發現金融 (DFS) 2010 Q4 法說會逐字稿

Welcome to the fourth-quarter 2010 earnings conference call.

My name is Rosa and I'll be your operator for today's call.

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

Later we will conduct a question-and-answer session.

Please note that this conference is being recorded.

I would now like to turn the call over to Craig Streem.

Sir, you may begin.

Thanks, Rosa.

Good morning, everyone, and welcome to this morning's call.

I want to begin, as always, by reminding you 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, in our Form 10-Qs for each of the prior quarters of this year, and in our Form 10-K for the year ended November 30, 2009, all of which are on file with the SEC.

In the fourth quarter 2010 earnings release and financial supplement, which are now posted on our website at DiscoverFinancial.com, and have been furnished to the SEC, we've provided information that compares and reconciles the Company's non-GAAP financial measures with the GAAP financial information and we explain why these presentations are useful to management and to investors.

And certainly we urge you to review that information in conjunction with today's discussion.

In addition, to make comparisons more meaningful we're providing historical results on a basis that excludes income statement impacts of the Visa/MasterCard settlement and the Morgan Stanley special dividend agreement dispute and also adjusts for the effects of FAS 166, 167.

This as adjusted information was made available in today's earnings release and in our 8-K filing on March 1.

Our call this morning will be led by David Nelms, our Chairman and Chief Executive Officer, and Roy Guthrie, our Executive Vice President and Chief Financial Officer.

And as always, we will take your questions following the formal remarks.

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

Thanks, Craig.

Good morning and thanks for joining us.

Before the market opened this morning we reported fourth-quarter net income of $350 million or $0.64 per share.

While we had strong results across the board, including a significant reduction in our net charge-off rate and higher transaction volume growth, this quarter also benefited from an unusually large change in reserve levels that points to a significant improvement in credit expectations over the next 12 months.

This morning I'm going to highlight the fourth quarter and then walk you through our full-year results.

I was pleased with Discover Card sales where sales volumes grew 6% for the quarter versus last year.

As you know, we have put in place a variety of programs aimed at growing wallet share with our primary card users and these efforts continue to pay off for us with sales in this segment of our portfolio up 10% compared to the last quarter of 2009.

Virtually all our sales volume growth in the first three quarters of this year was from the transactor segment of our base and the positive volume trend from this segment has continued through the fourth quarter.

In addition though, beginning with the month of September, our customers who revolve balances on their Discover Cards also increased their spending year over year and this has continued through October and November.

Turning to card receivables, we finished the year down 5% from last year end, but once again fairly flat to the previous quarter.

We've achieved some stability through the last two quarters and we are working to achieve some modest credit card portfolio growth in the second half of 2011.

Some of the expected growth should come from additional usage and revolving behavior as we continue to improve wallet share and some will come through more new accounts and higher balance transfer volume.

We've already increased our balance transfer activity and promotional volumes were up approximately $500 million from last year's fourth quarter.

That being said, total portfolio loan balances will increase from the acquisition of the Student Loan Corporation portfolio in the first quarter and we expect personal loans and private student loans to grow at a faster rate than cards, at least in the near term.

Our Payment Services segment generated volume growth of 21% for the quarter versus the prior year.

PULSE contributed most of the growth as volume was up 27% and transactions processed were up 33% which we were very pleased with.

In addition, volume from third-party issuers was up 16% year over year and I'm particularly pleased to report a new third-party credit card issuing agreement with the First National Bank of Omaha, a top 15 issuer of credit cards in the US.

The fourth quarter was a great finish to the year and now I'd like to review our full-year 2010 and results and achievements.

Net income was $765 million or $1.22 per share fully diluted, principally reflecting the impact of dramatic improvements in credit performance on the earnings of our Direct Banking segment as well as 33% higher earnings in our third-party payment segment.

This reflects on average a 12% return on equity which brings us back closer towards our long-term target of earning 15% or above ROE in more normalized environments.

Regarding credit performance, it should be apparent by now that our losses are no longer being driven principally by the total unemployment rate, which remains stubbornly high, but by more recent trends in jobless claims and our bankruptcy receipts both of which are showing improvement.

These positive trends, enhanced by the benefit of the risk mitigation and portfolio management actions we have taken over the last few years, have driven our total loan portfolio net charge-off rate from 8.4% in the fourth quarter of last year down to 6.6% in this year's fourth quarter.

We closed out the year with the total 30 plus delinquency rate at 3.9% which is now returning to levels one would expect in a more normal credit environment.

Not only was 2010 a good year from the standpoint of credit improvement and net income, but I'm also very pleased with the progress we made on our performance priorities.

First off, it was a record year for Discover Card sales volumes which grew 6% in 2010 to $92.5 billion reflecting our increased investments in marketing and rewards while also benefiting from the early stages of economic recovery.

We believe the growth in spending on the Discover Card reflects the payback from our investments to expand merchant acceptance and to further strengthen the Discover brand.

We've committed to a number of high-profile sponsorship agreements and have ramped up our advertising, focusing on our leadership and customer service and cash back rewards.

We are excited about all of these programs and believe we can continue to positively differentiate Discover in these critical areas.

We also made great progress on merchant acceptance in 2010 as the number of net active merchant outlets grew in high single digits and we activated more international outlets as well.

This trend should continue as we work with our merchant acquirer partners to ensure awareness of acceptance at the point-of-sale and as our card members become increasingly aware of broader domestic and international acceptance.

Going forward we think increased sales, marketing and acceptance will lead to additional Discover Card sales growth and modest loan growth over time.

Another very significant priority for us has been to grow other parts of our Direct Banking business.

On the deposit side in 2010 we grew direct-to-consumer deposits by 64% to over $20 billion, and this has become the largest component of our funding.

And in fact two-thirds of our total funding is now from direct-to-consumer and brokered deposits.

On the lending side we announced the planned acquisition of the Student Loan Corporation, a very important transaction that will significantly enhance our competitive position in private student loans.

I'm pleased to report that this acquisition is on track with the Student Loan Corporation shareholder vote occurring today.

We continue to expect the transaction will close on schedule by year end and we continue to anticipate EPS accretion of $0.09 a share in 2011 related to the acquired business.

2010 was also a year of important progress with our global network initiatives.

We signed new network partnership deals with BC Card and DinaCard which will ultimately add to transaction volume on the Discover network.

And our strategic partnership with JCB became a meaningful contributor this year with more than $500 million of sales volume on the Discover network in 2010.

We also broadened potential acceptance in Western Europe and Canada with a number of new merchant acquirer agreements.

So you can see that the key pieces of our global payment strategy are coming together.

Before I turn the call over to Roy, I do want to comment briefly on the exciting potential of the Isis joint venture announced on November 16 by AT&T, T-Mobile and Verizon.

Isis is working with Discover to develop an extensive mobile payment infrastructure.

We believe mobile commerce will be an important element of the future of the payments industry as it could provide significant enhancements to how consumers manage and spend money with new options at the point-of-sale.

Isis is still in the early stages, so it is too soon to estimate how much volume we may see.

The product is expected to be in the market in the next year and a half and more developments are anticipated in the coming months.

Now I'll turn the call over to Roy.

Okay, thank you David.

I'm going to discuss the performance of the business segments with a principal focus on the fourth-quarter results.

So let me begin with the Direct Banking segment which earned $554 million pre-tax here in the fourth quarter.

Starting at the top, we saw credit card interest yield fall 18 basis points sequentially to 12.68%.

The yield compression results from two principal factors -- first, the continuing reduction of higher yielding balances including those subject to default pricing which began following the implementation of the CARD Act; and second, a higher level of lower yielding promotional balance receivables particularly given our recent ramp up in new marketing initiatives.

These two factors were partially offset by lower charge-off interest due to the overall improvement of credit that we reported in this release.

Throughout 2011 we expect continued additional yield compression, as you see here in the fourth quarter, for the same reasons they occurred here in the fourth quarter.

But the exact magnitude is going to depend largely on how much growth is achieved and the pace of credit normalization.

Net interest margin for the segment, which includes the credit card business, student loans and personal loans, was 9.28%, up 12 basis points from the prior quarter driven principally by the impact of the sale of $1.5 billion of lower margin federal student loans to the Department of Education.

We expect to see headwinds impacting net interest margin during 2011 for reasons I just outlined with additional compression from a higher mix of lower yielding student loans following the SLC acquisition.

These are expected to be partially offset by funding cost benefits from lower cost newly issued deposits replacing higher cost maturities over the course of 2011.

Interest expense was down about 5 basis points sequentially here in the fourth quarter and I expect that that will be a tad higher on a per quarter basis as we move through 2011.

Moving on to other income.

We saw a decrease of $87 million from the prior year.

This decrease was primarily driven by CARD Act impacts on late and over limit fee income, as well as a $28 million charge related to our remaining federal student loans being reclassified to held for sale.

We expect to sell our remaining $800 million of federal loans during the course of 2011.

Sequentially other income was down $92 million from the third quarter as a result of lower discount and interchange revenue, lower late fees due to the CARD Act and lower delinquencies, the $20 million one-time gain in the third quarter related to Golden Key on a sequential comparative basis and a charge that I just mentioned related to the reclass of the federal student loans.

Personal loans increased to $1.9 billion or up 35% year over year.

The personal loan portfolio has grown steadily over the last few years and recent vintages continue to show very strong projected returns.

The 30-day plus delinquency rate in the quarter was 1.57%, down 18 basis points sequentially, and the charge-off rate was 4.7%, down 97 basis points sequentially.

Private student loans increased to $420 million or $1 billion in the quarter.

The acquisition of SLC will further increase student loans and the related assets by about $4.2 billion in the first quarter, netting back the $3.8 billion after the purchase discount is applied.

Based on the improved credit card performance and the outlook which David discussed, we released $414 million of reserves for the quarter, we had very strong delinquency performance and even more so in light of typical seasonality.

And in addition, had lower flow of bankruptcies that were experienced.

These factors led to a larger release than you've seen in the prior two quarters.

If these trends continue you should expect to see reserve releases continue throughout 2011.

However, not at the magnitude that we saw them here in the fourth quarter.

Operating expenses in the Direct Banking segment increased $49 million year over year as we invested to build wallet share, to grow new accounts and build the Discover brand through marketing and sponsorships.

One other component of the increase was a $9 million one-time cost associated with the acquisition of Student Loan Corp.

The sequential quarter growth in operating expenses included increased marketing expenses and a collection of smaller but in the aggregate about $20 million of one-time expenses associated with franchise tax true-ups, charitable contributions and in particular the SLC acquisition charges I just mentioned.

Moving on to the Payment Services segment, pre-tax income was up 32% to $31 million for the fourth quarter with total volumes up 21% compared to the same period a year ago.

The increase in income was driven by PULSE volumes in particular and margin expansion there, partially offset by increased incentive expense.

Payment Services revenue was up 14% in the quarter year over year and expenses were up just 3%.

Before I move on to liquidity and capital I want to just comment on the effective tax rate for the quarter which was 40%.

The tax rate was slightly higher due to some state-level provisioning and I would guide you back to something just below 40% for 2011.

Liquidity remained strong and during the quarter we saw a couple of key open items resolved.

First of all, the FDIC grandfathered existing credit card master trusts which provides clarity around how trust assets would be treated under an FDIC conservatorship.

A very good outcome there.

In addition, the SEC has extended indefinitely the previously issued new action letter on Rule 436(g) relating to the rating agency's liability for the use of their ratings in public offerings.

So both of these resolutions I think are good and help to restore confidence in the future of the public credit card asset-backed markets.

In terms of liquidity investment pool, it was $10.1 billion at the end of our fiscal year, higher than the last quarter as we saw the opportunity to continue to grow our direct-to-consumer deposit channel.

Overall contingent liquidity finished at $22.5 billion, including the cash I just mentioned, $10.1 billion, conduit capacity at partner banks of $3.3 billion, the bank credit facility of $2.4 billion and Fed discount window access of $6.7 billion.

Also our capital is in great shape as our tangible common equity ratio ended the year at 10% and our regulatory capital levels finished well above the capital levels proposed by the Basel III capital approach.

In terms of the dividend, we announced a regular $0.02 dividend for the quarter and our plan is to work towards restoring the dividend to a higher level during the first half of 2011.

A strong balance sheet is a great way to finish the year and begin a new one and, importantly, we're also looking forward to making it a significant acquisition of the Company -- addition to the Company with the SLC acquisition here in the first quarter.

So we're very pleased with where we stand.

And so with that I'm going to turn it back over to you, Rosa, for questions.

(Operator Instructions).

Sanjay Sakhrani, KBW.

Okay, thank you, good morning.

Just a quick question -- clarification on the other income line because that was an area I think where investors had a bunch of questions for me.

If I just adjust for some of the one-time items sequentially -- you still saw roughly a $40 million decline in fees.

Or in other income.

Is it fair to assume that was all kind of penalty fee income regulation related?

Let me -- Sanjay, that's a good question.

And I think that you have teased out I think the main thing that is there which is about $40 million.

Now that involves -- about 50% of that relates to late fees and the issues associated with transitioning into the post CARD Act time related to late fee.

But also seasonality associated with the discount and the seasonality of the spend -- our peak quarter is the third quarter and that you can see seasonally comes off, discount will follow that, and I think some investments that we made that are probably best characterized as one-off relative to the rewards programs.

So I think it's about half CARD Act and the principal other part of the half is seasonal aspects of [discount] (corrected by Company) interchange revenue.

Okay, and just two quick follow-ups.

Just on expenses, just going forward, could you just walk us through what your expectations are with and without SLC?

And then, David, you mentioned you expect card growth kind in the second half of next year.

So is it fair to assume first half we'll continue to see a modest decline?

Thank you.

Okay.

So, back in March I think things are starting to come back to a point where you're starting to see let's get these one timers and that sort of thing behind us, Sanjay.

I think we're starting to talk about where we were in March around the business model.

And you've seen over the last couple of quarters as we've sort of started to spend again for reinvigoration of the portfolio and new accounts that we're getting into that 4.5%, 4.6% Direct Banking expense ratio.

And I think that's where I would continue to guide you as we move into 2011.

I think what might have been a little touch hot on that because of some of these one timers in the last couple quarters.

But I think we're coming into sort of the zone where you should expect to see us moving forward.

Overall you look into the SLC financial statements and about -- they're spending about $10 million a month to run the place.

And there's a large portion of that that's going to get reallocated away from SLC following the acquisition.

And so I would probably prefer to maybe step back and wait until we actually talk to you about that in the first quarter and really stick with the guidance that you heard David provide, which is that we're very confident that the $0.09 will be at the bottom and we need to sort out exactly where the expense and the revenue are going to be.

And, Sanjay, in terms of card growth, let me break it into two parts.

On sales we've been pleased to -- with the 6% year-over-year sales growth and that has continued in November and even into December.

And the nice thing is we're now looking back at stronger comparable figures.

It was November of last year that we first started seeing portfolio growth and so it's now in our portfolio on sales.

And so it's a tougher comparison and yet we're still continuing some nice growth rates on sales.

In terms of how that translates into receivables, do remember that the first quarter is when we would expect a normal seasonal paydown of some balances post holiday season.

But I think if you look at the year-over-year basis what I would expect is that we saw 5% year over year this quarter reduction.

I would expect that comparison to improve and so have less of a reduction year over year in the first half of this year.

And then our goal is to have that actually turn positive on a year-over-year basis in the second half of this year.

Okay, thank you very much.

Mike Taiano, Sandler O'Neill.

Hey, good morning.

Roy, could you just go through the one-timer expenses again for this quarter related to STU and other things?

Yes.

So, the big thing that's in there is principally the SLC one-time charge.

You can see that marketing is up sequential quarter $20 million, and so we're running something like $65 million over where we were in the second quarter.

It lifted in the third quarter, we lifted it further in the fourth quarter.

So sequential quarter you can see there that the marketing is up $20 million and there's probably another $10 million outside that line on professional fees related to agency relationships and so forth that relates to marketing.

So, overall between the marketing line that we've disclosed to you and -- professional services marketing is up something like $30 million.

Then there are those SLC transaction expenses that are also in the professional fees line amounting to about $9 million, those are nonrecurring.

Marketing may be more of a build toward a recurring level, but the SLC transaction expenses are nonrecurring.

And then I mentioned $20 million of I would call it -- none of them rise to the level of disclosure, but there's a basket of about $20 million of them related to a franchise tax reclassification, there were some contributions made in the quarter, there was a couple of legal accruals made, there was a small investment in some global incentives around our payments business.

So I'd say there's a basket of about $20 million in there that would also be nonrecurring.

So, if you go back to that and you say you've got $9 million in SLC and $20 million in this basket, you've got about $30 million of nonrecurring and then about $30 million of additional marketing expense sequential quarter.

Okay, that's helpful.

And then I was just curious -- gas prices have ticked up here in the last few months.

Did that have a material effect on charge volumes in the quarter?

Well, certainly you'd expect higher gas prices to help.

I don't have the exact breakout in front of me, but I think that -- I don't think that was the majority of the increase.

Okay.

And then just lastly, just was curious on the deposit side of things.

I mean given your expectations with loan growth, I guess particularly in the card business being relatively modest, what do you do on the deposit side?

Do you just continue to grow that?

Do you maybe have a larger investment portfolio until maybe loan growth picks up?

Or do you pull back in terms of growing deposits given the loan growth is not there yet?

Well, I think that we are -- we will continue to seek to grow our direct to consumer deposits.

I think the growth rate may slow a bit as the business matures and we get it up to a scale that we've been shooting for.

And I think also as the business matures we can focus even more attention on product development and competing on basis -- other than in addition to APRs and we may be able to back off a little in terms of how much we are using to attract people into the product in the first place.

Okay, great, thanks a lot.

Craig Maurer, CLSA.

Good morning, thank you.

I had a question regarding the guidance you gave at your investor day.

Considering the trends we're seeing in the market, how much of that do you believe is achievable next year versus being pushed out further?

Specifically I'm discussing loan balance growth and perhaps achieving what a lot of people believe -- well, the 10% volume growth you thought you could do on average over time?

Thanks.

Well, I think what we said was 5% to 10% in total and I think if you take my previous discussion of our expectation that card loans should turn positive by the second half of the year and you add in the SLC acquisition and the other loan growth acquisition, I mean I think you'd quickly conclude that next year, largely with the SLC acquisition on student loans, that we will easily be at the upper end of that 5% to 10% year-over-year guidance.

So then I think the question becomes more how do you -- at what level do you sustain it into 2012?

But hopefully we'll have some good momentum going into that year as the economy continues to improve and as we take advantage of the broader foundation we're building with SLC and with all the things we're doing on the credit card as well, plus the more normalization of the economy.

Bill Carcache, Macquarie.

Good morning.

A follow-up question on other income.

So, Roy, you talked earlier a little bit about the CARD Act impacts on the other income line.

And so adjusting for the $28 million charge resulting or relating to the federal student loans, should other income as a percentage of managed loans now stabilize going forward after this quarter's decrease?

Can you help frame that for us?

I think that's fair, Bill.

I think you can pull -- you've got the $28 million charge in there, you can pull that out.

And then I think you're going to get a level that should now be subject to the seasonal aspects of the spending, the growth of our spending and the seasonal aspects of the spending.

And so you clearly see spending move up and down over the quarter as I was highlighting that in the context of sequential quarter.

But I think if you incorporate those seasonal trends and you pull the $28 million out I think you've got a good benchmark.

(Operator Instructions).

Jason Arnold, RBC Capital.

Hi, good morning guys.

I was just wondering if you could share your thoughts on debit interchange regulation?

It seems PULSE stands to largely be well poised among the other players in the space regardless of what the Fed decides on.

But it would be great to hear your perspective particularly any thoughts on the exclusivity end of the equation.

Well, Jason, we hope to learn more even later today.

So it's a little difficult to comment before we know what we're shooting at.

But certainly we have been doing a lot of strategizing as to how to best take advantage of what opportunities may present themselves regardless of what the outcome is.

And so I'd say that probably by the time we get to Investor Day we'll certainly be in a much better position to know how things are going to shake out and how we're going to be positioning for PULSE to compete.

And we certainly think we have a good foundation to provide a great alternative for the market.

Scott Valentin, FBR Capital.

Thanks for taking my question.

You mentioned balance transfers offers picking up.

I'm just curious if you can give us some color on solicitation volumes the industry is picking up and you're seeing -- or if can you tell us maybe -- where initial rates are and where you're seeing competition go and maybe what response rates are?

Well, I guess without commenting specifically I would say generally if you look at the industry statistics we saw a substantial pickup of marketing across most of the industry and certainly you saw that in our numbers as well.

And with those additional solicitations you get some balance transfers with those -- with those new accounts as well as we're putting more effort into engaging with our existing cardholders to grow our share of total balances.

I think that generally there is a headwind in that consumers continue to deleverage, that's really helping us on the credit line.

But -- and we continue to feel we're gaining market share.

But it -- I think there's clearly a headwind in terms of total market growth as consumers deleverage.

Moshe Orenbuch, Credit Suisse.

Great.

David, I was hoping we'd get an update on the international network and where that stands, what we can look out for from that?

Sure.

I'd say we did achieve the total number of new countries that have come online by year end in excess of 120 countries.

And we're starting to see some volume come through.

I'd say the battle turns more to making sure that those countries -- that we have more robust acceptance in those countries, that our card members are aware of the acceptance, that it works flawlessly, and some of the areas we have stronger acceptance than others.

We have very strong acceptance throughout the key parts of Asia and in Europe, we've talked before it's an area that we really needed a lot more development on.

Certainly the -- we signed some major acquirers in Canada, DinaCard in Europe has come online and so some of these new acquirers that we've just signed we'll be working over the next year to turn on significant additional acceptance throughout the world.

Don Fandetti, Citigroup.

Hi, good morning.

David, I know that you can't really sort of speculate on what the Fed might do, but I'm sure you've seen these studies out there on cross routing of signature and PIN debit.

I was just curious what your view on that -- if it's sort of technically feasible and if you think at some point that may sort of be an issue.

I think that anything is technically feasible given enough time and attention.

But, I think that until we see what the actual proposals are it's going to be I think a lot of guesswork as to where the Fed comes out.

They've taken a lot of input from the industry, from retailers, from various banks.

And I'm glad I don't have the job to sort out what the right answer is.

But, we're going to look forward to hearing it this afternoon.

And I think what I'd rather do is comment more specifically once we see what the actual proposals are.

Brad Ball, EverCore.

Yes, thank you.

A couple of follow-ups.

Roy, sorry, again on the non-interest income line.

Was the gain on the sale of the federally guaranteed student loans in there and how much was that?

Yes, so, this is -- one more time, Brad, because I think it is a little confusing.

You're looking at -- if you're looking at a sequential comparative, remember that we've got the Golden Key gain in the third quarter, that's the $20 million.

The fourth quarter has got a charge of $28 million related to the re-class of the remaining federal loans to held for sale.

So there's a $48 million swing sequential quarter.

Does that make sense?

He dropped after the question was asked.

Okay.

Ready for the next question, Rosa.

Chris Brendler, Stifel Nicolaus.

Hi, thanks.

Just a housekeeping question on Brad's question.

Was there a gain on the student loan sale?

And then my broader strategic question is, as you look to 2011 you mentioned continued margin pressure -- or a little bit of margin pressure from teaser rate marketing.

Are you seeing any less in demand there?

I know you mentioned it's still pretty anemic, but recently, over the last month or so, it seems like we're seeing a little better consumer tone in retail sales.

I didn't know if that had translated into your marketing efforts?

And then finally on the marketing side, you mentioned the increase in merchant acceptance and the need to communicate that message to consumers.

Is there a larger branding campaign that you think you need to do to try to communicate the increasing acceptance to consumers to make them aware that they can use their Discover card pretty much everywhere they can use Visa and MasterCard today?

And if so, can you just give me a sense of the magnitude of that if it's 2011?

Thank you.

I'll thank take the first one, Chris, and I'll hand it over to David.

And thanks, by the way, for having Brad's back on that.

I didn't know exactly where he was coming from.

Yes, there was -- it was over par at the Department of Education [pay desk], but we also discharged unamortized origination expenses.

And so the gain was de minimus associated with that sale.

And therefore it became a loss on sale that was reflected (multiple speakers).

The $1.5 million is not really in the $28 million.

The $28 million relates to the $800 million of reclass.

The $1.5 million is a de minimus gain that just didn't rise to a level of discussion.

And then in terms of retail sales, certainly we are encouraged by some of the sales trends.

As I indicated before, the fact that we're continuing to achieve 6% plus year-over-year gain in November and December on top of what were pretty strong comparable periods for our network from a year ago makes me a little more bullish about this recovery having legs.

I'm seeing more of the card member base participate in this, specifically the revolvers I called out.

And that is indeed part of the reason that we have restored our market into more normal levels in the second half of last year and we expect to continue next year.

In terms of acceptance and advertising, we do plan to employ a variety of ways to increase our awareness of acceptance.

I keep saying the sticker at the point of sale is the single most important thing.

But to the extent that it finds its way into advertising, I would not expect any incremental advertising, it may be what we spend our advertising dollars on.

Right now we're very focused on service and the Peggy ads seem to have gotten -- performed very well from all of our testing and hit a chord.

But we'll continue to think about what kind of rotation is appropriate between acceptance, service and cash rewards.

Henry Coffey, Sterne, Agee.

He dropped, Rosa, let's move on.

Rick Shane, JPMorgan.

Thank you.

Good morning, guys.

When we look at what's happening I think one of the potential outcomes of increased regulation is that it's narrowing the strategic options that card issuers have in managing their portfolios and potentially the products -- the breadth of products that are available to consumers.

When you guys look ahead, how do you think that you sort of differentiate yourself strategically and more importantly from a product perspective, especially I think you guys are probably in the sweet spot of products that are available, that's the good news.

The bad news is that you're probably going to see a lot more competition.

How do you differentiate from a product perspective without just giving away price?

Well, I'd say two things.

As you point out, the diminished product set or more restrictions I think disproportionately hit the products that we weren't in such as subprime cards.

And so I think the remaining competition is indeed concentrated more on the prime segment and more specifically on the rewards because that's what consumers want.

But I don't see that as a big change for us.

I mean over the last five years, there has been intense competition specifically on prime rewards as well.

So, we have not seen -- we clearly have had to change how we price credit cards and have moved back to more the way we did it 12 years ago, setting a rate high enough upfront and then living with that rate over time as opposed to the risk-based pricing that the industry had moved to.

But that adjustment has been made by us and the whole industry and I don't see that as diminishing our product set.

I would say though that the second thing is we do see this as opening a lot of opportunities in non-card space.

And I think some of the spaces have opened up on Direct Banking whether it is in deposits and consumers seeking higher rates from lower cost providers of deposit products, consumers moving generally towards financial services over the Internet, get people who want a better deal on student loans and other things.

So I would say that some of the regulatory and technical environments have really moved towards us being in the sweet spot of a branded direct bank player who actually has far more strategic options open to us today for profitable growth than I think we had 5 or 10 years ago even before these regulations started migrating.

Bruce Harting, Barclays Capital.

Roy, sorry to repeat.

But can you explain again the reason for the magnitude of the reserve release in the fourth quarter?

And was it roll rate-related?

I think you mentioned something else, but just a little more detail.

And then if you don't mind, your comment that we should expect reserve release again in 2011.

But I think you said, quote, not the magnitude of the fourth quarter.

I guess if you looked at the provision in this quarter annualized over the loans, it would be about a 4% charge-off rate.

And I don't know if you have any thoughts you can share on this call about the 2011 sort of starting and ending charge-off ratio.

But I guess, David, in previous meetings, you have said that like after the bankruptcy law changed several years ago, this recession may be such that coming out of this, charge-offs may go even lower than normal, whatever that number may be.

Just if you have any more thoughts on that.

Thanks.

Okay, Bruce.

That's three questions without a breath, so compliments to you on that.

But let me just kind of take the first part of it and I'll let David take the back.

I think that the -- we said a couple of things.

We said that we saw a reduction in 30-day balances past due and we saw it despite what was normally seasonal headwinds.

And when you look at this quarter's credit performance and you overlay it against the seasonal aspects of our business, it was actually the strongest quarter that we've experienced this year.

And so you're looking at 33 basis points of sequential reduction.

But that's in the face of what's normally a 20 or so basis point headwind from seasonality.

So, if you take the tailwind out of the second quarter, you add the headwind in the fourth quarter, you're looking at a major movement in our portfolio.

So I think we're seeing acceleration on the contractual line.

In addition, we're seeing bankruptcy filings begin to steady if not slow.

So 2009 bankruptcies were 33% over 2008 and we entered this first year in the first quarter up 20%, second quarter up 16%, third quarter up 18% -- 8% -- 20%, 16%, 8%.

The fourth quarter actually may be flat.

It's hovering right against year-over-year neutral filing.

So, the deceleration in bankruptcies we expect to see continue into 2011 and I think we're putting that into the expectations for losses as well.

So it's a combination, I think, of that enormous contractual relief and the expectation for lower bankruptcy that drove the size of the release.

I mentioned throughout next year because I think we see credit stabilization or normalization actually extending into 2012.

And so you're going to probably see improvements occur over the course of next year depending on how fast that happens and whether it's linear or whether it's front-end loaded.

There's a back-end pop in this normalization, I think we'll let that -- for the calls that we have with you all next quarter -- unfold.

But our expectation is that there are four or five more quarters at least left in normalization and therefore you should expect to see reserve releases through 2011.

And in terms of the reserves that we're anticipating, we are not anticipating anything near the 4% number that you mentioned.

And in fact if you take a look at our $3.3 billion of reserves that we have after this reserve release, you would conclude and recognize that that is anticipated to cover the next 12 months of on balance sheet loans, you would come up with much higher coverage than that would suggest.

And so I would think about how much reserves we have to cover the losses on our portfolio.

What we anticipate is a continual improvement throughout next year and maybe it would reach a more normal level in 2012.

I'm not to the point of saying it's going to go well below normal levels yet, but certainly I think it's likely to go below the levels one would anticipate with 9% total unemployment in the country.

David Hochstim, Buckingham Research.

I wonder if you could give us a sense of what you expect from the recent marketing endorsements of the NHL and the College Bowl series.

And maybe give us a sense of how much your account base and card base has changed over the last 12 months, what do you have in the way of new cards or card runoff?

Well, I think that we are very excited about those new sponsorships.

We sponsored the Chicago team last year and they won the Stanley Cup.

And so that marketing spend ended up being quite leveraged.

We're very excited about the fit of the Orange Bowl and look forward to that on January 3 down in Miami.

And I'd say that part of what we're doing is concentrating more of our spending in these sponsorships and I'd say that the fit with in particular college football is a fabulous fit with spending on ESPN and so on not only with the demographics of our cardholder base, but also with the increased focus on student loans and the appeal to parents and students as Discover increasingly competes in that space.

So, we don't have specific account goals for this, we're not marketing into schools, we're advertising and concentrating our advertising spend.

And so I think the best way to measure it is looking at overall sales and overall receivables and growth in student loans, growth in deposits -- those outcomes I think are the best measures.

Also, it's not just new accounts.

The biggest opportunity we've talked about is how do we activate more of our current customers and increase market share.

And our current customers are seeing these advertisements.

Edward Groshans, Height.

Hi, David, Roy and Craig.

How are you today?

So, I know debit interchange is on everyone's mind, but I guess if you don't mind just take a second to remind us -- what drives the activity in the card issuance for the PULSE network.

And then you stated that you've been doing some strategizing regarding the potential outcomes.

Can you tell us what are the things that you think could be positive for debit card activity and issuance, then the things that could be potential headwinds?

Well, to remind people, PULSE is our primary debit play and we have 4,500 banks and other financial institutions who issue on that, so it's a very broad customer base, interchange as they pass through and we have revenues that are primarily transaction-based, so how many transactions go through.

And we are -- particularly we've got some very large customers, but we're particularly focused on some of the smaller banks who are technically exempt from the new regulations but we think in practice are likely to be heavily impacted.

So I think our focus is going to be on helping -- helping obviously implement whatever the rules are and working with our customers to make sure that they are continuing and their business continues to be viable as issuers of debit cards.

And then in terms of opportunities, some of the routing rules that may require multiple networks and may not allow some of the exclusives that some others have operated within recent years -- there may be an opportunity for us to play that role as a competitive network on a given card.

So we also look forward to working with merchants where we've tried to maintain the relationships.

And I think really no one wanted this to probably become price setting or price regulation, but we do think it's important and possible to maintain the balance for everyone and for everyone's business to benefit from a great product that debit is.

John Stilmar, SunTrust.

Good morning, guys.

Roy, just two quick data points.

One, were there any fee reversals in the quarter?

And two, if you could help me -- tell me what a blended yield is of your student loan portfolio at quarter end given that the composition is pretty different.

And then finally, David, for you, as you talked about the return of the revolver and it seems like it's becoming more pronounced, can you give us a sense as to whether that return of the revolver is accelerating, staying relatively the same, as well as just some color around the types of spending that that revolver is putting on their card as compared to prior times in a different credit environment?

Thank you, guys.

So, the first one was the fee reversals.

And we -- I mean fees, interest, both have contra revenues associated with the charge-offs.

So fee recognition, interest recognition, revenue recognition policies are very similar, they continue to accrue and post until either they're contractually or through a bankruptcy filing are discharged and charged off.

And so, yes, inside the fees would also be a contra or I would call it a charge-off effect that would also be following the principle charge-off line just like a suppression in the interest margin.

We have -- looking at a blended yield, I mean we are exiting the student loan business on the federal side.

And so I think that I had mentioned topline revenue for -- I think for Student Loan Corp.

in the 7% to 8% range and that's probably a good benchmark to use as you look forward into topline for that business.

I'll remind you that we will be accreting a discount into the revenue line associated with the booking of SLC, so that includes not only the contractual level of interest but also an enhancement due to the discount on the portfolio.

So the combination of those two as we guided you is then going to be in that 7% to 8% range.

In terms of the revolver spending, certainly we've seen an acceleration of spending on revolvers because we went from declining to growing just starting in September and that's continued until now.

I'd like to see a couple more quarters of trends to draw any more conclusions than that.

But at least they're dipping their toe back in the water in terms of spending.

I think they're being careful and one of the things that I think is important is that most of our spending growth is from customers who have over a 760 FICO score.

And in fact if you look at the under 700 FICO score customers, the sales in that group is continuing to decline.

So I interpret the overall trends as consumers are being much more careful, they're dipping their toe back in the water, but they're continuing to spend carefully, deleverage, save more -- that shows up in our growing deposits -- and spend more carefully and that shows up in our loan-loss rates and delinquency rates.

Betsy Graseck, Morgan Stanley.

Hey, guys, it's actually Matt Kelly calling from Betsy's line.

We just wanted to ask what level of dividend pay-out ratio do you guys consider normal and what capital ratio are you sort of managing to over the next year?

Well, so -- look, without giving a whole lot away I would just point you back to where we were when we came out and we had more of a normal environment which was roughly a 15% pay-out.

I don't want that to be characterized as guidance; I'm going to lay that out there as an actual fact that can help guide your guys' thinking.

Capital, I had mentioned TCE is the foundation we used.

We obviously are going to respect all the regulatory requirements as well as those that are being proposed in Basel.

But something in the 7.5% to 8% range of TCE is where we -- TCE to total managed assets is the benchmark that we run the place on.

And that's actually not changed, that's been very stable all the way back to the initial spin-off.

Just to sort of reiterate, the capital count has no -- it's completely tangible common equity, there are no hybrids or any unqualified forms of capital that reside in that TCE measure.

And so it's a clean level and, as I mentioned earlier, sitting now at 10%.

So we're guiding 7.5% to 8% in that zip code and the balance sheet shows 10% in place.

Kenneth Bruce, Bank of America-Merrill Lynch.

Thanks, good morning.

Firstly, if you could maybe just elaborate on the timing of how you may be looking at releasing some of that capital?

As you point out 10% going to between 7.5% and 8%.

So if you'd just give us some context on how you're thinking about the timing of that, how much you would arguably reserve for acquisitions would be helpful as well.

And also if you would provide some thoughts around the interest expense going forward and if you're prepared to provide any loss guidance for at least Q1 2011, please.

Let me handle the first one and then I'll have Roy take the second.

I think that we're getting a lot of new guidance on capital, there are some new -- some new guidance that came out just two weeks ago from the Federal Reserve to all the bank holding companies.

We've seen Basel III proposal, but there's some more specific guidance around that that will come out in the future.

And so I think that it is really premature to comment on what we might do over time in total in the capital account.

I think there are obviously four decisions, the first is dividend and that is -- we're hopeful we'll be in a position to do something on that in the first half of next year.

Second is organic growth and we're taking efforts to accelerate our profitable organic growth which would utilize some capital well.

And the third is acquisitions and you're seeing the STU acquisition this quarter which is important both from a use for the $4.2 billion of loans that we're buying, but also because of the platform to help the organic growth more quickly develop.

And then the fourth would obviously be stock buybacks, which we don't have an active plan in place today and, again, it would be really premature to talk about stock buybacks at this point.

Roy, if you could maybe handle the interest expenses.

Sure.

So, I think the -- so just talking about 2010 just for a moment.

Ken, I think -- I've spent a lot of time when I see people either in the field or here in Riverwoods, they're talking a lot about the maturity profile and the issuance profile and how that is going to begin to bleed into -- as a good guy into the interest expense number.

And I think if you look back at 2010 and it was 50% of our maturities come out of our asset-backed program.

And the asset-backed is looking back on the good times, so you're basically seeing I would say very cost effective maturities unfortunately being replaced with our deposits.

The good news about 2011 is only about one-third of our maturities are going to come from our asset-backed program, so there's going to be more traction with [deposit/deposit] programs being remarked and we're going to get a lot more traction than I think we got in 2010 for that reason.

Also in 2010 you recall we did some straight bond funding.

And so there were some debt issuance out of the holding company and subordinated issuance out of the bank that had I think reasonably high coupons on them and we don't see any need for that or liquidity programs in 2011.

So for both of these reasons I think you can take the run rate we showed you in the fourth quarter here and probably say we're going to see a better experience.

Assuming we leave a base rate at 25 basis points through the end-of-the-year, you're going to see a higher accretion into earnings from lower interest expense as those new deposits fund old deposits and you're going to see a higher spread between the two, that's going to give us a tailwind.

Also on the loss line, I think that the -- we've sort of come under a lot more stability here.

Delinquencies are far better at predicting where losses are going to be.

In subsequent quarters we had a lot of changes in the speeds at which accounts were advancing through delinquency buckets.

There was a lot of noise going on and I think we felt like we needed to provide more guidance.

I think through the last three quarters there's been tremendous stability in what you should expect coming out of delinquency.

We posted at the end of the quarter so we're going to back off and really try to give you more broader guidance as opposed to specific quarter-to-quarter guidance on the loss line.

Craig Maurer, CLSA.

Yes, thanks.

So, in regards to marketing, you're seeing some of your competitors market at or above all-time high levels and it's showing up in their growth.

So, your peak was 4Q 2006 at $198 million, and I'm curious if we could see you get back there?

Secondly, I was hoping you could comment on a theory that's gaining a little momentum in that when the Fed goes ahead and trims interchange that the spread between PIN and signature could close to a point where PIN is no longer worth the time for the merchants to slow down the transaction at the point-of-sale and that this amendment could actually wind up killing off PIN systems more than helping them?

Thanks.

Well, I would say -- I probably wouldn't add too much to what Roy said on the marketing spend.

I think we're kind back up to the levels that are -- that we want to have in card marketing.

I think if you added some of the marketing efforts that we're putting across other areas, whether it's student loans or deposits or personal loans, we might get back up to those higher levels in total.

But at least over this coming year I'm not sure we'll actually get to that all-time high peak quarter level just in cards.

We're just going to be more selective in cards.

In terms of the interchange, I think it's going to be -- I do think that if interchange is lower then -- and then to some degree having -- banks are going to want to have more the lowest cost option and there is still lower fraud cost on PIN than signature.

So I wouldn't necessarily jump to the conclusion that a higher cost option would be a winner in a lower price environment.

Jason Arnold, RBC Capital.

Actually my follow-up was answered.

Thank you.

Brad Ball, EverCore.

Thanks, my follow-up was answered as well.

Bruce Harting, Barclays Capital.

Sorry, you probably wanted to get on to other things.

But on Isis, can you just -- how would you rank the revenue opportunity from that and the timeline on that compared to say Diners Club and other initiatives you have?

And is this a much bigger thing potentially for you?

And can you just talk about -- the customer goes into one of the wireless stores to buy a phone in a year and a half or so and then they cross sell your product, is that how that would work?

And can you size that opportunity at all for us?

And then with regard to the issue of lack of terminals that read the mobile phone, any comments you have on what that will look like in terms of a rollout over the next two years, getting that number up from a very low fraction of all the terminal readers today?

Thanks.

Well, we're really early in this process.

So it's a bit of speculation on how this will develop over the next five years plus.

And I do think Diners versus Isis are kind of apples to oranges on comparison.

Diners is a great strategic fit and supports our whole base business, both our network and our card issuing business, it's the international leg for us.

And it's immediate, it's here and now.

Isis is something I'm incredibly excited about.

This next year is going to be one of developing the infrastructure, getting the terminals put in place, working with our retailer partners to bring them in to the fold in terms of acceptance on the wireless terminals and we really don't expect any volume to start -- occur until 2012 plus.

If it works like we hope it will we think it could be very substantial over a number of years.

But we're a few years out from that.

The thing that I think is so exciting about this one is, first, the partners who have distribution and a huge customer base; but secondly, because this is truly mobile commerce, we have been involved in a lot of other pilots and we're even rolling out to customers some mobile payments and lots of other networks have done mobile payments.

But there's not too many others that are focusing on the broad mobile commerce and what people can do to encourage sales, to get better value to consumers, to allow them to manage their accounts more on the phone, integrate it all into their existing handsets that they get when they sign up for phone service.

So I think that is part of -- the combination of the partners and the promise for consumers, that this -- Isis is focused on makes this just one of the opportunities that I'm spending a lot of my time on and am very excited about.

Thank you, ladies and gentlemen.

This concludes today's conference.

Thank you for participating, You may now disconnect.

Thank you all.