發現金融 (DFS) 2011 Q1 法說會逐字稿

Welcome to the Discover Financial Services first-quarter 2011 earnings conference call.

My name is Christine, and I will be your operator for today's conference.

(Operator Instructions).

Please note that this conference is being recorded.

I will now turn the call over to Craig Streem, Vice President, Investor Relations.

Mr.

Streem, you may begin.

Thanks, Christine.

Welcome, everybody.

Glad you are with us for this afternoon's call.

Let me begin as always by reminding you that today's discussion contains certain forward-looking statements about the Company's future financial performance and business prospects which are subject to risks and uncertainties and speak only as of today.

Factors that could cause actual results to differ materially from these forward-looking statements are set forth within today's earnings press release, which was furnished to the SEC in an 8-K report and in our Form 10-K for the year ended November 30, 2010, which is on file with the SEC.

In this first-quarter 2011 earnings release and supplement, which are now up on our website at discoverfinancial.com and have been furnished to the SEC, we have 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 of course, we urge you to review that information in conjunction with today's discussion.

Finally, let me remind all of you that we will be holding our annual financial community update tomorrow morning at 8.30 here at the New York Palace Hotel.

If you want more information about that meeting, please get in touch with me later this evening via e-mail.

With that event in front of us, we are going to keep this call and your questions hopefully focused on our first-quarter results and performance.

We will have much more for you tomorrow regarding our strategies for growth, and we will have ample opportunity to take your questions in regard to those strategies and issues tomorrow morning.

Our call this afternoon will include formal remarks from David Nelms, our Chairman and Chief Executive Officer, and Roy Guthrie, our Chief Financial Officer, and, as I said, a Q&A period following.

Now it is my pleasure to turn the call over to David.

Thanks, Craig.

Good afternoon and thanks, everyone, for joining us.

As Craig mentioned, we will be holding our annual financial community update tomorrow morning.

So we will keep this conference call focused specifically on first-quarter results.

During tomorrow's meeting, we will give you a full update of the driver of our current performance and on our strategic priorities for delivering profitable growth into the future.

After the market closed today, we reported record first-quarter net income of $465 million or $0.84 per share, and we were very pleased to announce the restoration of our quarterly dividend to $0.06 per share, making Discover an early mover to fully restore its dividend to pre-financial crisis levels.

Our financial first-quarter performance can be attributed to strong results in both of our business segments.

In Direct Banking, we earned pretax income of $677 million, driven by the ongoing improvement in credit.

Our Payment Services segment contributed $43 million of pretax income, reflecting growth of 16% from last year's first quarter.

For the Company as a whole, I was very pleased that we achieved network volume of $68 billion, an increase of 15% from a year ago.

Turning now to some of our first-quarter highlights for each segment, in Direct Banking Discover Card achieved sales of $24 billion, which represents a 7% year-over-year growth rate.

We continue to focus on increasing our merchant acceptance, emphasizing our reward programs and leveraging our marketing investments to increase sales.

Our total loan portfolio increased 3% from last year due to the acquisition of the Student Loan Corporation.

We continue to be very excited about the growth potential and earnings contribution of our private student loan business.

Based on our first two months of results since closing on SLC, we reaffirmed that we are on track for $0.09 EPS accretion in 2011 related to the SLC acquisition, excluding a one-time related gain.

Looking only at our credit card loans, they were down 3% year over year this quarter, an improvement over the 5% decrease last year and trending towards our expected modest card portfolio growth year over year by the second half of 2011.

Our direct to consumer deposit business continued to grow this quarter as we added a net $1.2 billion in deposits.

In February we announced our intent to acquire $1 billion in deposits from Allstate Bank, which also includes a multiyear banking product marketing relationship.

Subject to regulatory approval, we expect the transaction to close midyear.

Our Payment Services segment turned in another strong quarter with 21% volume growth leading to a 16% increase in pretax income compared to last year.

I was really pleased with the growth in PULSE dollar volume, which increased 24% over the same quarter a year ago.

In closing, we are off to a great start for 2011 with record first-quarter profits, the successful closing of a very important acquisition and the restoration of our dividend to pre-recession levels.

We look forward to meeting with you tomorrow where we will share our model for long-term profitable growth and the initiatives that will help us to achieve our goals.

And now I will turn it over to you, Roy.

Okay.

Thank you, David.

So before I go into detail on the financial performance, I wanted to comment on a couple of things.

First of all, the enhancements that we made to our financial supplement, which I think you will be pleased with.

I mean the simplified reporting.

I think now that we are one year past FAS 166/167, we are not looking back on the settlement adjustments.

We are taking -- (technical difficulty).

So, as a result, we are no longer going to need the as adjusted numbers in that presentation.

We have also added several new disclosures to the financial supplement to provide more detail in other income with credit metrics within the portfolio, and we have added a balance sheet.

One of the biggest impacts to the Direct Banking segment reporting, as David said, was the introduction of Student Loan Corporation, so let me begin by taking you through how SLC impacted our financials.

(technical difficulty)-- on the deal was about $400 million.

That was [91.5%] of the loan assets less the assumed liabilities.

The difference between the $30 a share or $600 million announced price is a $150 million payment made to Discover from Citi as a part of the overall transaction.

The assets and liabilities were set up on our books at fair market value.

More on this in our first-quarter Q due out in a couple of weeks.

But the key point I wanted to make is that the receivables have been recorded at $3.1 billion, which represent about a $700 million discount to book.

The discount on the receivables will be set up in two buckets.

One will accrete into income over time based on cash flows, and the other bucket will serve to absorb the expected lifetime losses on the portfolio.

For that reason, no losses from this portfolio will flow through our P&L as long as the losses that are being incurred are in line with the initial expectations that we have made around sizing this non-accretable bucket.

The discount will also be applied against debt of about $270 million, and it will be amortized interest expense over the term of the underlying debt instruments.

And there is an indemnification asset of about $100 million that was created, which will wind down over time as cash is received from Citi for the expected losses that they indemnified us for.

We had two months of results from SLC in the quarter, which contributed $30 million in pretax income, including a one-time gain of $16 million related to our consent to the commutation of certain insurance policies, and this was previously disclosed for those of you that were not aware of that in an 8-K at the closing of the SLC deal.

The Direct Banking segment in total earned $677 million pretax in the first quarter.

Recall that in the first quarter last year we enhanced our reserve methodology, which had the effect of bringing reserve coverage to a full 12 months of losses.

And that resulted in a pretty sizable reserve build and a loss in last year's first quarter of $208 million.

Moving to yield, credit card interest yield dipped 3 basis points from the fourth quarter to 12.65%.

The modest compression here was due to increased level of lower yielding promotional balances, the continued reduction of high rate balances, and an increase in customers who pay their balances in full each month.

The impacts were mostly offset by lower levels of interest charge-offs.

As mentioned last quarter, we expect further card yield compression throughout 2011 due to these same factors.

The degree and pace of the compression will depend upon the rate and composition of growth in the card portfolio over the course of the year, and certainly total portfolio yield, which declined 14 basis points sequentially, will be influenced by now the SLC receivables and the growth of that over the course of this year.

Net interest margin for the Direct Banking segment, including student loans and personal loans, was 9.22%, down 6 basis points sequentially, reflecting the acquisition of student loans and a modest decline in the credit card yield I just referred to.

And this was partially offset by ongoing lower funding-related costs associated with lower levels of cash and liquid assets.

So we expect the net interest margin to continue to decline and likely at a faster rate than you have seen here in the first quarter as loan yield compression outpaces the improvements in funding costs and lower charge-offs in the interest line.

Other income, which was $6 million up over the prior year, included the $6 million gain I mentioned related to SLC.

So recurring revenues were down about $10 million year over year, and this was driven by lower fees from the CARD Act implementation.

Moving on to operating expenses, we will continue to spend a bit more aggressively as credit improvements allow, particularly for the opportunity to accelerate investments and growth.

And you can see this in the significant year-over-year increase in the marketing line.

Total operating expenses for the segment were up $115 million over the prior year, again primarily related to the increase in marketing, but also due to higher professional fees from collections activities, the inclusion this year of SLC in our results, to mention just a couple.

If you recall, we recorded a one-time credit of $23 million a year ago related to the resolution of our dispute with Morgan Stanley over a Visa/MasterCard settlement issue.

Turning to our portfolio, total loans were up 3% from the prior year due to the acquisition of SLC and again partially offset by lower credit card loans.

Credit card receivables decreased 3% from the prior year; however, as you heard David say, we are seeing stability in the portfolio and expect modest growth in the second half of 2011.

In terms of credit performance, card loans greater than 30 days past due dropped 47 basis points sequentially to 3.59%.

The card net principle charge-off rate decreased almost 100 basis points sequentially to 5.96%.

Based on the continued positive credit card performance and the outlook we have for future losses, we released $271 million in reserves for the quarter.

The reduction in the reserve rate and the 30-day plus days delinquency rate for credit cards, those two rates were right on top of each other if you look at their movement on a sequential quarter basis.

And so delinquency continues to be a very good benchmark for the way we are reserving the portfolio.

Personal loans increased $573 million year over year as we expanded further into the broad market.

In terms of credit performance personal loans greater than 30 days past due dropped 37 basis points sequentially to 1.20%, and the personal loan net charge-off rate decreased 60 basis points from the fourth quarter to 4.10%.

Private student loans increased $3.8 billion compared to last year, again driven by the acquisition of SLC and new originations, including $500 million from the combined business in the first quarter, new originations from the combined business in the first quarter.

In our financial supplement, we refer to the acquired portfolio as purchase credit impaired or what I will refer to here as PCI loans, which is the way GAAP characterizes the loan portfolio acquired with a balance of non-accretable discount designed to cover loan losses.

So, as I mentioned, losses on this PCI portfolio will flow to this non-accreting discount rather than through our P&L.

And so, as a result, we will give you measures of loan portfolio quality with and without PCI loans.

Yield on the private loan portfolio decreased -- sorry, increased 222 basis points compared to last year, and this increase in yield was primarily due to the addition of the SLC portfolio.

In terms of credit performance of the private student loan portfolio, the 30-day plus delinquency rate was 72 basis points, and this excludes the PCI loans.

We have given you charge-off data for student loans with and without PCI loans.

The charge-off rate for student loans excluding PCI was 29 basis points on our Discover-originated loans, and you should keep in mind that this portfolio is quite young with a very small portion of it in repayment.

Both credit metrics I just discussed decreased sequentially, and this was a result of an increase in the denominator as we added roughly $500 million of new originations from the combined platform in our first quarter.

Shifting gears to the Payment Services segment, pretax income was $6 million or 16% from the prior year to $43 million.

As you heard David say, a record quarter for our Payment Services business as our PULSE business drove revenues and volumes much higher year over year.

2010 was a successful year for the Payment Services business.

It was a record year for them, and I think this quarter really represents a great start to what we hope is going to be another great year for our payments business.

The effective tax rate for the Company came in at 35%, lower than recent quarters as we settled a few open returns at the state level and released associated reserves with those settlements.

Over time I would guide you back to an effective tax rate in the 38% to 39% area.

Our liquidity position remains very strong looking forward.

The second quarter of 2011, the next quarter out, at about $5 billion is the highest maturity quarter over the next 12 months.

At the end of the first quarter, our liquidity investment portfolio totaled $10.3 billion, up slightly from the prior quarter but down from $12.7 billion a year ago.

Including these assets, our overall contingent liquidity has increased $24.7 billion as we brought on additional multiyear conduit capacity from partner banks this quarter to begin to balance the flexibility and economics of various means of providing contingent liquidity.

As it relates to funding, we are pleased with the strength that we have seen on the direct to consumer deposit business and remain opportunistic across not just this but all of our funding channels.

I mean we just after the quarter ended we closed a $1 billion floating rate three-year ABS transaction priced at one month LIBOR plus 35 basis points.

This represented our largest non-TALF public transaction since October of 2007 and the tightest spread on a Class A floating-rate tranches since the master trust was enhanced to be able to issue de-linked issuances in 2007.

I think it is a benchmark transaction and indicative of the health of that channel for us.

Proceeds of this transaction are going to be reflected as I mentioned in our second quarter.

Our first-quarter capital account was very strong.

Tangible common equity to tangible assets was 10.2%.

We are pleased to announce the increase in our quarterly dividend to $0.06 a share from $0.02 a share, representing a full restoration of our dividend.

Even after this, I think meaningful first step in returning capital to our shareholders our capital account leaves us well-positioned to invest opportunistically across our existing businesses, to consider opportunities that present themselves in the marketplace, and return additional capital to our shareholders, including through the use of over time share repurchases.

So, as David said, this was a strong quarter in terms of profitability, in particular credit performance and further progress in the strategy.

More on the strategy tomorrow.

But this quarter was also the fourth in a row which we have now exceeded our 15% return on equity target, and clearly this quarter we are above 15%, even excluding the benefit of the reserve release I talked about.

Tomorrow we are going to be going into a heavy focus on the plans and the strategies for the future, and we will be available to answer questions on other topics.

So now I look forward to seeing everyone tomorrow, but I'm going to turn it back over to Christine for our question-and-answer period.

(Operator Instructions).

Betsy Graseck, Morgan Stanley.

Could you -- I just want to dive in a little bit to the loan growth that you got in the quarter.

I know you talked about some of the strategies that you employ to do that.

Could you give us a sense as to how much balance transfer added to that and what other strategies worked successfully in the quarter?

I would say the first thing I would point you to is the sales growth that was about -- that increased our 7% year over year.

And if you take that higher sales growth and the lower charge-off, I think those two things were a major factor.

Balance transfer continues to be much higher this quarter than it was a year ago, but I think is less of an impact sequentially in terms of any increase.

And I would say we are going to talk more about this tomorrow, but a big part of our focus is gaining market share and wallet share from existing customers, leveraging our cashback bonus, our service and our value.

You have obviously seen us do a lot more brand marketing sponsoring the Orange Bowl, etc.

So it is no one single thing.

Certainly I would not isolate just balance transfer.

Okay.

And then separately can we talk a little bit about the type of capital ratios that you are managing to over time I understand there's opportunities to acquire different kinds of portfolios.

Could you just give us a sense of what type of capital ratio you are looking to manage to eventually?

And I know you alluded to buybacks.

Can you just give us a sense as to what point you start doing buybacks as opposed to the more acquisitive activities?

Sure, Betsy.

We have -- I think one thing we would say is that we have been if anything consistent around the way we feel like we should be capitalized, and we really have not changed through this crisis what the feelings were on that.

Today we have talked about an 8% TCE target, and obviously we have a tremendous amount of respect for the requirements around the regulatory targets.

But in terms of the way you think about loss-absorbing capital, solvency through the cycle, all those sorts of things, it is going to be in that 8% TCE range, which does create at 10.2% some options and alternatives that we have available to us as we sit here today.

And then let me just add, we will talk more about this tomorrow at Investor Day, but we would certainly profitable organic growth and then probably attractive acquisition targets, and then after that, we would think about dividends, which you obviously saw us take action on now, as well as buybacks.

We're not to a point of having a buyback program in place, but it is certainly something we are likely to consider later this year.

Okay.

Because you could say you want to get to 8% over the course of the next couple of years, or you have your eye on a couple of potential opportunities that if they don't pan out, then you start the buybacks up?

I'm just trying to understand how you -- what is the catalyst to getting to that 8% if organic and acquired growth is not occurring at the pace with which you need to get down to 8% by a certain period of time like, call it, year-end?

I would not want to give a set timeframe at this point.

I mean we are very pleased that our ratios improved this quarter, even after doing the largest acquisition we have ever done.

And so we take note of that, but I don't think there is anything magic.

We are continuing to earn a very strong ROE, even with the high levels of equity we are carrying right now.

But we are going to want to keep our options open.

We are going to evaluate this, and over the course of the next few quarters, I'm sure you will see us take additional actions to hopefully move a little closer to that target.

Mike Taiano, Sandler O'Neill.

Roy, I apologize if I missed it, but the $700 million discount to book on the SLC portfolio, did you give the breakout between what was accretable and non-accretable?

I did not, Mike.

So I think -- well, it is just a little bit of a blur here.

There may be additional disclosure on that in our Q, but I think we will have to get back with you on that.

What is important perhaps -- and it might be worthwhile just taking a moment that should speed this up -- is making sure everybody is comfortable with the three components that I outlined.

And the transaction itself was an 8.5% discount at $3.8 billion in receivables, so we can all do the math on that.

We get about $325 million broke into those three components, including $700 million of discounts, an asset of $100 million due to indemnification, and a premium on the liabilities of $270 million.

So you are going to see all of it but the non-accretable portion that you just ask a question on find its way into income.

But the reality, of course, is that by absorbing those losses, it shields the P&L from that and is a form of accretion.

Do you know what I mean?

So I would almost guide you to think about this almost as all of it one way or another finding its way back through the P&L.

One in the form of deferring losses or deflecting losses from entering the P&L.

The other is from systematically being introduced as cash flows systematically find their way through the quarters.

Okay.

No, that is helpful.

You have got a lot more than you were looking for there.

I just wanted to make sure an abundance of caution that no one walks away confused about that $700 million.

Okay.

So I mean it sounds like it is really -- you take the $700 million, and you have to subtract off the $100 million and $270 million, and that will get you to the number of which some portion is a non-accretable discount?

That is right.

Okay.

And then on the same sort of topic, you mentioned the amount of loans that are in repayment.

Obviously those are probably most relevant from a credit standpoint.

Do you roughly have the numbers in terms of both your organic portfolio as well as SLC in terms of how many of those loans have actually entered repayment at this stage?

Yes.

You know, the largest portfolio is the Student Loan Corporation portfolio, and about 75% of that is in repayment.

So we have got some good history there.

I would say for our own loans, it's a very low percentage have entered repayment.

Most of those loans have been acquired in the last two years.

Okay.

Great.

And then just the last question, I am just curious to what extent gas prices helped in terms of volumes this quarter?

I know the big spike came towards the end, but I think on a year-over-year basis it was still up pretty significantly.

Can you give us some color on that?

Yes, they did have some impact, favorable impact, on sales, but we had been running about 5% or so each quarter.

And this quarter we jumped up to 7%.

Maybe half of that increase could have been gas-related.

But even if you back out the price of gas, it was a bigger increase over this quarter versus the previous four quarters, each of which had good solid growth.

And I would say further more in the last six weeks the growth has picked up even further, and even that is not all the recent gas increase.

So we are seeing some pretty favorable trends on sales.

Thanks a lot.

Christine, as we go to the next question, could we ask each questioner to limit his or her questions to one and then to re-queue if need be, and we will try to get to everybody.

But let's try to keep it balanced, all right?

(Operator Instructions).

Sanjay Sakhrani, KBW.

Congratulations on getting the approval for the dividend and the solid results, by the way.

I had a question on the margin, the net interest margin.

Roy, you talked about the margin coming down going forward at a little bit of a faster rate.

And I was hoping you could just walk us through the pluses and minuses because I thought there might be -- is it just mix shift related, or is it on a core basis ex the acquisition?

And then just on a question asked before on capital management, I was just wondering that 8% TCE, was that part of your capital -- was that included in your capital plans submitted to the Fed?

Well, let me take them in reverse order.

There is obviously as much transparency there as there is here, and that has always been our target.

So you should probably count on that being front and center in terms of the way we deal with all audiences in terms of setting TCE targets.

In terms of the yield, I think that the components of this are the same rubric that we have sort of been dealing with really as we have gone through this discussion over the course of the last five quarters.

There is a (inaudible) default bucket that obviously post CARD Act is not being reinitiated.

There are very varying degrees of promotional balances that are being introduced to the program.

I think Betsy talked about that.

You heard David's comments regarding the use of promotional balances among other things to sort of grow the business.

There is the suppression.

I learned that word from you guys.

But the reduction in charge-off interest that occurs as charge-offs get smaller, the suppression that occurs within the finance charge line also get smaller.

There are obviously repricing aspects due to CARD Act that begin here this month in the month of March as we look forward that will inevitably put some pressure as repricings are pursuant to the CARD Act's specification for repricing accounts that would warrant that downward to their original point.

And then there is the usual construct of other forces in the market around revolve and non-revolve.

And so one of the things that we have struggled with here a little bit, just to be frank, is giving you guys precise answers when there is -- I think initially when so many things were being governed and dictated by CARD Act, it was a little bit more -- we could be a little bit more prescriptive around here are the various things that we were looking at.

But, again, obviously it is a rubric, and it is a dynamic market.

And, to be frank, some of these things have gone at a rate and paste that actually have impressed us, in particular the credit improvement that we have seen over the last four quarters.

So, as we look forward as I said, I think that that nets to a headwind.

And we are continuing to signal that so there is room for this thing to move downward.

But the reality is our business model does not need this level of finance charge income to be effective.

And so it's not a concern to David and I that we have that headwind pressure on us, although it is something that we are going to continue to manage.

And I don't think we are going to be any more articulate in exactly what the magnitude of that is going to be, but rather you're going to see that net headwind from all those headwinds and tailwinds continue to be a force that we are dealing with.

The one thing I might add to be helpful that I will be mentioning tomorrow is we do expect that 8.5% to 9% is a more normal range for us, and we are obviously above 9% today.

And so we do expect it to decline over time to that kind of range.

David Hochstim, Buckingham Research.

On the student loan acquisition, my math has it basically at about $14 million of income pretax for the two months, $21 million for the quarter, and that is kind of a run-rate.

The balance is paid down, but you have still got accretion.

Accretion is coming in faster.

Is that --?

That is roughly right.

We would expect to reaffirm that we expect about $0.09 accretion from that acquisition during the course of this year.

So just to clarify again what Sanjay was asking about, could you give us some sense of how much internal balances increased in the first quarter this year versus the fourth quarter of last year and how much you expect that to be increasing as part of that margin change?

I would direct you to -- we are going to show a statistic on that tomorrow if I could just defer that until then.

But it's a little bit north of 10% now.

I would think probably closer to 12%, but we will show you what we expect over time.

Brad Ball, Evercore Partners.

Roy, in terms of the effective tax trade this quarter, I think you guided to expect to gradually return back to the 38% to 39% level.

Does that mean that some of the benefits this quarter related to the state tax matters will carry into future quarters, or will we jump back up?

Yes, that is right, Brad.

I mean we have been -- this is a blessing that we all got from FIN 48 around states where basically it is asymmetrical the way you need to provide.

But once you resolve the matter, the carry on that state goes down as well.

So I do think it takes a little pressure off the carry as well as the reserves that were settled a part of it.

Now it is not a big thing.

There are three states.

One of them has to be a big state.

So maybe three out of 50 is not representative.

But it is a little bit of a relaxation on the future carry.

So thank you for bringing that question up.

That is why I guided a little lower to 38%, 39% rather than 39% plus/minus.

Brian Foran, Nomura.

When we think about revenue suppression or the finance charges billed but deemed uncollectible, I guess are we at a normal run-rate now, or are we at a cyclical trough?

How should we think about where it is running relative to history?

And then also what would correlate with it further declining and/or increasing in the future?

Would it just be the direction of delinquencies, or should we watch something else?

I would say you correlate it closely to charge-offs.

And at 5.9% charge-offs, we are still on the high-end.

So I would expect that this would still have some room to run in terms of some more benefit for reduced interest charge-offs as the charge-offs stabilized.

But, as Roy indicated, that is one reason we expect the net interest margin to kind of decline a bit because we have already seen maybe a fair amount of that normalization already occur.

If I could ask one follow-up on funding costs, I mean the LIBOR plus 30 or 35 debt ABS deal seems like most of your CDs are now being priced below 2%.

How should we think about future funding costs, and is that improvement baked into the 8.5% to 9% NIM guidance, or are current funding markets a little bit more favorable than you had budgeted for?

Well, I think David's 8.5% to 9% was more of an over the cycle.

So please exercise some caution if you drop that into the next three quarters.

I think there is a good tailwind, and we have residual pools of liabilities that were created prior to the Fed movement down to 25 basis points of that effective target.

And so we have got maturities over this year and next that are going to be a significant tailwind for us.

And the longer the rates stay where they are today to your point, LIBOR plus 35, all the deposits being raised under 2, that is going to be a nice piece of support for the net interest margin.

It is with that in mind that we sort of say that there are a lot of offsets to these other things that I sort of countered as headwinds, but they are strictly -- there really is a great tailwind coming though from the liability and the funding costs.

Moshe Orenbuch, Credit Suisse.

Thanks for the new disclosure on the fee income.

I was wondering if you could round that out a little bit?

Because if you look at the revenues from interchange, they are kind of flattish year on year, and you have got some pretty significant growth in volume.

Even if you add in the transaction, processing revenue is still kind of the 3%-ish area significantly slower.

Could you reconcile that to see if there is either contras to that or other categories that are not in there?

The big contra is cashback bonus, and we are doing more promotional cash programs.

That is part of what is driving the sales activity and the receivables up.

So I would say that is the biggest contra there.

So it is like the 5% promotions type thing?

It is all of our programs, but (inaudible) particular yes, 5% programs and our other cash rewards programs.

Don Fandetti, Citigroup.

David, I was curious, during the quarter we obviously got some proposed rules from the Fed around exclusivity, and I wanted to know what your thoughts are on that in terms of Discover?

Well, I would say that we are closely following this.

As you know, we are not a debit issuer ourselves, so interchange is a passthrough for Discover and for PULSE.

But I would say that it seems like in the last month or two things may have gotten a little more uncertain, and I would not want to speculate on the full outcome whether there will be a delay or not, whether there will be a change from the proposed or not.

It would be pretty speculative.

I would say we are focused on being prepared for whatever the outcome is.

And in particular, on the routing rules, I am hopeful that regardless of the outcome that some large issuers may conclude that they are smart strategically whether required or not to maybe split their signature and PIN volume.

And if they start doing that, I think PULSE is one of the networks that is well-positioned to pick up some gains.

And so we are in particular focused on that.

Ultimately we believe in competition as the answer, and we would like to be one of the competitors that provides that to the marketplace.

Rich Shane, JPMorgan.

Most of my questions have been asked, and frankly, it is a very good quarter.

One quick question.

When we look at discount and interchange revenue because you give us the breakout, it does not increase nearly as much as the volume does on a year-over-year basis.

What is the disconnect there just so we know?

You might have missed the earlier answer, but it is really capital rewards program and cashback bonuses at contra revenue, and we have certainly ramped up that program as we see it continue to gain share.

John Stilmar, SunTrust.

Just a follow-up.

On the topic of spending velocity, you had highlighted the spending velocity continues to exist past the February 28 reporting timeline.

I'm wondering how much of that is macro-improved economic activity?

How much of that is improved effectiveness of cashback marketing, and potentially how much of that effectiveness potentially could come from several large issuers abandoning rewards-based debit products?

I know that is not all since February 28, but it seems like momentum at least since last quarter on the velocity of card sales volume has picked up, and I'm wondering if there was any sort of statistical or anecdotal or detailed evidence that we can kind of glum onto?

Thank you.

Sure.

It is very difficult.

It is sort of proving how well your advertising is working.

I would say on the third hypothesis, I don't think we have seen that yet.

We have seen some recent announcements on debit rewards cards going away and so on, but in my opinion, there has been very little actual impact to date.

So then you get down to what is our marketing and what is the economy.

I believe that it is a mix.

I cannot tell you whether it is 50-50 or what the number is, but I can tell you we have certainly picked up our marketing spending.

We think that our spending is going further with some of our new things like the Discover Orange Bowl and some of our cash rewards programs that we think are giving this really good payback.

But certainly I think we are also picking up some -- the economy is also helping us as well.

Chris Brendler, Stifel Nicolaus.

Just on credit for a second, it seems just to be astoundingly good on the credit card portfolio.

Delinquencies continuing to fall on a seasonally weaker period.

Can you talk about all the, if you see any stabilization, the improvement at some point later this year, how much better was this quarter's trends versus your expectations?

And did any of that run through the income statement this quarter and relieve suppression and does that fall from here?

Well, I would say we have been pleasantly surprised.

I think about a year ago we really started focusing on new loss of jobs as opposed to the overall unemployment rate.

We have talked about that before, but that seems to be a big driver that the credit is outperforming what one would expect versus the overall unemployment rate.

We think that this has some room to continue to normalize.

At some point it does need to -- it will start slowing down in terms of the improvement.

And I think it's a bit of an open question as to whether it kind of overshoots or goes to a new normal that is a lower level or not.

Clearly one of the things that has happened is we were very careful going into this crisis.

A lot of people got pushed over the edge from unemployment or housing prices.

And when anyone -- a lot of those losses, though, have already been recognized.

And so increasingly what we are left with is people that actually survived through this really tough perfect storm, if you will.

And so we are seeing the backside of that now.

And, frankly, we have never had such a severe shock to the system, and so it is a little bit hard for us to tell how good it is going to get on the other side.

And so we are pleased, and we clearly are going to have some continued improvements through this year.

Is it fair to say at this point that you're not seeing any signs of the improvement slowing down, and if you had to guess, losses are probably going below the long-run average?

And I will stop there.

Thank you.

Yes, if you look at the sequential improvement, it does not show any sense of slowing down yet.

But clearly it will start slowing down, and I would expect that over the coming quarters the quarterly improvement on delinquency and charge-off rate will start to moderate, will start to approach whatever the trough is.

Jason Arnold, RBC Capital Markets.

Nice job this quarter.

Also, Roy, thanks for the enhancements.

Very helpful.

I'm just curious if you could give us some additional detail on the other income line.

You mentioned a one-time gain of around $16 million, but were there other identifiable nonrecurring items there?

Yes.

You know, I think, as you look at the first quarter, $16 million is probably the one thing I would point you to.

Unfortunately when you look to the quarter that preceded it, there's a few more in there.

I mean clearly other income back there had the influence of the -- I think we had a $28 million charge we took to position the federal loan portfolio to held for sale.

We had some other enhancements or things that were being run through there, $10 million or $12 million.

So if you look at the swing, it is not necessarily this quarter, and I think if you take the $16 million out of the $65 million and that other income number, I would say that is probably a good benchmark and maybe -- not to throw the past out, but I think the past is chock-full of a lot of issues.

It is a volatile line, in particular fourth quarter of last year to first quarter of this year.

So $65 million, excluding the $16 million one-time gain, I think is a pretty good guide to the things that we would expect to see in there on a recurring basis.

And there will be a commentary around this in the Q that is out in a couple of weeks that will supply you additional detail.

That concludes the question and answer session for today.

I will turn the call back to Craig for final remarks.

Thanks, Christine, and I want to thank all of you for your attention and your questions this evening, and we are certainly excited about tomorrow's meeting and looking forward to seeing you there.

Have a good evening.

Thank you for participating in the Discover Financial Services first-quarter 2011 earnings conference call.

This concludes the conference for today.

You may all disconnect at this time.