發現金融 (DFS) 2007 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2007 Discover Financial Services Earnings Call.

My name is Tanya, and I will be your coordinator for today.

(OPERATOR INSTRUCTIONS).

As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Mr.

Craig Stream.

Please proceed, sir.

Thank you, Tanya.

Good morning, everyone.

I want to welcome you to this morning's conference call, and we certainly appreciate your joining us today.

I want to begin, of course, by reminding everyone that the discussion today contains certain forward-looking statements about the Company's future financial performance and business prospects which are subject to risks and uncertainties and speak only as of today.

Factors that could cause actual results to differ materially from these forward-looking statements are set forth within today's earnings press release, which was furnished to the SEC this morning in an 8-K report, and in the Company's Registration Statement on Form 10, already on file with the SEC.

In the fourth quarter 2007 earnings release and financial supplement, which are now posted on our Website at discoverfinancial.com and have been furnished to the SEC, we have provided information that compares and reconciles the Company's managed basis financial measures with the GAAP financial information, and we explain why these presentations are useful to and to management and to investors.

We urge you to review that information in conjunction with today's discussion.

Our call this morning will include formal remarks from David Nelms, our Chief Executive Officer, and Roy Guthrie, our Chief Financial Officer, and, of course, a question and answer session.

And, now, it's my pleasure to turn the call over to David Nelms.

Thanks, Craig, and good morning to all of you.

This quarter marks our first full quarter as an independent public company.

And, despite a more challenging environment, we remain on track for meeting our corporate objectives.

My comments this morning are going to focus on that progress.

But, first, I must acknowledge our disappointment with the impairment charge in our UK business.

We are making meaningful progress with our turnaround plan for the UK business, but the very difficult operating and financing environment in that market, coupled with the implications of our decision to shrink that portfolio to a more profitable core, led to the conclusion that the charge was necessary.

Excluding the impairment charge, we turned in strong results in the fourth quarter, led by our U.S.

Card segment, where pretax income of $328 million was up 43% from last year.

We achieved solid growth in U.S.

Card sales volume and receivables while maintaining a favorable loan loss rate.

We also increased our revenues, driven by higher merchant income, higher interest income, and reduced rewards expenses.

We also cut expenses as we rolled out additional efficiency efforts and reduced overhead expenses.

We continue to be very pleased with the performance of our Third-Party Payments business, and this quarter we achieved a 28% increase in debit and credit volume versus last year.

Looking at the full-year growth in volume of 25% and the 28% growth in pretax income, that can give you a sense for why we are so excited about this business.

I want to focus now on reviewing our performance against the principal commitments we set forth during our pre-spin road show related to growth, credit risk management, merchant acceptance, the UK business, and capital management.

Roy will then take you through some of the key drivers of our fourth quarter performance.

Our first objective was to achieve consistent, controlled growth in U.S.

Card receivables in the range of 4% to 8%, and I'm very pleased that again this quarter we met that objective with managed receivables growth in the fourth quarter of 5% and sales volume growth of 6%.

During the quarter, we launched a new advertising campaign, Discover Brighter.

We heavily promoted our cash-back bonus rewards program, including promotions in over 160 malls this holiday season, and we continued to grow our newer products, such as Motiva, Discover business card, and Discover personal loans.

We also remain acutely focused on credit quality, and I'm very pleased with our U.S.

charge-off rate for this quarter, which was below 3.9%.

Despite strong current results, it is apparent that we are heading into a more challenging phase of the credit cycle, so I want to spend a few minutes discussing several reasons I believe we are well positioned in our U.S.

portfolio.

First, our recent delinquency experience is quite good.

Although our delinquency rates are increasing, they remain low relative to historical levels.

During the quarter, we increased our loan loss reserves by over $130 million, given the higher delinquency rate and on-balance-sheet loan growth, which I think positions us well heading into 2008.

Second, trust data shows that our U.S.

portfolio is well seasoned compared to competitors, with 78% of our loans on accounts that were originated over five years ago.

Third, we have consistently originated high FICO score counts over the past several years.

For the full year 2007, our average FICO score at origination was 734.

Fourth, we tightened our credit and marketing criteria a number of years ago in areas of the country that had high average debt versus income levels.

This had the effect of reducing our exposure to some of the markets that are having the greatest stress today, such as California and Florida.

Fifth, and finally, while we recognize that there is a broader set of housing- and mortgage-related issues that some customers are experiencing, we have relatively low exposure to consumers whom we believe are most exposed to these problems.

In fact, we estimate that only about 1% of our customers have adjustable, non-prime mortgages.

Nevertheless, given recent market credit trends, we have taken a number of additional actions to maintain strong credit quality.

These actions include changing underwriting criteria for applicants with certain mortgages, suppressing credit line increases on accounts with high-risk mortgages, investing in our high-risk unit that focuses on review and proactive contact with certain customers, even those who remain current with Discover, and reducing our contingent loan exposure by closing longer-term, inactive accounts.

Our next objective was to grow our third-party credit and debit volume.

In response to requests for additional transparency, beginning this quarter, we are now disclosing volumes for PULSE and our third-party Discover Network issuer business.

Our growth target is to exceed 18%, and, as I mentioned, we passed this target this quarter with growth of 28%.

Both PULSE and Discover Network third-party issuers achieved high growth rates during the quarter, driven by increased volume from existing financial institution partners, as well as the impact of new signings.

A very important objective for Discover's long-term growth is implementing our enhanced merchant acceptance strategy, which we discussed in some detail in last quarter's conference call.

We signed a number of additional agreements with acquirers this quarter, and that means we now have acquiring agreements with firms representing an estimated 95% of industry credit card volume in the U.S.

Acquirers are now increasingly selling Discover to new merchants as part of an integrated package with bank card products.

Working with our acquirer partners, we have turned our focus to enabling non-Discover-accepting outlets within their client portfolios and to consolidating statements and other servicing for small- and medium-sized merchants.

We remain on track to complete implementation of this critical initiative over the next 18 months, which should help support growth of our U.S.

Card business, as well as our Third-Party Payments business.

Another very significant objective for us is to achieve acceptable returns in our UK operation.

We have begun to see important progress in the UK performance, where, excluding the impairment charge, we reported a pretax loss in the quarter of $32 million, the lowest quarterly loss in more than a year, despite a recent spike in our UK cost of funds.

The managed portfolio yield on the UK book increased 32 basis points sequentially, reflecting the beginning of pricing and product actions we are taking to improve profitability.

Operating expenses, excluding the impairment charge, were down over $9 million from last year, as we continue to push for lower costs.

Credit ratios worsened a bit from the third quarter, despite some improving bankruptcy and roll-rate trends, largely reflecting the reduction in loans, which were down $75 million sequentially and about $270 million from last year.

But, in absolute terms, UK charge-off dollars in the fourth quarter were flat with the third.

We continue to press on a variety of aggressive initiatives to increase revenue; reduce expenses, including loan losses; and remix and shrink our portfolio to become more profitable with a higher revolving rate.

I'm very proud of our team in the UK, who's working so hard to achieve these results.

This quarter, we completed a number of actions, such as system conversions and collection changes.

Next quarter, we plan to implement a series of additional pricing and product changes.

Finally, I want to say a word about our commitment to responsible management of our capital position.

Discover became an independent company with a very solid financial foundation and an expectation of strong operating performance and capital generation.

In that context, we have implemented a quarterly cash dividend and just recently announced a three-year, $1 billion share repurchase program, even as maintaining a very strong balance sheet and investing for growth remain paramount.

Right now, I want to turn the call over to Roy Guthrie, and then Roy and I will be avail for your questions.

Thank you, David.

As we announced earlier this month, we have taken an impairment charge against the intangible assets in our UK business.

And I'll give you some color around that; I just want to open this up by quantifying that and characterizing it properly.

That charge really is substantially all of the intangible assets that arose from the Goldfish and Liverpool Victoria acquisitions in that market, or about $391 million pretax.

The after-tax amount is $279 million, and the charge is being recorded in expense within our International Card segment.

So, looking at the Company overall, including the impairment charge, we reported a loss of $84 million, and, excluding the charge, we earned $195 million, or $0.40 a share, up 4% from a year ago.

Pretax income for the quarter, before impairment charge, was $303 million, again, up significantly from the prior year -- in fact, up 63%, reflecting positive contributions from all three of the business segments.

I want to note at this point that we had a very small amount, just $5 million, of spin-related costs that were incurred across these segments in the quarter.

Looking at the segments, U.S.

Card turned in solid receivables growth of 5%, which represented our seventh consecutive quarter of organic growth.

Credit quality continues to be very sound.

Charge-offs in the U.S.

Card at 3.84% for the fourth quarter were up 14 basis points sequentially but still below where we were a year ago.

30-day delinquencies came in at 3.59% for the quarter, up 43 basis points sequentially.

The fourth quarter delinquency number was impacted by a higher level of dollars in the later-stage delinquency buckets, and this is going to drive slightly higher charge-offs in the next few quarters.

In addition, national bankruptcy filings continue to rise, and we expect that to continue into next year, as well, translating into higher losses.

Given the increase in delinquency and the outlook for bankruptcy filings, we added over $130 million to our credit loss reserves in the U.S.

business, of which about $70 million reflected a higher reserve rate and the remainder due to higher balance sheet receivables.

This reflects our views regarding the trends that I just outlined within the portfolio, as well as market conditions.

But, to be clear, the underwriting philosophy of the Company remains very conservative, and you heard that outlined in David's remarks.

Looking at other income, the U.S.

Card segment earnings were—Sorry.

Excuse me.

Within the U.S.

Card segment, earnings were $328 million, up 43% from last year, and this was driven by higher revenues and lower expenses, which, combined, more than offset the higher provisions that we incurred in the quarter.

The net yield of 7.81% for the fourth quarter was flat the last couple of quarters and up from a year ago at 7.75%.

So we essentially see net income growing at the same rate in which receivables are growing, or 6% year over year.

While we did see the interest expense ratio rise in the fourth quarter due to market conditions, elevated Libor spreads, in particular, the impacts were largely offset by finance charge income stemming from higher-yielding promotional balances, slower payment rates in our higher-yielding balances, and higher default and other repricing revenues.

So we're very pleased with the outcome of that.

Within other income, sales growth has driven merchant discount and interchange higher, and we continue to see loan fees move up.

Other income also includes a $37 million write-up of the I-O strip receivables, attributable to lower absolute Libor rates in the quarter.

In addition, we recorded about $34 million of income related to a collection of items, which will not be recurring.

These include gains on sales from merchant contracts, rewards forfeitures related to changes we've recently made in our programs, and a markdown on an investment in our short-term investment portfolio.

Turning to the provision, the increase in provision year over year is a result of the reserve additions that I mentioned previously, over $130 million for the quarter.

We clearly believe this is a prudent and conservative move.

The charge-off rate at 3.84% for the quarter was actually down year over year.

Operating expenses in the U.S.

Card segment declined by $65 million, partly because of timing of some of our advertising spending but also reflecting lower overhead and a reduction in litigation costs.

And expenses continue to be a very, very key focus area for the management team here.

Our Third-Party Payments segment earned $8 million for the quarter with 28% growth in Network volumes.

So, looking ahead, we expect to see some lumpiness quarter by quarter in these profit results.

But, as we continue to invest in growth, you're going to see a solid year-on-year performance coming out of this segment.

For the full year, we achieved 25% growth in transaction volumes from third-party issuers on the PULSE and Discover Networks, which drove 8% revenue growth.

I think it's important to note that the revenue in this segment includes charges associated with incentives paid to third parties, which suppresses it slightly during a growth period.

Expenses, however, were virtually flat, up just 1%, and thus driving a 28% improvement in the segment earnings for the year.

Turning to the International Card business, I want to begin with that $391 million charge we booked this quarter to recognize the impairment of goodwill and the other intangibles in the UK business.

The impairment review result of continued elevated funding costs, capital market disruptions we've seen in the UK, coupled with our plans for shrinking our receivables in the UK to rebalance the [transact-to-revolver] mix there.

All of this has implications for the long-term valuation of the business, so it became clear to us that an impairment had occurred and should be recorded and has been here in the fourth quarter.

Excluding the impairment charge, the International segment had a pretax loss of $32 million in the quarter, and that compares with a loss of $67 million in the prior quarter and $50 million a year ago.

Managed receivables in the UK were down $75 million from the third quarter, and this reduction reflects that strategy to reposition the UK book, focusing it on more profitable segments.

The lower asset base had the effect of elevating the charge-off ratios, so I'd like to point out that charge-offs expressed in dollars were virtually flat the prior two quarters.

The operating improvement measured before the impairment charge is attributable to other income and lower expenses, both of which have been key focus areas for us.

Net yield on receivables is down from a year ago -- again, principally due to higher funding costs in this market.

But we did see it rise sequential quarter, reversing the previous trend.

And you've heard from David earlier we have initiatives against many aspects of this business to drive improved results, and we're very pleased with some of the positive signs that we see developing here.

Before we go to Q&A, I want to briefly comment on liquidity and capital.

And David touched here on both the dividend and the repurchase (inaudible), but I want a little color around funding that I think is probably appropriate.

Both our capital position and contingent liquidity position have improved since we spun off from Morgan Stanley in June and during the quarter.

Tangible capital at November 30 was $5.2 billion, just over 10% of managed receivables, and up almost $450 million since we spun off.

In addition, we closed November with nearly $11 billion of accessible liquidity in the form of cash at $8.8 billion and committed conduit capacity at partner banks representing $1.9 billion.

This is up from $7.4 billion from these sources at spinoff and $600 million higher than where we ended the third quarter.

Further, since the spinoff, we've begun to sell securities under our new D-Link Master Trust.

During the quarter, we issued $2.25 billion of AAA notes in two separate deals and finished the year with $2.75 billion of AAA capacity within that structure.

These liquidity sources combined with our bank revolver bring our total contingent funding sources to just at $16 billion.

We have a good balance between bank deposit sources of funds and capital market sources.

Presently the capital markets are clearly a challenging place to fund, particularly with consumer assets as collateral.

While we executed the $2 billion in notes in the fourth quarter I mentioned previously, it does seem that this market is very, very tight.

It's our expectation that the credit card ABS markets will begin to normalize early next year, albeit at significantly higher risk spreads.

To summarize, dealing with the circumstance in the UK, putting the impairment charge behind us, and feeling better about our progress operationally in that business are certainly positives.

But I think, more importantly, the continued strength of the U.S.

portfolio, the progress that we're showing with our Third-Party Payments business, and our strong balance sheet make me really feel good about the position we closed at at the end of the year.

So, with that, we're ready to take your questions, and I'd ask the conference operator to begin that process.

(OPERATOR INSTRUCTIONS).

Our first question comes from the line of Howard Shapiro with Fox-Pitt.

You may proceed.

Congratulations on a good quarter.

Two questions, if I could; the first is on 2008.

Are you still comfortable with your guidance on managed charge-offs, which I believe is 425 to 475?

And then I had one other question.

At this point, the delinquency trends we're seeing are consistent with that range.

Okay.

Great.

And the other question is -- you mentioned the high FICO scores of the new receivables that you're originating.

I'm sure you're aware that, in the mortgage market, at least, FICOs have become less predictive of ultimate credit performance.

Are you seeing any signs of divergence in performance relative to FICO scores?

One thing to recognize is that we do not purely rely on FICO, and we use a variety of credit attributes.

And, as we've seen some changes in the credit market, we've continued to refine our credit criteria, including mortgages, particularly in certain regions.

So we are comfortable with our credit criteria, which evolves appropriately.

Okay.

Thank you very much.

Our next question comes from the line of James Fotheringham with Goldman Sachs.

Please proceed.

Roy, just a quick question about the growth in other income, which I guess was driven by several factors -- the I-O strips, sale of contracts, higher fees, and lower rewards costs.

But, just more generally, what proportion of the incremental growth in other income would you consider to be potentially recurring?

Thanks.

Well, James, the reason why I wanted to specifically sort of isolate those three items were I think those were clearly the ones that would be, to flip the question, nonrecurring.

What we see in there is basically you can see, in effect, growth.

And, if you use the growth in sales, that's not a bad proxy for the growth rate that you're going to see the lion's share of that revenue line growing, which is the merchant interchange and discount fees, as well as, to a certain extent, loan fees.

I'd also point out that within that line is the I-O strip revaluation.

So I think we need to acknowledge that other income comprises organic, business model-centric, spin-centric sort of dimensions.

They're going to grow along with the sales as well as these two other pieces, and I think you'll find that that pretty well reconciles it.

Fantastic.

That's really helpful.

Thanks, Roy.

Our next question comes from the line of Sanjay Sakhrani with KBW.

You may proceed.

I have two questions, one on the UK business.

I was just wondering what you guys think about the loss trends going forward.

Should we expect improvement from sort of the normalized basis during this quarter onwards?

I would say that there is some uncertainty.

We're pleased that things appear to have stabilized, and there are some encouraging trends.

Bankruptcies have actually fallen a little bit in the last few months in that market, and we're now starting to see some improvement in roll rates.

But you do have some factors that we continue to be concerned about, such as the housing market and the overall UK economy and what they may do in the future.

So I think we-- What we wanted to see is some improvement over a sustained period before I'd be ready to make the call that we are now past peak and we're improving.

Okay.

Great.

And just one follow-up for Roy.

On sort of the funding side, could you just talk about sort of the funding requirements in '08 and what the game plan there is?

And then, just on the movement that we've seen in the Libor to prime spread, how should we think about that as far as it impacting the results in '08?

Thanks.

Sanjay, let me take them in reverse order, because I think, at the end of the day, that's sort of the way I think about them.

I think the pricing-- We're going to see a couple of things in 2008.

We're going to see credit spreads on new capital markets issuance be higher, and that's clear, if anything, from the process that we've been through here in the market over the last three or four months.

So we acknowledge that.

And I think that it's important for our investor community to understand that that will not reprice itself into our book until we've turned the entire $28 billion of capital markets instruments we have outstanding, which would be-- Some last ten years; others will turn this year.

We have about $8 billion in maturities in that book coming up in 2008.

So I think, to a certain extent, the risk premiums in that need to be incorporated.

Number two, the elevated Libor relative to benchmark rates that you've seen recently in the market is troubling to us.

I see that more as a short-term issue.

I would guide our analysts to something like 12 to 15 basis points of pressure, if we see those spreads remain at where futures have indicated they will be during this quarter.

That's not dissimilar to what we highlighted the third quarter as we came into the fourth quarter.

But I do see that as a transition sort of issue, and the recurring credit spread is something that's going to be more with us for a long time.

The funding next year really revolves around growth in the business.

And you heard David talk a little bit about our confidence in our ability to continue to grow.

We're going to have, obviously, requirements in the UK and less requirements in the UK, and I think that is a good thing, given that the UK is a more troubling market to fund in than the United States.

We have confidence in both the channels that we use - our deposit channel as well as our capital markets channel.

As I mentioned earlier, the capital markets is a little more troubling in the short term.

But, between the balance of each and the liquidity that we carry within our portfolio, we're confident that we will be able to move ahead uninterrupted from a funding standpoint.

The key thing I would point to is that the 5% growth and, say, $8 or $10 billion of maturities across some of our various portfolios really represent new issuance that would be required, if you're looking for that.

Okay.

And does that elevated spread in the Libor to benchmark work its way into the I-O strip valuation?

It does indeed.

And I think that the-- It does.

And I might just take this opportunity to outline that spread is one important part, but, also, the absolute level of Libor is important as well.

When we came through the third quarter and positioned our I-O, it was a mark that was attributable to the gapping spread between Libor and Fed funds.

So it was all about that higher spread.

The remark that we're seeing now - in effect, to increase the asset-- The spread is still there.

We still have this very dislocated high spread between Libor and Fed funds, but the absolute level of Libor has changed.

And so you think about this as a position-to-position, balance sheet-to-balance sheet measure, where you squeeze the income statement aspect.

And, at this point in time, Libors are 60 to 70 basis points less than where they were a quarter ago, and that's what's driving the mark up in this particular spread instrument.

So it's both the gap as well as the absolute level, and you've got both working in this, which complicates it.

But I think, if you really just think about it in terms of absolute levels of Libor, your models will work appropriately.

Okay.

Great.

Thank you.

Our next question comes from the line of Eric Wasserstrom with UBS.

You may proceed.

Roy, just before I ask my question, just one quick clarification.

How much AAA capacity did you say that you had?

$2.75 billion.

$2.75 billion?

Great.

And I see that you-- In the period, it looks like you guys added about $1 billion of receivables to the balance sheet.

Was that a conscious strategy, given where the ABS spreads are, or is that just a timing issue?

It's some of both.

I mean, you're continuously making decisions about how best to position the liability structure - which markets are the appropriate to go to and so forth.

So I think it's important to note that the markets weren't necessarily closed to us; we did issue $2.25 billion in the third quarter but chose, as spreads began to gap, to use deposit instruments in lieu of capital markets.

Okay.

And, just a final issue.

You kind of indicated that the marketing was down sequentially, in part because of a timing issue.

Do you have a sense of where the run rate might go?

Yes.

I think that-- Let me just point out that marketing spend for the year was very similar '06 over '07, and it was just the way in which the orders rolled out.

And that was the important point that I wanted to make with regard to my formal comments.

Rolling into 2008, clearly, we want to continue to build the marketing spend, and we'll take that in the context of the overall expense structure we're trying to seek for the Company and the opportunities that we see in the market.

Thanks very much.

Our next question comes from the line of Chris Brendler with Stifel, Nicolaus.

You may proceed.

A couple questions on credit quality, if I may, focused on the U.S.

portfolio.

Do you see any particular geographies where the delinquencies are increasing more rapidly?

Obviously, the question's focused on the housing issues.

Is there any tie-in there to your trends this quarter?

Yes.

We do see more of an increase in some of the markets that are most stressed with housing and mortgages, such as Florida, California, as well as states that have higher unemployment, such as Michigan.

And I think one of the reasons that we have had, I think, a reasonably modest increase in delinquency is because we have managed our exposure to some of the higher-risk areas that are experiencing the most stress.

But, nonetheless, we do have customers in all of those markets and would expect to be affected, which I think is being reflected in our numbers.

Sure.

Can you talk at all about-- You said you managed your risk.

Does that just mean cutting models a little tighter in terms of credit granting in those states or reduced marketing activity?

And is that--?

Are you tightening up even further today?

I would say we're continuing to refine and, in some cases, yes, tighten.

I think that the reason we have less exposure to some of these markets are some actions that we took five years ago to have higher cutoffs and reduced marketing to certain metropolitan areas which are, at the moment, experiencing the greatest stress.

And I think that the reason is that we had focused quite a while back on some areas in which the income versus the debt levels, including mortgages, was seeming a little out of whack, and so we had established higher cutoffs for those markets.

So we continue to change our credit criteria to respond to more information about mortgages, housing prices, regional performances.

Excellent.

Can you also comment--?

If you look at your portfolio and increase in delinquencies this quarter, do you see better performance out of the accounts that are five years or older?

Absolutely.

A key part of any credit performance is how long someone has been with you and paying you on time.

And so many people, I think, incorrectly look at FICO as being "the" measure of risk.

But I would say tenure and experience is probably more important in my view.

If I've got a customer who's been making ten years of on-time payments to Discover, I feel a lot better about that than someone who has just been with us for six months.

Okay.

One final question on credit.

Do you see-- Several issuers have talked about changing payment patterns and increasing minimum payments, and industry payment rates are down.

(Inaudible) data, I think, a little less than the industry.

Any changes in payment patterns that you're picking up?

I think you did mention slower payments as one of the positives in the quarter.

Just give me some color there, and how do you feel about payment patterns?

Average payment rates have increased over the last few years, and so they're still at a fairly high level.

But they seem to have flattened off.

And I think the fact that there are tighter alternatives, such as home equity loans, is probably one of the factors that I would suspect is benefitting us as some of the good loans we were losing before may be sticking with us today.

Got you.

Any increase in minimum payment rates?

Well, when you say--?

Are you referring to the percent of customers who make a minimum payment?

Yes.

I have not seen any significant change on that to date.

Okay.

Great.

David, thanks for the color.

Our next question comes from the line of Kenneth Posner with Morgan Stanley.

You may proceed.

Thank you.

Good morning.

David, I just wanted to ask what you are seeing in the marketplace in terms of competitive intensity.

Are your competitors still barreling ahead with aggressive offers, or are people starting to pull back, given questions about the environment?

We have seen some, certainly, moderation in the increase we've seen over a number of years and, in some cases, some pull back in mail volumes and some increases in pricing.

And I think we're, for the first time in a while, starting to see some response rates, as a result, that are rising, which is a good thing for us.

Thank you.

Our next question comes from the line of Jordan Hymowitz with Philadelphia Financial.

You may proceed.

Most of my questions have been answered.

My only remaining one is that, if you guided to about $70 million in kind of one-time gains and if I kind of assume the loss provision is about the same on that, that means you provided about $15 million over charge-offs, so about 110% of charge-offs.

If I think about that 110% number, is that a good number to think about, provision to charge-off, looking into '08?

Well, I might guide you just a little differently, Jordan.

I might guide you to think about the balance sheet and the growth measures that we've indicated would be our goals, as well as some measure of where we would see reserve rating against that, given the economic climates and the portfolio performance.

I think what you get into with a measure like you've outlined is a little distortion from on and off balance sheet and the rate at which-- and the changing of the reserve rates.

And, objectively, more of your growth will be coming on balance sheet (inaudible) off, given the funding environment.

Correct?

Yes.

I don't think we'll see a different balance.

I don't intend for us to see a different balance.

But I do think, quarter to quarter, they're going to be $1 billion on/$1 billion off, like you saw this particular quarter.

And I don't want you to get tripped up by the sequencing of those occurrences.

Let me put it this way; you're about 46%, if I calculated right, on balance sheet funding at this point of your U.S.

receivables.

Is that 46% a good number, or will it continue to trend up slightly, given the capital markets issues?

I think that's not a bad measure.

If I would-- Maybe 50/50 or something like that.

Okay.

Thank you.

Our next question comes from the line of Mark Sproule with Thomas Weisel Partners.

You may proceed.

Maybe sort of touching on a question a few back, as some of your competitors maybe pull back or temper their attempts to grow receivables and you're continuing to indicate a willingness or desire to grow at 5% plus, how do you balance that out with the risk spectrum of deteriorating credit in the environment right now?

Well, we would not be seeking more risk, certainly in this environment.

And our growth achievement and appetite will be somewhat dependent on how this environment continues to roll out.

On the one hand, if we see significant opportunities because of pull backs from competitors and modest changes in unemployment rates, which ultimately drive a lot of risk for a consumer lender, we would be more aggressive.

And, conversely, if the environment deteriorated more than expected, we would certainly take that into account as well.

Okay.

And then, with the non-active accounts, I think you mentioned earlier that you were starting to purge some of those accounts or try to purge some of those accounts.

Is there concern that those accounts may become more likely to default down the road if trends erode a little bit?

What's the pressure there?

I think it's out of an abundance of caution that, in a higher-risk environment, one of the things that we can do to help control that risk is to reduce our contingent liability.

And so we're taking some actions to do this.

Okay.

And then, lastly, on the UK business, as far as getting to breakeven or profitability, are we still looking towards the end of next year, net of, obviously, impairment issues?

Putting impairment aside, I think we were very pleased with the improvement.

We're not happy that it's still losing money, but it was the best quarter in a while.

It showed some progress.

And I think we have indicated all along that we expect to achieve a substantially reduced loss but not likely breakeven or profit for the full year.

And so what we want to see is a couple of quarters of improvement before I'm, again, ready to say we're going to break even in this quarter or we're going to start making money in that quarter.

Great.

Thanks, guys.

Our next question comes from the line of Mike Taiano with Sandler O'Neill.

You may proceed.

A couple of questions.

The first one is - Can you just help me understand the decline in the provision in the UK business, particularly when delinquencies went up?

Was it really driven by the shrinkage in the portfolio, or was there something else driving that?

That's right, Mike.

It relates to the shrinkage of the portfolio, offset by a rising rate.

And it sort of interacts with some of the provisioning that was made earlier this year against our hardship portfolio as it actually runs off through charge-off.

So it's a number of things but, basically, exactly what you characterized it as being.

Okay.

The other question is just a follow-up on the earlier question on the I-O.

I'm having, I guess, a little difficulty understanding.

I understand how you indicated that Libor absolute rate has come down.

But wouldn't the asset yield, as well, come down, offsetting that, or is there something I'm missing there?

No.

I think what I was-- Again, if you cut right through it, I guess what I was asking you to do is look at where Libor was.

Libor from the second quarter to the third quarter rose on the back of increased spreads.

It rose-- The measure rose, but it gapped away from Fed funds target.

Libor from the third quarter to the fourth quarter fell.

So this mark will generally go in lockstep with the direction that the absolute level that Libor takes.

Okay.

Great.

And then the last question.

Do you have any update on that $120 million of commercial paper that got downgraded that you disclosed in your 10-Q?

Mike, that was-- When I mentioned the other income and a mark against a position in our short-term investment portfolio, we did take a small mark against that.

And that was what was netted in with those other two items in other income.

Okay.

And is that basically going to be mark to market each quarter?

It was marked as a position that was-- It's a little technical.

It came to us through the trust.

It was marked at the point of time it was distributed to Discover and will be marked through OCI hereafter until it's liquidated, unless it's a permanent change.

But any short-term marks that don't involve a permanent impairment will be marked through OCI.

If it's a permanent impairment, it will go through other income.

Okay.

Thanks a lot.

Our next question comes from the line of Meryl Witmer with Eagle Capital.

Please proceed.

I'm just trying to get some detail on these one-off items.

We have the I-O strip was $37 million.

I guess you sort of said these numbers tally up to $70 million.

Is that correct?

If you wanted to, say, normalize, you might add that-- I mean take away $70 million?

No.

Meryl, I think what I would guide you to is I think the I-O is a little bit-- We were going to have I-O move--

Right.

Okay.

So take the I-O out.

Are these other ones one-time?

The other ones I deliberately called out because I do think they're nonrecurring.

And, between the three of them, which were gains on merchants' contracts associated with our partnering with the acquiree industry, the charge against that position in our short-term investment portfolio we just discussed, and some tweaks that we did to the rewards liability, sum to that $37 million.

I'm sorry.

What was the number?

$34 million.

Okay.

So they were $34 million.

Okay.

I appreciate that detailed number.

And, then, on just-- Libor's up, and that's how you fund.

Can you, let's see-- With your credit card receivables, why don't you just go through and say, for example, on my card, increase the amount over prime that I'm charged?

Can you just--?

Do people even notice or care?

Couldn't you just up that 30 basis points and be done with it?

Well, recognize that over half of our credit card loans are at fixed rates.

Obviously, not those but the other--

Right.

But, just, if we think about the impact of a falling rate, over half of our credit card loans are at a fixed rate.

So, generally, a falling Libor and a falling cost of funds tends to widen spreads, which is a good thing, which should-- is what one normally looks for to help offset a rising charge-off environment.

On the variable rates, they're tied to prime rate.

And, normally, prime rates would go in lockstep with Libor.

I think, as Roy talked about, there's a very unusual spread right now between those instruments.

But we would expect that to normalize more during the next year.

So I'm not sure I would take actions on something that is a short-term phenomenon.

Well, what do you think the implication is with your cardholder base if you do that?

I mean, can you do it?

Well, we can change pricing on our card base, but I would say, generally, the whole variable-priced, prime-based pricing is designed to rise and fall with funding costs.

And, in normal environments, that's exactly what happens.

Right.

But maybe there's a new normal.

I'm not-- Without regard to whether or not you think you should change it, can you change it?

Well, we can.

And, if you look at the spread this quarter, we changed some rates where it makes the most sense - so new customer accounts-- Promotional rates, Roy mentioned, were running higher, and that's something that one can change more quickly.

And so we have a variety of levers that we can pull for pricing, and we try to manage that appropriately.

Right.

But what about the-- like just the loans that are outstanding.

Is there--?

What is the lag?

Do you send out a notice, and-- Is it one month later you can change it?

We would normally give a 30- or a 45-day notice if we were going to change rates, if that's your question.

Yes, it is.

And, then, do you actually--?

You think it's temporary, but it may not be temporary.

If it is temporary, you could raise rates now, and then, if it is temporary, you can then lower them for your customers.

So why wouldn't you do it now?

You really think it would have a negative effect on balances?

We certainly try to manage this appropriately over time and make the right tradeoffs between income and growth and look at our funding costs and credit and just manage it appropriately.

(OPERATOR INSTRUCTIONS).

Our next question comes from the line of [Adam Herwich] with (Inaudible) Management.

You may proceed.

This might be very quick.

Yesterday, the EU passed an opinion on MasterCard.

Do you think there are any corollaries in the U.S.

that might affect you?

No.

That was a cross border, so we would not expect it to have any impact on Discover Network or on our Payments business.

Thank you very much.

Our next question is a follow-up from the line of Eric Wasserstrom with UBS.

You may proceed.

Roy, could you just--?

Going back to the issue of the D-Link capital-- Sorry-- the D-Link Master Trust, are you--?

You had a collateral account in your old trust.

Is that capital flowing back to you now?

Eric, it will over time based on the maturities of the instruments that were in place the day we ceased using it.

And so they stretched out as far as five to seven years.

But, as those mature, the cash balances in those trust subordinated deposits will free up and be available to us.

Did any of it come back, to you in '07?

Yes.

As the instruments that have matured-- Yes, they do come back.

I would guide you into the trust prospectus that shows the maturity profile of the entire outstanding issuance base.

And you only need to take account for the two last transactions that don't have cash collateral accounts with them.

Everything else would have accompanying cash balance freed up.

Thanks very much.

Our next question comes as a follow-up from the line of [Robert Hajda] of RiverSource.

You may proceed.

This really isn't a follow-up; it's the first time I'm on.

But did you talk about what the carrying value of Goldfish is remaining on the balance sheet?

Robert, we did not, so it's a good question.

You could obviously squeeze that when you see the 10-K.

It's about $40 million.

It's about a $40 million intangible that remains.

Okay.

And, with respect to your stock buyback, you guys kind of stand out among my coverage universe as-- It sounded like you're more inclined to continue regular buybacks going into '08.

And, given the funding environment and the premium on capital, does that still seem appropriate?

Well, Robert, I think what you heard David say, and, again, I don't know that I'm quoting directly, but we will be employing prudent capital management.

And I think that having the Board authorize the share repurchase gives management an important tool in the box for capital management.

That doesn't mean necessarily that we, in this kind of environment, run into the market and begin aggressively buying stock up.

So we will look at capital in the context of the environment, the risk profile, and funding issues associated with our business.

And I think what this was designed to do was, in effect, give us that tool so that, over the course of the next three years, it's available to us when appropriate to be deployed.

Okay.

Thank you.

This concludes the presentation as far as Q&A regarding the timeframe.

I would now like to turn the call back over to Mr.

Craig Stream for closing remarks.

Thanks, Tanya.

I just want to thank you all for your attention this morning and for your interest and encourage you to get back to me if you have any additional follow-up questions and wish you all a very happy holiday season.

Thank you.

This concludes the presentation.

You may now disconnect.

And have a great day.