發現金融 (DFS) 2008 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first quarter 2008 Discover Financial Services earnings conference call.

My name is Fab and I'll be your coordinator for today.

At this time all participants are in listen-only mode.

(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 Streem, Vice President of Investor Relations.

Please proceed.

Thank you, Fab.

Good morning, everyone.

I want to welcome you to this morning's call.

Appreciate your joining us.

Also want to remind you that we will be hosting a financial community briefing tomorrow morning at the New York Palace Hotel and we will be webcasting that event, and the webcast will begin at 8:30 New York time, and we would certainly encourage you to join us for that.

I want to begin 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 in an 8-K report, and in the company's form 10-K for the year ended November 30, 2007, which is on file with the SEC.

In the first quarter 2008 earnings release and supplement, which are now posted on you're website at discoverfinancial.com, and have been finished 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 explained why these presentations are useful to management and to investors, and 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 at the end.

Now it's my pleasure to turn the call over to David.

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

Let me begin by saying that, where relevant, we will be talking about results from continuing operations, which excludes items related to the sale and operating results of the U.K.

business, now reported, and discontinued operations.

Overall, our results this quarter demonstrated strong profitability despite rising credit costs.

Continuing operations net income was $239 million or $0.50 a share, down a bit from last year as we added $100 million to loss reserves in this year's quarter versus a $41 million reserve release last year.

This quarter we achieved what we generally expect from our U.S.

Card business model in a soft economy; historically lower funding costs have tended to offset higher credit losses.

We achieved continued solid growth in U.S.

Card sales volume, up 5%, with receivables up 2%, which we believe is appropriate growth in the present environment.

Sales growth generally became more concentrated in everyday categories such as groceries, gas or discount stores, with less growth in specialized retail segments such as department stores and home improvement.

This quarter we reduced balance transfer volumes by 43%, which boosted our yield, reflecting higher balance transfer pricing and tighter credit and marketing criteria for balance transfers given recent market trends.

Managed net interest income for the U.S.

Card business was almost $1 billion this quarter, up 11%, with a net yield on receivables widening to 8.09% in the quarter, 42 basis points above last year.

Fewer low rate balance transfer loans more than offset lower pricing on variable rate APR accounts during the quarter.

On the credit side, managed charge-offs were 4.37% in the quarter and our managed 30-plus day delinquency rate came in at 3.93%.

These two measures reflect the weaker consumer credit environment, but remain consistent with our current expectation for a full-year average managed charge operate in the range of 4.75% to 5%.

We continue to be intensely focused on strong credit risk management, and I am very pleased with our strong relative performance over the last year.

The U.S.

consumer is dealing with a softer economy, which has implications for card industry credit performance.

However, our consistent prime credit criteria and controlled growth over the past several years has positioned us well for a more difficult part of the credit cycle.

I will remind you that as recently as last May, Discover achieved its lowest 30-plus day delinquency in 20 years.

In fact, today only 4% of our balances and 2% of our active customers are 30-plus days past due on their accounts.

Over the past several years, we have focused on geographic regions and customer segments where credit characteristics were consistent with our prime lending approach.

Our receivables growth has not been overly aggressive, so we do not anticipate seeing the same sort of [vintage] pressure we saw in the 2003 cycle.

We will have more to say about credit risk management during our Investor Day presentation tomorrow morning that Craig mentioned.

Now I want to briefly recognize our third-party payments business, which turned in a another very solid quarter, with pretax income of $16 million, up 30%, as total debit and credit volume reached over $26 billion, which was up 24% from last year, above our long-term 18% target.

We continue to be quite pleased with the progress our network businesses are making to grow volumes, profits and especially acceptance, as we continue implementing our new merchant acceptance model across North America.

Before I turn the call over to Roy, I want to briefly comment on our recent announcement to exit the U.K.

card-issuing business.

That decision fundamentally reflected the likelihood that the credit and funding environment in that market will not allow us to achieve appropriate return levels in a reasonable time period.

The U.K.

Office of Fair Trading has cleared the sales transaction as of March 7, and we are on track for a closing during our second quarter.

At this time, I'd like to turn the call over to Roy Guthrie for his comments.

Okay.

Thank you, David.

I think as David commented on some of the continuing operations, I'd like to quickly review the financial impacts of the sale of the U.K.

business, so that we can lock together the reported results with our continuing operations and then get back on track with a discussion of the great quarter he was outlining.

As you can see, all in we earned $81 million in the first quarter, or $0.17 a share, including the after tax loss of $158 million attributable to what we're characterizing now as discontinued operations, which in effect is the U.K.

business.

On a per share basis, the U.K.

impact was $0.33, so EPS from continuing ops is $0.50 for the quarter.

As David said, it was a very strong quarter reflecting, I think, a lot of balance in the business model and the conservative underpinnings of our approach to risk management coming into this credit cycle, and I'll get to that more fully in a moment.

But back to the U.K..

Our agreement to sell this card business was announced back in February and, as a result, we have reclassified the business to discontinued operations and have restated the prior period balance sheets and income statements for comparability.

The first quarter loss from discontinued operations includes a $172 million charge to write the assets down to their fair value, which will be the way they're carried on the balance sheet; and as you recall, when we announced this transaction last quarter, we estimated that loss to be in the 190 to $210 million range, so recording here 172, we've somewhat recorded a lower loss there.

The improvement in that loss is driven by several factors.

First of all, we benefited from a lower exchange rate compared to November; our shutdown or transaction that were recognized in the first quarter were lower; and our contract termination costs will be much lower than we had originally anticipated in our estimate.

And finally, I think we've refined the tax position that we used against the charge.

Discontinued operations also includes net income from the operation as a segment for the quarter of $14 million, and those results include a gain, a $33 million of pretax gain from the sale of certain assets that didn't go along with the sale of the business to Barclays.

Closing conditions for the transaction have proceeded as we would hope they would, and so we continue to expect the sale to close in our second quarter.

The sale of the U.K.

business removes just over 10% of the receivables of Discover, and importantly also removes an almost equal amount of funding requirements.

Within the sale transaction we will transfer our interest in the [Cumbernauld] Trust, which has $1.2 billion of asset-backed securities outstanding, as well as $2.7 billion of funding which was sourced from the U.K.

asset-backed commercial paper markets through partner banks.

So accordingly, I think Discover's risk profile will be reduced, and in effect this deal frees up capital to be used in other parts of the business.

Looking now at results in each of our segments, the U.S.

Card turned in a very strong quarter earning $375 million pretax, as higher loss provisions were largely offset by pretty significant increases in net interest income and other income.

The net yield on loan receivables improved nicely from last year, and looking then to the asset side, we benefited first of all from the lower -- or the fixed-rate receivables that are inherent in the portfolio, and the sharply lower level of balance transfer activity that you heard David mention.

On the liability side, our funding cost benefited from the sharp reduction in the Fed funds target rate, primarily - or principally, excuse me, offset by unusually wide spreads between LIBOR and Fed funds.

Our asset backs reset off of LIBOR.

That gap historically has been about 8 basis points, but as you know into the last couple of quarters we've seen that gap widen to 30 and 32 basis points respectively for the last two quarters.

And I'm please to say that by the end of this first quarter, we began to see that spread normalize; so if that continues, we should see an additional benefit into our spread going forward, and I think that's a great platform for continued strong yield on into the rest of the year.

Other income on the U.S.

Card segment also grew substantially from last year, reflecting a $75 million writeup in the residual interest that we maintain in our asset-backed securities, and higher merchant discount and interchange revenue that are consistent with the sales growth that you heard David talk about.

Similar to what we saw in the fourth quarter, the residual interests were written up largely due to lower absolute LIBOR rates that we saw at the end of the quarter.

Operating expenses in the U.S.

Card segment were up just 2% in the quarter ,as marketing and business development were up slightly from last year while all other expenses remained relatively flat.

Expense control remains a very strong focus here at the company, and we continue to make a lot of progress that we've talked to you about, with the tail end of our separation from Morgan Stanley, where we'll see expense - relief from -discontinued of their transition service support in the back end of this year.

As a final note on the P&L for the quarter, our tax rate you see here at 38.9%, that's running about 1% higher than we saw last year, and this is attributable to various state legislation that's been put in place, as well as our adoption of FIN 48 and the provisioning associated with that.

So I'd like to guide you to think about this year's full year tax rate in the 37.5 - 38.5, excuse me, percent range, about 1% higher than last year.

The last topic I want to cover this morning relates to capital and liquidity, and a simple measure of capital is tangible equity to manage receivables, and by that measure our capital has grown from the 9.4% you recall us talking about at spinoff to over 11% at the end of this first quarter.

We have finished the quarter with about $5.3 billion in tangible equity or 11.5% of managed receivables.

Using the spinoff benchmark of 9.4% on the February receivables, this would indicate that we've built about a $1 billion cushion into our balance sheet capital.

That improvement is due to earnings that have been retained in excess of capital requirements of the business, as well as I think importantly the previously mentioned positive results of the U.K.

sale.

We have not as yet executed any share repurchase activity against the previously-announced repurchase authorization, principally because of the pending U.K.

transaction that we have already discussed here, as well as conditions that we see in the markets today.

So tangible capital therefore has continued to grow.

In terms of funding, the credit card asset-backed markets so far this year have seen issuance actually higher than a year ago.

We have seen up through today $23 billion of domestic credit card ABS issuance, and I think many are estimating that 2008 could be a record year for volume.

However, I'd like to point out that there are some pretty significant differences in the two years' markets.

In 2008 we're seeing spreads that are significantly wider, [tenors] that are shorter, and a buyer universe that has significantly narrowed.

It's important to note, however, that the fundamentals of our issuing trust remain very, very sound.

Excess spread from last month was just reported earlier this week for our trust at 8.29%.

So we have continued to be successful in issuing ABS in the public market; $900 million in the first quarter, and a $1 billion deal that was launched in the first week of March, both upsized from the initial launch size that's we had indicated.

These have been complemented by the use of partner-bank conduits and CD issuance to keep all of our funding programs well on track.

We closed the first quarter with pretty good contingent liquidity as well that comes from three principal sources.

Number one, cash, at $8.3 billion; number two, committed conduit capacity at partner banks representing about $900 million; and thirdly, capacity in our master trust to issue AAA securities representing just over $5 billion.

When you add that to the $2.5 billion bank revolver we have in place, we have in total about $16.7 billion of contingent liquidity, 1.4 billion higher than the last quarter.

So let me conclude by saying I'm very comfortable with the balance sheet.

It's well-capitalized.

I believe we have sufficient funding capacity to continue to grow the business.

So that concludes my formal remarks, and I'll turn it back to you, Fab, for the Q&A.

(OPERATOR INSTRUCTIONS)

Your first question comes from the line of Howard Shapiro from Foxx-Pitt.

Hi.

Thank you very much and congratulations on the quarter.

I wasn't sure I heard it, Roy, could you just tell us what - again, the capital was freed from the U.K.

transaction and then also what percentage of your managed loans are fixed?

Okay, Howard, of that about $1 billion that I cited, I would say between 30 and 40% of that would have been attributable to the U.K.

sale.

Okay.

The rest really I think relating to earnings over the period since then.

And in terms of fixed, we have really not disclosed the fixed rate portion of our domestic receivables, but I would give you, you know, some guidance that it would be in excess of 50%.

Okay.

And then just one other question.

Where did you see the LIBOR/Treasury spread at the end of the quarter?

We saw it was very difficult to read at the end of the quarter, given the anticipation of LIBOR, you know, in the Fed target -- the Fed reductions, so it's probably a little bit of a misread, but I think that the -- we use the forward curves in the IO valuation, so to the extent that the anticipated reduction in interest rates was built into that over the coming three to four months following the February balance sheet date, it would have been incorporated in the IO calculations.

Perfect.

Thank you very much.

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

Thanks.

Good morning.

You know, I think some of the surprise in terms of your results versus where the consensus was had to do with the -- perhaps people not realizing the net interest margin would expand in this environment.

The Fed just lowered rates by 75 basis points yesterday.

Can you give us a sense as to what that would mean for the margin, given how your balance sheet is currently positioned?

Well, I think it's not unlike what we saw last month, so your best guide would be to go back and monitor fourth quarter flowing into first and the results that we saw from that, because in effect it's taking it down, that's pretty much what we saw right on the heels of the 75 basis points that occurred in the first quarter.

You know, I think at the end of the day the -- there's a number of things, you heard David talk about them, I tried to articulate on a couple of them, but there's more than just short-term interest rates at work here.

I mean, there's clearly the operation of default pricing that is -- associates itself with the underlying performance of the portfolio, there's the promotional rate discussions that both, I think, David and I made in our formal remarks that, in effect, gives a lift to the spread, as well as the liability sensitivity that inherently is built in as a market risk control by our team here.

So a lot of things at work there.

I wouldn't lay it off on any one of those, but I think that there's a number of things that perhaps were underestimated by the street, notwithstanding the fact that we've tried to articulate that there are a lot of building controls that balance this model during periods of rising stress on the portfolio.

And if I could also ask a little bit about the reserves, David mentioned that you built reserves by $100 million.

Can you just tell us where you are in terms of reserves to the [own] portfolio, and every company seems to have a different philosophy for reserves, so how would we think about where you want to be reserved going forward?

Well, I think that what I would suggest that you -- I mean, I think what you will see with Discover is a very consistent application of a reserving policy, and I would guide you to follow the 90/30-day balances in the portfolio.

You can clearly calculate the reserve rate.

We've offered it in our statistical supplement.

You see the owned receivables; that's what the reserve is established against.

And I think that you should expect to see those move in lock step, unless we report to you some change in the way we're going to be anticipating portfolio behavior.

And in that regard, it's very consistent -- it's been very consistently applied across, you know, many, many quarters beyond - you know, preceding when we became public.

Okay.

And then my last question, if I may, obviously you guys have been embarked on this process of outsourcing the -- some of the merchant processing function to third parties, and my understanding is that that could lead to more favorable revenues for Discover, or a more favorable balance of revenues and costs, and I wanted to know when we might expect to see that flowing through the numbers.

Well, Ken, we will be providing a little more detail tomorrow at our Investor Day, our first Investor Day and the Head of our Network, Harit Talwar, will be one of the presenters, in fact.

I would say we're already starting to see some increase in revenue.

Roy cited the other income has been rising.

In part, that's because sales are growing faster than receivables, and in part we're continuing to see some net benefits from effective merchant discount or interchange as we switch to the new model, see some benefits.

You know, this is very much an implementation year.

We had announced that 95% by volume of the acquirers had been signed, and we're pleased with the progress of our implementation, but certainly not all the benefit is in our numbers yet.

But it is starting to flow in quarter by quarter, as we continue to bring the rest of the small merchants online for Discover Card acceptance across the country.

Thank you.

Your next question comes from the line of Chris Brendler from Stifel.

Chris, your line is open.

Please proceed with your question.

Hi.

Thanks.

Good morning.

You mentioned in your press release that you cut back pretty significant on balance transfer promotional activity.

Can you just talk about what are the effects that we should be looking for as you go forward?

Is that going to help the margin, as more of your portfolio is not at the teaser rate, and is there any credit effect from slowing down that activity?

Well, Chris, would I say we took the action to pull back on balance transfers for two reasons, and I should point out one of the reasons we're down 43% is because the first quarter of last year was a particularly high quarter, but apart from that, early in the quarter, as Roy mentioned, LIBOR was unusually elevated versus Fed funds, and so we did proactively take some action to help reduce particularly 0% promo rate balances to help offset what otherwise would have been some yield compression.

Now the pressure on that has diminished, as Roy mentioned, but that was one of the reasons.

But - excuse me.

We also took some credit actions as we saw some parts of the country and some consumers pull back from, you know, maybe have -- have some issues in the real estate area, we wanted to ensure that we just didn't end up with balance transfers of what might be problem loans for us, and so we took some -- we were -- we did become a little more conservative on credit criteria to ensure that we don't end up with something unfortunate.

Okay.

And then I guess on the credit side, just how things trend in the quarter, are you still comfortable with your loss guidance and what do you think the impact will be from the additional tax refund?

Is that in your guidance?

Well, as we said in the press release, we remain comfortable with the 4.75% to 5% full year number.

We now, obviously, have one quarter of actuals, and we also have a strong visibility for particularly the next two quarters, and so our certainty will, obviously, increase as we go through the year.

In terms of the tax refund, we're not anticipating any particular impact one way or another.

You know, on - net, I would hope it would be a positive for consumers, and therefore for us, but it's a little hard to predict.

Okay.

And then just in terms of transaction volume X the cash, still pretty healthy, 5%; any deterioration to that number within the quarter or in the [pulsed] net volume, are you seeing any signs of slowdown in spending in your portfolio as we stand today?

You know, it's been a bit uneven.

Actually, the weakest time period was the three weeks right before Christmas, and - during the quarter, and I would say that is consistent with the -- that's when the most discretionary income or spending happens, and so then it's been stronger since that first three weeks, but, you know, there are still some consumers who I think are starting to pull back a little bit on spending.

So, you know, we were pleased with the overall 5% and it wasn't as -- it wasn't that we saw some big tailing off in that number.

Great.

Thank you very much.

Your next question comes from the line of Sanjay Sakhrani from KBW.

Thanks.

You mentioned the surplus of capital.

I was just wondering, I mean, should we expect that you guys will be in the market buying back stock this quarter and subsequent quarters this year and/or are there other opportunities to deploy that capital?

Sanjay, I think I tried to sort of indicate a couple of things there in my formal remarks.

Maybe it would be worthwhile to articulate them again here.

Clearly with the U.K.

transaction in motion, we stayed out of the market, but having said that, I mean, market conditions as they exist today are not, I think, as conducive as we'd like for them to be for us to aggressively pursue that program.

You know, so I think it's -- capital is sort of a complex collection of a lot of things, and clearly we have indicated over the term, the long, intermediate term, that clearly the authorization we put in place was intended to be, you know, a capital management tool to manage the level of capital that we see appropriate against the risks that we see in our business.

The evaluation of those are going to be very dynamic, and so I think right now I'm suggesting to you that there are sufficient things going on - I don't want you to soft circle a large, aggressive stock repurchase program, but having said that -- actually I'm not going to give any guidance because we're going to publish at the end of the quarter what transpired during the quarter, but I want to make sure everyone understands we're looking at this thing in a very balanced, very wholesome way.

And I think one of the things that you can read into the way we run this company is very conservatively, and very much in anticipation of contingent things that could occur.

And so you're going to see that sort of balance, you see it in the way we position the portfolio, you see with the way we're provisioning for the portfolio, you see in the way we're managing these segments.

And so at the end of the day I'll conclude by saying, yeah, there could be potential uses of it in the form of inorganic uses and those should never be left off of the table, but they will be episodic and so we're not going to really comment on those, either.

Okay.

And then just, Roy, on the funding side, I mean, how much in funding commitments do you have on the securitization side, and how much in AAA capacity do you guys have?

Well, we have -- I've got about $1 billion committed by banks and I have $5 billion structured in the trust for AAA.

Okay.

And then -- and how much are coming due over the course of the - you know, next six months or so?

We have about $5 million in maturities over the remaining year and most of it's in the fourth quarter, half of it -- over half of it is in the fourth quarter.

Okay.

Great.

And just one other question.

I recall you guys had a large sort of inactive account base.

I mean, are steps being taken to shut those down or mitigate the risk associated with that?

Yes.

That's one of the actions we took - that we started taking over the last few months, is to more aggressively call our long-time inactive accounts to reduce our contingent liability.

Okay.

Is that a disclosure we'll get tomorrow maybe or sometime soon, like what the inactive to active account base is?

Let me think about that and we'll look at when and how we might disclose that.

All right.

Great.

Thank you very much.

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

Hi, good morning.

I had a question on the portfolio that's priced at a fixed rate.

How should we think about that in the context of the recent Fed rate cuts?

Is there greater risk of attrition on those accounts because they're priced at a fixed rate that a competitor can potentially come along and price those loans away from you?

Well, a couple of things.

One is most promotional rates are fixed rates and so that - those are obviously attractive -- very attractively-priced loans, and so those would be at very low risk.

In terms of the other -- the rest of the fixed rate portfolio, you know, these are on accounts that didn't rise with -- generally rise when -- as rates went up and generally would tend not to fall significantly as rates -- as rates fall.

And so we have not in past cycles typically seen a big change in fixed rate performance up and down.

Obviously, at some level of funding cost it might allow us to take some action on reducing even some fixed rates, but generally we've got customers who like the fixed rate and like the fact that across cycles, it's a consistent rate.

Okay.

Could you give us some quantification of what the breakout is between the fixed rates that are on introductory rates that -- versus the ones that are just permanently fixed?

I don't believe we have published the percentage of promo rates.

I think in the past we had at one point a couple of quarters ago disclosed that about 60% of our portfolio is considered fixed generally, and I think just a general guideline might be that about 1/3 of that might be some type of promotional rate and the other 2/3 roughly might be fixed APRs on retail.

And then just a last question on expenses.

It looks like your sequential operating expenses declined by about $34 million versus the fourth quarter.

Is the first quarter a good run rate to use through the rest of the year?

Well, I think that the -- yeah, the -- I would say that the first quarter is generally speaking, and you can see the seasonal flows where, in effect, the first quarter tends to be the lowest month - quarter as it was last year, and the fourth quarter tends to be the highest.

I would suggest that we'll see probably a more stable pattern unfold during the course of this year, and I'd like to just reinforce the point that we made earlier about, number one, high priority to the management team, number two, we're on track to get the Morgan Stanley interim services disconnected midyear to begin to realize the benefits of that on the back end.

Okay.

Thanks very much.

Your next question comes from the line of Eric Goldberg from [Oberam] Capital.

Hi.

Good morning.

This is actually Andy [Retchoff] from Oberam.

I just had two questions.

First was regarding the share buyback that you touched on earlier, you know, the stock was around these levels when you authorized the buyback back in December, and as you dipped quite a bit lower during the quarter, I understand that the transaction was pending, but if you authorized the buyback and the stock is trading at what many would argue are levels well below where it should be, what would it take or is there a level at this point where you might be convinced to exercise the buyback, or do you think those markets are simply too uncertain right now?

Well - this is David.

I would point out that we have not opened our window period since that authorization was put in place because of at the time a potential U.K.

transaction that in fact became a U.K.

transaction, so, you know, the level of stock price has really not entered the equation.

It simply wasn't an option for us.

And I think we, you know, also are careful just not to signal and just to manage -- use a buyback more to manage capital and - as opposed to trying to time the market.

I see.

Okay.

But the authorization was put in place with the intention of actually using it as - just as a symbolic gesture?

Yeah.

Our intent is to execute on -- on -- you know, towards that billion dollar authorization.

It's a 3-year time period, so, you know, it was not necessarily put -- been put -- it was not necessarily put in place to execute it all in one year, but we're going to continue to monitor and make decisions quarter by quarter, report on those results, and it is still our intent to be in the market at some point during the rest of this year.

Okay.

My other question relates to -- I haven't had a chance to speak with you, a comment that was made when the company reported earnings back in December as related to the company's independence.

I was just curious if you can comment on the comment that you made was that if the share were at these levels, it ran the risk of being a takeover target, and I just was wondering, as a new story that ran on the 25th of December, if you could elaborate on that a list.

Do you ever that Discover should be an independent company?

I assume there wasn't any approach made, but if you could explain what you meant by that, that would be great.

I'm not sure that that would be an accurate quote and, you know, we generally do not comment on or speculate on that kind of matter.

Well, the quote I have here, it says, "You can become a target if your stock price is too low," you were quoted as saying in a Bloomberg study on December 20th.

I don't know if there was any context for that comment or just to get your thoughts on Discover's independence.

I guess I would just point you back to our focus is on delivering shareholder and building shareholder value through great operating performance across cycles, and I think that our results this quarter demonstrate that.

They also demonstrate the fact that we did enter an agreement to sell the U.K.

business, which was the one area that -- where we were not achieving adequate returns on shareholder capital, shows that management is very focused on building shareholder value and doing the right thing and - but our operating performance through cycles is what we are focused on on delivering.

Okay.

Thank you.

And your next question comes from the line of Moshe Orenbuch from Credit Suisse.

Thanks.

Roy, just a quick one, and then I've got a question after it, but this $5 billion of AAA capacity that you mentioned, I thought that number was a little under $3 billion, and you used some of it.

Were you able to issue more BBBs during the quarter?

We did issue BBBs and retained them on our balance sheet.

So if you were to securitize the AAAs, does that still get sale treatment?

Yes, it does.

Okay.

That's good.

Separately, just going back to the comments both you and David made about the margin, you've got kind of a comparable decline in rates, possibly even a little larger decline in LIBOR going into, you know, the next quarter, and you had a 30 -- low 30s basis point improvement in the margin.

I guess I wasn't sure how to interpret the comments that you made about the introductory rate balances.

Should we be thinking that you're going do more of that because rates are lower, or the same amount or less, and the margin improvement should be comparable or higher, or are you going to be doing more of it and therefore it would reverse some of that?

Well, this is David.

Let me suggest two things.

One is in several of our investor presentations we've shown some charts that show history during which Discover's margin has typically whitened during times when charge-offs have increased, and we have established our business model to try to have that be true and it is developing in that way at this particular time, and so we would expect some continuing expansion of margin as a result of falling interest rates, cost of funds.

I would say this quarter may be a little bit of an aberration because the LIBOR versus Fed funds was unusually wide, and the actions we -- and we took unusually aggressive actions on balance transfer to help offset that.

As Roy mentioned, we don't expect that kind of a spread to continue and - nor do we expect to have quite the level of reductions in balance transfer over the next few quarters year-over-year, we don't think that will be as necessary to have the yield and spread go in the right direction.

Okay.

Thank you.

Your next question comes from the line of Darrin Peller from Lehman Brothers.

Thanks.

Most of my questions were answered but I guess just to touch quickly on the expense side.

You know, I think there were two specific line items that really dropped off quite a bit, in particular professional fees.

Now, it might be seasonal, but it went from 94 down to 73, information process communication fees also.

Can you just -- I mean, is that a run rate on those specific lines that we should be using?

Well, they're in the volatility -and I'll just maybe articulate this for the broader group, but those of you that follow the trends in our expenses quarter-to-quarter, volatility really resides on two lines, marketing business development and professional fees.

And so you're going to see, you know, basically those two lines sort of move around.

I think at the end of the day, you know, we are -- the level at which -I think I had mentioned some seasonality in the marketing business development spend, so keep in mind that, you know, we would guide you to a full year spend similar to what we saw there in 2007.

And then the rest of these are all being pressed on aggressively, as it relates to the expense initiatives that we have across the complex here in Chicago and in the field.

So professional services tends to be a little bit of a bubbler that sort of moves in there, but the volatility on that line is not going to be as significant as what you see in marketing and business development.

So think about the trend line comment we made earlier, think about the back end of this year enjoying the benefits of moving off the transition from Morgan Stanley Services, and the guidance that we've given you here for marketing and business development, and I think you'll come right on top of where we're going to land.

(OPERATOR INSTRUCTIONS)

Your next question comes from the line of Jeff Feinberg from JLF Asset Management.

All the questions have been answered.

Thank you very much.

Thank you.

This does include the question-and-answer session of today's conference call.

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

Craig Streem for closing remarks.

Thanks, Fab.

Thank you all for your interest, and we look forward to either seeing you or speaking with you tomorrow during the briefing in New York.

Have a good day.

Thank you.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Have a wonderful day.