發現金融 (DFS) 2011 Q2 法說會逐字稿

Welcome to the second-quarter earnings conference call.

My name is John, and I will 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 will now turn the call over to Mr.

Craig Streem.

Mr.

Streem, you may begin.

Thank you very much, John.

Good morning everybody and welcome to today's call.

As normal, let me begin by reminding all of 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-K for the year ended November 30, 2010, and in our Form 10-Q for the first quarter 2011, both of which are on file with the SEC.

In the second quarter 2011 earnings release and supplement, which are now posted on our website at DiscoverFinancial.com, and have been furnished to the SEC, we have provided information that compares and reconciles the Company's non-GAAP financial measures with the GAAP financial information, and we explained why these presentations are useful to management and to investors, and we urge you to review that information in conjunction with today's discussion.

Our call this morning will include formal remarks from David Nelms, our Chairman and Chief Executive Officer, and Mark Graf, our Chief Financial Officer, and of course, a Q&A session at the end.

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

Good morning, everyone, and thanks for joining us.

Before the market opened this morning we reported all-time record quarterly earnings of $600 million or $1.09 per share, driven by continued improvements in credit as well as outstanding fundamental performance in both of our business segments.

Our results this quarter reflect the Discover business model delivering exceptional results despite a slow and uneven economic recovery.

There are two items in our results this quarter that really stand out for me.

First, our 30 plus day delinquency rate for the card portfolio reached 2.79%, the lowest level at any point in our 25-year history.

And second, Discover Card receivables grew almost $650 million from the first quarter.

The very positive trends in delinquencies suggest that charge-offs will continue to decline while our reinvigorated marketing efforts are now resulting in cards receivables growth, as well as accelerating sales and revenue growth.

We continue to have a very positive outlook for profitable receivables growth in all of our lending businesses, and feel very good about the outlook for our payments business, which together with ongoing improvements in credit, should lead to continued generation of excess capital.

As a result, on June 15 our Board authorized a $1 billion share repurchase program, reflecting the strength of our capital base and our intention to be responsible stewards of our shareholders' capital.

Looking at our results for this quarter I was very pleased with our 5% growth year-over-year in total revenues and receivables.

This contrasts sharply with what you see from most of the traditional banking industry which has been struggling to generate revenue and receivables growth.

We believe this speaks very well of our Direct Banking model versus the approach being taken by most of the banking industry.

Now let's take a look at some of the key drivers of our record results this quarter.

First, in our Direct Banking segment Discover sales volume was $24.8 billion, up 9% year-over-year.

An important contributor to the growth in sales has been providing greater value to our cardmembers through rewards, marketing programs, increased brand presence, and the benefits of increasing acceptance.

We are seeing healthy growth in our active and primary card base, leading the gains in wallet share.

Also, we significantly grew new accounts in the quarter.

Continuing the trend we have seen in previous quarters, the number of active merchants grew 8% from last year as we continue to push towards rounding out our US merchant coverage.

The very positive trends in merchant activation and card usage have been in place for some time now and we expect them to continue contributing to future receivables growth.

Increases in balance transfer activity have also been a factor in our cards receivables growth.

Our emphasis with BTs has been to grow balances with our existing customers, whose spending and credit performance are well understood.

But we are also carefully using balance transfer strategies to originate profitable new account relationships.

In addition to wallet share gains and balance transfer activity, receivables growth has also been positively impacted by trends in principal charge-offs, with the card portfolio net charge-off rate decreasing almost a full percentage sequentially to 5%.

Regarding our noncard lending products we continue to be extremely pleased with the performance of both our private student loans and personal loan businesses.

Mark will take you through key metrics of both products, but both are tracking well against our growth and profit targets, and also demonstrating very solid credit trends.

Turning to our Payment Services segment, pretax income for the quarter was $43 million, up 19% versus last year, driven by strong performance principally in PULSE and Diners Club.

PULSE generated a 25% increase in the number of transactions to a record 1 billion debit transactions in the quarter.

This accounted for the majority of the revenue and earnings growth for the segment.

Diners Club reported solid dollar volume growth, up 10% from the prior year and contributed to segment profitability by reducing operating costs.

Our third-party issuing business also posted 10% year-over-year growth in dollar volume.

Regarding developments with the Durbin Amendment our view is that many issuers have delayed signing new debit network deals, while we all waited for resolution of the Tester Bill and more clarity from the Fed on actual implementation.

We are hopeful that the Fed will act in a thoughtful and balanced way in issuing final regulations on June 29.

A major banking industry concerned with the Durbin Amendment has been about the proposed level of debit interchange.

This has been closely watched by the banking industry.

But another requirement in the amendment prohibits exclusive debit network deals.

We believe a number of issuers will need to add another PIN debit network to their cards.

PULSE is an excellent platform and has capacity to accommodate potential customer needs.

Also, during the quarter we announced the planned acquisition of Home Loan Center's operating and related assets from Tree.com.

HLC operates a direct mortgage origination business, and the acquisition will help us build out our Direct Banking product suite.

Over the last year we spent a lot of time developing the right strategy and structure to enter the direct mortgage business, and we believe this acquisition makes strategic and financial sense.

We look forward to working towards becoming a leader in this business as well.

In terms of the US economy, it is apparent that we are still not on firm footing.

We have all seen recent weakness in certain economic indicators, but our business continues to perform well.

Before I turn the call over to Mark, I do want to acknowledge the retirement of Roy Guthrie.

Roy has been a trusted and valued colleague since he joined Discover six years ago as our CFO.

He played a critical role in our transition to becoming an independent public company in 2007, and built the finance organization to accomplish all that was needed for that process, including establishing a very sound capital base and liquidity profile.

He helped us to successfully navigate through the shocks and uncertainties of the financial crisis of the recent years, and has left us well-positioned in virtually every element of his responsibility.

We will miss him, but we respect his decision to step back from active management, and we wish him and his family the best for the future.

Let me now take the opportunity to formally introduce Mark Graf.

Those of you who didn't already know Mark had the chance to meet him by phone during our conference call regarding the planned acquisition of HLC assets.

He is a veteran financial services executive with over 20 years of leadership experience in banking, and for the past six years in private equity.

He was Chief Financial Officer of Fifth Third Bank, and prior to that served in senior financial and operating roles at a number of other leading regional banks.

He brings to Discover a very relevant set of skills and capabilities, and I'm sure you're going to enjoy getting to know Mark and working with him over time.

Now I am going to turn the call over to Mark Graf.

Thanks, David.

Before I add my comments on our second-quarter performance I would love to take a minute to say that I'm really very excited to be part of the Discover team.

My first few months have validated my initial perspective that I was joining a great organization.

So I'm looking forward to the future and also very much to working with all of you.

Now on to the business at hand.

Turning to the segments, Direct Banking, which includes cards, student loans and personal loans, earned $883 million pretax this quarter versus $386 million last year.

In terms of yield on the card portfolio we reported an 8 basis point decrease from the first quarter.

This compression wasn't unexpected, as we have grown the level of lower-yielding promotional balances and have continued to experience impacts from the CARD Act.

These combined impacts were partially offset by lower levels of interest charge-offs, and as a result, the overall trend in card yield continues to track above the level reflected in our card profitability model.

Our total portfolio yield declined 17 basis points due to the card yield impacts I just mentioned, plus the effect of our strategic shift toward lower yielding, but also lower charge-off student and personal loans.

Looking forward we expect some additional yield compression throughout 2011 due to these same factors, but expect this to be partially offset by ongoing improvement in credit.

Second-quarter net interest income was up $46 million year-over-year and $23 million from the first quarter.

Net interest margin for the segment was down 7 basis points sequentially, driven primarily by card and student loans.

This was partially offset by lower funding and related costs as interest expense as a percent of loans decreased 10 basis points.

All-in we expect net interest margin to be relatively stable throughout the rest of the year.

Other income was $22 million higher than the prior year.

The primary driver of the increase was in the second quarter of 2010 there was included a decree of over-limit fee charge-offs that bled into the quarter after we ceased assessing over-limit fees in February of that year.

The current quarter also included transition services revenue related to The Student Loan Corporation and a small increase in the value of the federal student loans held for sale.

Other income includes discounted interchange revenue.

And as you can see in the financial supplement, we are now giving you gross discount and interchange revenue as well as rewards costs, so you don't have to wait for the Q to be issued to see this data.

This quarter discounted interchange revenue increased a bit ahead of our sales growth, but this was offset by an increase in rewards.

This increase resulted from some enhancements to the program, as well as increased customer engagement.

Continuing with expenses, we have spent a bit more aggressively on the back of credit improvements, as operating expenses increased $119 million over the prior year.

The primary components of the increase were as follows.

First, marketing spend was up year-over-year as we increased investments for new account acquisition.

Second, higher professional fees related to recovering charged-off accounts and key technology and growth initiatives.

Third, increased compensation partially related to the acquisition of SLC.

And, lastly, other expenses were higher year-over-year because of increased legal and fraud reserves.

Approximately $18 million of the OpEx increase over the prior year came from the addition of SLC.

David has already discussed the trends in sales volume, receivables and credit performance in our card business, so I'm going to shift to credit performance for our personal loan and student loan businesses.

In terms of personal loan credit performance loans greater than 30 days past due dropped 24 basis points from the prior quarter to 0.96%.

The personal loans net principal charge-off rate decreased by 122 basis points from the prior quarter to 2.88%.

Credit performance for the private student loan portfolio also improved with a 30 day plus delinquency rate at 55 basis points, excluding the purchased credit impaired loans.

The charge-off rate for student loans, excluding the PCI loans, was 51 basis points.

Let me call out one additional point in the private student loan credit metrics.

You will see in our financial supplement that the reserve rate increased for student loans.

This was a result of enhancements we made for our reserve estimate based on data we attained in acquiring SLC.

The enhancements are specifically related to loans that may become uncollectible while the student is in school or during deferment, and are intended to account for various events that can not become known until after the student enters the repayment phase.

Based on the positive credit performance trends and outlook primarily relating to our card portfolio, we released $401 million in reserves for the quarter.

Our business is delivering solid financial results.

Even if you exclude the reserve release, we generated a return on equity of approximately 19%.

On the payment side we had another quarter of double-digit pretax income growth versus the prior year.

PULSE continues to drive both revenues and volumes higher.

However, we expect comparisons to be more difficult in the second half of this year due to the addition of a large bank PIN debit issuer in the second half of 2010, as well as a delay in new deal signings as issuers waited to see how Durbin would ultimately be resolved.

The second-quarter effective tax rate came in more favorable than expected, as we had a $23 million reversal of a tax valuation related to a previously realized capital loss when we sold the Goldfish business in the UK.

We still believe our effective tax rate will be in the 38% to 39% area going forward.

Before I wrap up, I want to touch on liquidity and funding.

The second quarter included the largest dollar amount of maturities for 2011, and our liquidity levels remain strong.

Our contingent liquidity ended the quarter at $24.3 billion, which includes cash, liquid investments, conduit capacity, our bank credit facility, and capacity at the Fed discount window.

We are pleased with the continued growth we have seen in Direct-to-Consumer deposits which now make up 43% of our funding base.

We like the funding costs and customer relationships which come with Direct-to-Consumer deposits, but will continue to remain opportunistic across our other funding channels as well.

As a case in point, just after the quarter close we placed a $1 billion floating-rate two-year ABS transaction at one month LIBOR plus 21 basis points.

This represented the tightest LIBOR floater spread since our de-linked trust was formed in 2007.

The proceeds from this transaction will be reflected on the third-quarter balance sheet.

Our second-quarter capital levels were very strong, with our tangible common equity to tangible assets ratio reaching 11.2%.

At our financial community briefing last March we discussed a targeted TCE ratio of around 8% and the various alternatives for deploying excess capital.

With the addition of our recently announced share repurchase program we now have a more complete set of tools available to effectively manage excess capital for the benefit of our shareholders.

Overall, we remain pleased with sales volume growth, credit performance trends and our capital levels, and we expect the first two factors to help drive card loan growth in the second half of this year.

That concludes my remarks.

So at this point I will turn the call back to the operator to provide instructions for the Q&A period.

We will now begin the question and answer session.

(Operator Instructions).

Sanjay Sakhrani, KBW.

Two questions.

One was I thought the credit card receivables growth was particularly encouraging this quarter.

Should we assume that we are past the inflection point now and growth should persist through the second half?

And maybe you could just talk about, David, the distribution of that growth, how much of it came from existing customers versus new accounts.

Then second question is -- is it fair to assume that most of the look back on the repricing related to the CARD Act is now behind us?

Thank you.

Well, yes, we were pleased with the sequential receivables growth.

And, yes, we believe that suggests that we are still on track for getting to year-over-year growth in the second half.

We have certainly increased our new account acquisition, our marketing spend, put in place programs, and we have some of the things that have been working for a while now, like increased acceptance, that are continuing to help grow, not only sales, but now receivables.

In terms of the CARD Act and in terms of the look back specifically I would say that we had just a very modest impact in the current quarter, and going forward that impact would be de minimis.

Ryan Nash, Goldman Sachs.

Just a couple of quick questions.

So you saw 9% year-over-year spending growth.

I think that was a little higher than I had expected.

Can you talk about what some of the key drivers of that were?

I know, you, David, mentioned a little bit in the prepared remarks.

Was it really new customer acquisition, existing customer spending more?

Was it anything else outside that like higher gas prices?

Well, I think that the higher gas prices probably drive 2% to 3% of that, if you assume no substitution, and there probably is some.

We don't know how much.

But that really was in place of last quarter when we were up 6% year-over-year.

If you look at the sequential acceleration, I would say the accelerated new account growth is probably the biggest single factor.

But the underlying trends are the acceptance, the marketing, the branding is all continuing to work very nicely for us.

Just one other question on credit.

Losses came in roughly at 5%.

I am assuming we saw sequential improvement in each of the months.

So from what you are seeing in the portfolio can we move much lower?

Are we starting to bottom out?

How sustainable are we at these levels in terms of risk-adjusted returns at this point in the cycle?

Well, I would say that we have not bottomed out yet.

If you look at the reduction in delinquency rates, as I mentioned in my prepared remarks, it will go lower from here.

How much lower we don't know.

We don't know exactly when or at what level it will bottom out.

But we certainly didn't see too many trends of it bottoming out if you look at the last quarter -- this last quarter's improvement.

Craig Maurer, CLSA.

Two questions.

First, could you discuss spending growth, if you can, on a same-store sales basis?

So I am trying to figure out, excluding the addition of new merchants, what you saw in terms of spend volume growth.

Secondly, how do you see Capital One's acquisition -- or proposed acquisition of ING Direct and the asset generation capability or skills they might bring to that bank as threatening your own Direct Banks?

Thanks.

Well, I don't think I can give you much on same-store sales.

I would just say that we are -- we believe we are growing marketshare, and it is coming from a combination of new merchants, growth of existing merchants.

And it is also a combination of new customers and growth in existing customers.

So all four of those factors are improving.

In terms of ING Direct, we love Direct Banking.

I think I just see this as a validation that we are not the only ones who see value in Direct Banking.

To me, Direct Banking is the future of banking.

I think we are particularly well-positioned because we are much more of a pure Direct Bank without the legacy branches and all that comes with it.

Mike Taiano, Sandler O'Neill.

I just had a couple questions.

I guess the first on capital.

Obviously, you guys announced the $1 billion share buyback, but I guess if you just roll forward the model towards the end of 2012, and unless your loan growth is going to be a lot faster then you have suggested or if you're going to do a big acquisition, it seems like your TCE could end up north of 12%, even with the share buyback.

I am just curious maybe, Mark, you can help us understand at what point would you also maybe reconsider about potentially upping that?

And how do you think about it from the standpoint of SIFI buffers and having some dry powder for acquisitions?

Sure, Mike, I would be happy to.

I guess regarding the SIFI, I would start there.

We obviously don't have any clear guidance on the SIFI topic at this point in time.

We've got a lot of speculation and hearsay out there.

We are hopeful that the regulators will take into account the relative size and complexity differences between ourselves and the majority of the other institutions in the over $50 billion bucket.

What I can say definitively is that the current capital plan that we've got was developed with full transparency with our regulators.

And the same regulators provided us with a notice of non-objection to that plan, so we were very, very comfortable moving forward on that basis.

Regarding the size and timing of the program itself, we took into account a couple of different factors, I guess, as we were looking at it.

I would list our current capital position, our ability to continue to generate excess capital, and the current understanding and the likely direction of that evolving regulatory landscape we just talked about.

We sized the program at about 8% of our current market cap.

If you compare that to pure bank programs it is within the range, but it is at the high end of the range.

I don't have the numbers in front of me, but I think the range was like 2.5% to 8.5% roughly a market cap is what we have seen folks do.

So we felt comfortable that from a signaling perspective to the market that was the right place to be.

I would tell you we will continuously monitor the market conditions as well as all those factors I noted we evaluated when we established the program.

If needed, we can have discussions with our Board and our regulators about adjusting the program upward if we see that as necessary.

Great.

Then just a follow-up on what the competitive environment looks like.

I think, particularly, Chase has gotten very aggressive in terms of cash back reward programs of late.

I'm just curious, given the widening out of risk-adjusted margins in the business with credit improving so rapidly, how do you think about where pricing is likely to head over the next six to twelve months?

Do you think you could get back to some irrational pricing, or do you think given the consolidation in the industry that the guys that are there are likely to stay fairly rational at this point?

Well, I do expect rational competition.

As you say, it is consolidated and I think the people who are left are fairly rational and profit driven, just as we are.

We certainly have seen competition be restored and marketing be restored in the industry, but interestingly, our attrition rates remain low, in fact, near historic lows, so really have not seen an uptick in our attrition.

In new accounts we have picked up our marketing, but we are seeing good response rates anyway.

And then you are seeing in our results sales and receivables showing good, solid gains despite the higher level of competition.

So overall my read on a macro basis is that both supply and demand have recovered at about the same rate, with consumers being more receptive and with more being available from competition.

Betsy Graseck, Morgan Stanley.

Two questions, one on the account growth.

Can you give us a sense of the composition, how much of that was BTs?

And are you seeing the same type of response rate as you were precrisis, or has there been an improvement beyond what you are experiencing before?

Well, without giving specifics, I would say we have been pleased both with our response rates holding up, and maybe even improving a little bit, even as we ramp up mailings and Internet marketing and so on, which is a great sign.

I have also been pleased with the activation, usage and come in particular sales usage of these new accounts.

So we have been very focused on -- sometimes you get an account that only does a balance transfer, but we have been very focused on using that as a tool, but ultimately getting customers who spend and earn their cash back bonus and contribute to the sales gain.

Those metrics all look very good.

So I would think that, given Internet usage as well, that maybe your cost to acquire is flat to potentially down.

Are you reinvesting in the customer service end to get the usage rate up?

Is that the right way of thinking about how the businesses are being run right now relative to maybe what it was precrisis?

I would think more about the improvement in credit giving the ability, and credit returning to more normal levels quickly is giving us some flexibility to increase more in both activation of current customers as well as more acquisition of new customers.

We have taken steps.

You saw, for instance, the cash back bonus line was up quite a bit this quarter.

That is partly because we have marketed it more.

We are seeing customers engage in it more.

We are having less breakage.

We have more spending at the higher tier because the spend per account is higher.

So I think we are looking across the portfolio of marketing investments and getting some nice gains both from current and new customers.

Okay, thanks.

Then the second question was on Durbin impact.

David, you mentioned a little bit about what the opportunity is to the degree we go with nonexclusive.

Could you give us a sense as to how much extra capacity you think you have in your PULSE Network?

Could you talk about how quickly you think you could start new relationships up in the event that the legislation went that way?

Then, lastly, could you talk a little bit more holistically about what you think the Durbin impact is as we head into the third quarter for the various components of your income statement?

Well, I think there is a lot we don't know right now.

Hopefully, we will learn a bit more next Wednesday when the Fed comes out with their guidance.

And one of the important factors is not just what is the guidance, but what is the timing.

I would say we have -- our PULSE Network is highly scalable.

We have taken actions to build capacity in advance of potential demand because we were afraid we might not have time to ramp it up as quickly.

And if we need to add even more capacity, we will add even more.

But we are positioned so that even if it was substantial that we would be able to, we think, accommodate a lot of that substantial volume increase, should it be needed.

Are you're talking about multiples of what you're doing today or --?

I wouldn't want to speculate on exact amount, but it could be substantial for us.

But we don't know how quickly, and we don't know if it will really occur or not.

We need to see the final rules.

And there is going to be a lot of competitive dynamics at play out probably over the next year or two.

Sure.

Then is there anything that would lead you -- add to the debit offerings that you have to date, including more in the way of signature based on how Durbin comes out?

Well, today we are the -- only the third -- there are only three signature debit products out there in the world; we have the third, but it is tiny in terms of percentage.

So we would certainly remain poised if that should be needed as well.

Certainly most of industry observers are thinking more that it is going to be one signature, one PIN sufficient.

But should that not be the case, we would certainly -- we've got some maybe unique options that we would need to look at to help fulfill our customer needs.

So you've got flexibility either way it goes?

Yes.

In the interest of time, please limit yourself to one question and one follow-up question.

Brian Foran, Nomura.

I guess, do you think delinquencies can keep diverging from unemployment?

And if delinquencies are at a 25-year low should we expect losses to be at a 25-year low by the end of this year?

Well, I would say that certainly losses should continue to fall.

Delinquencies are not as good of a predictor of bankruptcies, and I don't think -- bankruptcy filings are not anywhere near a 25-year low in the economy.

So that is maybe a factor that could hold things up a bit.

As we have talked about on earlier calls, we do think that the new job loss right now is probably having more of an impact, because we have increasingly already recognized the losses from the longtime unemployed and from the people that are significantly underwater on their houses, so we think that is why it is diverging.

If you look at our current delinquencies relative to new job losses, it is not as far off the curve as if you look at the overall unemployment rate, which reflects a lot of people that had been unemployed for quite a long time.

I apologize if I missed this, but did you give us a core expense number for the quarter?

I know -- I guess you didn't want to break out some of the individual items, but what kind of run rate should we think about going forward?

I think if you look at the run rates going forward I would guide you to our financial summary, and I would point out a couple of different points.

The employee comp and benefits line, that $230 million we are showing there for the quarter is probably a reasonable range proximity for what you should be looking at going forward.

The additions from the primary quarter were really due to growth initiatives, and the impact of SLC where we had only two or three months in the prior quarter.

Marketing and business development at $124 million for the quarter.

I would guide you back to the previous two quarters and say going forward I would be looking at something slightly higher, more in the range of those prior two quarters.

Everything else I would say is pretty accurate for modeling purposes in terms of what you should be looking at.

Bill Carcache, Macquarie.

I have first a big picture question for David.

David, can you share your thoughts on the prepaid opportunity in the industry, and whether you see that in any way serving as a growth driver for Discover in the future?

And then a second question on student loan balances.

Are you still targeting $1 billion net receivables growth in 2011?

And can you clarify what the growth outlook is both with and without PCI loans?

And, also, is the rate at which the PCI loans decrease this quarter a reasonable proxy for how quickly they will run off going forward?

Thanks.

I am not sure I can remember all those questions.

In terms of the first one -- and, Mark, maybe you could --.

The prepaid is already -- is a nice network opportunity, particularly in PULSE, but also a growing amount of Discover Network third-party volume is actually prepaid.

And we work with a number of the market leaders in the prepaid space.

So that is contributing, for instance, to our 25% year-over-year PULSE growth in particular.

Then we also issue some prepaid cards.

Some of our rewards are delivered through them.

And in the future we are going to continue to find profitable cards of the prepaid space.

We don't think everything will necessarily be profitable in that space.

But we do think that it is clearly a growing market opportunity and one that we will participate in in a growing way over time.

With respect to the student loan growth, yes, I think we are still comfortable with the plus or minus $1 billion number for the year.

And I think the other question was related to PCI loans this quarter and what is going on there.

Is that $1 billion with and without -- that $1 billion, does that include PCI loans when we look at the growth in 2011 or is that without?

Bill, maybe it is best if we clarify that --.

That's fine.

That is fine.

Then the last part of that was whether the rate at which the PCI loans decreased this quarter if you view that as a reasonable proxy for how quickly they will run off going forward.

I would say the overall expected cash flows from the PCI loans increased very modestly.

So they're performing pretty much right in line with our expectations for the impact on yield and amortizations and materials, so it is probably a pretty good assessment.

John Stilmar, SunTrust.

This is Jason Freuchtel stepping in for John Stilmar.

We have seen in the monthly trust data elevated dollar recoveries recently.

How should we think about longevity of recoveries helping loss improvement?

Do you think there is going to be a near-term inflection point or is this a longer-term phenomenon?

I would say that right now we have an awful lot of inventory because of the last three years' elevated charge-offs.

Also, as some people have gotten back to work and have an ability to repay some of their loans that has been helpful.

I wouldn't expect any major movements necessarily one way or another.

Over time I would expect it to eventually start to diminish as we work through some of that inventory.

And, obviously, we are producing fewer charge-offs today at 5% to recover against in future periods.

Mark DeVries, Barclays.

With your reserves currently a little over 5% and 2Q charge-offs at 4.42% and, as you indicated, still trending lower, and basically your reserves at -- above what would be the implied run rate for the next 12 months charge-offs -- with that as a backdrop, could you just help us think about how you understand what the appropriate level of reserves are at this point?

I would say we are very comfortable with the current level of our reserve profile.

Obviously, we have entered unchartered territory here in terms of credit performances as I think we have indicated a few times on the call.

And we continue to watch those developments intently.

But I would say from our perspective the reserving methodology is pretty heavily prescribed by the SEC.

We are making sure we follow that to the letter of the law.

So we feel comfortable with the reserves given where we say right now.

Is it reasonable to assume though if charge-offs continue to trend lower we will see more reserve releases?

Absolutely, yes.

No question about it.

Jason Arnold, RBC Capital Markets.

Congratulations on the great results this quarter.

It was also great to hear about adding to wallet share in new cardmembers.

I am just curious if you could talk about marketing and rewards expenses going forward in a little bit more detail, just given that there seem to be more opportunities to gain traction with consumers and potentially gain marketshare.

Do you expect this to lead to somewhat higher expenses here that you have talked about in the past?

Well, certainly, our cash back bonus and rewards line is significantly higher now than it was a year ago.

Some of that is because of the higher sales itself, but even the rate relative to the sales is elevated.

And I do expect that to continue.

The higher-level of engagement, marketing, some of the factors I went through earlier, we do expect to continue.

I don't expect it to keep rising at the rate that you have seen it -- an acceleration like you have seen in the last year.

But I think we have had a little bit of a step function up to a new higher run rate as we have enhanced our program and are getting great customer response.

And with respect to the marketing expense overall I would say that, again, this quarter's number is probably a little bit light for what I would be expecting going forward.

I would point you back to the last two quarters previous to this one, and something in that range is really what you should be looking for from us going forward.

Okay, so it sounds pretty consistent with what you have talked about in the past, you have spend a little bit more to make a little bit more.

Is that a fair assessment?

That's right.

Our marketing expense will vary quarter-to-quarter.

So for instance, our first-quarter we had some of our larger sponsorships with college football, Orange Bowl, hockey this past quarter.

So it can be a bit up-and-down.

And this was a little bit down even though the sales results are high.

That partly reflects what we have spent last quarter.

Don Fandetti, Citigroup.

David, obviously, some of the economic data we have seen over the last month or two signaled some moderation.

I was curious if you have seen that in your spend trends, if you strip out your marketshare gain going into June.

Well, it is -- I really can't strip out the marketshare gains, because competitors report after us.

And we do feel we are making marketshare gains, if I look at retailer sales.

But what I would say is I have looked very closely at the last couple of weeks to see if we have seen any moderation as we started to see some of those lower confidence numbers in others.

The good news is I am not seeing it in my numbers at this point.

Our sales gains year-over-year are continuing to hold.

Do you attribute that to anything or is it more a lag issue?

When customers use their card it posts within days, so I don't think we would have -- expect any lag issue unless there is -- you know, customers haven't reacted yet.

I would certainly like to think we continue to have momentum.

And that I am just really pleased with our marketing efforts and how our customers are responding.

Rick Shane, JPMorgan.

Thanks for taking my questions.

I just wanted to delve a little bit more into promotional balances.

At Investor Day you talked about migrating from a Q1 level of about 12% ultimately to a normalized level of about 15%.

Mark mentioned balances were up -- promotional balances were up.

I was just curious, how far along you are from that 12% to 15% migration?

How quickly you think you'll hit that target?

And then, finally, given what is going on competitively, is there any reason to think that target rate may move up or down, that 15% long-term target?

I would say it could move up or down, but right now I think that is still a pretty good number.

We are not at 15% yet, but we do expect it to modestly move higher as we -- when we put on new accounts, for instance, you tend to have a higher percentage of promotional balances.

So as that mix of new accounts grows, you would expect it to normalize more to that order of magnitude 15% range.

Again, is that a pretty quick migration given what is going on competitively?

Is that something you think you will see that target rate in the next couple of quarters?

I would say just looking at the numbers more specifically, right now, that number is sitting at about 12%, give or take -- 11%, 12%, in that range.

So we've got some room to grow to get to that 15% some level.

We kind of look at BTs as a very cost effective way to generate new receivables and increase our engagement and our relationship with our customers.

So we're pretty comfortable with them in that range, and I would say that the ultimate level you are looking at probably isn't a bad place to be settling in.

David Hochstim, Buckingham Research.

Just following up on those questions, the spending of your existing customers or older customers, are you seeing any mix change in the quarter or since the quarter in terms of canceling or discretionary purchases does it sound like?

No, I think the gasoline impact was about the same this quarter as it was last quarter.

We continue to see larger gains with more creditworthy individuals.

And we are continuing to see transactors increase sales faster than revolvers.

But as you can see from our growing revolving balances, that we are now seeing those gains be really across the board, and that is why you are seeing us return to receivables growth.

There was a question earlier about look back with the CARD Act.

But when you're issuing 18 month 0% teasers, how do you avoid having some effect on existing accounts from that?

I'm not sure I understand the question.

The CARD Act look back doesn't have anything to do with new promotional balances being put on.

Rather it had to do with looking back on repricing that took place in past periods to see if we are able to cure people to lower rates.

Aren't you obligated to compare rates on new accounts to existing accounts prospectively?

No.

So it is really just the repricing after the rule change and that is it?

If I understand you correctly, yes.

That is correct.

We continue to be allowed to price the way we feel is appropriate.

We just have significant restrictions on being able to change those rates for new accounts after the accounts are booked.

Brad Ball, Evercore.

Another follow-up on the promo balances.

Did you say what portion of the growth in the quarter were promotional balance driven?

We didn't, but I think if you look at our yield you have to conclude that it wasn't -- that we saw growth -- we didn't just see growth in promo balances, we saw growth in full rate balances as well.

Right.

What was it -- 8 basis point decline in the yield you are saying was not entirely driven by new promo balances?

Not at all.

If you decompress that a little bit, I guess a couple of different things.

On the CARD Act side you have the runoff of the default in the cash balances.

And then you also have the increased use of the promotional balances.

I would say the CARD Act piece of that was disproportionately larger.

Chris Brendler, Stifel Nicolaus.

I also want to talk about promo for a second.

If I recall correctly, you made a change couple of years ago where you amortized balance transfer fees into interest income now.

Is that helping support the yield, given your pick up in balance transfer activity or are those amortized over so long a period it wouldn't have an effect on a quarter-to-quarter basis?

I would say that is the accounting methodology we follow, and the impact is relatively immaterial.

Then just more broadly on the same topic of the yield, I think the other part of that slide I thought was interesting at Investor Day was the default rate balances and how high they continue to be despite how strong the credit trends have been.

Have those started to tick down at all yet or are we still looking at some potential card yield compression over the next year or so as that follows to a more normal level?

I would say we have seen some modest production there, but not dramatic reduction there.

In the near term I would expect some relative stability in the margin, because the CARD Act impact the increased use of promos are being heavily offset by the lower levels of charge-offs, as well as improvements in our cost of funds.

Over a longer-term horizon clearly there will be impacts from those.

And I would point you back to our Investor Day discussion for March in terms of longer-term expectations for margin.

(Operator Instructions).

Bob Napoli, Piper Jaffray.

David, I was hoping you could give us an update on your thoughts -- on your movements on your mobile strategy with Isis being more open.

Are you still -- how closely are you still working with Isis, and where do you think -- there is obviously announcements every day with Visa and American Express coming out with -- as well as MasterCard.

Where do you stand and in what direction do you think this all goes from here?

Well, I remain bullish on the potential for mobile payments.

We continue to be very active, not only with Isis, but also with many other efforts throughout the industry.

I think, importantly, we continue to expand mobile-enabled terminal deployment throughout the country.

And our Zip has very broad representation in terms of acceptance on terminals.

We also have passed the 0.5 million account mark in terms of cards that have Zip, and we have really focused our efforts on some of the early adopters and people who have requested cards.

So we continue to make progress on a lot of fronts with it.

But I think sitting here today it is going to be tough to pick necessarily the winners and losers.

But I am convinced that it will gradually gain traction and be important for us and our customers.

We have no further questions at this time.

I will now turn it back to you, Mr.

Streem, for closing remarks.

Thanks, John.

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

Of course, please feel free to get back to us with any follow-ups.

Have a good day.

Thank you.

Thank you, ladies and gentlemen.

This concludes today's conference.

Thank you for participating.

You may now disconnect.