發現金融 (DFS) 2020 Q3 法說會逐字稿

Good morning.

Good afternoon.

My name is Maria, and I will be your conference operator today.

At this time, I would like to welcome everyone to the Third Quarter 2020 Discover Financial Services Earnings Conference Call.

(Operator Instructions)

Thank you.

I will now turn the call over to Mr. Craig Streem, Head of Investor Relations.

Please go ahead.

Thank you, Maria, and good morning, everybody.

Welcome to today's call.

We will begin this morning on Slide 2 of our earnings presentation, which you can find in the financial section of our Investor Relations website, investorrelations.discover.com.

Our discussion today contains certain forward-looking statements that are subject to risks and uncertainties that may cause actual results to differ materially.

Please refer to our notices regarding forward-looking statements that appear in today's earnings press release and presentation.

Our call today will include remarks from our CEO, Roger Hochschild; and John Greene, our Chief Financial Officer.

And after we conclude our formal comments, there will be time for question-and-answer session.

During the Q&A session, please limit yourself to one question.

And if you have a follow-up, please queue back in so we can accommodate as many participants as possible.

Now as always, it's pleasure to turn the call over to Roger.

Thanks, Craig, and thanks to our listeners for joining today's call.

In these uniquely challenging times, I'm pleased with Discover's results and how well our business model has performed.

In the third quarter, we earned $771 million after tax or $2.45 per share.

We clearly benefited from the actions we took in the first half of this year to protect employees, manage credit risk and control costs while preserving momentum on long-term investments.

While significant uncertainty remains as to the extent and timing of a recovery, we were pleased to see the return to year-over-year sales growth in September.

Managing credit remains a top priority.

We entered this recession from a strong credit position due to our traditionally conservative approach to underwriting as well as actions taken over the past few years to reduce our contingent liability and tighten credit at the margin.

We quickly implemented changes to credit policy at the onset of the pandemic, including tightening criteria for new accounts and line increases and additional income verification.

While we saw very strong credit performance this quarter, we expect to see deterioration in the coming quarters as the prime consumer may be impacted by increasing permanent white collar unemployment.

That said, we believe we have taken the appropriate credit actions and don't see the need to make significant changes at this time.

The improvements in sales volume continued during the quarter, with a return to growth in the month of September.

Sales have improved across all categories, with particular strength in online retail, home improvement and everyday spend categories, partially offset by continued weakness in travel and entertainment spending.

Loan growth continues to be affected by the pandemic, with total loans down 4% year-over-year, including card loans down 6% and personal loans down 5%.

The drop in spending during the pandemic and our own credit tightening has impacted loan growth, but another driver has been significantly higher payment rate in our card and personal loan portfolios.

Consumers have had improved household cash flows due to reduced spending and government stimulus and have taken this opportunity to boost savings and make larger payments against their loans.

In our student loan business, originations in the peak season were down year-over-year reflecting the large number of students who chose not to enroll this fall.

Even in this challenging environment, our organic student loans were up 7%, reflecting innovative features like our multiyear loan and our strong competitive position.

In terms of operating expenses, we remain on track to deliver $400 million of cost reductions this year, while continuing to invest in core capabilities such as advanced analytics to increase efficiency and drive long-term value.

In conclusion, this quarter, our business generated high returns as we remain focused on disciplined credit management, profitable growth and an industry-leading customer experience supported by our 100% U.S.-based customer service.

The economic environment remains uncertain, but our strong capital and liquidity and actions we've taken to strengthen the business position allows us to continue to drive long-term value for our shareholders.

I'll now ask John to discuss key aspects of our financial results in more detail.

Thank you, Roger, and good morning, everyone.

Thanks for joining us.

I'll walk through our results starting on Slide 4. We earned $2.45 per share, driven by solid credit performance of our portfolio and significantly lower operating expenses.

While total revenue was down from last year, reflecting the slowdown in the economy, sales volume turned positive in September and net interest margin expanded nicely.

Net interest income was down 6% as the impact of lower market rates was partially offset by lower funding costs.

In addition, average receivables were down 3%, contributing to the decline in net interest income.

Noninterest income was down 10%, driven by lower fee income reflecting fewer late fee instances and the impact of lower overall spending on cash advance fees.

The decrease in net discount and interchange revenue was driven by sales volume in the quarter.

The provision for credit losses improved by nearly $50 million from the prior year as a result of a decline in net charge-offs and a lower reserve build.

Operating expenses were down 9% year-over-year, driven by marketing expenses and professional fees.

Turning to loan growth on Slide 5. Total loans were down 4% from the prior year, driven by a 6% decrease in card receivables.

Lower card receivables were driven by 3 factors: a higher payment rate as customers continue to be mindful of their debt obligations; a decline in promotional balances as a result of credit tightening, which will benefit net interest margin going forward; and third, lower sales volume.

In the quarter, sales were down just 1% on a year-over-year basis.

Sales returned to growth in September, up 4% year-over-year, with improvement in all categories.

Grocery, retail and home improvement were very strong.

The trend continued through the first half of October, with sales up 7%.

In our other lending products, organic student loans increased 7% from the prior year, and personal loans decreased 5%.

Moving to Slide 6. Our net interest margin bottomed out in the second quarter and improved 38 basis points to 10.19% in the current quarter.

Relative to the second quarter, NIM increased primarily due to favorable consumer deposit pricing.

Since June 30, we have decreased our online savings rate 41 basis points, down to 0.60%.

Approximately 2/3 of our consumer deposits are indeterminate maturity accounts, primarily savings, which has provided an immediate benefit from deposit rate decreases.

Average consumer deposits were up 22% year-over-year and up $2.7 billion from the second quarter.

Looking at Slide 7. You can see how our funding mix has changed over time.

We're also providing details on our funding maturities and corresponding rates over the next couple of years.

Given our current excess liquidity position, we expect to issue very little wholesale debt in the near term.

The majority of our new deposits have been in online savings, and we would expect this trend to continue in the current low-rate environment.

As we move towards our target at 70% to 80% of funding from consumer deposits, we expect to see continued benefits to net interest margin.

Turning to Slide 8. Total operating expenses were down $102 million or 9% from the prior year.

Marketing and business development expense was down $90 million or 39%.

The bulk of the reduction was in brand marketing and card acquisition.

Professional fees decreased $38 million or 20%, mainly driven by lower third-party recovery fees related to court closures as well as favorable vendor pricing adjustments.

Employee compensation was up $32 million or 7%, driven by staffing increases, mainly in technology as well as higher average salaries and benefit costs.

To date, we've realized approximately 90% of the targeted $400 million of expense reductions we discussed over the past 2 quarters.

We're on track to deliver the remaining 10% in the fourth quarter and continue to review the business for efficiency opportunities.

Turning now to Slide 9, showing credit metrics.

Credit performance remained very strong in the third quarter.

Net charge-off dollars actually came down $7 million, while the rate increased 13 basis points.

Sequentially, the card net charge-off rate improved 45 basis points.

The 30-plus delinquency rate improved 59 basis points from last year and 26 basis points from the prior quarter as credit performance of our card portfolio continue to be stable, demonstrating the strength of our prime revolver customer base.

Our private student loan portfolio had another quarter of strong credit performance, with net charge-offs down 1 basis points compared to the prior year.

Excluding purchased loans, the 30-plus delinquency rate improved 37 basis points from the prior year and 8 basis points sequentially.

Credit performance in our personal loan portfolio continued to be very strong this quarter, reflecting our disciplined underwriting and the benefit of credit actions implemented over the past several years.

Net charge-offs improved 130 basis points, and the 30-plus delinquency rate was down 39 basis points from the prior year.

While overall credit performance remained strong through the third quarter, we expect the economic environment to lead to deterioration in consumer credit, with delinquencies likely increasing in 2021.

The timing of the rise in delinquency and subsequent losses could be impacted if there is a second government stimulus program or economic trends shift materially.

Slide 10 shows our allowance for credit losses.

In the quarter, we added $42 million to the loans driven by a $354 million increase in organic student loans.

Other loan products were generally flat from the prior quarter.

With the backdrop of an uncertain but improving macroeconomic environment, we modeled several different scenarios and maintained a conservative view in the quarter.

Our key macro assumptions were an unemployment rate of 11% at the end of 2020 and slowly recovering over the next several years.

We also consider the current trends in unemployment and the increasing number of COVID cases.

Moving to Slide 11.

Our Common Equity Tier 1 ratio increased 50 basis points sequentially, primarily due to the decline in loan balance.

In March, we suspended our share buyback program in response to the economic environment at that time, and it remains suspended.

We have continued to fund our quarterly dividend of $0.44 per share.

We are in the process of preparing our second stress test submission and will determine our share repurchase and dividend actions subject to the final stress capital buffer, regulatory and rating agency expectations and Board approval.

In summary, solid results in the third quarter.

The portfolio remained stable with improvements in overall delinquency levels, reserves were flat except for those pertaining to student loans where the balance and commitment levels increased.

Net interest margin improved from the second quarter and is trending positively as a result of our aggressive deposit pricing.

And finally, strong execution on our targeted expense reductions.

With that, I'll turn the call back to our operator, Maria, to open the line for Q&A.

(Operator Instructions) Our first question comes from the line of Sanjay Sakhrani of KBW.

Appreciate all the color on reserves and provisions.

Roger, clearly, there's nothing that we see within the credit metrics that suggests weakness outside of the headlines on potential white collar layoffs.

Are there any specific signs you're seeing inside the portfolio that leads you to be concerned?

And how significant the change in the environment would there have to be for you guys to have to build reserves again?

So I'll let John cover the part about reserves, Sanjay.

But in terms of the environment, I think the jobless claims numbers, and we'll see what this week has, but 7 straight weeks, over 800,000 and more and more of that permanent unemployment in white collar is a reason for ongoing concern.

But I think as you look at our portfolio, I am very pleased with the performance across all products.

And you can see that from the broadest metric, we disclosed the 30-day delinquency rate.

Yes.

And Sanjay, in terms of reserving, we modeled a number of different assumptions and took a conservative approach across the Board.

What we saw was, actually, as Roger said, excellent underlying portfolio performance.

There is that level of concern in terms of jobless claims and the impact on prime consumers.

But to date, we don't see anything that -- that's out there that would suggest that reserves are, I'll say, weak or deep strengthening at this point.

We did model a second round of stimulus.

We don't know if that's going to happen.

There's some reason to be optimistic, but no one can tell on these sorts of things these days.

So we'll see.

But we'll look at it through the quarter, the fourth quarter and make the call in terms of what's appropriate from a GAAP standpoint.

Our next question comes from the line of Rick Shane, JPMorgan.

Look, we're entering what's historically the most important part of the year in terms of spending in consumer behavior.

I'm curious, 2 things.

You're seeing an uptick in spending, which is a good sign.

I'm curious how you will approach this from a marketing and rewards perspective.

We know you pulled back a little bit to this point to manage expenses.

But given the consumer seems to be rebounding, will you be a little bit more aggressive on rewards and marketing as we head into the holiday season?

Yes.

Thanks, Rick.

In terms of marketing, while we did cut expenses in line with the economic environment, we have continued to market across all of our products and have been very excited actually about the quality of new accounts we're bringing in on the card book as well as some of the costs we're seeing as competitors pulled back more aggressively.

Now I do expect some of that to normalize over time.

But again, we're going to continue marketing through the fourth quarter.

In terms of the rewards program, our program is well suited to this environment.

Consumers prefer cash over miles.

I think a lot of the miles programs I see in the marketplace are struggling to add relevance and redemption options.

In particular, our strong partnerships with PayPal and Amazon, some of the programs we're already putting in market with Amazon will serve us well in the fourth quarter.

Our next question comes from the line of Don Fandetti of Wells Fargo.

So Roger, I mean, these are the times where you can potentially step in and gain share and be opportunistic.

We saw American Express buy Kabbage.

Do you have any thoughts on your position of strength?

How you could use that, maybe on acquisitions?

Or are you going to just sort of hold tight given the uncertainty?

Yes.

I think we are leveraging that position of strength.

I believe we're gaining share, both in terms of sales and loans and card, and had a very strong peak season for student loans.

Acquisitions are a little more challenging.

And so as we think about how we use capital, the top priority is supporting organic growth.

Next comes a mix of dividends and buybacks.

Acquisitions tend to be a distant third.

Our primary interest is in the payments space.

But while valuations have come in a bit, especially where cross-border type companies, they're still very high.

And so a lot of what we're seeing are opportunities for either investments, partnerships.

So we'll look at it.

But I think we're probably more likely to be aggressive on the organic side, subject to our conservative credit policy than making acquisitions.

Okay.

And just one quick clarification.

What percentage of the portfolio is promo right now?

Because it sounds like that's going to help on the card yield going forward.

Yes.

It's come down recently.

We've been intentional about that in terms of taking a look at promo balances as well as balance transfers, so.

And so where does that -- I think usually, you guys are in the mid-teens or somewhere in that range?

Yes.

It's right around 15% or so.

Our next question comes from the line of Bill Carcache of Wolfe Research.

It's encouraging to see positive operating leverage in this environment.

That's consistent with what we've seen over the last decade plus from you guys.

But there had been some concern among investors when you guys gave guidance earlier this year, pre COVID, that Discover lost its expense discipline.

And that's the reason that you guys had, at the time, guided to negative operating leverage was due to years of chronic underinvestment.

Roger, understanding that there will always be one-off investments that need to be made.

Put that aside, can you speak to your confidence level in being able to continue to generate consistent positive operating leverage as we look to the other side of this?

Yes.

Thanks, Bill.

So first, having been here for over 20 years, I have to maybe disagree with the phrase chronic underinvestment.

I think our investments have been appropriate.

But at the beginning of the year, we saw an opportunity to invest more.

And so I would characterize it that way.

Clearly, the year changed dramatically.

And hopefully, you've seen very strong expense discipline in terms of the target we put out there and how well we're progressing against that target.

It's a little challenging just to look at operating leverage because that includes, what I'll call, sort of day-to-day corporate type expenses that we're always trying to bring down but then also marketing investments that drive profitable growth and high-returning accounts.

And so it's a blend of those 2.

But again, I think you can expect to see the continued expense discipline that I think has always been a hallmark here at Discover our overall lower-cost operating model, but we will invest according to the opportunities we see in the marketplace.

And I guess I'd point to the returns we're generating as an example of the effectiveness of that business model even through extremely challenging cycles.

Our next question comes from the line of Ryan Nash of Goldman Sachs.

John, on the net interest margin, you saw some really nice expansion.

You talked about the benefits that you're seeing from lower promo activity.

Can you maybe just talk about some of the puts and takes from here?

Asset yields are obviously going to be improving.

And it seems like the funding tailwinds are sizable over the next couple of quarters.

So if we had peaked out in the low 240s, could we actually potentially see the margin somewhere in excess of that over the next few quarters?

Yes.

So we were mindful in terms of what we included here in the presentation as well as in terms of the comments to provide, frankly, an additional insight in terms of what's happening to the funding mix, the maturity profile and the cost of our debt stack.

And what you can see there is based on the maturity profile and the cost we're seeing versus online deposits that there will be an opportunity to expand net interest margin.

Now that's subject to a lot of different things, right?

Obviously, there's one piece, which is the health of the portfolio, and that's been strong.

Certainly, the mix of revolvers and transactors will also have an impact and typically impacts the fourth quarter a bit.

But overall, as you look at where we are this quarter, I see some upside from that from my vantage point today.

Got it.

And maybe if I can ask a follow-up question from a topic that was hit on before.

So John, I think in your prepared remarks, you commented that you're looking for additional efficiencies.

Maybe can you just help us understand and maybe Roger can hop in on this, too.

Of the 90% of the $400 million that you've said, how much of that was -- is just investments that have been deferred versus actual core efficiencies that you guys have identified and taken out?

And what could this mean for the trajectory of the cost base outside of marketing as we look into 2021?

Yes.

So thanks.

So I would characterize it this way is the $400 million of cost savings from the previous guidance, I wouldn't necessarily call that a deferral.

What I would say is we took a look at the economic environment and took $400 million of our planned spending.

Now as I said in the remarks, which you clearly picked up on, Ryan, was that the bulk of that has been on marketing and brand.

Now as we look through the balance of this year and some of the actions that we took, we saw benefits across a host of P&L lines, expense lines specifically.

And we're going to use that, frankly, as a new benchmark in order to really make some determinations on what we need to spend in 2021 to ensure that we continue to grow profitably.

I would say this.

If the economic environment continues to improve, it's natural that we're going to spend more money on customer acquisition in order to drive profitable growth into the future.

But the other expense lines, professional fees, information processing, other miscellaneous expense, we're going to keep a foot on those to ensure that we're disciplined about how we're spending the dollars.

Our next question comes from the line of Moshe Orenbuch of Crédit Suisse.

Great.

Most of my questions have been asked and answered.

But I guess, I sort of am struck by the fact that the efficiency ratio in the quarter was actually better than it was in 2019.

And you're kind of demonstrating certainly likely to be the best growth in spend volume and one of the better growths, if not the best, in receivables or smallest decline.

And I guess I'm also struck by stuff we see in the industry that there's continued more cash back mail from some of your big competitors where that wasn't as big a focus.

And so kind of maybe some of this has been discussed already, but I'm sort of struck by that.

It seems like you have an opportunity.

And where does -- where can you direct that attention?

And how much do you have in kind of available, whether it's spending on rewards or marketing?

Like, what are the tools?

And how are you going to use them over the next few quarters, particularly now as we're going into the holiday season?

Yes.

Thanks, Moshe.

We're using all the tools we have available.

I would point out, there still is a good amount of economic uncertainty.

And so we are not changing credit policy on the card side.

I think we want to see more and more signs of sustained recovery.

But the cash back program is resonating well, as I said earlier.

And there's always a lot of competition in cash rewards from major issuers.

So I wouldn't necessarily characterize it as more intense than ever.

But it is a time where consumers are rethinking which cards they want, do they really need another frequent flyer mile at this point?

And then the other part is the only major issue was no fees on any of our card products.

But knowing a fee message resonates surprisingly well.

But then probably a point we're seeing great strength on the other side of the balance sheet on the deposit side, where we compete the same way, right, good value, but an outstanding customer experience.

So we're really excited.

Certainly, uncertainty as to what the holiday season will bring, as I talk to retailers out there.

But I feel good about our ability to continue to gain share.

Our next question comes from the line of Kevin Barker of Piper Sandler.

I'd just like to follow-up on some of the NIM comments.

I mean, you're seeing some -- a little bit more resiliency on the asset yields, in particular, some of the personal loans and card rates.

Could you talk about the competitive environment in both of those products and your expectations for those yields, at least in the next couple of quarters, just given the resiliency that we've seen in the near term?

Yes.

So we look at the card yield.

They'll overall be relatively stable, subject to kind of the mix of balance transfers and promos.

And as I said earlier, we're going to be mindful in terms of those sorts of decisions.

If we can do that, do some promos or balance transfers safely in a credit environment, we'll do that because it would be high returning customers.

But the leverage that we're going to get in future quarters will come out of the funding base.

Yes.

And Kevin, maybe one thing I'd add, too.

As we set pricing, given how hard it is to reprice cards after the CARD Act, we're not reacting to specific competitors in a given quarter.

We're taking -- working closely with financing, very disciplined through the cycle look.

And so it's really where our growth is occurring and that promo mix that will drive it as opposed to reacting to competitors.

Yes.

That all makes sense.

And then regarding the liability side, the order of magnitude in the drop and liability costs over the last couple of quarters are obviously very strong, just given the rate environment, I mean, how much more room do you feel like you have to bring deposit costs lower, just given the current rate environment and the outsized amount of liquidity on your balance sheet?

Yes.

So we continue to look at that.

And the decision would be subject to two factors: One, the amount of liquidity we have on the balance sheet, and right now, we're in a situation where we have excess liquidity; and then the second piece of the equation is the competitive landscape; and then third, which is a consideration of this business is certainly the customer relationships and ensuring that our long-term good-quality customers aren't feeling like they're impacted in a way that's unfair.

Now with all that said, I'm seeing a persistent low-rate environment.

And with a persistent low rate environment, I do believe that there is some amount of room to price downward.

But again, it's caveated by all those points that I just mentioned.

Our next question comes from the line of Bob Napoli of William Blair.

Just wondered what your build -- what you built into your reserves as far as the trajectory of charge-offs?

And I would expect -- I mean, I guess, you're not -- really, given where delinquencies are, you're not expecting to see charge-offs move up much in the fourth quarter and then more back half weighted to 2021.

Yes.

So I would start off by stating that the portfolio performance versus what we thought it potentially could be when we closed the book in March has been extraordinarily strong, and we're really, really pleased by that.

In terms of trajectory of both delinquencies and charge-offs, yes, we are seeing a certainly a push from '20 into '21.

And the absolute quantum of that will obviously depend on all the factors that we've built into our reserve calculation: GDP, unemployment, new jobless claims, stimulus or lack thereof.

So we will -- we're going to monitor the portfolio.

But just to kind of net it for you and the other folks on the call, '20 looks super solid, '21 level of uncertainty, and we expect the bubble to push through into certainly beginning maybe in the midpoint of the year into the second half of '21.

Got it.

And then a follow-up, just the jobless claims 787,000 this morning, a big improvement, but ridiculously high report of that sort.

But I mean, direct bank your position, Roger, as a direct bank, gives, I think, is the right strategy for the long term.

Are there new products or services that you're planning to build through that direct bank.

I mean we have, obviously, a lot of these neobanks that are delivering different products and maybe to a different demographic than Discover focuses on.

But where do you see opportunities to leverage off of your direct bank strategy?

So in terms of positioning ourselves as the leading digital bank, I think we're in great shape.

And it's leveraging the products we already have.

I don't see the need for expanding our products.

If you look at the breadth from home equity to a broad range of deposit products, including checking or debit accounts, great strength, of course, on the card side and personal loans.

So we have the products.

I think the opportunity is building awareness of the products we have and that can drive a lot of growth.

So I'm very excited about where we're positioned.

I'd say maybe one of the big differences versus the neobanks is perhaps a different focus around profitability.

So we'll see how that plays out over the long term.

But I couldn't be more excited about where we're positioned.

Our next question comes from the line of Mihir Bhatia of Bank of America.

First, I just wanted to clarify, did I hear correctly, you said you have modeled the second round of stimulus in your modeling for credit?

Yes, we did.

There is an input in our modeling, reflecting a second round of stimulus.

Understood.

Okay.

And then just one quick one on the -- I was hoping that you guys operate more in the network business.

Specifically, I was looking at -- it looks like your volumes are growing pretty nicely in both PULSE and Network Partners.

But yet, you attributed the revenue decline to both those businesses.

So I was just wondering, what is happening there?

Is it just competitive factors?

Is there a mix issue?

Just hoping to get a little more color there.

Yes.

Thanks for the question.

So it was actually a combination of 2 things.

So there was a bit of a mix shift to some products with lower fees and rates.

There was also some higher incentives that came through based on the mix that we enjoyed in the quarter.

I would say that in terms of overall volume, it was up 16% year-over-year, at least for PULSE.

And certainly, we are happy about that.

We are continuing to look at the mix and incentives to ensure we're driving appropriate level of profitability for the investments we're making there in the payments business.

Our next question comes from the line of Betsy Graseck of Morgan Stanley.

Couple of questions.

Just first off, on the outlook for growth, I know, typically, it's a function of account growth and balances per account.

And obviously, you've had some shrinkage recently because of the spend levels that we all know about.

I'm just wondering if we could dig into the account growth aspect of that equation just to understand how account growth has been going.

What COVID has meant to account growth?

How you flexed?

And do you see any opportunity to accelerate account growth from here as we go into the back half of the year and into '21?

Yes.

So just -- one thing on the receivables growth.

The higher payment rate is a big factor as well.

So good news on what it's doing on the deposit side of our business.

But that is having a significant impact on loan growth for both card and personal loans.

In terms of new accounts, while we don't disclose a number on that, what I would say is that we think we probably sustained new account marketing more than a lot of competitors as I look at industry metrics, and so we feel good about that and kept our marketing spend sort of appropriate for the environment and for our somewhat narrowed credit box with the changes we made earlier in the year.

So I would not expect dramatic changes until we get more certainty in terms of the pace of recovery, but we've continued to market across all of our products.

Okay.

So you've been pleased with your account growth that you've generated over the past couple of quarters.

That's what I'm hearing from you, Roger.

Is that right?

Yes.

And in particular, I think we called out on the last call some of the cost per account that we were seeing in different channels as competitors pulled back more.

Right.

Okay.

And then just separately on credit and the outlook for credit here.

One of the questions is around stimulus, and if you don't get it, how much does that impact potential changes in the reserve?

And then the other piece is on the mortgage forbearance.

I think I believe a majority of your customers have mortgages.

And I'm wondering if you know through credit data checks how many of those people are benefiting today from the mortgage forbearance?

And does that feed into your reserve analysis as well?

Okay.

Yes.

So I'll talk about the credit outlook and then handle the mortgage question on the back end.

So in terms of the stimulus that we modeled, and it is one of many inputs, and we'll look at what happens in the fourth quarter and see how the roll rates are progressing in the portfolio through the quarter to get, I'll say, a bottoms-up view of actually the impact there.

So no specific information on that other than to say that underlying roll rates are far more positive than we thought they would be at this time.

And if another round of stimulus doesn't come in, I think that's going to be tough for a number of people that have been impacted by the pandemic.

And progressively, it will start to impact the prime revolver base.

And that's why we're conservative in terms of our reserve outlook here for the third quarter.

But overall, we're -- again, we're pleased with our positioning.

Now in terms of the mortgage forbearance, I see, we really don't have any data on that.

What we are seeing is our home equity business continues to -- it's open for business.

We -- our underwriting standards have tightened mildly through this, and it's positioned pretty well and open for business.

Our next question comes from the line of Meng Jiao of Deutsche Bank.

I wanted to take a look at capital trends and the buybacks.

And I know that you guys are in the midst of preparing your second stress test submission.

But I was wondering in terms of timing as to when you would get a better sense of the economy in order to possibly execute the buybacks one more time?

Is it in the back half of '21 into -- more into '22?

Just any thoughts on when you guys feel you would have more clarity in terms of the economy in order to reinstate that buyback program?

Great.

Thanks for the question.

So we're submitting our second round of stress test in November, and included in there are a number of judgments.

I'm not going to get into the details.

It'd be premature on that.

I would say, as you take a look at the capital trends for the business, they're super solid.

Our capital levels are higher than our targeted levels.

And Roger was specific in terms of our tiering of capital allocation priorities.

So there's no change to that, and we're going to work through kind of the details with the Fed, other regulators, rating agency and then report.

Sorry, I can't be more specific than that at this point.

Our next question comes from the line of Mark DeVries of Barclays.

Just wanted to drill down a little bit further on the funding tailwinds.

Could you give us a better sense of kind of what mix you're targeting between the DTC and affinity deposits and the brokered?

Is there a minimum level of brokered that you want to maintain?

And also, kind of what's the funding difference between those 2, just to give us a sense of how much your deposit funding on average could compress?

Yes.

So we want to keep the broker CD channel open.

So we'll continue to kind of test that.

The relative change or difference between the direct-to-consumer and the brokered deposits narrowed significantly.

In the early stages of the pandemic, there was a substantial difference, and the market took care of that and narrowed the gap.

We do enjoy a slightly better pricing if it's a direct relationship versus through a broker.

So that -- that will be our focus.

In terms of overall kind of mix of those, I would expect the broker channel to continue to contract a bit and the direct channel expand.

Okay.

In the -- with such low funding on the ABS, why not maintain that or expand it?

Or are there like liquidity concerns of having assets unencumbered that you're managing to?

Or is there something else I'm not thinking about?

Yes.

No, the cost there on the ABS that's reflected is net of the hedge impact.

So fortunately, we hedged those and have a nice benefit coming through over the next couple of years.

The actual, I'll say, contract rate on those ABS transactions, quite a bit higher than that.

So that would -- frankly, that was -- the rates we're enjoying there, it's just good work on the part of our treasury team to hedge that.

So we'll continue to ensure that the ABS channel is there and present and available to us.

But it will certainly come down as maturities profile indicates.

Our next question comes from the line of Dominick Gabriele of Oppenheimer.

I just wanted to see if we could kind of square the circle around unemployment and where the unemployment rate is and the kind of liquidity that the consumer has been given up until this day.

And it sounds like, obviously, we both agree that delinquencies probably, given this liquidity, don't even start rising until the first of the year.

And so when you think about your expectation for unemployment at 11% by year-end and then where we are and the idea of a white collar rush of unemployment, that would be quite the rush of white collar unemployment versus the amount of people that are unemployed now versus a steady state.

And so can you just talk about where the -- perhaps the job losses come from?

And why such a large magnitude of white collar versus the still unemployed call it, blue collar that we saw now and how that's influencing your outlook for the 11% unemployment rate?

Yes.

Thanks, Dominick.

So you touched on a lot there.

And I would sum it up by saying there's a level of uncertainty around what actually will happen on unemployment.

Now the 11% does feel at this point like, I'll call it, a robust number.

But what we're trying to get good clarity on is as the service workers who initially were impacted by the pandemic containment activity went to the unemployment ranks, some of those have returned, we certainly have seen some indications across the economy that across the nation and, frankly, the world that it could be a tough winter here from a COVID standpoint.

So that's going to further impact not only service industry, but the entire economy.

And so as we sit here today, we're mindful of that as a risk and continue to kind of maintain the reserves where they are.

So we don't expect there to be a rush of white collar unemployment.

But what will be clear, and we've seen some of this already is businesses are sizing both their professional staff and the blue collar staff for the business at hand.

And there's enough indications today that there could be some contraction.

And as such, the unemployment, numbers not exactly an easy number to predict, but we feel like as an input to our model, it's appropriate at this point.

Great.

And if I could just have one follow-up here, I really appreciate that.

And if you look at the other expenses on the expense base, it looks like the acceptance incentives came down as well as fraud, even though we're kind of in this more online environment.

Could you talk about what you're doing on the fraud side and how that was -- and did you negotiated in the global acceptance?

Or is it a function of just volume and mix year-over-year versus the third quarter of '19 on how your expense base and other expense came down?

Yes.

So in terms of fraud, it doesn't reflect any renegotiations with any of our merchant partners.

Fraud is one of the areas where we're deploying advanced analytics and next-generation modeling and leveraging additional information sources.

So I'm really excited about the progress the team is making there.

And it's part of why we're so committed to continuing to build out our analytics capability.

Yes.

And then I would just add in terms of the other expense line.

So we did see lower global acceptance expense in the quarter.

And that's a function of 2 things.

A little bit on the economy and liability associated with some of our partners executing on kind of terms associated with previous incentive agreements.

And then, frankly, just a level of uncertainty that's caused us to be cautious on, I'll say, signing up new rich incentive deals.

Now we're still doing that where it makes sense.

But in terms of timing, a little bit cautious on that one.

But we've seen actually great effectiveness from our procurement team, driving year-over-year savings on the entire indirect cost base.

And we're still, as we said in the remarks, investing in advanced analytics and some digital capabilities that's driving up the information processing.

But my expectation is that we continue -- that we are and we will continue to get more efficient in overall information processing and technology spend.

Our next question comes from the line of Bill Carcache of Wolfe Research.

A quick follow-up on credit.

There had been a lot of consternation around booming credit headwinds in the TDR portfolio.

Can you discuss how that's been performing?

Yes.

So thanks for the question, Bill.

So you folks don't have the TDR disclosures, but they'll come out in the Q when it's published.

And what you'll see there is relative to the first quarter, TDR volumes will be substantially down.

But there is also the impact of the CARES Act with a regulatory exclusion for certain modifications that banks such as ours make.

So if you put those 2 together and compare where we are in the third quarter versus where we were in the first quarter and call the first quarter pre-pandemic, relatively stable.

So the point there is that there's not an abundance of activities or a massive jump in any sorts of activities there that's impacting delinquencies.

We do these programs to improve the cash flows of the company and ensure that when there's a temporary issue with a customer that they can manage through it and return to paying their bills.

So from a credit standpoint, TDR standpoint, there's been good execution from our customer service teams.

And ladies and gentlemen, that was our final question.

I'd like to turn the floor back over to Craig Streem for any additional or closing remarks.

Thank you, Maria.

Thanks, everybody, for your interest.

Enjoy the conversation this morning, and we're available for any follow-up questions that you may have.

Thanks.

Have a good day.

Thank you, everyone.

Thank you.

Ladies and gentlemen, this does conclude today's conference call.

You may now disconnect.