發現金融 (DFS) 2011 Q4 法說會逐字稿

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

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

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

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

Please note today's conference is being recorded.

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

You may begin.

Thank you, Christine.

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

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 third-quarter 2011, all of which are on file with the SEC.

In the fourth-quarter 2011 earnings release and 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, of course, we urge you to review that information in conjunction with today's conversation.

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 then, as always, a question-and-answer session.

I would encourage you that during the Q&A period it would be helpful if you limit yourself to one question and one related follow-up.

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

Good morning, everyone, and thanks for joining us.

Earlier today we reported fourth-quarter net income of $513 million or $0.95 per share, driven by continued improvements in credit and receivables growth in all products.

Our strong results and positive outlook for Discover led us to announce a 67% increase in our dividend and to continue to execute on our share repurchase program.

This morning I'm going to start off by discussing our fourth quarter and then walk you through some of the highlights of our full-year results.

First, regarding the fourth quarter, Discover Card sales volume grew 8% compared to the prior year.

The strong sales performance continues to include higher spending from the revolver segment of our portfolio, helping us to grow card receivables to $47 billion.

Our continued success in growing sales and receivables reflects greater effectiveness in marketing programs, cash rewards leadership and expanded merchant acceptance, all of which contribute to increases in profitable growth.

One example of this is our recently announced program with Amazon.com in which Discover Card members can pay directly with Cashback Bonus at the site, as well as earn double rewards on their purchases until the end of the year.

Since we launched the program in October, we have seen a significant increase in cardmember purchases at Amazon.

Another highlight this quarter is the continued improvement in card credits as our 30 plus day delinquency rate set another all-time record low at 2.39%.

In addition, the card net charge-off rate dropped to 3.24%.

I'm very proud of these strong results, which were due in large part to our efforts in credit risk management, collections and marketing.

In our other lending product portfolios, which include personal and private student loans, we grew loans to $10 billion with the acquisition of approximately $2.5 billion in additional private student loans from Citi.

Our ongoing expansion outside of card continues to drive earnings growth with attractive yields and strong credit performance.

Our Payment Services segment experienced total volume growth of 7% for the quarter versus the prior year.

All segments -- PULSE, Diners Club and third-party issuing -- delivered good volume growth year over year this quarter.

As it relates to PULSE'S strategy to win new PIN debit volume post-Durbin, we are responding to numerous RFPs and should have more to report in this regard next quarter.

Our fourth-quarter performance provided a strong finish to 2011 with all-time record net income of $2.2 billion for the full year.

These results were primarily driven by improved credit costs and profitable loan growth in our Direct Banking segment and 18% higher Payment Services profits for the year.

On our three payment networks, we achieved record volume of over $280 billion.

Additionally return-on-equity for the year was 30%, considerably higher than our 15% long-term target.

Let me now share some thoughts on how we performed against our priorities for 2011.

Our first priority was to return to card growth by gaining wallet share and generating new accounts.

We returned to year-over-year card growth in June and ended the year up 3% from last year.

Closely tied to our receivables growth priority was our objective to expand merchant acceptance and marketing partnerships to drive Discover Card sales.

Many milestones were achieved along the way to accomplish this priority, including a record number of card members using us as their primary card, a 10-year low level of attrition, record levels of engagement in our rewards programs, and record levels of active merchants.

I am very pleased that these accomplishments helped drive us to a record Discover Card sales volume in excess of $100 billion for 2011.

We had two principal priorities for our other lending products -- to integrate the Student Loan Corporation and to continue generating strong returns in private student and personal loans.

We have completed the organizational integration of the Student Loan Corporation and are on track to deliver the remaining technology and operations migration.

In addition to the two accretive acquisitions, we delivered significant profitable organic growth in private student loans and in personal loans.

Staying within Direct Banking, our next priority was to leverage the retail deposit channel to provide liquidity and optimize funding costs.

We grew Direct to Consumer deposits by 27% over the course of the year, while reducing our cost of funds and broadening relationships with our customers.

Lastly, we had two priorities for our Payments business.

The first was to capture opportunities in the changing debit market, which remains in process, and the other priority was to leverage our strategic partnerships as we continue to build out our global network.

For example, our inbound volume from JCB cardholders grew 15% to over 700 million, despite the catastrophic events earlier this year in Japan.

We also recently announced an inquiring agreement with WorldPay that will significantly increase our acceptance in the UK and Western Europe.

Here in the US we made some great progress on increasing acceptance and growing volume.

For instance, PULSE full-year debit volume grew 19% year over year.

To wrap up, we delivered exceptional results for the year, despite a relatively challenging economic environment.

Our strong results have positioned us to return excess capital to our shareholders by increasing our dividend 67% and reducing our share count by 3% through our share repurchase program during the last two quarters.

As we enter 2012, I am looking forward to capitalizing on growth opportunities such as building out our Direct Banking platform, continuing to drive profitable growth in receivables, and winning new business in PIN debit.

We look forward to providing you with an up-to-date on our 2012 growth strategies at our financial community briefing in March.

Now I'll turn the call over to Mark.

Thank you, David, and good morning, everyone.

I'll begin my comments by focusing on our Direct Banking segment's fourth-quarter results.

The segment earned $776 million pretax this quarter versus $554 million last year.

Reserve releases contributed only $68 million to pretax earnings in this quarter versus $414 million in last year's fourth quarter as we saw a slowdown in the rate of credit improvement.

Turning to interest yield on the card portfolio, we reported a 32 basis point decrease from the prior year to 12.36%.

The principal components of the decrease are the same as I've mentioned during prior quarters.

First, the CARD Act impact on higher price default balances; second, an increase in promotional volumes; and finally, an increase in the number of customers who pay their balances in full.

These were partially offset by lower interest charge-offs.

Total portfolio yield declined 68 basis points from the prior year.

This resulted from the card yield compression that I just mentioned and the private student loan acquisitions in the first and fourth quarters of the year.

These acquisitions have the effect of reducing overall portfolio yield; however, it's important to note that we also expect student loans to produce much lower average credit losses than the card product.

Net interest income increased $136 million or 12% versus the prior year, driven by asset growth, lower charge-offs of accrued interest, and the benefit of lower funding costs.

On a net interest margin basis, we had 18 basis points of compression from the prior year and 16 basis points from the prior quarter.

This was due to the yield compression I noted a moment ago, partially offset by lower funding costs.

If you remove the effect of the additional student loans we acquired in the quarter, net interest margin would actually have been up 2 basis points sequentially.

The lower funding costs reflect the benefit from the rolloff of higher-priced time deposits.

We expect to continue to benefit from this funding cost tailwind through 2012 as we replace these existing deposits with lower-cost borrowings through our three main funding channels and as we continue to benefit from the Fed's current monetary policy.

The combination of these yield and funding cost trends should drive NIM down slightly from where it is now at 9.1% to around 9% next year.

Other income was $66 million higher than in the prior year period.

You may recall that we recognized a $28 million charge to other income in the fourth quarter of 2010 when we classified our remaining federal student portfolio as held for sale.

The growth in other income was also driven by higher discount at interchange revenue, which was partially offset by higher rewards expenses.

Our rewards expense dropped to 86 basis points for the quarter.

However, going forward we expect this number to be somewhat higher as we continue to refine our rewards program in the ordinary course of business.

Other expenses for the segment grew by $44 million or 7% over the prior year.

$18 million of the increase comes from expenses related to the purchase of the Student Loan Corporation.

The remaining $26 million increase from the prior year consists primarily of higher employee compensation for technology infrastructure improvements, enhancements for our credit and collection processes, and higher call-center staffing.

Before I turn to Payment Services, let me comment briefly on loan growth and credit performance for our other consumer lending products.

Receivables in our personal loan product were up $770 million from the prior year.

Loans greater than 30 days past due increased 2 basis points from the prior quarter to 87 basis points.

Personal loans net principal charge-off rate decreased by 15 basis points to 2.58%.

The improvement can be attributed to portfolio growth and risk initiatives.

We continue to focus on thoughtful measured growth in this asset class by leveraging our established underwriting competencies.

Private student loans grew $6.3 billion compared to the prior year with approximately $3 billion of the growth coming from the acquisition of the Student Loan Corporation in the first quarter and an additional $2.4 billion from the purchase of private student loans from Citi at the end of September.

You may remember from the initial announcement the face value of these loans was $2.5 billion.

However, since we bought the portfolio at a discount, the loans came on our books at $2.4 billion.

Credit losses on these loans will not flow through the P&L as the accretable yield includes expected future credit losses.

Reserves against these loans will only be booked if expected credit losses increase after the acquisition date.

In addition to the acquisitions, we achieved organic growth of approximately $1 billion in net receivables for the year.

Our 30 plus day delinquency rate for private student loans dropped 17 basis points sequentially to 63 basis points, excluding the purchase credit impaired loans.

The charge-off rate, again excluding PCI loans, was also down 17 basis points as it decreased to 45 basis points.

The decrease in both of these metrics is typical with the seasonality in this product.

Having launched the product offering in 2007, we will see an increasing level of loans entering repayment as students graduate.

Of course, we will start to experience some degree of credit losses that will eventually increase these rates toward our targeted levels.

This phenomenon has contributed to the increase in our reserve rate.

Turning to the Payment Services segment, we increased pretax profit by 35% year over year to $42 million.

Revenues increased faster than volume growth, reflecting a bit of a mix shift toward higher-margin volume at PULSE.

Expenses were down 8% compared to the prior year, primarily due to the timing of some marketing programs.

Before I discuss capital, I want to touch on liquidity and funding.

As expected, our investment portfolio ended the quarter at $8.5 billion, down from $9.4 billion at the end of the prior quarter as we utilized liquidity built up during the third quarter to fund the recent private student loan acquisition.

The size of our liquidity investment portfolio from here will be a function of receivables growth, upcoming funding maturities and seasonal needs.

Our total liquidity ended the quarter at $26.2 billion or roughly flat to the third quarter.

This includes cash, liquid investments, conduit capacity, our bank credit facility and capacity at the Fed discount window.

Our total liquidity has grown by $3.5 billion over the past year.

As a result of this enhanced liquidity position, as well as our having obtained a number of new conduit facilities, we've made the decision to terminate our existing $2.4 billion syndicated credit facility.

Excluding this, our contingent liquidity position would have been $23.8 billion.

Moving on to funding, direct-to-consumer deposits continue to be our largest source of funding at 45%.

While we expect them to remain our largest funding channel going forward, we will continue to opportunistically access our other funding channels, which include broker deposits and the ABS market.

Before the end of the quarter, we closed a $400 million floating-rate five-year ABS transaction priced at one-month LIBOR plus 35 basis points.

The pricing for this transaction was 23 basis points better than our last five-year ABS issuance just over one year ago.

Next, I want to touch on our strong capital position.

Our tangible common equity to tangible assets ratio decreased in the quarter to 11.4%, which is still one of the highest ratios among large financial institutions.

The ratio decreased slightly from last quarter for all the right reasons as we deployed capital by closing on the additional private student loan acquisition, declared our regular quarterly dividend and repurchased $227 million of our shares.

There is roughly $575 million of capacity remaining under our current share repurchase authorization.

Regarding the 2012 capital planning process with the Fed, like everyone else, we just received around Thanksgiving the guidelines.

We are currently preparing the required submission and will provide you with an update on our capital plans next March.

In summary, I'm very pleased with our financial performance for 2011 as we were able to deliver outstanding credit performance and strong receivables growth and also able to responsibly deploy our capital through increased dividends, share repurchases into accretive acquisitions.

That concludes my comments.

So, at this time, I'll turn the call back to the operator to provide instructions for the Q&A period.

(Operator Instructions).

Sanjay Sakhrani, KBW.

I have two kind of unrelated questions, sorry.

But, just the first one I was wondering if you could just talk about your reserve methodology?

Because when I look at the reserve rate, excluding PCI loans to charge-offs, that ratio kind of expanded in this last quarter versus the previous quarter.

And it seems like your credit metrics are pretty solid and are trending pretty solidly through November.

So I was just wondering what the rationale there was.

And then just secondarily, on capital, Mark, you just kind of touched on it a little bit, but I was just wondering what the game plan is in terms of next year and you guys asking for permission in the context of this trust case?

Should we expect kind of similar type of action next year as you guys have done at least on a quarterly basis this year?

Thank you.

I guess, with respect to the first question on the reserving methodology, it's really just mathematics driving that reserve coverage ratio.

We reserve based on a forward 12-month rolling loss estimate basis.

So, as our models show any forecasted turns in that, the reserving responds accordingly.

As I've said on the call before and as I've told you before, I wish we had more judgment in how we set reserves.

We don't have that flexibility, so it is pretty much an arithmetic process with GAAP being very prescriptive.

With respect to the capital side of the equation, obviously I am limited in what I can say there.

I guess the best way I can answer your question is to say, well, we have never really formally disclosed our thoughts on a payout ratio.

If you look at what it's been historically, we think we have some room to increase it from where it's been.

Okay.

Thank you.

John Stilmar, SunTrust.

Good morning, gentlemen.

Very quickly to dovetail onto Sanjay's question, should we think about when you're talking about return of capital, is it relative to a payout ratio, or is it relative to an absolute level of capital that you're kind of targeting in the relative near-term?

I'm just wondering what kind of the bogey is that you're using as a target without obviously getting into the specifics that you can't reveal.

I would say from that perspective it's -- let's call it a multi-varied equation.

We clearly have telegraphed.

We think we are in a somewhat target-rich environment right now, and given our demonstrated ability to earn through some of that excess capital, holding onto some of it right now while we look across the spectrum makes sense to us as long as we can keep burning through it.

That said, we also recognize we are accreting capital at a pretty significant rate, so I would say that my earlier comments about our belief that we can increase the payout ratio relative to historical norms is probably the best guidance I can give you in that regard.

We do tend to think about things in terms of a payout ratio internally, but again we don't tend to disclose that number publicly.

Perfect.

And then the second question has to do, David, I think a more theoretical concept is we are starting to see momentum certainly building in mobile payments with Google Wallet and some of the shifting plates there.

I'm wondering, other than your relationship with Isis, which we've obviously discussed in prior quarters, what should we start to expect from Discover in terms of this rapidly developing landscape of mobile wallets, mobile payments, and sort of the changing landscape, and how is Discover set up to capitalize on it, and what should we be looking for as evidence of that in the coming quarters or years?

Thank you.

Obviously we were the first player involved with Isis, but we had said at the time that we intend to be part of multiple efforts and, in fact, have already been announced to be part of Google, as another example as well, and we are continuing to aggressively pursue many opportunities.

We've issued a good number of ZIP cards to our customers.

We continue to make sure that we are integrated with the terminals at the merchants as they deploy the wireless terminals.

We're working with multiple handset manufacturers and technology companies, and where possible we are going to try to do some innovative things to really help us gain market share both as a network and as an issuer.

Great.

Thank you.

Craig Maurer, CLSA.

Good morning.

Thanks for taking my questions.

Two quick questions, one on the tax rate.

Mark, where do you see that settling out for '12.

It's bounced around a little bit this past year.

And secondly, to narrow the focus of the previous question, how do you see Verizon moving forward?

Isis has clearly proven disappointing to them as they've had some material setbacks on technology, and clearly they're not exactly launching in big markets.

But they have chosen to play hardball with Google Wallet, clearly the superior product.

So I'm curious as to where you think Verizon comes out on this whole debate.

Is this just a revenue extracting tactic to try to gain advertising revs from Google?

It is Mark.

I will tackle the tax rate, and then I will pass it off to my boss to handle the Verizon and Isis question.

From a modeling perspective, I think we for the fourth quarter had an effective rate of about 37.3% or so.

I would encourage you modeling-wise to kind of maintain that rate through 2012 would be a pretty good estimate at this point.

And in terms of mobile, I wouldn't want to comment on a specific company or effort, but more broadly I would say we are going -- I expect we're going to see a lot of twists and turns in this as new technologies are offered and as we see how consumers and merchants and issuers test things.

Not everything will work, and that's one of the reasons that we are hedging our bets to be involved in a number of efforts so that we are aligned with what ultimately emerge as winners in this.

And I also think there are likely to be more -- there is going to be more than one winner.

Thanks, gentlemen.

Jason Arnold, RBC Capital Markets.

Good morning, guys.

I was just curious if you could give us a little color on the network volume trend this quarter.

It looks like most were down sequentially, so curious if this is more macro-driven or perhaps what other factors are at play here.

Any color you could provide there would be great.

Well, certainly I was pleased with a continuing 8% volume growth on Discover sales, and PULSE, if you look at the full year, we were up 19% as I mentioned on volume year over year, which is one of the strongest in the world of debit.

We do see quarterly movements in this, partly because there are some chunky volumes that can move in or out.

And one of the trends that we saw this year is that there were a number of large issuer deals that kind of were on hold waiting to see what the ultimate Fed rules came out related to Durbin.

And so the second half of this year, there just wasn't a lot of share that shifted hands.

And I think, as I mentioned in the call, we are right now in the middle of a lot of RFPs, and I think that by April 1, when the network routing rules go in place, we will see some more shifts.

And so we don't have more to report on that now.

But, as we have consistently reported, we wouldn't expect to see any volume pickup from that until hopefully if we are successful in the second quarter onward as some of this volume starts to move around in debit.

Okay.

It certainly seems like more opportunity than anything else for you to gain share on the PULSE side.

Can you comment anymore on that, or do you want to save it for next quarter?

I would just say that we have been a leader in the under $10 billion size institutions, and so I think that volume is sort of not particularly at risk.

And I would say also virtually all of our cards have two brands on the cards.

We are typically a PIN debit, and there's almost always someone else's signature on the front.

So we do view it as more opportunity versus risk.

And how much that opportunity is is the thing we are working aggressively to try to pursue right now, and we just can't comment on where we'll end up.

Terrific.

Thank you very much, David.

Chris Brendler, Stifel Nicolaus.

Thanks.

Good morning.

I have two questions.

Let's just follow-up on the PULSE question real quick, if I could.

Can you remind us what's causing the sharp deceleration in PULSE volumes throughout 2011?

I think we are calculating high 20s rates in the first half of the year, and falling down to 8% this past quarter, I just wanted to know is there anything in there.

And on the RFPs that you are proposing for PULSE to be added as a PIN debit network, can you tell us if a lot of the banks are adding or considering adding PULSE as an exclusive on the back of the card, or is it going to be PULSE in addition to an existing network that needs to satisfy exclusivity, if you can give us any color there?

And I also have a credit card question as a follow-up.

Well, on your second question, I think it's too early to say that's one of the things that I think the larger issuers will be determining whether they're going to be adding or replacing PIN debit networks, and we should have more color on that next quarter.

On your first question, we had some very significant growth in the fourth quarter of last year as we had some big wins, and so this quarter we are now a year from that with -- so we've got a much higher comparable, and we're through the annualization of that.

As I said, we didn't have as much opportunity for big wins in the last half of this year as people waited to see what the new rules were going to be.

So that's the reason for the change during the year.

But, again, I point back to the big picture, which is for the year we are up to 19%.

(multiple speakers).

It's well above that market growth rate.

Very solid, indeed.

And then my second kind of question would be on the credit card side, just to comment on competition for lending volumes and what you're seeing as you market to consumers.

I notice marketing ticked down at least on a year-over-year basis this quarter; your cash advances levels fell a little bit amid a little bit of reduced teaser activity.

And the average loans for the quarter in the credit card business are actually below the last two debit points third quarter and fourth quarter ending period, if you could just give me a little help there on what caused that, thanks a lot.

I think I was pleased with our lending volume.

At our investor day, we had been targeting 2% to 4% long-term organic growth as our target.

And this quarter we moved up from ending receivables growth year over year from 2% last quarter to 3% this quarter.

So we are right in the middle of that range, and we are one of the very few credit card companies that is showing organic growth combined with great credit quality.

And I think in terms of competition, as I said on the last call, I do feel like many of our competitors who have cut way back on their marketing have restored a lot of that marketing, and I don't think the marketing intensity is or is likely to go as high as it was before the great downturn and the consolidation in the industry, but I think we're back to the new normal, if you will, in terms of competitive intensity, and our marketing I would say is the same.

We had less of a cutback on marketing, but we had restored that, and you will see some changes from quarter to quarter as we sequence some of our promotional activity.

But generally we are at about the run rate we think we need to generate that 2% to 4% long-term receivable growth that we are striving towards.

Thanks a lot.

Appreciate it.

Ryan Nash, Goldman Sachs.

Thanks.

So just on the NIM, (inaudible) you saw card yields fall 10 basis points, and it looks like the funding declined a little bit more than that.

And now you're telling us credit card marked 9% on the NIM for next year.

So can you just help us understand what is actually going to drive it lower?

I would've thought that given the size of the funding benefit that we could have actually seen some sort of stability in the margins.

So can you maybe help us understand that?

I know you laid out some of the potential puts and takes, but maybe if you could just flesh those out a little further?

I think the biggest delta in what I'm hearing in the question is probably just going to be simply a mix of receivables on the balance sheet and the ultimate effect on NIM as a result of that.

We continue to expect the relative magnitude of the funding advantage that we expect to see over the next couple of years in line with what we had guided to you before, which anybody who hasn't seen those, you can go to our website and get those off our couple most recent investor presentations where we kind of give a sense on CD maturities and rates.

So I think the bigger issue is just going to be some of the stronger growth is likely to come from some of the products other than card.

And that will just simply have an effect of depressing the NIM somewhat.

That said, though, I would reiterate my earlier comment that despite having a lower margin, we expect meaningfully lower credit loss on that product as well as opposed to a card product.

So the profitability metrics are pretty solid.

I would just remind you we are continuing to have some higher rate balances that are amortizing off.

So the CARD Act, as each year goes past, will have less and less impact, but this year you've seen somewhat of an offsetting factors with higher rates rolling off and a benefit of lower funding costs and lower interest charge-offs.

Just one follow-up, if I can.

Just on credit, I think we talked a lot about on last quarter's call that you guys were going to start building reserves at some point in 2012.

Now I understand that it is pretty formulaic, but if you think about the economic factor and we have seen some of the data begin to improve, we see jobless claims down materially today, we have seen a pickup in GDP growth, are you still comfortable with the guidance that we are going to need to build reserves next year, or is there any change in the outlook?

No, I would still be very comfortable with that guidance.

I would say that comment was based not so much on the turn in the credit environment as it was based on growth expectations.

Okay.

Thanks.

Ken Bruce, Bank of America.

My question also relates to the NIM.

I hope I'm hoping you might be able to give us some additional granularity on the quarter over quarter changes, how much was being driven by CARD Act, and how much from promotional balances, and how much from the student loans, please?

We haven't provided that level of detail historically, so can't go there right now.

But I think on the March investor day that's the time of year we typically will talk about the mix and some of those components a little more.

Maybe to just better understand the comment you made in your formal presentation, you had indicated that if you remove the student loan impact, it would -- the asset yields would've been up quarter over quarter, could you give us some clarification around that?

The NIM would've been up quarter over quarter had we removed the student loan acquisition, that's correct.

So, in other words, the way to think about it at a high-level is the impact of the funding costs with respect to the credit card look specifically out-ran the yield compression that we saw.

Thank you very much.

Don Fandetti, Citigroup.

David, as you look into 2012, I was just curious if there's anything you're looking at on a strategic front in terms of bolt-on acquisitions, any areas that you think look interesting, or if you're even looking at any smaller type transactions?

Well, we would continue to look for opportunities, given our capital position, and our desire to build out our direct banking and payment strategies.

But I would also say that we would continue to be very careful on that.

You saw what we did in 2011 with the two student loan acquisitions.

We are looking forward to continuing to build off of that student loan position during this coming year, we are looking forward to closing on during the course of the year and launching our Discover home loan origination area.

So I would not say that any acquisition is even required to continue fulfilling our objective.

But, if the right thing is available at the right price and terms and it fits our strategy, fits our financial model, then, of course, we would be interested.

Quickly on the spend in transaction volumes, where there any -- how did (inaudible) for end of the quarter look, and into December, I mean are things still moderating in terms of year-over-year growth rates?

What I would say is that we are reporting about a week earlier than we did last year, so I don't think we have as much of a view for the full holiday sales.

I think the one general trend I've noticed is continuing good transaction accounts and debit activity on our programs, some moderation in average ticket.

Some of that you would expect with falling gas prices, which I think is a good thing for our customers, but it impacts volume.

But it also could possibly reflect a little more discounting by some of the retailers that could impact average ticket.

So we'll obviously know more as we finish out this season.

It's an important last couple weeks here.

Thanks.

Rick Shane, JPMorgan.

Two quick questions.

One, in terms of you made some comments about marketing and competitive environment.

Can you just tell us specifically where you are in terms of your normalized promotional balances?

Are you now at the 15% level?

I would say we disclosed back in the third quarter that we were at total promotional balances of around 15%.

That includes not just balance transfer activity, but it's all promotional activities, and I would say we haven't seen any significant shifts from that level since we last disclosed it.

Great.

Second question, this is just a little bit further ahead.

You guys are ultimately a pretty large consumer of the Postal Service business.

When you look ahead to the changes in terms of service quality from the US Postal Service going forward, what percentage of your customers are actually mailing their monthly payments as opposed to paying online?

Just so we can get a sense of what the impact might be on the industry going forward?

We are a big customer of the post office.

We've been very pleased with our continuing service, so I'm not particularly concerned about that.

I would say that a lot of it, we are not going to disclose the exact numbers.

But a lot of our business, whether it's for new accounts for payments and other activities, customer self-servicing on the Internet, a lot of it is moving to the Internet.

And just as a general guide, we had a couple years ago we had three payment processing and statement centers, and we've now consolidated down to just one.

And a lot of that is because of the big move that we are seeing to the Internet, and I think that is one of the main reasons that -- main focuses that we have on our future costs position because we think that doing things online can drive an increasing level of efficiency across our organization.

Great.

Thank you.

Bob Napoli, William Blair.

On the -- I'd like to get a little more color on the student loan business and kind of your thought process on the outlook.

I mean I do sense the opportunity there, but also certainly seems to be some concern in the market about that business.

And, as you did talk that the credit losses were awful low right now, going to start to move up to normal levels, what kind of organic growth are you hoping to drive out of that business and over what time frame?

I think people are going to be watching the credit quality on that business, investors pretty closely, maybe you could give some feel for how that's going to -- how we should expect that trend over the next year.

Well, we really like the private student loan business, and I think some of the confusion is over the federal student loans, which are about 95% of the market versus the 5% or so that's private student loans, and you have seen some figures come out, industry figures in the quarter and I think on deteriorating credit quality, but I would just remind you that those are on the federal side.

As Mark mentioned, our statistics have continued to perform per our expectations, which means that we continue to expect much lower loan losses and much better credit quality than the credit cards or the federal student loans.

And I think that we've tried to be very careful in what we do with a lot of co-signatures.

So, to a large degree, we are lending not just to students, but we are involving the parents, which we think significantly helps the credit and makes better decisions.

And we are very focused on ability to pay and being cautious to help make sure that our students don't get in over their heads in terms of the debt that they are taking on.

And so I think in terms of growth, in the investor day, we said that we had hoped to grow organically by about $1 billion this year, and that's about what we hit.

And next year we think we can do a bit more than that, and we will be more specific with some targets during investor day.

And with respect to the implicit question regarding profitability in light of the changing loss profile, I would point you back to last year's investor day metrics as well.

We wouldn't see any reason to give any different guidance on the long-term profitability or the longer-term credit performance of that book.

In fact, on that regard, we said that the student loan acquisition we closed on a year ago, we were looking for a $0.09 earnings accretion, and I'm happy to report that it was right in the $0.09 to $0.10 range of earnings accretion from that.

So it's tracking along well so far.

Thank you.

My follow-up question -- sorry, it's unrelated as well -- on the payment segment, just some thoughts around there, and you talked out a bit about the mobile.

But one area that you have, that Discover has kind of been going against the grain on, if you will, is it's lack of interest in the prepaid market.

I mean certainly Visa, MasterCard, American Express and -- I just wondered why maybe give a little color on -- that is -- I mean it is forecasted to be probably the fastest-growing area of payments over the next decade.

Why is there this lack of interest in that product by Discover?

I actually wouldn't characterize it as lack of interest.

I would say we are a big player on the network side.

In fact, there is a -- we don't disclose the exact numbers, but we have a significant volume, particularly on PULSE, but also on Discover Network from prepaid.

And the largest -- some of the largest prepaid providers in the country operate on our network.

So we may be just a little more quiet about it, but we are certainly pursuing multiple opportunities in that regard.

Thank you.

Moshe Orenbuch, Credit Suisse.

Thanks.

Following up on the previous discussion on competition kind of in your core product, I think you had mentioned that you expected that the cost of rewards to drift upward in the coming year.

Could you talk a little bit about the competitive environment from rewards?

Because I guess there's a lot of people out there offering them.

I think your numbers are pretty good and just talk about what you're seeing there, and I've got a follow-up.

I guess, I would say, as David mentioned earlier, we see the competitive environment as having returned to basically, call it, a normalized level more or less where everybody is once again competing for activity balances and wallet share.

I think we do think the rewards cost in the quarter at 86 basis points was unsustainably low.

We don't think that's the right number to be looking at going forward.

I'm not prepared to give guidance on exactly where I think it will be going forward.

But I guess what I would say is we are disciplined in how we manage that process and will continue to be disciplined.

We would expect the first quarter to be a little bit elevated, and we will monitor the results and kind of see if we need to make any adjustments to the program based upon them.

I guess I was more asking about how you see it stacking up against the competitive offers from other issuers who are offering cash back.

Well, what I would say is that we have been the leader in rewards and cash rewards specifically for 25 years.

We do have a number of competitors who have been copying some of our features and programs, and so we continue to have innovations.

And one of the things that we are very focused on is working with retailers where we have many retailers on our ShopDiscover program that work with us on the 5% program and have more ways to earn and redeem than our competitors, and it's an area that we think we need to continue to be the leaders, and we need to have stability.

There's an awful lot of competitors that have come in and then gone out when they realized that it is expensive and it is specialized, whereas you've seen us stay the course and continue to be the leader recognized by consumers broadly in this area.

My follow-up, you had mentioned that you had wished you had more flexible on the setting of the reserve.

If you had that, what would you be doing differently?

I can't comment on that.

That would really kind of run counter -- I don't blame you for asking.

I don't hold it against you one iota.

That's fine.

Scott Valentin, FBR Capital Markets.

Thanks for taking my question.

Just earlier you referenced you're now moving up to top of wallet, becoming a primary card for more of your cardholders.

Can you give any sense of how that has shifted over time?

Maybe I don't know if we have a range or some measure, but just curious as to how that's changed over time?

Well, what I would say is that it probably accelerated during the downturn, and one of the things that if you look at our sales volume on Discover Card the last three years, our sales did not drop off as much as any of the other competitors.

And now we are growing 8% during this quarter, and we've also disclosed in investor day and a couple of times some other metrics both in growth in active merchant and in growth of sales on primary customers.

I can't go into great detail on how we track it, but we certainly are very focused on our wallet share, which we see on the credit bureaus and on getting not only more active customers but getting our active customers to use us more.

And there is great leverage in having a couple more transactions a month on our card versus someone else's card, and we are very focused on that, usually using our rewards program.

Just as a follow-up on the M&A discussion, is there any preference for an asset-generating acquisition versus a funding acquisition?

I think you've seen us do both over time, well, really probably three times.

We've done some funding with E*TRADE funding acquisition from two years ago.

You've seen us do assets and a business, which are the student loan acquisitions, and then you've seen us announce the home loan, which is more of a fee-generating business since we don't intend to keep those on books.

And then finally, you've seen us do payments ones with both Diners Club and PULSE over the years.

So I think that anything that fits our strategy and has the right financial metrics for our shareholders is something that we would at least pay attention to.

Thanks very much.

Brian Foran, Nomura.

Hi.

I missed the first part of the Q&A, so stop me if this is redundant.

I guess I would have expected revenue suppression to be a little bit bigger tailwind than it seems to have been in the quarter.

And can you just remind us -- I know you don't have the reserve component of your revenue suppression, so that's one big difference versus Cap One and versus the interest charge-off -- interest and fee charge-offs at AmEx.

But historically you're kind of in between Cap One and AmEx.

Now you seem to be much higher.

Is there something structurally that's changed in your revenue suppression rate, or is there just a lag factor that's working its way through?

Post the CARD Act, we've obviously seen a lower absolute level of revenue suppression.

But the ultimate suppression is going to depend on how low charge-offs go and where they normalize ultimately.

And I think the relative degree of suppression we've had is obviously relative to some of those other names you've mentioned is obviously tied to the relative performance on our charge-off line item relative to those folks as well.

Okay.

So I guess if we continue to see charge-offs go down, it would continue to improve, and if we see charge-offs go up, it would start to become a bigger contra revenue line item?

All else equal, that would be the trend.

And then I know you have kind of touched on it in multiple questions, but just given the offers that BofA and Chase have in Cashback Rewards and to a lesser extent Capital One, is the rewards commentary kind of about matching those offers, or is it about one upping those offers, or just how do we think about the offers, the big guys who are running in the cashback space right now?

Remember that we have been running at around 90 basis points and had suggested some stability.

So part of the comments were the 86 basis points is below that and was intended to signal that we are not -- it's probably a little bit lower level.

It will fluctuate to a large degree by how much promotional work we do in a given quarter, how much we do in our 5% program and our other programs.

And we go through a rigorous process, particularly on the promotional programs, to do testing and see what kind of incremental sales we have, what kind of spend we have that is sustained both in other categories and in the categories in which we have promotions.

So while we certainly look at competitors, I'd say our biggest focus is making sure that we are delivering the maximum value at an achievable cost for us, and I think we've proven that we are the best at that over the long haul.

As David noted, we've seen the big guys come in and out of this in the past.

We are not going to respond, we're not going to beat, we are not going to match; we're going to do what's right to engage our customers and to drive growth.

We stayed the course in this product for a long period of time, they have been into it and out of it.

We're going to continue to stay the course, and we are not concerned about our ability to do that.

Thank you for taking my question.

David Hochstim, Buckingham Research.

Thanks.

Can you tell us what portion of the government guarantee loans you have are eligible for the refinancing into direct loans and if you have a sense yet of how much that might happen and then what kind of discount you've got the loans on the books for now?

I would say everything we have in student loans is small book.

It is like $700 million, give or take, if I remember the number correctly.

It's all in the held for sale category, and it is marked to appropriate market rates at this point in time.

So I think that has a limited shelf life on our books.

Right.

But if you could get them refinanced away at par, that would be better.

I just wondered if you worked out that's likely to happen or it's possible to happen?

No.

I would say that's not likely to happen at this point in time.

And then could you maybe go back and provide a little more color in terms of credit card loan growth, sort of what was different in Q3 versus Q4, and the balanced growth you had during those two quarters?

The average balances, as Chris pointed out, were down, even though the period-end balances were up in Q4 and Q3?

Remember, there is obviously seasonality in credit cards whether it's back-to-school or the holiday period that we are coming into.

So I think the thing we typically point to is the year-over-year growth in loans, and you've seen us kind of consistently move from neutral to 1% to 2% to now 3% year over year, and that was our ending balance.

And so I think I wouldn't overly analyze on seasonality.

I would suggest that you look year over year.

But just the average balance didn't go up as much in the fourth quarter as the ending balance?

I guess I am just curious about that.

It seems that the average balance for the fourth quarter is below the beginning and the ending balance in between.

I think we've had momentum, and if you go from 1% to 2% to 3% ending, then you're going to see bigger numbers at the end than you are during the middle because you are growing during the course of that quarter.

Okay.

Thanks.

There's time for one last question.

Matthew Howlett, Macquarie.

Thanks for taking my question.

Just a modeling question, regarding the student loans, I know you referred to sort of the economic guidance regarding that portfolio, but is there a default period that may be elevated, let's just say, a couple years after the payment rates start that could skew the margin temporarily?

As we've discussed in investor day, normally in student loans there is definitely vintages that you have to look at, and you have minimal defaults during the time people are in school.

You would expect to have about half the default that the lifetime defaults during the first two years of repayment and then the other half of the defaults during the remaining life of these loans.

And so as the book matures and you have more people in that first two years after repayment, you would expect to have elevated losses.

And if you look at our, what, 45 basis points of losses, that's obviously well below what we would expect this business to be when it's at maturity, and that's why we internally look at the vintage curves and will as it seasons, comes up to more normal levels of losses.

Is the portfolio stance today, would those sort of the peak years be 2012 and 2013, sort of the repayment periods, sort of peak default periods as the portfolio stands today?

It's going to obviously depend on how much we grow over the next few years.

So I wouldn't want to -- to a lesser degree maybe on what's going on in the economy, we are pleased that it's performing well right now at a time when unemployment for new grads is not cooling off the best.

So I wouldn't want to say what year we will be peak.

The other thing I would remind you is that the majority of our portfolio is now purchased seasoned loans.

So we've got a lot of history.

The company that we purchased, Student Loan Corporation, has been in the student loan business for 50 years, and we're one of the top three in the business.

So we are the originators.

So I think we feel we've got a lot of expertise now in-house.

Great.

Thanks, guys.

That concludes today's question-and-answer session.

I'll turn the call back to Craig Streem for final results.

Thanks, Christine.

I just want to thank all of you for your attention this morning and your interest, and then certainly on behalf of my colleagues, we want to wish all of you a very happy and healthy holiday season and New Year's, and we'll continue to stay in touch.

Bye, bye.

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

This concludes the conference for today.

You may all disconnect at this time.