發現金融 (DFS) 2009 Q1 法說會逐字稿

Good day ladies and gentleman and welcome to the first quarter 2009 Discover Financial Services earnings conference call.

My name is Dan I will be your coordinator for today.

At this time all participants are in listen only mode.

We will conduct a question and answer session towards the end of the conference.

(Operator Instructions) As are reminder, this conference call is being recorded for replay purposes.

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

Craig Streem, Vice President of Investor Relations.

Please proceed sir.

Thanks, Dan.

I want o welcome all of you to this mornings call, certainly, as always, we appreciate you joining us and your interest.

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 and 8-K report and in our form 10-K for the year ended November 30, 2008 which is on file with the SEC.

In the first quarter 2009, earnings release and supplement, which are now posted on our web site at discoverfinancial.com, and have been furnished to the SEC, we've 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 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 Chairman and Chief Executive Officer and Roy Guthrie, our Chief Financial Officer and of course we will leave ample time for questions and answers.

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

Thanks Craig, I'm going to start this mornings call with some comments on our first quarter results and the challenging economic environment.

And then share a brief comment on the dividend we announced this morning.

As you can see from our results this quarter, and the actions we have taken since the end of the quarter, we are focused on maintaining a very strong capital position as we significantly build reserves in light of rising delinquency rates and growth in on-balance sheet loans.

First quarter net income from continuing operations, was $120 million, or $0.25 a share driven by net interest margin expansion, expense reductions and the second payment in our anti-trust settlement with Visa and Master Card, offset by significant loan loss provisions.

Roy will take you through out first quarter results in greater detail, but I'd like to highlight a couple of important areas beginning with credit performance.

Our charge off rate for the quarter came in at 6.5%, consistent with our Investor Day guidance.

However, unemployment rates and our delinquency rates have risen significantly and we anticipate, at this time, that our loan loss rate for the second quarter, will exceed 7.5%.

In response to these trends we added this quarter over $500 million of reserves in excess of charge offs some of this related to previously securitized loans that came back on balance sheet and Roy will discuss that in greater detail later.

But the majority of the increase was for reserve rates strengthening.

In addition to building our loan loss reserve, we recognize that our customers are facing the highest unemployment rates in over 25 years, in fact, since before Discover was launched a a business.

And we are taking actions to help our customers through this difficult period, particularly those customers in hardship situations.

In 2008, we worked with over 1 million of our customers by reduce APR's, waiving fees and establishing payment plans to help them get through tough times.

And for the benefit of our entire card customer base we recently launched a number of tools to help our customers manage their debts and spending more affectively including Discover's pay down planner and the Discover spend analyzer.

I want to turn now to key performance measures for our card and payments businesses.

Sales volume for Discover Card was down 8% from last year, however removing the impact of lower gas prices, the decline was closer to 4%, which is comparable to the level of decline we began to see late last year.

I am pleased that the decline seems to have leveled off and I am hopeful that when we see the first quarter results from our competitors, we will again see less of a decline for Discover than for the others, consistent with Discover's stronger relative performance in the fourth quarter.

In terms of credit card receivables, our managed credit card loan portfolio was up 4%, year-over-year.

As slowing payment rates offset the affects of lower sales volume, fewer new accounts booked and the 17% reduction in balance transfer volumes.

Credit card payment rates have fallen significantly as consumers, in general, have diminished access to credit and less discretionary income to pay down debt.

The balance of our year-over-year loan portfolio growth came from discover personal loans and discover student loans.

Regarding the personal loan product, I want to remind you that we are primarily originating these loans to existing customers using under writing criteria that are appropriate and conservative enough for the current environment including significant use of manual under writing and we're generally positioning these loans for debt consolidation.

Concerning student loans we added a little over $300 million in receivables this quarter, driven by dispersements for a second semester of school.

We are pleased with the prospect for this business as it now stands especially since we are originating through 250 schools, and obtaining government guarantees or cosigners on most of these loans.

However, we are well aware of the proposed legislative changes in the area of student lending and we will be looking very closely at the implications for future originations.

So, to summarize, concerning loan growth for all of our lending businesses, we do expect our owned loan portfolio to grow significantly as maturing asset backed securitizations are funded on balance sheet.

On the other hand, we expect that reduced marketing spend and appropriate risk management practices will reduce the level of managed loan growth from the 7% year-over-year that we reported this quarter, to a lower level later in the year.

And in fact, on the sequential quarter basis, the overall managed portfolio came down a bit this quarter.

Now, turning to our payments business we continue to achieve double digit growth in dollar volume despite what appears to be a global recession.

[Hault], our pin debit business, turning in 11% volume growth and we believe we are continuing to take share from our major competitors in this space.

At Diners Club, volumes slowed year-over-year, reflecting the global decline in corporate and T&E spending.

Nevertheless, we are very pleased with profits that the Diners Club acquisition is contributing and we are making strong progress on integrating our networks and are on track with providing global ATM acceptance.

As we have said before the integration of Diners Club and Discover is a critical initiative and we will continue to invest to complete the integration and maximize the benefits of global acceptance.

Finally, I would like to comment briefly on our decision to reduce the quarterly dividend to $0.02 per share which will provide a capital benefit of about $80 million on a annualized basis.

The savings is modest compared to our $5.5 billion dollar of tangible common equity, but it will help us maintain a strong capital position in the midst of this uncertain environment.

That includes changing accounting rules and rising loan loss provisions and is consistent with our conservative approach to managing the business.

It is also consistent with our desire to be in a position to repay the US treasury capital purchase program investment as soon as it is prudent to do so.

Now, let me turn the call over to Roy for more details on your results.

Okay, thanks, David.

I'm going to start with a review of our US card and third payment segments and then go on into our funding, liquidity and capital.

And then we will open it up for questions.

Starting with US card, the segment earned $167 million pretax this quarter.

Which includes the anti-trust litigation settlement income of $475 million.

On an after tax basis, the litigation payment benefited capital by about $297 million.

David already spoke about sales and receivables (inaudible), so, I'm going to go to, really the details of margin and the other aspects for the P&L.

Net interest margin increased to 9.11%, up 102 basis points from the prior year, 56 basis points from the prior quarter.

Both comparisons here benefited from a significant decrease in our cost of funds, and the year-over-year comparison also benefited from the balance transfer fee amortization that we talked about previously, which was worth 36 basis points.

These were offset by a decrease in the yield on our variable rate assets and the impact of higher charge-offs.

So, spread income continues to be a bright spot for us, up $86 million sequential quarter and up over $180 million or 19% year-over-year.

Other income in the card segment includes this Visa settlement of $475 million, as well as an IO asset write down of about $98 million.

IO write-down reflects both maturing ABS as well as excess spread compression associated with higher expected charge-offs.

Excluding these impacts in the BTP impact I just mentioned other income was affectively flat year-over-year.

Turning to credit performance charge-offs, came in at 6.48%.

30 day delinquency was 5.25%, a sequential quarter increase of 69 basis points.

We added a total of $504 million in reserves in excess of charge-offs in the quarter.

$351 million of that was reserve strengthening attributable to the impact of the deteriorating environment on our credit trends and $153 million principally due to the shift onto the balance sheet of $3 billion of maturing ABS deals.

Our reserve rate for the quarter was 6.70%, that represents an increase of 125 basis points from the last quarter.

In terms of expenses beginning last year, we implemented a variety of cost control measures throughout the company with the benefit starting to show in our results during the second half of last year, we expect those operating costs benefits to continue to show during the course of this year and in the first quarter our US card segment operating expense was down 10% year-over-year.

Reflecting principally lower marketing spend and professional fees and even as we spend, I think, aggressively in the collections effort and around portfolio control.

Turning to the payments segment, third party payments earned $29 million for the quarter, with total volume of $35 billion, including $6 billion from Diners Club.

The segment had significant growth in revenues, driven by higher transaction volume, and the inclusion of franchise fees -- or revenues, from the Diners Club international acquisition.

Expenses were higher primarily, due again, to the inclusion of Diners Club and investment spending related to integrating our networks and enhancing the relationships with Diners Club licensees.

Now, we're very pleased with the record pretax profits in the payment segment this quarter, but over the next couple of quarters we are going to see heavier investment spending related to the integration of Diners Club and our other networks and so we don't expect to see this level of pretax contributions from the payment segment to continue for the foreseeable, near term future.

I'm going to move on to funding liquidity and capital and begin with the positives which reached $28 billion at the end of the first quarter, representing 14% year-over-year increase.

With the direct to consumer and affinity programs once again growing $1 billion during the quarter, to reach $7 billion at quarter's end.

While we continue to emphasize our direct to consumer channel, I want to point out that the broker channel remains a very affective funding source for us.

The temporary liquidity guarantee program now has a I accounted for over $200 billion of term funding since its acception and I think, we believe that this has had the affect of shifting issuers focus away from this broker channel and thereby reducing competition in that market.

Our maturities for the balance of 2009 total about $10.5 billion.

Including $6.5 billion from our deposit programs, $2 billion more of public term asset backed deals and $2 billion in short-term borrowings.

So, to put that $10.5 billion in context, over the last year using an equivalent 9 month forward look, we've had maturities ranging anywhere from $9 billion to $15 billion, so we don't view this $10.5 as unusually high.

We anticipate we will continue to meet those commitments through on going deposit issuance, plus the recent $1.2 billion capital purchase program investment.

To the extent that maturities include previously securitized receivables, I want to remind you that we will add loan loss reserves and write down the IO strip as those receivables come back on balance sheet similar to what happened here in the first quarter.

ABS maturities for the rest of the year represent virtually zero in the second quarter, with that $2 billion I mentioned all spread between the third and fourth quarter.

Our contingent liquidity at the end of the quarter included $8.3 billion of cash liquidity, $1.5 billion of conduit capacity, $2.4 billion in our credit facility and $4.5 of borrowing capacity (inaudible) discount (inaudible).

And I think, importantly now, given (inaudible) is an active program, we have about $6.5 billion of (inaudible) qualifying capacity that could potentially be funded using this new program.

Our Trust is presently structured with sufficient subordination to issue $5 billion of AAA securities.

The first transactions under the (inaudible) program were introduced here today and yesterday and we are going to be studying the levels at which these transactions were executed very closely.

While our funding plan for the rest of the year assumes no additional ABS issuance, if the economics of the (inaudible) program become attractive we could begin issuing under that program.

Regarding FAS 140 and FIN 46, the FAS has come out -- FAS came out and indicated they will issue a final pronouncement during the second calendar quarter of the year, likely to be affective for fiscal years beginning after November 15, 2009.

Based on expected ABS maturities between now and November 30 of this year, our current assumption is that $20.6 billion of securitized receivables will be restored to the balance sheet upon implementing these new regulations -- or accounting rules and will be required to be reserved against with appropriate level of reserves, and the IO strip will be reversed and that impact along with the impact of reserve additions will be recorded as an after tax charge to the opening retained earnings of our fiscal year beginning December 1, 2009.

Last month, consistent with actions they've taken recently with a number of other credit card ABS issuers, Standard & Poors put certain of our asset backed funds on watch for potential downgrade and were actively discussing that with S&P and you'll hear from us further as we draw conclusions there.

As we announced last week, we have issued preferred shares and warrants to the US treasury for $1.2 billion under the capital purchase program and have registered as a bank holding company.

The incremental capital received under the program will help to support the significant increase in our on-balance sheet loans that is resulting from maturing securitizations and ultimately the transition to on-balance sheet accounting for the entire investor interest in the trust.

And I think importantly to echo what David said, will help us continue to meet our borrowing needs of the credit worthy card members we have in our portfolio.

I want to wrap up my formal comments by summarizing our capital position.

At the end of the first quarter, we reported $5.5 billion in tangible common equity, or $11.51 a share.

Which was 11.3% of managed receivables and 8.8% of total managed assets.

Taking in to account the $1.2 billion received under the capital purchase program on a pro forma basis, at February 28, our tier one capital ratio would be 17.1%.

So, in summary we've taken, I think, measured steps to further strengthen our balance sheet.

We've made the reserve additions that we've discussed, we've reduced our dividend by $0.04, we are participating in the US treasuries capital purchase program and liquidity levels have been maintained as our deposit channels have proven themselves to be affective and adequate and now, in addition to that, we have the potential benefit of TALF.

Operationally, US card provisions have been high but margin expansion, lower expenses and visa proceeds more than offset them.

The Visa settlement will include three additional payments during this course of this year, all expected to be at that $472 million level.

In addition this quarter we recorded record earnings within our third party payment segment.

So, now with that, I'd like to turn it back to you, Dan, and David and I will take your questions.

(Operator Instructions) Your first question from the line of Ed Groshans from Omega, please proceed.

Good morning, thank you for taking my call.

Mines, I guess, a basic question, just on the IO write downs, you took $98 million of those, I guess, part of them as you said, was pulling some of the assets back on balance sheet and (inaudible) of it was relative to prior loss rates.

And I was wondering, what are the loss rates you're now expecting for the trust and I guess over what time frame are you expecting those losses to be incurred?

Yes, I think the loss rate that would be resinate in this estimate, are consistent with what your heard us, sort of, outline in terms of guidance for the second quarter and beyond.

So, in the mid 7's -- 7.5% range.

The breakdown of the two component pieces I would say rate compression, is around 80% of the write-down and the volume attributes associated with the $3 billion of maturities is around 20% of the write-down.

Okay, excellent, thank you very much.

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

Hello, thanks, I think you guys have pretty good sense of kind of what is in store for the next six months as far as credit is concerned.

I was wondering if you could give us some color as to what your expectations are, kind of looking to the third quarter -- on credit, please?

Well, Sanjay, I think things have actually moved fairly rapidly in terms of unemployment rates.

And so, that's one reason we're only forecasting one quarter out at this time.

Our base expectation would be that losses continue to rise through the year.

But we would expect a slower quarter-over-quarter increase than what we've been seeing the last two quarters.

But, I would say that it's more uncertain than it normally is.

I mean one of the other wild cards is potential legislative changes if a bankruptcy crammed down law passed and if it was fraud, than that would obviously have an impact that we couldn't foresee sitting here today.

No, understood.

I mean I think -- I mean I guess, what's your sense on that cram-down legislation?

I mean is it -- it seems like the latest talk has been something less onerous on secured lenders.

I think that's fair.

But I would say there is a pretty broad range of proposals out there.

And so, I think we -- I think that the industry has been trying to put facts on the table about what would -- to try to avoid some of the most onerous changes that I think would be detrimental not only to the credit but to the economy generally and consumers who would be wiping out their credit for 7 years if that's the stuff they had to take to simply renegotiate their mortgage.

And so I think some of those concerns have been heard I hope.

But again we need to wait and see what actually happens.

Okay, great.

And Roy, I had a couple of questions for you -- very quick ones.

Just if we look at the sequential increase the the margin, could you just break out what the impacts were from the accretion of the balance transfer fees et cetera?

And then, just kind of give us a sense of kind of what to expect on the go forward basis.

And then the second question's on TALF.

You know, what would be the execution price?

You know, kind of at what level does it make sense to go to TALF route?

Thanks.

Okay, sequential quarter -- we made the change to reclass the balance transfer fees in -- during the course of 2008, and so I think third quarter forward they're resinate in the margins.

So, as you look at the sequential quarter increase here in margin, it is in affect -- does not have any impact from the reclass, sort of resonant within it.

I think the important thing to sort of point here is that we had a significant amount of interest expense head wind in the fourth associated with that spike in LIBOR, which put the spread under fair amount of pressure, but both the asset side and the liability side, helped the sequential quarter look.

In the year-over-year perspective, its around 35, 36 basis points.

Because again, the first quarter of last year would have had them recorded as fees.

So, 35 on a year-over-year basis, non-existent if n the sequential quarter.

TALF is -- the long awaited TALF is out and -- so we're going to see deals -- and we'll see what the print is on the deals sort of later on today.

We heard a credit card deal in the market this morning, and so we don't know what the final terms are going to be there.

But it could be in the high 100s.

And I think at -- when you talk about this in the context of where we would see it advantageous, it would be somewhere south of that.

But I'm very pleased to see that somebody could be printing 175 over with credit card collateral.

And -- because that gets us a lot closer to the zip code where we would find it advantageous.

But, more than likely it's 50 to 70 basis points higher than we would prefer.

I think its important that we demonstrate capacity in this market.

And so we may make decisions around simply demonstration of capacity in terms of deal execution where a slight more expensive piece of debt would be offered than would otherwise could be offered.

But just to put it in perspective, this particular quarter we were issuing, at 30 months plus I think, on a weighted average maturity, with under 3% execution, fixed rate funding for the company from these deposit channels.

So, I'd like to echo what I said earlier about the nature of what is going on in the deposit markets.

We've seen a lot of the large institutions withdraw, we're getting a great execution out the curve at low prices, and its with great expectation that we may even see better given what the government has done to try to bring long-term rates down.

So, I think TALF has to compete with that.

I think assuring that it's their force may drive us into the market to do a deal just to demonstrate capacity.

And as we get further into this and study the deals here, we'll keep everybody apprized as to our feelings on it.

Okay thank you.

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

Please proceed.

Hello, thanks.

Just a quick follow up on the TALF question, wouldn't it make sense not only to demonstrate access to securitization market but also to lock up a little longer term funding and 175 doesn't sound too bad to me, when -- if your talking about LIBOR at 50 basis points, you're still all in less than 2.5%, is that not correct?

Is there additional costs that I'm not thinking about?

Well, I think that's right, Chris.

Except that, you know, I think you can go out three years under the program and so you're basically saying do you want to take that interest rate bet.

And I think it's important for all of us to keep in mind that we will get through these troubled times.

And we want to make sure that we're cognizant of the fact that there could be significant inflationary pressures that follow this unprecedented period we're in right now of difficult economic conditions.

So, I'm clearly cognizant of that.

And I think letting things float, is something we're willing to do if we can see advantageous execution, but nonetheless, that is a reasonably significant risk when you're going out three, four and five years and subjecting a liability to floating.

Excellent point.

On the -- a related topic, have you had any initiatives around getting more of your accounts on variable or sort of, getting ready for increases in interest rates to take advantage of that, where do you stand in terms of your account pricing right now?

Well, I would say we have been rebalancing our portfolio and I think under the new guidelines that will be going in, you know, fixed rate credit card loans will largely be nonexistent because you'd be locking in a fixed rate for an indefinite time period.

And so, I would expect that all of our new originations have been variable for sometime.

And we've been shifting our accounts predominantly to variable rates to be consistent with the new guidelines.

And what percentage of your book is on variable rate now?

And then another question would be on FAS 140 and the impact on tier one capital, do you have any since that the regulators -- I think from a management perspective it's not too bad, because you're looking at the denominator including the off balance assets for that.

So, I believe for tier one it's a pretty big impact to have those loans (inaudible) on balance sheet.

Do you have any sense on the regulators as to how they're going to view that?

Is there going to be, sort of a window of period where you can get your capital ratios up or for FAS 140, do you think its going to all come in on (inaudible) and be as onerous as it could be from a tier one perspective?

I will let Roy answer the second question.

But on the first question, I don't have a snapshot for you here today, but I would say we will soon be mostly variable rate credit cards, loans, at least within our active portfolio.

Roy?

Chris, it's a very good question.

I think, there's really two, sort of, audiences that we are appealing to regularly to try to get this matter cleared up and get the uncertainty out of the air.

Clearly the FAS (inaudible) in also then, you know, treasury as it relates to how reg capital rules are going to be set against the new accounting principals going forward.

I think in the absence of clarity on that and we would expect clarity to follow on reg capital once the accounting pronouncements are out there.

In the absence of clarity our stress testing includes worse case scenarios or both.

The FAS 140 will come on and that no capital relief will be afforded.

The receivables that are now on the GAAP balance sheet.

And we've stressed that to the extent we're satisfied that we'll maintain well capitalized status even with that event taking place and in addition to additional stresses within the economic conditions.

Okay, thanks, guys.

(Operator Instructions) Your next questions from the line of Don Fandetti from Citi.

Please proceed.

Good morning, David, a question about your comment on spending.

It sounds like you think that maybe things have stabilized, correct me if I'm wrong.

And I just wanted to get a sense on your outlook if you -- what gives you that confidence, I mean it seems like the economy is still pretty weak.

So, if you can comment on that, that would be great.

Yes -- well -- I mean what I'm seeing is that sales continue to be below a year ago.

But I am at least to date not seeing any signs of an acceleration of that trend.

And I think that -- you know, I think what happens from here on through the rest of the year will be a little bit dependant -- will be dependent on various actions how much credit is available in the economy, how much higher does unemployment rates go, et cetera.

But I'm not forecasting anything.

I'm just saying, to date, it seems to be pretty stable.

Okay.

Thank you.

Your next question comes from the lind of Bill Kardash from Fox Pitt.

Please proceed.

Can you share your thoughts on the difference between the incremental reserves that you're booking really to maturing ABS that are coming back on balance sheet and there being funded via deposits versus the, I guess, kind of inherent reserve that was built in via the excess spread and your expected future losses that were baked into that?

And therefore were kind of built into the retained interest on the balance sheet and therefore flowed through the securitization income line item.

You know, incrementally the difference between those two if you could just speak to that.

Yes.

Bill, I get this often.

And it's both techniques do involve future losses.

The -- obviously the on balance sheet clearly with an allowance have set against it.

And its recorded at what would be viewed as net realizable value.

So, the historical cost adjusted for the reserve.

In the IO valuation, the excess spread of calculation is permitted to use not only losses, but revenue attributes of the portfolio as well.

And in that it's structurally different than the way GAAP treats on-balance sheet receivables.

So, they both have the same forward looking loss perspective in them.

The IO simply has revenue attributes that are permitted by accounting for that to be netted against them.

Okay.

Thank you.

Your next question comes from Mike Di' Anno from Sandler O'Neil.

Please proceed.

Hello, thanks for taking the question.

When you guys look at credit across the various geographies in the US, are you seeing other states catch up to California and Florida in terms of delinquencies?

Or in other words is there a narrowing in the credit performance from other states versus the states that have been most impacted by home prices?

I would say yes.

I think what we originally saw in places like California or Florida, has spread to most of the country.

And I think you could just look at unemployment rates by state and have a pretty good feel for how delinquencies by state have spread.

And we've already got several states that in total are over 10% unemployment.

But as much as the country is -- is on average the country has gone to 8.1%.

You know that's striving -- you know losses across the country to be the higher levels that started out in housing but now are being driven by unemployment.

Okay so does that -- you know, presumably does that mean that the benefits that you guys have enjoyed over the last year or so is having less exposure to those states should narrow vis a vi your competitors?

No, I don't -- I wouldn't expect the difference to narrow.

I mean we still have both the geographic advantage and a portfolio maturity advantage.

I mean there is still a better likelihood of continuing payments for customers who have been on the books for five or ten years than for new customers.

And so those two things continue to help us.

But given that this is now become more unemployment driven, we're rising as well as others.

But I think as you look at the numbers there's still a gap that I would expect to be consistent between us and most of our large competitors.

Okay.

And then just a separate question, do you -- given where credit losses are trending right now and the acceleration of unemployment, do you expect to have to trap crash in your Trust at some point this year?

And if you could maybe give us some color on what's sort of the maximum amount of cash that you would trap if -- you know, before, I guess you would get -- or potentially get to 0% and have early amortization event?

Sure, Mike.

I think there's a couple of important points here.

Only -- we operate through free trusts and the last one, the trust we put in place in 2007 (inaudible), which issues notes is the only trust that have cash trapping resonant in it.

It only represents about 30% of our ABS portfolio, so out of that $22.5 billion or so, we've got out -- its around $7 billion.

So, we're less exposed in that regard, is number one.

Number two, trapping begins in the structure of the trust around 4.5% spread and we're 150 basis points higher than that right now, based on the run.

So, you know, you'd have to see losses -- losses we reported in our trust were just over 7%, so you need to see losses go dramatically higher before that would actually occur.

The maximum amount -- if we -- if we trapped the maximum amount in this it would only be -- it would be less than $500 million.

So, the trapping I think, goes up to around 4.5%, 5%, so -- maybe 6%, something like that.

But it would be less than $500 million.

So, when you think about that from a liquidity perspective, it is not a significant impact on us and that's principally because of the trapping mechanisms only are resonant in 30% of our outstandings.

Okay, great, thanks a lot.

Your next question comes from the line of Bruce Harting from Barclays Capital.

Please proceed.

Thank you.

How much flexibility do you have left on the expense side, Roy, in terms of the outlook for this year and then if I may, just any comments on line management open to buy and contingent liability management?

And some of your competitors have been showing declines in receivables and I don't know if that's a function of active purging or other things?

But if you could comment on line management.

Then -- and just a final quick one, you have talked in the past about showing discount revenue as a separate line item.

Any progress on that?

Thanks.

Okay.

I think they're -- the -- you know, as I think as I said a lot -- our expense initiatives really began last year and we began to see some of those manifest themselves in the numbers in the second half of this last year.

We've seen it here in this quarter and we would expect to see more of it come through as we go through the rest of this year and on into 2010.

I don't want to size it for you but I do want to emphasize how important it is to management here, to keep that trend going in the right direction.

I don't think you're going to see the bottom fall out of expenses, but on the other hand I think you're going to see that the direction we have set is going to be consistent.

And Bruce, in terms of your second question, contingent liability is something we try to manage carefully in total it is down for us by about 15%, year-over-year.

But if you looked within it, to look at our active base versus inactive base, our active base is pretty flat.

And that suggests that we're continuing to give line increases and those are roughly offsetting line decreases.

So, it's pretty stable and that's what our customers are actually able to spend their money on.

The primary focus on managing the inactive is purging long-term inactive accounts which we've previously discussed.

And we have felt that one of the responsible things to do is to ensure that there aren't excess lines out there that customers could conceivably get themselves in to trouble with.

And so, we'll continue to purge the longer time inactive accounts.

And then to just take this in order, Bruce, the last question, I think what we have given some consideration to, when we consolidate the Discover Card master trust, I think one of the benefits of that will be improved transparency around the discounted inner change line, which really only gets clouded when it goes into the excess spread calculation associated with the trust not being consolidated.

So, more than likely we would move to those disclosures when that consolidation occurs.

Thank you.

Your next question comes from the line of Brian Foreign from Goldman Sachs.

Please proceed.

Thanks, I know we've asked a lot about the reserves.

But I guess just to come back to it, you're building reserves pretty aggressively here and some competitors are much more (inaudible).

For example, (inaudible) is giving guidance kind of at the same time for year end reserves that at 6.7% where you are now, even though they've got delinquencies at 7% and you're at 5%.

So, I know you can only comment on what you're doing, but what should we look for, for reserves to peak?

Is it delinquencies peaking, is it early delinquency inflow peaking, you know, or is there some other factor from the outside that we can monitor to try to get a sense of when reserves might peak?

Well, Brian, I think it's -- I'll say with -- what I'd historically say is monitor the delinquency and I think that's your best -- that's the best broad -- 30 day plus is the best broad measure of impairment that we have.

The thing that has caused I think, this particular cycle to sort of disconnect from that, is the velocity at which or the speed with which you see accounts roll once they go into default status.

So, what you have seen here in the last couple of quarters we've raised the reserve over 1% each of the last two sequential quarters.

And that's been significantly above the rate at which we've seen our 30 day balances past due rise and that's principally to take in to account the fact that there's a continued expectation that the velocity that we've seen over the course of the year is going to continue.

So, I really can't give you anything as tangible as you might have as we might have been able to afford you in a more traditional sort of downturn.

But I still think the peaking of delinquency will also signal the peaking of reserve.

So, its a triggering event in that regard, it may not be as good as it used to be in terms of the absolute size.

Thanks, and if I could ask a follow up on TALF, if you participate is there any concern about political pressure to increase lending volumes?

.

Well, I think most of the political pressure, it appears to me, is on the people borrowing from the government to buy AAA qualifying collateral.

And I -- hopefully we can get that cleared up in the market.

Because obviously for us to issue, we need people to buy and be comfortable borrowing from the government.

We are a -- you know, we're in the CPP program, so we're already in the middle of all that.

And I'm just hoping that these don't cause this program to be anything but a robust success on people that may not have been financial institutions that were in [tarps] initial programs.

Thank you.

Your next question comes from the line of John Stilmar from SunTrust.

Please proceed.

Good morning, thank you for allowing me to ask my question.

My first one is going to be with Roy, and just with regards to net interest margin.

Clearly at the Investor Day, you talked about margin expansion.

And it showed remarkable strength this quarter.

Have we sort of reached a run rate especially given the feds actions yesterday or is there a little bit more opportunity for a little bit -- for some more margin expansion from here and how would you characterize that?

You know, I'm glad you brought that up.

I think that might have actually been a part of a previous question that maybe I didn't address.

We have seen, I think structurally, the major things that -- we finally got this thing to settle down a little bit here.

Obviously LIBOR all over the place, which can put a lot of noise in the interest expense.

And you know, a number of other things including pressure on the yield associated with charge-offs.

So, I'd like to guide you -- you know, not to see substantial margin expansion particularly in the size that you've seen here sequential quarter going forward.

We got interest expense down at 3%, I've indicated to you that we're borrowing through that at the margin, so that has probably some room, some downward sort of, opportunities and yield in terms of the positioning of the portfolio possibly has some upward opportunities.

But I'm not going to ask you to think about this continuing at the pace it's continuing here this quarter.

But rather think about it in this range that we've got it at now.

Just low 9% -- 9%, 11%, and 9.11% here the first quarter, is pretty much where I'd think you should be thinking about it for the rest of the year.

Excellent.

Thank you, and then with regards operating expenses, just trying to put a finer point on some comments that were made earlier.

You've clearly talked about operating expense improvement but continuing to invest in the network business, as we net all those out and I look at your operating expenses for the quarter right around $560 million, frankly is that number kind of a run rate?

Or should we be also thinking about that expense number to come down very modestly or there's opportunities to drive further synergies?

Well, how about option "B" with a little of "C?" I think, $559 million is going to -- we're going to continue to I think, be able to offset some of the investment criteria that we've got in our operability, we've talked about portfolio control.

There are a number of things that we are continuing to dedicate you know abundant resources to.

But our view is that that number is probably going to move flat to down over the course of this year, as you net those things together.

And I think that was somewhere in where you were talking about with your second and third views.

Perfect.

And then David, just returning, again, to put a finer point on spending composition and one of the statements made by a fellow bank executive, I believe on his earnings call, in which he saw spending change from non-discretionary, what he say of migration from debit to credit for non-discretionary types item.

And even though overall spending volumes certainly, you talked, may have stabilized, are you seeing a shift in the mix similar to those kinds of statements?

Are you seeing a shift in the types of purchases that are made and how would you comment given even though credit -- your credit and debit networks may not be competing in (inaudible) as a product, but can you infer such changes from the types of the information that you see from your customers and transaction volume?

Well, I would say that we continue to see people pull back on their discretionary spending as opposed to their non-discretionary spending.

And I would say the -- so things like travel, and eating out, some of those kind of things, even some home improvement pieces, where people can pull back spending, they're pulling back spending because their incomes are lower right now.

I think on the non-discretionary and I would include gas purchases in that, what we see is its more reflective of the price the spending is down purely because gas prices are down.

And I think -- you know I'm hopeful that some of that will eventually get reflected and grocery prices and so on.

So, you may see dollars come down.

But it's -- they're still buying food, they're still buying gas.

In terms of credit to debit, I'm not sure that I would agree that I've seen that kind of shift, and obviously we've got -- you know, we're the third largest pin debit network and 11% pin debit growth year-over-year is healthy growth.

So, I'm still seeing maybe debit not grow at the same pace it was but I'm seeing more growth on debit than I am on credit.

And you know, I am sure that there are some consumers that don't have enough money in their checking account and they're relying on a credit card, so there is no doubt that happens, but I think that is somewhat offset by some people who are just cutting back on credit right now if they can and paying down debt.

Making more in savings.

So, some offsetting factors.

Great, thank you very much.

(Operator Instructions) Your next question comes from Moshe Orenbuch from Credit Suisse.

Please proceed.

Thanks.

I was just wondering if you could kind of look forward a little bit, possibly to -- towards the end of the economic downturn, what things would you look for to start rebuilding kind of account acquisition?

What would you need to see before that would happen?

Well, what I would want to see is delinquencies coming down and credit improving fundamentally.

And I think that there have been a lot of changes, certainly credit, but also some of the new laws in terms of how one has to price less ability to price for risk.

And so, we have to adjust with all those things to make sure that we're returning our business to that 1.5% to 2% after tax ROA that a credit card company needs to be profitable appropriately over time.

And I do think that if you look past this current time, consumers deleveraging, having left that out there, I do believe longer term, we may see lower charge off rates in the credit card business, and it may have to -- it may shrink a little bit, but you know I think the business model will adjust to earn adequate profits and it may be with a little less risk.

Great, thanks.

At this time, there is are no further questions in queue I would now like to turn the call back over to Mr.

Craig Streem for closing remarks.

Thanks Dan, and thanks to all of you for your interest and questions this morning.

And of course, feel free to come back to me if you need any clarification or follow up.

And we wish you all a good day, bye.

Thank you for your participation in today's conference, this concludes the presentation you may now disconnect, good day.