC. AEFC is a wholly-owned
subsidiary of American Express Company (American Express), a New York
corporation, with headquarters at World Financial Center, 200 Vesey Street, New
York, New York 10285.
On February 1, 2005, American Express announced plans to pursue a tax-free
spin-off of the common stock of AEFC through a special dividend to American
Express common shareholders. The final transaction, which is subject to certain
conditions including receipt of a favorable tax ruling and approval by American
Expresses' Board of Directors, is expected to close in the third quarter of
2005.
AECC is registered as an investment company under the Investment Company Act of
1940 ("the 1940 Act") and is in the business of issuing face-amount investment
certificates. Face-amount certificates issued by AECC entitle the certificate
owner to receive at maturity a stated amount of money and interest or credits
declared from time to time by AECC, at its discretion. The certificates issued
by AECC are not insured by any government agency. AECC's certificates are sold
primarily by American Express Financial Advisors Inc. (AEFAI), and American
Express Bank Ltd. (AEB), both affiliates of AECC. AEFAI is registered as a
broker-dealer in all 50 states, the District of Columbia and Puerto Rico. AEFC
acts as investment advisor for AECC.
As of the date of this report, AECC offered the following nine different
certificate products to the public:
1. American Express Cash Reserve Certificate
o Currently sold without a sales charge.
o Available as qualified investments for IRAs, 401(k) plans, and other
qualified retirement plans.
o Single payment certificate that permits additional investments and AECC
guarantees interest in advance for a three-month term on these
certificates.
o Distributed pursuant to a Distribution Agreement with AEFAI.
o Current policy is to re-evaluate the certificate product interest
crediting rates weekly to respond to marketplace changes.
o AECC refers to an independent index or source to set the rates for new
sales and must set the rates for an initial purchase of the certificate
within a specified range of the rate from such index or source and for
renewals, AECC uses such rates as an indication of the competitors'
rates, but is not required to set rates within a specified range.
o Published rates of the U.S. ninety day treasury bill are used as a
guide in setting rates.
1
o Competes with popular short-term investment vehicles such as
certificates of deposit, money market certificates, and money market
mutual funds that offer comparable yields, liquidity and safety of
principal.
2. American Express Flexible Savings Certificate
o Currently sold without a sales charge.
o Currently bear surrender charges for premature surrenders.
o Available as qualified investments for IRAs, 401(k) plans, and other
qualified retirement plans.
o Distributed pursuant to a Distribution Agreement with AEFAI.
o Single payment certificate that permits a limited amount of additional
payments and on which AECC guarantees interest in advance for a term of
six, twelve, eighteen, twenty-four, thirty or thirty-six months, and
potentially other terms, at the certificate product owner's option.
o Current policy is to re-evaluate the certificate product interest
crediting rates weekly to respond to marketplace changes.
o AECC refers to an independent index or source to set the rates for new
sales and must set the rates for an initial purchase of the certificate
within a specified range of the rate from such index or source and for
renewals, AECC uses such rates as an indication of the competitors'
rates, but is not required to set rates within a specified range.
o Published rates of the BANK RATE MONITOR(R) Top 25 Market Average (the
BRM Average) for various length bank certificates of deposit are used
as the guide in setting rates. BANK RATE Monitor and Top 25 Market
Average are marks owned by BANKRATE.COM(SM), publication of Bankrate,
Inc., N. Palm Beach, FL 33408.
o Competes with popular short-term investment vehicles such as
certificates of deposit, money market certificates, and money market
mutual funds that offer comparable yields, liquidity and safety of
principal.
3. American Express Installment Certificate
o Currently sold without a sales charge.
o Currently bear surrender charges for premature surrenders.
o Available as qualified investments for IRAs, 401(k) plans, and other
qualified retirement plans.
o Distributed pursuant to a Distribution Agreement with AEFAI.
o Installment payment certificate that declares interest in advance for a
three-month period and offers bonuses for up to four certificate years
for regular investments.
o Current policy is to re-evaluate the certificate product interest
crediting rates weekly to respond to marketplace changes.
o AECC refers to an independent index or source to set the rates for new
sales and must set the rates for an initial purchase of the certificate
within a specified range of the rate from such index or source and for
renewals, AECC uses such rates as an indication of the competitors'
rates, but is not required to set rates within a specified range.
o Average interest rate for money market deposit accounts, as published
by the BRM Average(R), is used as a guide in setting rates.
o Intended to help clients save systematically and may compete with
passbook savings and NOW accounts.
2
4. American Express Preferred Investors Certificate
o Currently sold without a sales charge.
o Currently bear surrender charges for premature surrenders.
o Available as qualified investments for IRAs, 401(k) plans, and other
qualified retirement plans.
o Distributed pursuant to a Distribution Agreement with AEFAI.
o Single payment certificate that combines a fixed rate of return with
AECC's guarantee of principal for investments ranging from $250,000 to
$5 million and interest crediting rates are guaranteed in advance by
AECC for a term of one, two, three, six, twelve, twenty-four or
thirty-six months, at the certificate product owner's option.
o Current policy is to re-evaluate such rates on a daily basis.
o AECC refers to an independent index or source to set the rates for new
sales and must set the rates for an initial purchase of the certificate
within a specified range of the rate from such index or source and for
renewals, AECC uses such rates as an indication of the competitors'
rates, but is not required to set rates within a specified range.
o Published average rates for comparable length dollar deposits available
on an interbank basis, referred to as the London Interbank Offering
Rates (LIBOR), and are used as a guide in setting rates.
o Competes with short-term products, and references LIBOR rates.
5. American Express Stock Market Certificate
o Currently sold without a sales charge.
o Currently bear surrender charges for premature surrenders.
o Distributed pursuant to a Distribution Agreement with AEFAI.
o AEFAI has a Selling Agent Agreement with American Express Bank
International (AEBI), a direct subsidiary of AEB(1), to sell a version
of American Express Stock Market Certificate.
o AEFAI has a Selling Agent Agreement effective March 10, 1999 with
Securities America Inc., an affiliate of AECC.
o Single payment certificate that offers the certificate product owner
the opportunity to have all or part of the certificate product returns
tied to fifty-two week stock market performance, up to a maximum
return, as measured by a broad stock market index, with return of
principal guaranteed by AECC and the owner can also choose to earn a
fixed rate of interest after the first term.
o Certificate is also marketed by AEBI under the Selling Agent Agreement
with AEFAI to AEBI's clients, who are neither citizens nor residents of
the United States.
o Current policy is to re-evaluate the certificate product interest
crediting rates weekly and maximum return rates at least monthly to
respond to marketplace changes.
o Certain banks offer certificates of deposit that have features similar
to this certificate.
6. American Express Market Strategy Certificate
o Currently sold without a sales charge.
o Currently bear surrender charges for premature surrenders.
o Available as qualified investments for IRAs, 401(k) plans, and other
qualified retirement plans.
o Distributed pursuant to a Distribution Agreement with AEFAI.
3
o Flexible payment certificate that pays interest at a fixed rate or that
offers the certificate product owner the opportunity to have all or
part of the certificate product returns tied to fifty-two week stock
market performance, up to a maximum return, as measured by a broad
stock market index, for a series of fifty-two week terms starting every
month or at intervals the certificate product owner selects.
o Current policy is to re-evaluate the certificate product interest
crediting rates weekly and maximum return rates at least monthly to
respond to marketplace changes.
o Certain banks offer certificates of deposit that have features similar
to this certificate.
7. American Express Equity Indexed Savings Certificates
o Currently sold without a sales charge.
o Currently bear surrender charges for premature surrenders.
o Distributed pursuant to a Distribution Agreement with AEFAI.
o AEFAI has a Selling Dealer Agreement effective July 31, 2000 with
Securities America, Inc. There is no assurance that AECC's certificates
will be sold by Securities America Inc.
o Available as qualified investments for IRAs, 401(k) plans, and other
qualified retirement plans.
o Single payment certificate that offers the certificate product owner
the opportunity to have all or part of the certificate product returns
tied to a fifty two week stock market performance, up to a maximum
return, as measured by a broad stock market index, with return of
principal guaranteed by AECC.
o Current policy is to re-evaluate the certificate product interest
maximum return rates at least monthly to respond to marketplace
changes.
o Certain banks offer certificates of deposit that have features similar
to this certificate.
8. American Express Investors Certificate (including a version of American
Express Investors Certificate offered to select investors who expect to
invest at least $50 million in the aggregate in this certificate)
o Currently sold without a sales charge.
o Currently bear surrender charges for premature surrenders.
o Selling Agent Agreement with American Express Bank International
(AEBI), a direct subsidiary of AEB (1).
o Distributed pursuant to a Distribution Agreement with AEFAI.
o Single payment certificate that generally permits additional payments
within fifteen days of term renewal and interest crediting rates are
guaranteed in advance by AECC for a term of one, two, three, six,
twelve, twenty-four, or thirty-six months, at the certificate product
owner's option.
o Currently this certificate is sold only to AEBI's clients who are
neither citizens nor residents of the United States.
o Current policy is to re-evaluate such rates on a daily basis.
o AECC refers to an independent index or source to set the rates for new
sales and must set the rates for an initial purchase of the certificate
within a specified range of the rate from such index or source and for
renewals, AECC uses such rates as an indication of the competitors'
rates, but is not required to set rates within a specified range.
o Published average rates for comparable length dollar deposits available
on an interbank basis, referred to as the LIBOR, and are used as a
guide in setting rates.
4
o Competes with short-term investment products and references LIBOR
rates.
9. American Express Special Deposits
o Marketed only through offices of AEB, an indirect wholly-owned
subsidiary of American Express in England, and is not registered for
sale in the United States.
o Currently sold without a sales charge.
o Currently bear surrender charges for premature surrenders.
o AECC has a Marketing Agreement with AEB.
o Single payment certificate that generally permits additional payments
within fifteen days of term renewal and interest crediting rates are
guaranteed in advance by AECC for a term of one, two, three, six,
twelve, twenty-four, or thirty-six months, at the certificate product
owner's option.
o Only sold to AEB's clients who are neither citizens nor residents of
the United States.
o Current policy is to re-evaluate such interest crediting rates on a
daily basis.
o AECC refers to an independent index or source to set the rates for new
sales.
o Published average rates for comparable length dollar deposits available
on an interbank basis, referred to as the LIBOR, and are used as a
guide in setting rates.
o Competes with short-term investment products and references LIBOR
rates.
(1) AEBI is an Edge Act corporation organized under the provisions of Section
25(a) of the Federal Reserve Act.
The specified maturities of most of AECC's certificate products range from ten
to twenty years. Within that maturity period, most certificates have interest
crediting rate terms ranging from one to thirty-six months. Interest crediting
rates are subject to change and certificate product owners can surrender their
certificates without penalty at term end.
To AECC's knowledge, AECC is by far the largest issuer of face-amount
certificates in the United States. However, such certificates compete with many
other investments offered by banks, savings and loan associations, mutual funds,
broker-dealers and others, which may be viewed by potential clients as offering
a comparable or superior combination of safety and return on investment. In
particular, some of AECC's products are designed to be competitive with the
types of investment offered by banks and thrifts. Since AECC's face-amount
certificates are securities, their offer and sale are subject to regulation
under federal and state securities laws. AECC's certificates are backed by its
qualified assets on deposit and are not insured by any governmental agency or
other entity.
5
AECC's certificate product payments received and certificate surrenders paid for
each of the three years ended December 31, 2004 were (in millions of US
dollars):
2004 2003 2002
---- ---- ----
Single Payment Certificates
Non-Qualified
Payments through:
AEFAI $ 1,650.5 $ 1,124.2 $ 1,116.1
AEBI and AEB $ 1,259.4 $ 1,095.4 $ 512.6
Surrenders through:
AEFAI $ 1,022.4 $ 1,039.2 $ 865.1
AEBI and AEB $ 980.0 $ 999.6 $ 601.5
Qualified
Payments through:
AEFAI $ 342.3 $ 312.4 $ 361.6
Surrenders through:
AEFAI $ 268.9 $ 292.6 $ 224.1
Installment Payment Certificates
Through AEFAI
Non-Qualified
Payments $ 32.9 $ 38.6 $ 40.8
Surrenders $ 41.7 $ 47.9 $ 57.2
Qualified
Payments $ 0.5 $ 0.6 $ 0.3
Surrenders $ 0.4 $ 0.7 $ 0.5
For the year ended December 31, 2004, 38.7 percent of single payment certificate
products payments were through AEBI and AEB and 10.5 percent of payments
received by AECC on single payment certificate products and 1.5 percent of
payments received by AECC on installment certificate products were from
tax-qualified certificate products for use in IRAs, 401(k) plans, and other
qualified retirement plans.
The certificates offered by AEFAI are sold pursuant to a distribution agreement
which is terminable on sixty days' notice and is subject to annual approval by
AECC's Board of Directors, including a majority of the directors who are not
"interested persons" of AEFAI or AECC as that term is defined in the 1940 Act.
The distribution agreement provides for the payment of distribution fees to
AEFAI for services provided. For the sale of the American Express Investors
Certificate and the American Express Stock Market Certificate by AEBI, AEFAI, in
turn, has a Selling Agent Agreement with AEBI. For the sale of American Express
Stock Market Certificate, AEFAI has a Selling Agent Agreement with Securities
America Inc. effective March 10, 1999. For the sale of American Express Equity
Indexed Savings Certificates, AEFAI has a Selling Dealer Agreement with
Securities America Inc., effective July 31, 2000. For marketing American Express
Special Deposits, AECC has a Marketing Agreement with AEB. These agreements are
terminable upon sixty days' notice and subject to annual review by directors who
are not "interested persons" of AEFAI or AECC except that such annual review is
not required for selling agent agreements.
6
AECC receives advice, statistical data, and recommendations with respect to the
acquisition and disposition of securities in its investment portfolio from AEFC,
under an investment management agreement, which is subject to annual review and
approval by AECC's Board of Directors, including a majority of the directors who
are not "interested persons" of AEFC or AECC.
AECC is required to maintain cash and "qualified investments" meeting the
standards of Section 28(b) of the 1940 Act, as modified by an order of the
Securities and Exchange Commission (the SEC). The amortized cost of such
investments must be at least equal to AECC's net liabilities on all outstanding
face-amount certificates plus $250,000. So long as AECC wishes to rely on the
SEC order, as a condition to the order, AECC has agreed to maintain an amount of
unappropriated retained earnings and capital equal to at least 5 percent of net
certificate reserves. For these purposes, net certificate reserves means
certificate reserves less outstanding certificate loans. In determining
compliance with this condition, qualified investments are valued in accordance
with the provisions of Minnesota Statutes where such provisions are applicable.
AECC's qualified assets consist of cash and cash equivalents, first mortgage
loans on real estate and other loans, U.S. government and government agency
securities, municipal bonds, corporate bonds, preferred stocks and other
securities meeting specified standards. AECC has also entered into a written
informal understanding with the State of Minnesota, Department of Commerce, that
AECC will maintain capital equal to 5 percent of the assets of AECC (less any
loans on outstanding certificates). When computing its capital for these
purposes, AECC values its assets on the basis of statutory accounting for
insurance companies rather than U.S. generally accepted accounting principles
(GAAP). AECC is subject to annual examination and supervision by the State of
Minnesota, Department of Commerce (Banking Division).
Prior to September 30, 2004, distribution fees on sales of certain certificate
products were deferred and amortized over the estimated lives of the related
certificates, which was generally one year but could have been up to 10 years.
Upon surrender prior to maturity, unamortized deferred distribution fees were
reflected in expenses and any related surrender charges were reflected as a
reduction to the provision expense for certificate reserves. During the third
quarter of 2004, and based on management's recent review of AECC's certificate
product portfolio mix and certificate portfolio maturities, AECC determined it
to be appropriate to not defer distribution fees in the future and to completely
write-down previously deferred balances to zero. As a result of these actions,
investment expenses increased $5.7 million on a pre-tax basis during the third
quarter of 2004.
ITEM 2. PROPERTIES
None.
ITEM 3. LEGAL PROCEEDINGS
AECC is a party to litigation and arbitration proceedings in the ordinary course
of its business. The outcome of any litigation or threatened litigation cannot
be predicted with any certainty. However, in the aggregate, AECC does not
consider any lawsuits in which it is named as a defendant to have a material
impact on AECC's financial position or operating results.
7
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Item omitted pursuant to General Instructions I (2)(c) of Form 10-K.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
There is no market for AECC's common stock since it is a wholly-owned subsidiary
of AEFC and, indirectly, of American Express Company. Frequency and amount of
capital transactions with AEFC during the past two years were (in millions of
dollars):
For the year ended December 31, 2004: Dividends Contributions
March 31, 2004 $ 10 $ -
June 30, 2004 10 -
December 31, 2004 - (20)
-------- ---------
Total $ 20 $ (20)
======== =========
For the year ended December 31, 2003:
August 8, 2003 $ 30 $ -
December 15, 2003 20 -
-------- ---------
Total $ 50 $ -
======== =========
Restriction on AECC's present or future ability to make return of capital
payments or to pay dividends to AEFC:
Certain series of installment certificate products outstanding provide that cash
dividends may be paid by AECC only in calendar years for which additional
credits of at least 1/2 of 1 percent on such series of certificates have been
authorized by AECC. This requirement has been met for 2004 and 2003 by AECC's
declaration of additional credits in meeting this requirement. This requirement
was also met for 2005.
Appropriated retained earnings resulting from the pre-declaration of additional
credits to AECC's certificate product owners are not available for the payment
of dividends by AECC. In addition, AECC will discontinue issuance of
certificates subject to the pre-declaration of additional credits and will make
no further pre-declaration as to outstanding certificates if at any time the
capital and unappropriated retained earnings of AECC should be less than 5
percent of net certificate reserves (certificate reserves less certificate
loans). At December 31, 2004, the capital and unappropriated retained earnings
amounted to 5.6 percent of net certificate reserves.
ITEM 6. SELECTED FINANCIAL DATA
Item omitted pursuant to General Instructions I (2)(a) of Form 10-K.
8
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Results of Operations
American Express Certificate Company's (AECC's) net income is derived primarily
from the after-tax yield on investments and realized investment gains (losses),
less investment expenses and interest credited on certificate reserve
liabilities. Changes in net income trends occur largely due to changes in
investment returns, interest crediting rates to certificate products, the mix of
fully taxable and tax-advantaged investments in AECC's portfolio and from
realization of investment gains (losses). AECC follows U.S. generally accepted
accounting principles (GAAP).
Net income in 2004 decreased $3.3 million, or 6.3 percent, reflecting an
increase in investment expenses which was mainly due to the write-off of
previously deferred distribution fees paid to AEFC. Net income in 2003 increased
$6.8 million, or 14.8 percent, reflecting increased investment income, increased
gross realized gains and decreased gross realized losses on sale of investments,
partially offset by slightly higher investment expenses and a higher provision
for certificate reserves.
In 2004, investment income increased $1.4 million, or 0.5 percent, reflecting a
slight increase in investment income from available-for-sale securities offset
by a decrease in net pre-tax gains on equity index options due to the effect of
lower appreciation in the S&P 500 on the value of options hedging outstanding
stock market certificates compared to 2003. In 2003, investment income increased
$43.1 million, or 19.5 percent, reflecting a $66.0 million increase in net
pre-tax gains on equity index options, partially offset by lower investment
portfolio yields. The increase in net pre-tax gains on equity index options was
due to the effect of appreciation in the S&P 500 on the value of options
economically hedging stock market certificate products.
In 2004, provision for certificate reserves decreased $1.5 million or 1.1
percent reflecting lower appreciation in the S&P 500. In 2003, provision for
certificate reserves increased $41.2 million or 41.1 percent reflecting the
effect on stock market certificates of appreciation in the S&P 500 during 2003
versus depreciation during 2002, partially offset by lower interest crediting
rates on the interest rate sensitive portion of AECC's certificate product
portfolio.
AECC's gross realized gains on sales of securities classified as
Available-for-Sale, using the specific identification method, were $6.1 million
and $47.1 million for the years ended December 31, 2004 and 2003, respectively.
Gross realized losses on sales were ($1.1 million) and ($2.8 million) for the
same periods. AECC also recognized losses of ($0.6 million) and ($36.0 million)
in other-than-temporary impairments on Available-for-Sale securities for the
years ended December 31, 2004 and 2003, respectively.
Certain Critical Accounting Policies
AECC's significant accounting policies are described in Note 1 to the Financial
Statements. The following provides a description of the critical accounting
policy on investment securities valuation that is important to the Financial
Statements.
Investment securities valuation
Generally, investment securities are carried at fair value on the balance sheet
with unrealized gains (losses) recorded in accumulated other comprehensive
income (loss) within equity, net of income tax provisions (benefits). At
December 31, 2004, AECC had net unrealized pretax gains on
9
Available-for-Sale securities of $21.8 million. Gains and losses are recognized
in results of operations upon disposition of the securities. In addition, losses
are recognized when management determines that a decline in value is
other-than-temporary, which requires judgment regarding the amount and timing of
recovery. Indicators of other-than-temporary impairment for debt securities
include issuer downgrade, default or bankruptcy. AECC also considers the extent
to which cost exceeds fair value, the duration and size of that gap, and
management's judgment about the issuer's current and prospective financial
condition. As of December 31, 2004, there were $31.9 million in gross unrealized
losses that related to $2.7 billion of securities, of which only $321.6 million
has been in a continuous unrealized loss position for twelve months or more. As
part of its ongoing monitoring process, management has determined that
substantially all of the gross unrealized losses on these securities is
attributable to changes in interest rates. Additionally, AECC has the ability
and intent to hold these securities for a time sufficient to recover its
amortized cost and has, therefore, concluded that none of these securities is
other-than-temporarily impaired at December 31, 2004.
Liquidity and Capital Resources
AECC's principal sources of cash are receipts from sales of face-amount
certificate products and cash flows from investments. AECC's principal uses of
cash are payments to certificate product owners for matured and surrendered
certificates, purchases of investments, and return of capital or dividend
payments to AEFC.
Cash received from sales of certificates totaled $3.3 billion, $2.6 billion and
$2.0 billion for the three years ended December 31, 2004, respectively.
Certificate maturities and cash surrenders totaled $2.4 billion, $2.4 billion
and $1.8 billion for the three years ended December 31, 2004, respectively.
AECC, as an issuer of face-amount certificates, is impacted by significant
changes in interest rates as interest crediting rates on certificate products
generally reset at shorter intervals than the change in the yield on AECC's
investment portfolio. The specified maturities of most of AECC's certificate
products range from ten to twenty years. Within that maturity period, most
certificates have interest crediting rate terms ranging from one to thirty-six
months. Interest crediting rates are subject to change and certificate product
owners can surrender their certificates without penalty at term end. AECC has
investment certificate obligations totaling $5.9 billion of which $5.4 billion
have terms ending in 2005, $0.3 billion have terms ending in 2006 and $0.2
billion have terms ending in 2007. Contractholders have the right to redeem the
investment certificates earlier and at their discretion subject to a surrender
charge. Redemptions are most likely to occur in periods of dramatic increases in
interest rates. AECC has investments in mortgage and asset-backed securities,
and to a lesser extent, intermediate term corporate debt securities. AECC enters
into interest rate swap contracts that effectively lengthen the rate reset
interval on certificate products. As a result of interest rate fluctuations, the
amount of interest paid on hedged liabilities will positively or negatively
impact reported earnings. Income or loss on the derivative instruments that are
linked to the hedged liabilities will generally offset the effect of this
impact. The Company views this strategy as a prudent management of interest rate
sensitivity, such that earnings are not exposed to undue risk presented by
changes in interest rates. Also, on three series of AECC's certificates,
interest is credited to certificate products based upon the relative change in a
major stock market index between the beginning and end of the certificates'
terms. To meet the obligations related to the provisions of these equity market
sensitive certificates, AECC purchases and writes index call options on a major
stock market index and, from time to time, enters into futures contracts.
10
AECC's investment program is designed to maintain an investment portfolio that
will produce the competitive portfolio yields within acceptable risk and
liquidity parameters. AECC's investment program considers investment securities
as investments acquired to meet anticipated certificate owner obligations.
Debt securities and marketable equity securities are classified as
Available-for-Sale and are carried at fair value. The Available-for-Sale
classification does not mean AECC expects to sell these securities, but rather
these securities are available to meet possible liquidity needs should there be
significant changes in market interest rates or certificate owner redemptions.
At December 31, 2004, securities classified as Available-for-Sale were carried,
in the aggregate, at a fair market value of $5.6 billion. Based on amortized
costs, fixed maturity securities comprise 92 percent of AECC's total investment
portfolio. Of these securities, 96 percent are investment grade. Investments
primarily include mortgage and asset-backed securities and corporate debt
securities. AECC's corporate debt securities are a diverse portfolio with
concentrations in the following industries: banking and finance, utilities,
communications, food processing and retail. Other than U.S. Government Agency
mortgage-backed securities, no one issuer represents more than 1 percent of
AECC's total investment portfolio.
AECC paid AEFC return of capital amounts of $20 million and $50 million during
2004 and 2003, respectively. In addition, AEFC paid AECC a capital contribution
of $20 million during the fourth quarter of 2004.
Cash used in investing activities was $1,130.2 million and $522.5 million in
2004 and 2003, respectively. This change was primarily due to the decrease in
sales and maturities and redemptions of Available-for-Sale investments partially
offset by the increase in the amount due to brokers.
Cash provided by financing activities was $1,050.2 million and $246.8 million in
2004 and 2003, respectively. This increase primarily resulted from an increase
in the payments received from certificate owners and lower amounts of return of
capital paid to American Express Financial Corporation.
Impact of Market Volatility on Results of Operations
The sensitivity analysis of two different tests of market risk discussed below
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 and a 10 percent decline in a major
stock market index. Computation of the prospective effects of hypothetical
interest rate and major stock market index changes are based on numerous
assumptions, including relative levels of market interest rates and the major
stock market index level, as well as the levels of assets and liabilities. The
hypothetical changes and assumptions presented will be different than what
actually occurs in the future.
Furthermore, the computations do not anticipate actions that may be taken by
management if the hypothetical market changes occur over time. As a result,
actual earnings effects in the future will differ from those quantified below.
11
AECC primarily invests in mortgage and asset-backed securities, and intermediate
term corporate debt securities to provide its certificate owners with a
competitive rate of return on their certificate while managing risk. These
investments provide AECC with a historically dependable and targeted margin
between the interest rate earned on investments and the interest rate credited
to certificate owners' accounts. AECC does not invest in securities to generate
short-term trading profits for its own account.
AEFC's Asset Liability Committee (ALCO), which is comprised of senior business
managers, holds regular scheduled meetings to review models projecting various
interest rate scenarios and risk/return measures and their effect on various
portfolios managed by AEFC, including that of AECC. AECC's Board of Directors
has appointed the ALCO as the investment committee of AECC. The ALCO's
objectives are to structure AECC's portfolio of investment securities based upon
the type and behavior of the certificates in the certificate reserve
liabilities, to achieve targeted levels of profitability within defined risk
parameters and to meet certificate contractual obligations. Part of the
committee's strategy includes entering into interest rate swaps to hedge
interest rate risk.
AECC is exposed to risk associated with fluctuating interest payments from
certain certificate products tied to the London Interbank Offering Rate (LIBOR).
As such, certificate product interest crediting rates reset at shorter intervals
than the changes in the investment portfolio yield related to new investments
and reinvestments. Therefore, AECC's spreads may be negatively impacted by
increases in the general level of interest rates. AECC hedges the risk of rising
interest rates by entering into pay-fixed, receive-variable (LIBOR-based)
interest rate swaps that convert fluctuating crediting rate payments to fixed
payments, effectively protecting AECC from unfavorable interest rate movements.
The interest rate swaps are treated as cash flow hedges per Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities". At December 31, 2004, AECC had $300 million
notional of interest rate swaps expiring by February 2005.
AECC is also exposed to risk associated with fluctuations in the equity market
from three series of its certificate products. Such amounts credited to
certificate product owners' accounts are tied to the relative change in a major
stock market index between the beginning and end of the certificates' terms.
AECC purchases and writes equity index call options on a major stock market
index in order to meet such obligations.
SFAS No. 133 establishes accounting and reporting standards for derivative
instruments and hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities on the balance sheet and measure
those instruments at fair value. Changes in the fair value of a derivative are
recorded in earnings or directly to equity, depending on the instrument's
designated use. Those derivative instruments that are designated and qualify as
hedging instruments under SFAS No. 133 are further classified as either fair
value hedges, cash flow hedges or hedges of a net investment in a foreign
operation, based upon the exposure being hedged. See Note 9 to the Financial
Statements for further discussion of AECC's derivative and hedging activities.
The negative impact on AECC's annual pretax income of a 100 basis point increase
in interest rates, which assumes certificate product interest crediting rate
reset intervals and customer behavior based on the application of proprietary
models, to the book of business at December 31,
12
2004 and 2003, would be $9.8 million and $11.8 million, respectively. A 10
percent decrease in the level of a major stock market index would have a minimal
impact on AECC's annual pretax income related as of December 31, 2004 and 2003,
because the income effect is a decrease in option related income and a
corresponding decrease in interest credited to the American Express Stock Market
Certificate, American Express Market Strategy Certificate and American Express
Equity Indexed Savings Certificates product owners' accounts.
The ratio of shareholder's equity, excluding accumulated other comprehensive
income (loss) net of tax, to total assets less certificate loans and net
unrealized gains (losses) on securities classified as Available-for-Sale (the
Capital-to-Assets Ratio) at December 31, 2004 and 2003, was 5.2 percent and 5.4
percent, respectively. In accordance with an informal agreement established with
the Commissioner of Commerce for the State of Minnesota, AECC has agreed to
maintain at all times a minimum Capital-to-Assets Ratio of 5 percent. In
addition, AECC is required to maintain cash and "qualified investments" meeting
the standards of Section 28(b) of the 1940 Act, as modified by an order of the
SEC. The amortized cost of such investments must be at least equal to AECC's net
liabilities on all outstanding face-amount certificates plus $250,000. So long
as AECC wishes to rely on the SEC order, as a condition to the order, AECC has
agreed to maintain an amount of unappropriated retained earnings and capital
equal to at least 5 percent of net certificate reserves.
Other Reporting Matters
In January 2003, the Financial Accounting Standards Board issued Interpretation
No. 46, "Consolidation of Variable Interest Entities" (FIN 46), as revised,
which addresses consolidation by business enterprises of variable interest
entities (VIEs) and was subsequently revised in December 2003. In general, FIN
46 requires a VIE to be consolidated when an enterprise has a variable interest
for which it is deemed to be the primary beneficiary which means that it will
absorb a majority of the VIE's expected losses or receive a majority of the
VIE's expected residual return.
During 2003, FIN 46 did not impact the accounting for $27 million in a
minority-owned secured loan trust (SLT) or $6 million in a collateralized debt
obligation traunche (solely supported by a portfolio of high yield bonds), both
of which were managed by third parties, as AECC was not the primary beneficiary.
AECC had a 33 percent ownership interest in the SLT, which provided returns to
investors primarily based on the performance of an underlying portfolio of high
yield loans. The aggregate fair value of the loans related to AECC's pro rata
share of this structure was $92.5 million. During 2004, the minority-owned
secured loan trust and the CDO were both liquidated.
In November 2003, the FASB ratified a consensus on the disclosure provisions of
Emerging Issues Task Force Issue 03-1, "The Meaning of Other-Than-Temporary
Impairment and its Application to Certain Investments" (EITF 03-1). AECC
complied with the disclosure provisions of this rule in its Annual Report on
Form 10-K for the year ended December 31, 2003. In March 2004, the FASB reached
a consensus regarding the application of a three-step impairment model to
determine whether investments accounted for in accordance with SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities", and other
cost method investments are other-than-temporarily impaired. However, with the
issuance of FSP EITF 03-1-1 on September 30, 2004, the provisions of the
consensus relating to the measurement and recognition of other-than-temporary
13
impairments will be deferred pending further clarification from the FASB. The
remaining provisions of this rule, which primarily relate to disclosure
requirements, are required to be applied prospectively to all current and future
investments accounted for in accordance with SFAS No. 115 and other cost method
investments. The Company will evaluate the potential impact of EITF 03-1 after
the FASB completes its reassessment.
Forward-Looking Statements
Certain statements in Item 7. of this Form 10-K Annual Report contain
forward-looking statements, which are subject to risks and uncertainties. The
words "believe," "expect," "anticipate," "optimistic," "intend," "plan," "aim,"
"will," "may," "should," "could," "would," "likely," and similar expressions are
intended to identify forward-looking statements. Readers are cautioned not to
place undue reliance on these forward-looking statements, which speak only as of
the date on which they are made. AECC undertakes no obligation to update or
revise any forward-looking statements. Factors that could cause actual results
to differ materially from these forward-looking statements include, but are not
limited to: AECC's ability to successfully implement a business model that
allows for significant net income growth based on revenue growth that is lower
than historical levels, including the ability to improve its operating expense
to revenue ratio both in the short-term and over time, which will depend in part
on the effectiveness of reengineering and other cost control initiatives, as
well as factors impacting AECC's revenues; AECC's ability to grow its business,
over time, which will depend on AECC's ability to manage its capital needs and
the effect of business mix; the ability to increase investment spending, which
will depend in part on the equity markets and other factors affecting revenues,
and the ability to capitalize on such investments to improve business metrics;
the accuracy of certain critical accounting estimates, including the fair value
of the assets in AECC's investment portfolio (including those investments that
are not readily marketable), fluctuation in the equity and fixed income markets,
which can affect the amount and types of certificate products sold by AECC,
potential deterioration in AECC's high-yield and other investments, which could
result in further losses in AECC's investment portfolio; the ability of AECC to
sell certain high-yield investments at expected values and within anticipated
timeframes and to maintain its high-yield portfolio at certain levels in the
future; and spreads in the certificate businesses; credit trends and the rate of
bankruptcies, which can affect returns on AECC's investment portfolios;
fluctuations in foreign currency exchange rates, which could affect commercial
activities, among other businesses, or restrictions on convertibility of certain
currencies; changes in laws or government regulations, including tax laws
affecting AECC's businesses or that may affect the sales of the products and
services that it offers, and regulatory activity in the areas of customer
privacy, consumer protection, business continuity and data protection; the
adoption of recently issued accounting rules related to the consolidation of
variable interest entities, including those involving collateralized debt
obligations and secured loan trusts, that AECC invests in, which could affect
both AECC's balance sheet and results of operations; and outcomes and costs
associated with litigation and compliance and regulatory matters. A further
description of these and other risks and uncertainties can be found in AECC's
other reports filed with the SEC.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Items required under this section are included in the Management's Discussion
and Analysis of Financial Condition and Results of Operations under the section
titled Impact of Recent Market-Volatility on Results of Operations.
14
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Index to Financial Statements at page F-1 hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
ITEM 9A. CONTROLS AND PROCEDURES
AECC's management, with the participation of the AECC's Chief Executive Officer
and Chief Financial Officer, has evaluated the effectiveness of the Company's
disclosure controls and procedures (as such term is defined in Rules 13a-15(e)
and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the
"Exchange Act")) as of the end of the period covered by this report. Based on
such evaluation, AECC's Chief Executive Officer and Chief Financial Officer have
concluded that, as of the end of such period, the Company's disclosure controls
and procedures are effective. There have not been any changes in the Company's
internal control over financial reporting (as such term is defined in Rules
13a-15(f) and 15d-15(f) under the Exchange Act) during the Company's fourth
fiscal quarter that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial reporting.
PART III
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The Audit Committee of the Board of Directors of American Express Company has
appointed Ernst & Young LLP (Ernst & Young) as independent auditors to audit the
consolidated financial statements of AECC for the year ended December 31, 2004
and 2005.
Audit fees
The aggregate fees billed or to be billed by Ernst & Young for each of the last
two years for professional services rendered for the audit of AECC's annual
financial statements and services that were provided in connection with
statutory and regulatory filings were $113,000 for 2004 and $160,000 for 2003.
Audit-related fees
AECC was not billed by Ernst & Young for any fees for audit-related services for
2004 or 2003.
Tax fees
AECC was not billed by Ernst & Young for any tax fees for 2004 or 2003.
All other fees
AECC was not billed by Ernst & Young for any other fees for 2004 or 2003.
15
Policy on pre-approval of services provided by independent auditor
Pursuant to the requirements of the Sarbanes-Oxley Act of 2002, the terms of the
engagement of Ernst & Young are subject to the specific pre-approval of the
Audit Committee of American Express Company. All audit and permitted non-audit
services to be performed by Ernst & Young for AECC require pre-approval by the
Audit Committee of American Express Company in accordance with pre-approval
procedures established by the Audit Committee of American Express Company. The
procedures require all proposed engagements of Ernst & Young for services to
AECC of any kind to be directed to the General Auditor of American Express
Company and then submitted for approval to the Audit Committee of American
Express Company prior to the beginning of any services.
In addition, the charter of AECC's Audit Committee requires pre-approval of any
engagement, including the fees and other compensation, of Ernst & Young (1) to
provide any services to AECC and prohibits the performance of certain specified
non-audit services, and (2) to provide any non-audit services to AEFC or any
affiliate of AEFC that controls, is controlled by, or under common control with
AEFC. Certain exceptions apply to the pre-approval requirement.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements:
See Index to Financial Statements on page F-1 hereof.
2. Financial Statement Schedules:
See Index to Financial Statements on page F-1 hereof.
3. Exhibits:
See Exhibit Index on pages E-1 through E-4 hereof.
(b) Reports on Form 8-K:
There were no reports on Form 8-K filed by AECC during the quarterly
period ended December 31, 2004.
16
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
REGISTRANT American Express Certificate Company
BY /s/ Paula R. Meyer
------------------
NAME AND TITLE Paula R. Meyer, President
DATE March 14, 2005
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
BY /s/ Paula R. Meyer
------------------
NAME AND TITLE Paula R. Meyer, President and
Director
(Principal Executive Officer)
DATE March 14, 2005
BY /s/ Brian J. McGrane
------------------------
NAME AND TITLE Brian J. McGrane, Vice President
and Chief Financial Officer
(Principal Financial Officer)
DATE March 14, 2005
BY /s/ David K. Stewart
--------------------
NAME AND TITLE David K. Stewart, Vice President
and Controller
(Principal Accounting Officer)
DATE March 14, 2005
BY /s/ Rodney P. Burwell*
----------------------
NAME AND TITLE Rodney P. Burwell, Director
DATE March 14, 2005
BY /s/ Jean B. Keffeler*
-------------------------
NAME AND TITLE Jean B. Keffeler, Director
DATE March 14, 2005
17
BY /s/ Thomas R. McBurney*
----------------------------
NAME AND TITLE Thomas R. McBurney, Director
DATE March 14, 2005
BY /s/ Karen M. Bohn*
----------------------
NAME AND TITLE Karen M. Bohn, Director
DATE March 14, 2005
*By /s/ Paula R. Meyer
--------------------
Name: Paula R. Meyer
Executed by Paula R. Meyer on behalf of those indicated pursuant to a Power of
Attorney dated February 22, 2005, filed electronically herewith as Exhibit
24(a).
- --------------------------------------------------------------------------------
18
Index to Financial Statements and Schedules
Financial Statements:
Part I. Financial Information:
Item 1. Financial Statements
Responsibility of Management F-2
Report of Independent Registered Public Accounting Firm F-3
Balance Sheets - December 31, 2004 and 2003 F-4 - F-5
Statements of Operations - Years ended December
31, 2004, 2003 and 2002 F-6 - F-7
Statements of Cash Flows - Years ended December
31, 2004, 2003 and 2002 F-8
Statements of Comprehensive Income - Years ended
December 31, 2004, 2003 and 2002 F-9
Statements of Shareholder's Equity - Years ended
December 31, 2004, 2003 and 2002 F-10
Notes to Financial Statements F-11 - F-30
Schedule No.:
Financial Schedules:
I Investments in Securities of Unaffiliated Issuers,
December 31, 2004
F-31 - F-45
II Investments in and Advances to Affiliates and Income
thereon, December 31, 2004, 2003 and 2002 F-46 - F-47
III Mortgage Loans on Real Estate and Interest earned on
Mortgages, year ended December 31, 2004 F-48 - F-51
V Qualified Assets on Deposit, December 31, 2004 F-52
VI Certificate Reserves, year ended December 31, 2004 F-53 - F-70
VII Valuation and Qualifying Accounts, years ended
December 31, 2004, 2003 and 2002 F-71
Schedules I, III, V and VI for the years ended December 31, 2003 and 2002 are
included in Registrant's Annual Reports on Form 10-K, and are incorporated
herein by reference.
All other Schedules required by Article 6 of the Regulation S-X are not required
under the related instructions or are inapplicable and therefore have been
omitted.
F-1
American Express Certificate Company
Responsibility of Management
The management of American Express Certificate Company (AECC) is responsible for
the preparation and fair presentation of its Financial Statements, which have
been prepared in conformity with U.S. generally accepted accounting principles;
and include amounts based on the best judgment of management. AECC's management
is also responsible for the accuracy and consistency of other financial
information included in this filing.
In recognition of its responsibility for the integrity and objectivity of data
in the financial statements, AECC maintains a system of internal control over
financial reporting which is designed to provide reasonable, but not absolute,
assurance with respect to the reliability of AECC's financial statements. The
concept of reasonable assurance is based on the notion that the cost of internal
control system should not exceed the benefits derived.
The internal control system is founded on an ethical climate and includes: (i)
an organizational structure with clearly defined lines of responsibility,
policies and procedures; (ii) a Code of Conduct; and (iii) a careful selection
and training of employees. Internal auditors monitor and assess the
effectiveness of internal control system and report their findings to management
and the Board of Directors throughout the year. AECC's independent auditors are
engaged to express an opinion on the year-end financial statements and, with the
coordinated support of the internal auditors, review the financial records and
related data and test internal control system over financial reporting to the
extent they believed necessary to support their report.
F-2
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
American Express Certificate Company
We have audited the accompanying balance sheets of American Express Certificate
Company (the Company), a wholly-owned subsidiary of American Express Financial
Corporation, as of December 31, 2004 and 2003, and the related statements of
operations, comprehensive income, shareholder's equity and cash flows for each
of the three years in the period ended December 31, 2004. Our audits also
include the financial statement schedules listed in the index at Item 8. These
financial statements and schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company's internal control
over financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. Our procedures included confirmation of
investments owned as of December 31, 2004 and 2003, by correspondence with the
custodian. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of the Company at December 31,
2004 and 2003, the results of its operations and its cash flows for each of the
three years in the period ended December 31, 2004, in conformity with U.S.
generally accepting accounting principles. Also, in our opinion, the related
financial statement schedules, when considered in relation to the basic
financial statements taken as a whole, present fairly in all material respects
the information set forth therein.
/s/ ERNST & YOUNG LLP
Minneapolis, Minnesota
February 18, 2005
F-3
Balance Sheets
AMERICAN EXPRESS CERTIFICATE COMPANY
December 31, (Thousands, except share amount) 2004 2003
- -------------------------------------------------------------------------------------------------------------
Assets
Qualified Assets (Note 2)
- -------------------------------------------------------------------------------------------------------------
Investments in unaffiliated issuers (Note 3):
Cash and cash equivalents $ 35,212 $ 25,099
Available-for-Sale securities 5,603,789 4,509,726
First mortgage loans on real estate and other loans 461,211 469,309
Certificate loans - secured by certificate reserves 13,006 15,606
- -------------------------------------------------------------------------------------------------------------
Total investments 6,113,218 5,019,740
- -------------------------------------------------------------------------------------------------------------
Receivables:
Dividends and interest 42,162 36,007
Investment securities sold 3,699 7,946
- -------------------------------------------------------------------------------------------------------------
Total receivables 45,861 43,953
- -------------------------------------------------------------------------------------------------------------
Equity index options (Note 9) 116,285 153,162
- -------------------------------------------------------------------------------------------------------------
Total qualified assets 6,275,364 5,216,855
- -------------------------------------------------------------------------------------------------------------
Other Assets
- -------------------------------------------------------------------------------------------------------------
Due from AEFC for federal income taxes - 22,963
Deferred taxes, net (Note 8) 34,483 9,321
Due from other affiliates 1,939 -
Deferred distribution fees and other - 6,453
- -------------------------------------------------------------------------------------------------------------
Total other assets 36,422 38,737
- -------------------------------------------------------------------------------------------------------------
Total assets $ 6,311,786 $ 5,255,592
- -------------------------------------------------------------------------------------------------------------
See Notes to Financial Statements
F-4
Balance Sheets (continued)
AMERICAN EXPRESS CERTIFICATE COMPANY
December 31, (Thousands, except share amount) 2004 2003
- -------------------------------------------------------------------------------------------------------------
Liabilities and Shareholder's Equity
Liabilities
- -------------------------------------------------------------------------------------------------------------
Certificate Reserves (Note 5):
Installment certificates:
Reserves to mature $ 116,637 $ 146,052
Additional credits and accrued interest 3,092 3,514
Advance payments and accrued interest 474 499
Other 2 32
Fully paid certificates:
Reserves to mature 5,666,939 4,573,514
Additional credits and accrued interest 48,053 64,114
Due to unlocated certificate holders 46 92
- -------------------------------------------------------------------------------------------------------------
Total certificate reserves 5,835,243 4,787,817
- -------------------------------------------------------------------------------------------------------------
Accounts Payable and Accrued Liabilities:
Due to AEFC (Note 7) 1,190 880
Due to other affiliates (Note 7) 687 560
Current taxes payable (Note 8) 16,096 -
Payable for investment securities purchased 25,541 9,173
Equity index options and other liabilities (Note 9) 89,960 133,949
- -------------------------------------------------------------------------------------------------------------
Total accounts payable and accrued liabilities 133,474 144,562
- -------------------------------------------------------------------------------------------------------------
Total liabilities 5,968,717 4,932,379
- -------------------------------------------------------------------------------------------------------------
Commitments (Note 4)
- -------------------------------------------------------------------------------------------------------------
Shareholder's Equity (Note 6)
- -------------------------------------------------------------------------------------------------------------
Common stock, $10 par - authorized and issued 150,000 shares 1,500 1,500
Additional paid-in capital 323,844 323,844
Retained earnings:
Appropriated for pre-declared additional credits and interest 549 184
Appropriated for additional interest on advance payments 15 15
Unappropriated 2,712 (46,556)
Accumulated other comprehensive income - net of tax (Note 1) 14,449 44,226
- -------------------------------------------------------------------------------------------------------------
Total shareholder's equity 343,069 323,213
- -------------------------------------------------------------------------------------------------------------
Total liabilities and shareholder's equity $ 6,311,786 $ 5,255,592
- -------------------------------------------------------------------------------------------------------------
See Notes to Financial Statements
F-5
Statements of Operations
AMERICAN EXPRESS CERTIFICATE COMPANY
Years ended December 31, (Thousands) 2004 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Investment Income
Interest income from unaffiliated investments:
Available-for-Sale securities $ 213,125 $ 204,932 $ 227,609
Mortgage loans on real estate and other loans 26,232 27,093 27,719
Certificate loans 772 933 1,095
Dividends 3,348 5,074 9,949
Equity index options (Note 9) 25,639 29,538 (36,421)
Interest rate swap agreements (Note 9) (5,367) (5,301) (9,780)
Other 1,879 1,969 980
- ----------------------------------------------------------------------------------------------------------------------
Total investment income 265,628 264,238 221,151
- ----------------------------------------------------------------------------------------------------------------------
Investment Expenses
AEFC and affiliated company fees (Note 7):
Distribution 37,960 29,731 29,762
Investment advisory and services 10,940 10,436 9,980
Transfer agent 3,522 3,378 3,203
Depository 414 349 321
Other 1,162 523 360
- ----------------------------------------------------------------------------------------------------------------------
Total investment expenses 53,998 44,417 43,626
- ----------------------------------------------------------------------------------------------------------------------
Net investment income before provision for certificate reserves
and income tax benefit $ 211,630 $ 219,821 $ 177,525
See Notes to Financial Statements
F-6
Statements of Operations (continued)
AMERICAN EXPRESS CERTIFICATE COMPANY
Years ended December 31, (Thousands) 2004 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Provision for Certificate Reserves (Note 5)
According to the terms of the certificates:
Provision for certificate reserves $ 6,416 $ 6,043 $ 7,888
Interest on additional credits 348 425 543
Interest on advance payments 16 17 19
Additional credits/interest authorized by AECC:
On fully paid certificates 131,888 132,975 88,201
On installment certificates 2,650 3,379 4,757
- ----------------------------------------------------------------------------------------------------------------------
Total provision for certificate reserves before reserve recoveries 141,318 142,839 101,408
Reserve recoveries from terminations prior to maturity (1,360) (1,356) (1,156)
- ----------------------------------------------------------------------------------------------------------------------
Net provision for certificate reserves 139,958 141,483 100,252
- ----------------------------------------------------------------------------------------------------------------------
Net investment income before income tax expense 71,672 78,338 77,273
Income tax expense (Note 8) (25,040) (27,296) (24,866)
- ----------------------------------------------------------------------------------------------------------------------
Net investment income 46,632 51,042 52,407
- ----------------------------------------------------------------------------------------------------------------------
Net realized gain (loss) on investments
Securities of unaffiliated issuers before income tax
benefit (expense) 4,616 2,944 (9,899)
Income tax (expense) benefit (Note 8) (1,615) (1,031) 3,631
- ----------------------------------------------------------------------------------------------------------------------
Net realized gain (loss) on investments 3,001 1,913 (6,268)
- ----------------------------------------------------------------------------------------------------------------------
Net income $ 49,633 $ 52,955 $ 46,139
- ----------------------------------------------------------------------------------------------------------------------
See Notes to Financial Statements
F-7
Statements of Cash Flows
AMERICAN EXPRESS CERTIFICATE COMPANY
Years Ended December 31, (Thousands) 2004 2003 2002
- -------------------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities
Net income $ 49,633 $ 52,955 $ 46,139
Adjustments to reconcile net income to net
cash provided by operating activities:
Interest added to certificate loans (530) (630) (738)
Amortization of premiums, accretion of discounts, net 17,915 14,907 (2,426)
Deferred taxes, net (9,127) (38,877) (3,288)
Net realized (gain) loss on investments before income tax
provision (4,616) (2,944) 9,899
Changes in other operating assets and liabilities:
Deferred distribution fees, net 6,453 (479) 1,801
Equity index options purchased and written, net (946) 44,273 13,306
Dividends and interest receivable (6,155) (1,893) 4,184
Due to American Express Financial Corporation - federal
income taxes 37,553 - 3,908
Other assets and liabilities, net (114) (6,856) (9,911)
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 90,066 60,456 62,874
- -------------------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Available-for-Sale investments:
Sales 124,575 1,132,131 887,193
Maturities and redemptions 842,427 1,305,953 1,111,493
Purchases (2,126,951) (2,626,239) (2,228,071)
Other investments:
Sales 25,022 16,972 59,515
Maturities and redemptions 128,463 117,159 39,195
Purchases (144,660) (231,478) (210,061)
Certificate loans:
Payments 1,902 2,805 2,919
Fundings (1,558) (1,553) (2,085)
Changes in amounts due to and from brokers, net 20,615 (238,262) 97,482
- -------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (1,130,165) (522,512) (242,420)
- -------------------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities
Payments from certificate owners 3,285,610 2,571,209 2,031,414
Net provision for certificate reserves 139,958 141,483 100,252
Certificate maturities and cash surrenders (2,375,356) (2,415,860) (1,788,995)
Payment of capital from American Express Financial Corporation 20,000 - -
Return of capital to American Express Financial Corporation (20,000) (50,000) (10,000)
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 1,050,212 246,832 332,671
- -------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 10,113 (215,224) 153,125
Cash and cash equivalents at beginning of year 25,099 240,323 87,198
- -------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 35,212 $ 25,099 $ 240,323
- -------------------------------------------------------------------------------------------------------------------------
See Notes to Financial Statements
F-8
Statements of Comprehensive Income
AMERICAN EXPRESS CERTIFICATE COMPANY
Years Ended December 31, (Thousands) 2004 2003 2002
- --------------------------------------------------------------------------------------------------------------------------
Net income $ 49,633 $ 52,955 $ 46,139
- --------------------------------------------------------------------------------------------------------------------------
Other comprehensive (loss) income net of tax
- --------------------------------------------------------------------------------------------------------------------------
Unrealized (losses) gains on Available-for-Sale securities:
Unrealized holding (losses) gains arising during period (47,844) (52,669) 82,904
Income tax benefit (provision) 16,745 18,434 (29,016)
- --------------------------------------------------------------------------------------------------------------------------
Net unrealized holding (losses) gains arising during the period (31,099) (34,235) 53,888
- --------------------------------------------------------------------------------------------------------------------------
Reclassification adjustment for (gains) losses included in net
income (4,395) (8,260) 8,142
Income tax provision (benefit) 1,538 2,891 (2,850)
- --------------------------------------------------------------------------------------------------------------------------
Net reclassification adjustment for (gains) losses included in net
income (2,857) (5,369) 5,292
- --------------------------------------------------------------------------------------------------------------------------
Net unrealized (losses) gains on Available-for-Sale securities (33,956) (39,604) 59,180
- --------------------------------------------------------------------------------------------------------------------------
Unrealized gains (losses) on interest rate swaps:
Unrealized gains (losses) arising during the period 1,062 (4,579) (8,141)
Income tax (benefit) provision (372) 1,603 2,849
- --------------------------------------------------------------------------------------------------------------------------
Net unrealized holding gains (losses) arising during the period 690 (2,976) (5,292)
- --------------------------------------------------------------------------------------------------------------------------
Reclassification adjustment for gains included in net income 5,367 5,300 9,780
Income tax benefit (1,878) (1,855) (3,423)
- --------------------------------------------------------------------------------------------------------------------------
Net reclassification adjustment for losses included in net income 3,489 3,445 6,357
- --------------------------------------------------------------------------------------------------------------------------
Net unrealized gains on interest rate swaps 4,179 469 1,065
- --------------------------------------------------------------------------------------------------------------------------
Net other comprehensive (loss) income (29,777) (39,135) 60,245
- ----------------------------------------------------------------------------------------------------------- --------------
Total comprehensive income $ 19,856 $ 13,820 $ 106,384
- --------------------------------------------------------------------------------------------------------------------------
See Notes to Financial Statements
F-9
Statements of Shareholder's Equity
AMERICAN EXPRESS CERTIFICATE COMPANY
Years Ended December 31, (Thousands) 2004 2003 2002
- --------------------------------------------------------------------------------------------------------------------------
Common Stock $ 1,500 $ 1,500 $ 1,500
- --------------------------------------------------------------------------------------------------------------------------
Additional Paid-in Capital
Balance at beginning of year $ 323,844 $ 373,844 $ 383,844
Receipt of capital from Parent 20,000 - -
Return of capital to Parent (20,000) (50,000) (10,000)
- --------------------------------------------------------------------------------------------------------------------------
Balance at end of year $ 323,844 $ 323,844 $ 373,844
- --------------------------------------------------------------------------------------------------------------------------
Retained Earnings
Appropriated for pre-declared additional credits/interest
(Note 5)
Balance at beginning of year $ 184 $ 811 $ 1,123
Transferred from (to) unappropriated retained earnings 365 (627) (312)
- --------------------------------------------------------------------------------------------------------------------------
Balance at end of year $ 549 $ 184 $ 811
- --------------------------------------------------------------------------------------------------------------------------
Appropriated for additional interest on advance payments $ 15 $ 15 $ 15
- --------------------------------------------------------------------------------------------------------------------------
Unappropriated (Note 6)
Balance at beginning of year $ (46,556) $ (100,142) $ (146,593)
Net income 49,633 52,955 46,139
Transferred (to) from appropriated retained earnings (365) 627 312
Other - 4 -
- --------------------------------------------------------------------------------------------------------------------------
Balance at end of year $ 2,712 $ (46,556) $ (100,142)
- --------------------------------------------------------------------------------------------------------------------------
Accumulated other comprehensive income - net of tax
Balance at beginning of year $ 44,226 $ 83,361 $ 23,116
Net other comprehensive (loss) income (29,777) (39,135) 60,245
- --------------------------------------------------------------------------------------------------------------------------
Balance at end of year $ 14,449 $ 44,226 $ 83,361
- --------------------------------------------------------------------------------------------------------------------------
Total shareholder's equity $ 343,069 $ 323,213 $ 359,389
- --------------------------------------------------------------------------------------------------------------------------
See Notes to Financial Statements
F-10
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of business
American Express Certificate Company (AECC), is a wholly-owned subsidiary of
American Express Financial Corporation (AEFC), which is a wholly-owned
subsidiary of American Express Company. AECC is registered as an investment
company under the Investment Company Act of 1940 ("the 1940 Act") and is in the
business of issuing face-amount investment certificates. Face-amount
certificates issued by AECC entitle the certificate owner to receive at maturity
a stated amount of money and interest or credits declared from time to time by
AECC, at its discretion. The certificates issued by AECC are not insured by any
government agency. AECC's certificates are sold primarily by American Express
Financial Advisor Inc. (AEFAI) and American Express Bank Ltd. (AEB), both
affiliates of AECC. AEFAI is registered as a broker dealer in all 50 states, the
District of Columbia and Puerto Rico. AEFC acts as investment advisor for AECC.
As of December 31, 2004, AECC offered nine different certificate products to the
public. AECC is impacted by significant changes in interest rates as interest
crediting rates on certificate products generally reset at shorter intervals
than the change in the yield on AECC's investment portfolio. The specified
maturities of most of AECC's certificate products range from ten to twenty
years. Within that maturity period, most certificates have interest crediting
rate terms ranging from one to thirty-six months. Interest crediting rates are
subject to change and certificate product owners can surrender their
certificates without penalty at term end. In addition, three types of
certificate products have interest tied, in whole or in part, to a broad-based
stock market index. Except for two types of certificate products, all of the
certificates are available as qualified investments for Individual Retirement
Accounts, 401(k) plans and other qualified retirement plans.
AECC's net investment income is derived primarily from interest and dividends
generated by its investments. AECC's net income is determined by deducting from
net investment income provision expenses for certificate reserves, and other
expenses, including taxes, fees paid to AEFC for investment advisory and other
services, distribution fees paid to AEFAI, and marketing fees paid to AEB, a
wholly-owned indirect subsidiary of American Express Company.
Basis of financial statement presentation
The accompanying financial statements are presented in accordance with U.S.
generally accepted accounting principles. AECC uses the equity method of
accounting for its wholly-owned unconsolidated subsidiary, Investors Syndicate
Development Corporation, as prescribed by the Securities and Exchange Commission
(SEC) for non-investment company subsidiaries. Certain reclassifications of
prior period amounts have been made to conform to the current presentation.
Accounting estimates are an integral part of the Financial Statements. In part,
they are based upon assumptions concerning future events. Among the more
significant is investment securities valuation as discussed in Note 3. These
accounting estimates reflect the best judgment of management and actual results
could differ.
F-11
Fair values of financial instruments
The fair values of financial instruments disclosed in the notes to financial
statements are estimates based upon current market conditions and perceived
risks, and require varying degrees of management judgment.
Interest income
Interest income is accrued as earned using the effective interest method, which
makes an adjustment for security premiums and discounts, so that the related
security recognizes a constant rate of return on the outstanding balance
throughout its term.
Preferred stock dividend income
AECC recognizes dividend income from cumulative redeemable preferred stocks with
fixed maturity amounts on an accrual basis similar to that used for recognizing
interest income on debt securities. Dividend income from perpetual preferred
stock is recognized on an ex-dividend date basis.
Cash and cash equivalents
AECC has defined cash and cash equivalents as cash in banks and highly liquid
investments with original maturities of ninety days or less.
Available-for-Sale investments
Debt securities and marketable equity securities are classified as
Available-for-Sale and carried at fair value. Unrealized gains (losses) on
securities classified as Available-for-Sale are reflected, net of taxes, in
accumulated other comprehensive income as part of Shareholder's Equity.
The basis for determining cost in computing realized gains (losses) on
securities is specific identification. Gains (losses) are recognized in the
results of operations upon disposition of the securities. In addition, losses
are also recognized when management determines that a decline in value is
other-than-temporary, which requires judgment regarding the amount and timing of
recovery. Indicators of other-than-temporary impairment for debt securities
include issuer downgrade, default or bankruptcy. AECC also considers the extent
to which cost exceeds fair value, the duration of time of that decline and
management's judgment as to the issuer's current and prospective financial
condition. The charges are reflected in net realized gain (loss) on investments
in the statements of operations.
Fair value is generally based on quoted market prices. However, AECC's
investment portfolio contained structured investments of various asset quality
as of December 31, 2003, which were not readily marketable. As a result, the
carrying values of these structured investments were based on future cash flow
projections that required a significant degree of management judgment as to the
amount and timing of cash payments, defaults and recovery rates of the
underlying investments and as such, are subject to change. The structured
investments were called in 2004 and AECC has no exposure as of December 31,
2004.
First mortgage loans on real estate and other loans
First mortgage loans on real estate reflect principal amounts outstanding less
reserves for losses, which is the basis for determining realized gains (losses).
Estimated fair values of mortgage loans on real estate are determined by a
discounted cash flow analysis using mortgage interest rates
F-12
currently offered for mortgages of similar maturities. Other loans reflect
amortized cost less reserve for losses. Fair values of other loans represent
estimated fair values when quoted prices are not available.
The reserve for loan losses is measured as the excess of the loan's recorded
investment over its present value of expected principal and interest payments
discounted at the loan's effective interest rate or the fair value of
collateral. Additionally, the level of the reserve account is determined based
on several factors, including historical experience and current economic and
political conditions. Management regularly evaluates the adequacy of the reserve
for loan losses, and believes it is adequate to absorb estimated losses in the
portfolio.
AECC generally stops accruing interest on mortgage loans on real estate for
which interest payments are delinquent more than three months. Based on
management's judgment as to the ultimate collectibility of principal, interest
payments received are either recognized as income or applied to the recorded
investment in the loan.
Certificate Reserves
Investment certificates may be purchased either with a lump-sum payment or by
installment payments. Certificate product owners are entitled to receive, at
maturity, a definite sum of money. Payments from certificate owners are credited
to investment certificate reserves. Investment certificate reserves accumulate
interest at specified percentage rates as declared by AECC. Reserves also are
maintained for advance payments made by certificate owners, accrued interest
thereon, and for additional credits in excess of minimum guaranteed rates and
accrued interest thereon. On certificates allowing for the deduction of a
surrender charge, the cash surrender values may be less than accumulated
investment certificate reserves prior to maturity dates. Cash surrender values
on certificates allowing for no surrender charge are equal to certificate
reserves. The payment distribution, reserve accumulation rates, cash surrender
values, reserve values and other matters are governed by the 1940 Act.
Deferred distribution fees and other
Prior to September 30, 2004, distribution fees on sales of certain certificate
products were deferred and amortized over the estimated lives of the related
certificates, which was generally one year but could have been up to 10 years.
Upon surrender prior to maturity, unamortized deferred distribution fees were
reflected in expenses and any related surrender charges were reflected as a
reduction to the provision expense for certificate reserves. During the third
quarter of 2004, and based on management's recent review of AECC's certificate
product portfolio mix and certificate portfolio maturities, AECC determined it
to be appropriate to not defer distribution fees in the future and to completely
write-down previously deferred balances to zero. As a result of these actions,
investment expenses increased $5.7 million on a pre-tax basis during the third
quarter of 2004.
Federal income taxes
AECC's taxable income is included in the consolidated federal income tax return
of American Express Company. AECC provides for income taxes on a separate return
basis, except that, under an agreement between AEFC and American Express
Company, tax benefits are recognized for losses to the extent they can be used
in the consolidated return. It is the policy of AEFC and its subsidiaries that
AEFC will reimburse its subsidiaries for any tax benefits recorded.
F-13
Supplemental Disclosures of Cash Flow Information
Net cash paid for income taxes in 2004, 2003 and 2002 was $6.5 million, ($71.6)
million and ($22.2) million, respectively. Certificate maturities and surrenders
through loan reductions in 2004, 2003 and 2002 was $2.8 million, $2.4 million
and $3.1 million, respectively.
Recently Issued Accounting Standards
In January 2003, the Financial Accounting Standards Board issued Interpretation
No. 46, "Consolidation of Variable Interest Entities" (FIN 46), as revised,
which addresses consolidation by business enterprises of variable interest
entities (VIEs) and was subsequently revised in December 2003. In general, FIN
46 requires a VIE to be consolidated when an enterprise has a variable interest
for which it is deemed to be the primary beneficiary which means that it will
absorb a majority of the VIE's expected losses or receive a majority of the
VIE's expected residual return.
During 2003, FIN 46 did not impact the accounting for $27 million in a
minority-owned secured loan trust (SLT) or $6 million in a collateralized debt
obligation traunche (solely supported by a portfolio of high yield bonds), both
of which were managed by third parties, as AECC was not the primary beneficiary.
AECC had a 33 percent ownership interest in the SLT, which provided returns to
investors primarily based on the performance of an underlying portfolio of high
yield loans. The aggregate fair value of the loans related to AECC's pro rata
share of this structure was $92.5 million. During 2004, the minority-owned
secured loan trust and the CDO were both liquidated.
In November 2003, the FASB ratified a consensus on the disclosure provisions of
Emerging Issues Task Force Issue 03-1, "The Meaning of Other-Than-Temporary
Impairment and its Application to Certain Investments" (EITF 03-1). AECC
complied with the disclosure provisions of this rule in its Annual Report on
Form 10-K for the year ended December 31, 2003. In March 2004, the FASB reached
a consensus regarding the application of a three-step impairment model to
determine whether investments accounted for in accordance with SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities", and other
cost method investments are other-than-temporarily impaired. However, with the
issuance of FSP EITF 03-1-1 on September 30, 2004, the provisions of the
consensus relating to the measurement and recognition of other-than-temporary
impairments will be deferred pending further clarification from the FASB. The
remaining provisions of this rule, which primarily relate to disclosure
requirements, are required to be applied prospectively to all current and future
investments accounted for in accordance with SFAS No. 115 and other cost method
investments. The Company will evaluate the potential impact of EITF 03-1 after
the FASB completes its reassessment.
2. DEPOSIT OF ASSETS AND MAINTENANCE OF QUALIFIED ASSETS
Under the provisions of its certificates and the 1940 Act, AECC was required to
have Qualified Assets (as that term is defined in Section 28(b) of the 1940 Act)
in the amount of $5.8 billion and $4.8 billion at December 31, 2004 and 2003,
respectively. AECC reported Qualified Assets of $6.2 billion and $5.1 billion at
December 31, 2004 and 2003, respectively, excluding net unrealized pretax gains
on Available-for-Sale securities of $22 million and $74 million at
F-14
December 31, 2004 and 2003, respectively, and unsettled investment purchases of
$26 million and $9 million at December 31, 2004 and 2003, respectively.
Qualified Assets are valued in accordance with such provisions of Minnesota
Statutes as are applicable to investments of life insurance companies. These
values are the same as financial statement carrying values, except for debt
securities classified as Available-for-Sale and all marketable equity
securities, which are carried at fair value in the financial statements but are
valued at either amortized cost, market value or par value based on the state
requirements for qualified asset and deposit maintenance purposes.
Pursuant to provisions of the certificates, the 1940 Act, the central depository
agreement and requirements of various states, qualified assets (accounted for on
a trade date basis) of AECC were deposited as follows:
December 31, 2004
--------------------------------------------------
Required
(Thousands) Deposits Deposits Excess
- ----------------------------------------------------------------------------------------------------------------
Deposits to meet certificate liability requirements:
Pennsylvania (at market value) $ 155 $ 100 $ 55
Texas, Illinois, New Jersey (at par value) $ 215 $ 185 $ 30
Central Depository (at amortized cost) $ 6,133,903 $ 5,791,501 $ 342,402
- ----------------------------------------------------------------------------------------------------------------
December 31, 2003
--------------------------------------------------
Required
(Thousands) Deposits Deposits Excess
- -----------------------------------------------------------------------------------------------------------------
Deposits to meet certificate liability requirements:
Pennsylvania (at market value) $ 162 $ 100 $ 62
Texas, Illinois, New Jersey (at par value) $ 215 $ 185 $ 30
Central Depository (at amortized cost) $ 5,004,553 $ 4,742,572 $ 261,981
- ----------------------------------------------------------------------------------------------------------------
The assets on deposit with the central depository at December 31, 2004 and 2003
consisted of securities and other loans having a deposit value of $5.7 billion
and $4.6 billion, respectively, mortgage loans on real estate of $322 million
and $331 million, respectively, and other investments of $81 million and $74
million, respectively. Additionally, these assets on deposit include unsettled
purchases of investments in the amount of $26 million and $9 million at December
31, 2004 and 2003, respectively.
American Express Trust Company, the custodian for AECC, is the Central
Depository. See Note 7.
3. INVESTMENTS IN UNAFFILIATED ISSUERS
Fair values of investments in securities represent market prices or estimated
fair values when quoted prices are not available. Estimated fair values are
determined by using established
F-15
procedures involving, among other things, review of market indexes, price levels
of current offerings and comparable issues, price estimates, estimated future
cash flows, and market data from independent brokers.
Investments classified as Available-for-Sale securities at December 31 are
distributed by type as presented below:
2004
--------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
(Thousands) Cost Gains Losses Value
- ---------------------------------------------------------------------------------------------------------------
Mortgage and asset-backed securities $ 3,226,417 $ 23,251 $ (17,372) $ 3,232,296
Corporate debt securities 2,279,295 29,927 (14,043) 2,295,179
Stated maturity preferred stock 24,043 348 (9) 24,382
Perpetual preferred stock 17,782 168 (81) 17,869
U.S. Government & agency obligations 25,365 62 (120) 25,307
State and municipal obligations 9,048 2 (294) 8,756
- ---------------------------------------------------------------------------------------------------------------
Total $ 5,581,950 $ 53,758 $ (31,919) $ 5,603,789
- ---------------------------------------------------------------------------------------------------------------
2003
-------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
(Thousands) Cost Gains Losses Value
- ----------------------------------------------------------------------------------------------------------------
Mortgage and asset-backed securities $ 2,605,686 $ 35,954 $ (10,975) $ 2,630,665
Corporate debt securities 1,710,353 53,497 (7,762) 1,756,088
Stated maturity preferred stock 44,340 1,178 (34) 45,484
Structured Investments 32,592 1,788 - 34,380
Perpetual preferred stock 17,782 270 - 18,052
U.S. Government & agency obligations 15,355 350 - 15,705
State and municipal obligations 9,539 6 (214) 9,331
Common Stock - 21 - 21
- ----------------------------------------------------------------------------------------------------------------
Total $ 4,435,647 $ 93,06