發現金融 (DFS) 2012 Q2 法說會逐字稿

Welcome to the second-quarter 2012 Discover Financial Services earnings conference call.

My name is Larissa 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 Bill Franklin.

Mr. Franklin, you may begin.

Thank you, Larissa.

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

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

Factors that could cause actual results to differ materially from these forward-looking statements are set forth within today's earnings press release, which was furnished to the SEC in an 8-K report and in our Form 10-K for the year ended November 30, 2011, which is on file with the SEC.

In the second-quarter 2012 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 explain why these presentations are useful to management and investors.

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 question-and-answer session.

I would encourage you that it would be helpful to limit yourself to one question and one related follow-up.

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

Thanks, Bill.

Good morning, everyone, and thank you for joining us.

Before the market opened this morning, we reported quarterly earnings of $537 million, an even $1.00 per diluted share, driven by 6% year-over-year increase in revenues and continued improvements in credit.

Additionally, we returned a significant amount of capital to shareholders with combined share buybacks and dividends of approximately $500 million in the quarter.

In Direct Banking, we continued to deliver strong growth in card, private student and personal loans and launched some new products for future growth.

I am very pleased with our total loan growth of 9% over the prior year, which reflects another quarter of nearly 4% growth in card loans, as we continue to focus on profitable revolver sales through cash rewards leadership, promotional offers, partnerships and advertising.

We continue to achieve strong receivables growth, while the overall card industry remains relatively flat.

In terms of credit card performance, the strength of our risk management capabilities and the quality of our portfolio resulted in new historic lows for the 30-plus delinquency and net charge-off rates.

The 30-plus delinquency rate fell below 2% and our 90-plus delinquency rate fell to below 1%.

This is truly outstanding credit performance.

Also, in card, we recently announced our first affinity partnership with Ducks Unlimited, the largest conservation group in the world with more than 600,000 adult members committed to wetlands and waterfowl conservation.

This partnership will leverage our leading rewards program and be a nice addition for new account and sales growth.

In student loans, we started offering a new fixed-rate, private student loan product.

This new fixed-rate loan product provides predictability with a set interest rate for the life of the loan.

Discover's fixed-rate private student loans are designed to have rates comparable to federal unsubsidized Stafford and PLUS loans for qualifying students without the upfront origination fees of up to 4%.

It is too early to tell how much long-term growth will come from this offering as it has been in the market for less than a month, but the early signs from customers and school financial aid officers are positive.

The third new product that we just started marketing is residential mortgages under the Discover Home Loans brand.

On June 6, we closed on the acquisition of the Home Loan Center business from Tree.com.

The platform we acquired has a seasoned management team, approximately 750 employees and a technology platform that gives us room to expand in the future.

We are originating prime fixed and variable-rate conventional and FHA loans, which will be sold to the secondary market with servicing released.

Home loans is a product our customers have been asking Discover for, and the mortgage business is a natural extension of our Direct Banking strategy.

We are entering this market in a sensible way, having acquired a platform at low cost without the complexities of MSRs or legacy assets.

After we launch a checking product later this year, I believe we will have achieved another key milestone toward building a full suite of Direct Banking products.

In Payments, PULSE growth was up 14% over the prior year to an all-time record of $42 billion.

As we have discussed previously, PULSE added 129 new relationships in 2011; however, merchant and acquirer routing discussions are still in process and competitors' pricing changes are still being implemented in the market.

We continue to remain concerned about one competitor's actions in the market, but that being said, I am pleased with how our PULSE team has responded.

In summary, credit performance continues to be exceptional, but we continue to expect that we must be at or near the bottom.

We are launching new products which will position us for revenue and asset growth in the future, and we are deploying capital in a thoughtful, meaningful way.

With that, I will turn it over to Mark to review our second-quarter results.

Thanks, David, and good morning, everyone.

I will begin my comment by focusing on our Direct Banking segment's second-quarter results.

The segment earned $820 million pretax this quarter versus $883 million last year.

Yield on the card portfolio declined 22 basis points from the prior year to 12.35%.

We continue to see our APR mix move away from higher-APR balances but at a slower pace than we expected.

And our promotional volumes increased over the prior year.

These were partially offset by lower interest charge-offs.

Sequentially, card yield increased 14 basis points, as we saw a higher revolve rate in our merchandise balances, and as we continue to benefit from lower accrued interest charge-offs.

Total portfolio yield was 11.55%, lower by 38 basis points compared to the second quarter of last year, driven primarily by the acquisition of the additional private student loan portfolio in the fourth quarter, as well as the card yield compression that I just mentioned.

I will remind you that while private student loans have lower yields than cards and personal loans, they also have lower charge-off rates and operating expenses.

The yield compression was slightly offset by the sale of our remaining federal student loans in the first quarter of this year.

Net interest income increased $122 million or 10% versus the prior year, driven by asset growth, the benefit of lower interest expense on our funding and lower charge-offs of accrued interest.

Net interest margin on receivables was up 16 basis points to 9.31% compared to the prior year due to lower charge-offs of accrued interest and continued funding cost improvement.

In fact, funding costs are down 50 basis points versus the prior year to 2.41% as a percentage of average receivables.

This was partially offset by card yield compression and growth in lower-yielding private student loans.

The sequential increase in net interest margin of 28 basis points was primarily driven by yield expansion across all assets and lower funding costs.

We expect the net interest margin to stabilize around the current level for the remainder of the year, primarily as a result of card yield holding up better than expected.

Other income for the Direct Banking segment decreased $21 million from last year's second quarter as a result of lower late fees, lower transition services revenue related to the Student Loan Corporation and a decline in protection products' revenue.

The largest component of other income, discount and interchange revenue, was up compared to the prior year, but offset by higher rewards, as we modestly increased our rewards rate on card sales to 95 basis points.

Rewards should be in this area for the remainder of the year as we continue to invest in our program to drive profitable sales growth, and feel this is the right level in this environment.

Total operating expenses for this segment were up $108 million from the prior year, or 18%.

This growth was primarily due to a $71 million increase in legal reserve expenses over the prior year as we added $90 million to the reserve in the quarter.

Excluding the increase in legal reserve expenses, operating expenses would have been up 6% compared to the prior year, which was essentially in line with revenue growth and would imply flat operating leverage.

For the second half of the year, we do expect marketing and business development expenses to increase relating to the timing of some marketing campaigns.

The acquisition of the Home Loan Center platform and launch of Discover Home Loans will also raise operating expenses by about $35 million a quarter, but with the new product launch, there will also be fee revenue.

Now I'll switch to Lending product growth and credit performance for the segment.

We achieved card sales growth of 5% for the second quarter versus the prior year.

The growth in card sales was driven by our continued focus on increasing our merchant acceptance, enriching our rewards programs and leveraging our marketing investments.

Lower year-over-year increases in gas prices as well as more difficult comps resulted in slightly lower card sales growth than in the prior-quarter year-over-year increase.

Our total loan portfolio grew $4.5 billion, with $2.4 billion of this growth attributable to the accretive private student loan acquisition in the fourth quarter last year.

Credit card loans were up $1.6 billion and personal loan receivables were up $703 million from the prior year.

Turning to card credit quality, our positive momentum continued this quarter as the net charge-off rate declined 28 basis points versus the prior quarter, and the 30-plus delinquency rate declined 31 basis points sequentially.

The card reserve rate decreased 32 basis points as well, which resulted in a $122 million card reserve release.

In private student loans, the net principal charge-off rate, excluding our purchased portfolios, was 67 basis points.

The charge-offs and delinquencies in our private student loan portfolio are performing according to our expectations and will continue to rise slightly as the portfolio seasons.

In terms of personal loan credit performance, loans greater than 30 days past due fell 2 basis points sequentially and the personal loan net principal charge-off rate was down 35 basis points.

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.

Shifting to the payment side, we had another quarter of strong pretax earnings and payment volumes.

Pretax income was up $4 million or 10% from the prior year to $47 million, driven by higher-margin point-of-sale volume from our PULSE PIN Debit network business and third-party issuing volume.

Higher contra revenues had an offsetting impact as incentives paid for transaction routing (technical difficulty) increased from the prior year.

Volumes were up 12% against the prior year, driven by 14% growth in PULSE and 19% growth in our Discover Network third-party issuing volumes, offset partly by Diners Club performance.

Let's move on to liquidity, funding and capital.

Our liquidity levels remain strong, with total available liquidity of $27.6 billion at the end of the quarter.

Our on-balance-sheet liquidity portfolio ended the quarter at $11.3 billion, up $2.6 billion from the prior year, but down from the end of the first quarter.

As you may recall, at the end of the first quarter, we had prefunded a large volume of second-quarter maturities.

While direct-to-consumer deposits continue to be our largest source of funding, we remain opportunistic across all of our funding channels.

During the quarter, we completed an unsecured debt exchange through which we traded approximately 80% or $322 million of our 10 1/4 percent senior notes due in 2019 for new 5.2% senior notes due in 2022.

While exchange offer had a slightly negative impact on results for the quarter, it will deliver a pretax benefit of approximately $8 million per year over the coming years.

Additionally, we completed a two-tranche ABS transaction after the quarter closed.

The deal included a three-year $800 million tranche priced at a fixed coupon of 86 basis points and a $650 million five-year floating-rate tranche priced at one month LIBOR plus 37 basis points.

Turning to capital, we ended the quarter with a 14% Tier 1 common ratio, slightly lower than last quarter as we repurchased nearly $450 million worth of shares in the quarter.

These buybacks included the completion of our previously disclosed $250 million accelerated share repurchase program.

With that, let me conclude with a few final comments.

In the second quarter, credit improvement and strong revenue growth paired with controlled operating expense growth generated strong earnings.

We are continuing to invest in our business through new products and global acceptance and believe these investments position us well for the future.

We are continuing to return capital to shareholders, with more than 2% of our shares repurchased last quarter and a $0.10-per-share dividend, which we have committed to revisit at least annually.

Before opening up to questions, I want to take a moment to formally announce and congratulate Bill Franklin on his recent promotion to Vice President and Head of Investor Relations.

I think most of you had the chance to interact with Bill as he has been a key part of our IR team over the past several years.

His knowledge of the Company and the function made him a logical choice to take the helm of the program.

That concludes our formal remarks, so now I will turn the call back to the operator to open up for Q&A.

(Operator Instructions) Sanjay Sakhrani, KBW.

Thank you.

Congrats, Bill.

So I have two questions; I'm going to ask them up front.

So first one, this is the third straight quarter where I think you guys took this charge for legal.

I assume it was largely PPI-related.

But could you just talk about where we are in the investigation and if we should expect additional impacts in the future?

And secondarily, on capital management, just on the share buyback, the roughly $450 million that you guys repurchased this quarter, is that a good quarterly run rate to expect in the future?

Or was part of this quarter's accelerated purchase related to last quarter?

And then maybe you could just talk about the M&A pipeline as well.

Thank you.

Sure.

There was a bunch in there, but I will be happy to tackle it here, and I will let David drop in too on the M&A pipeline, probably.

But with respect to the legal reserve matter, I think the matter is not resolved.

We are engaged in an ongoing dialogue with the CFPB and the FDIC, and we hope we can resolve it soon.

It is a constructive dialogue.

We obviously reserve in accordance with GAAP, and the reserve is set based on probable and estimable loss contingencies.

So I think beyond that, I'd just point you to the back of the disclosures in our first quarter 10-Q, as they contain a pretty fulsome discussion of the significant matters.

But given that is an ongoing investigation, that is really about all we can say.

With respect to the buybacks, I would say that the $450 million probably included a little bit of catch-up activity from being dark in the market in the first quarter while we went through the capital planning process.

I would still remain pretty confident in my guidance that over the course of fiscal 2012, we will probably use a little bit north of half of that authorization, is probably the right way to think about it.

So that should give you some sense in terms of how to think about sizing, what our thoughts are right now.

That is obviously our current thought; that is subject to change from time to time.

But that is kind of how we are looking at it at this point in time.

And on the M&A pipeline, David, do you want to specifically comment there?

Sure.

I would say first off, obviously we are pleased to have just closed our Home Loan acquisition.

And so our primary focus will be integrating and growing that acquisition.

And we remain open to other opportunities that fit our Direct Banking and payment strategy and work financially.

But we obviously have been very selective and careful, but would remain open to future opportunities.

I can't really comment any further on M&A pipeline, per se.

The only other thing I would type onto that one is -- because I know it is important to all of you -- I get asked regularly how we look at return hurdles when it comes to M&A transactions.

And obviously, we do hold them up to a higher standard because of the risk embedded in any M&A type transaction.

So I would just add that to David's comments.

Thank you.

Craig Maurer, CLSA.

Again, congratulations to Bill.

My questions revolve around one, David's comments around one competitor's actions in the market when referring to network activity.

I'm assuming that's Visa, and if you could be a little bit more specific about what their actions are that you are seeing and what is concerning you.

And secondly, we heard comments on the NIM through 2012, but when looking out toward next year, should we start to see the lower-yielding loans start to catch up with the NIM?

Thanks.

Well, I'll address the first one.

Obviously, in debit, one competitor represents 70% of the market share.

So when a 70% market share competitor makes moves tying products together and launching fixed/variable pricing designed to take advantage of that 70% market share, we become -- we and many others in the industry become concerned about having a level playing field.

Having a level playing field, I'm very confident in PULSE's ability to compete and bring choice and good financial performance for our financial institution customers, as well as our merchants.

But obviously, there is -- the Department of Justice has launched an investigation, so we are not the only ones who have some concerns.

Mark?

On the net interest margin side of the equation, I would still say over the longer term, the right way to think about a normalized margin for us is in that 8.5% to 9% range.

I think we have proven that we are not adept at forecasting the compression in the [card] deals in that higher-rate bucket that we have out there at this point in time.

So as that is taking longer, I think it will take longer to reach that normalized range.

That having been said, as we move into next year, Craig, I do expect we will start migrating down toward the high end of that range.

Okay.

Thanks, gentlemen.

Ryan Nash, Goldman Sachs.

Mark, in terms of credit, I know you've talked about losses bouncing around the bottom and David commented that losses are at or near the bottom.

But just when I look at your early-stage delinquencies, they are down almost 20% the past five months, and I know some of that is seasonal.

But is it fair to say that we could actually see losses come down from here, just given where we are on the delinquency trends?

Yes, Ryan, I think it is plausible that could happen.

I think, as I've said several times, one of the challenges we have obviously is we are in a tail environment, having just come through what we've come through.

And so everybody's models are a little bit less predictive than they otherwise might be.

So I would suggest that it feels like we must be approaching a bottom somewhere in here.

Could it possibly improve?

It could.

Could it possibly flatten out?

It could.

The raw (technical difficulty) of math on the delinquency side of the equation would lead a logical person to kind of the conclusion you are making.

But that notwithstanding, we do some see some absolute limits to how low these things can go.

So we tend to think about being somewhere near the bottom in the improvement.

We still think we will return to growth at some point in time over, let's say now, the next nine months in the reserve.

That growth being driven though not by a turn in the credit environment; that growth being driven simply by loan growth.

So provision for growth being the key issue there.

So I still think it is likely when we hit a bottom, we don't bounce off it in a V; I think it is more likely bouncing along the bottom for a while.

Okay.

And just a follow-up on Sanjay's question on the buyback.

You did almost 25% of your authorization -- the two-year authorization in one quarter.

Are there any restrictions in terms of the amount that you could actually buy back within the one-year timeframe -- I know some others have commented on that -- specific to Fed guidelines?

And also, in terms of the 9.5% capital target, this is the first quarter we actually saw the Tier 1 common actually come down.

And I know, Mark, you've commented not wanting to see it grow further.

So can we read across that this is actually the start of you guys (inaudible) it down, maybe you get a little bit more aggressive on it as we move throughout the year?

I would say with respect to restrictions, I'd point you back to my commentary about using probably a little bit more than half over the course of this year of that authorization.

And you should assume that our capital plan submission to the Fed allows us to act in a manner compliant with that guidance.

So that would be the general thought process I would have you think about there.

The other thing I would say in response to managing accretion going forward, I think, yes, the right way to think about this very much is that I think we returned a little bit north of 90%, roughly, in terms of total payout this quarter, which I think is pretty high.

Clearly, the goal at this point in time, while we are in this period of obviously very strong earnings, is to at the very least mitigate further accretion on that capital line.

So I think you should expect to see us act in that basis, if not begin to draw down a little bit.

Great.

Thanks, Mark.

Moshe Orenbuch, Credit Suisse.

The other way you could affect that capital ratio is by growing faster.

Could you talk a little bit -- you alluded to the Ducks Unlimited program.

Talk about the things that you're doing to kind of grow the receivables in an organic fashion a little faster.

And I've got a follow-up question also.

I would say if you look at our overall 9% year-over-year loan growth, I think we are near the top of the class in terms of being able to achieve growth.

And you've seen us do that through a combination of some M&A with particularly student loans as well as organic, both in credit card loans growing 4% organically, as well as personal loans growing nicely organically.

So we've got a whole host of actions that we have been employing in terms of marketing programs, emphasizing cashback bonus leveraging our newfound capabilities in student loans and our expanded capabilities in student loans, and really having some -- what I consider to be some good advertising and marketing programs plus our great service.

Going forward, I mentioned three new product areas that each, I think, have an opportunity to continue and in some cases maybe accelerate our growth, ranging from the first affinity program, which we think will be a good opportunity in card.

That space, that affinity space, has changed dramatically in the last few years.

Service is critically important to groups and group members.

And so we think we are well-positioned to help address that marketplace.

The fixed loan product in student loans is designed to help us accelerate growth in that area and meet some new needs.

And obviously, home loans won't be growing receivables, but over the long term, should grow our fee income.

So we are continuing to diversify across our Direct Banking and payment strategy in an effort to grow.

We obviously would love to be able to invest more capital in organic growth.

Just as a follow-up, you had mentioned, Mark, a $35 million kind of expense level for the mortgage business in the next quarter.

How long will it take for the revenues to kind of meet or exceed that level?

I think the right way to think about it is it is going to mean not meaningful, either in terms of detracting or contributing to the overall profitability of the Company, in the near-term.

So think about it as a breakeven kind of operation, is the right way to think about that.

Great.

Thank you.

Scott Valentin, FBR Capital Markets.

Congratulations, Bill.

Just on the marketing expense, you mention it is going to increase going forward as you have some -- I guess some activities planned.

Would the rate of increase be consistent with last year?

And then just overall, as a follow-up question to that, just overall operating expenses, you mentioned operating leverage this quarter.

Do you expect to continue positive operating leverage going forward?

I would say the marketing expenses, yes, probably the right way to think about it is somewhat in line with the seasonality that you would have seen in the prior years.

And in terms of -- maybe a little bit higher.

But in terms of the operating leverage, I would say right now, continue to see that being essentially flattish over the course of the year, is the right way to think about it, as some of the investments we've made over the course of the last year began to ramp up and I think we've made meaningful progress against what were some pretty significant negative operating leverage over the course of last year.

Thanks very much.

Don Fandetti, Citigroup.

Mark, obviously on your mortgage initiative, it is going to be pretty modest initially.

But if you sort of hit this $30 billion aspirational number of originations down the road, can you just sort of help us think about the level of capital that business requires?

I know you only hold the loans for sort of 15 to 30 days.

But I would assume at that type of origination level you have a couple billion dollars of debt at the end of any given quarter, and how do you think about equity capital against that business?

David, I'll let you address the vision for the business and I will tackle the capital -- how about that?

I think that we cited probably the leader in direct mortgage originations, who has been originating north of $30 billion a year.

And given our brand, customer base and service capabilities, we think it is not unreasonable that eventually we would get there.

But that being said, we've bought a platform.

We are going to have very have measured growth here.

And so I would not be expecting us to reach anywhere near that level of originations in the near-term.

In terms of capital, it's not a particularly capital-intensive business.

One reason we like it is a high source of fee income.

But anything you would like to add on that, Mark?

I think you are thinking about it the right way.

The goal is to clean out the warehouse about every 15 days, give or take.

The platform originated $3 billion of volume in 2011.

So that is kind of the run rate that is coming onto the books, if you will, if you want to think about it, or somewhere in that general neck of the woods.

And obviously, cleaning out that warehouse on a 15-day basis does not result in us having any significant capital tied up in that business at any point in time.

Okay, thank you.

And the $30 billion is aspirational.

Mark DeVries, Barclays.

My question is around what is priced into the card reserve here.

As I look at that -- this 3.68% reserve rate, but with the charge-offs, below 2.8%, and delinquency is down 30 basis points this quarter, which points to lower charge-offs the next quarter or two, it would seem to me like that rate is too high.

Can you just kind of talk about for the back half or the earlier part of next year what your expectations are for charge-offs that would lead to such a high reserve rate?

Yes, I think it is kind of hard, obviously, to get you the right answer there, because the data that you've got available to you is all historical, backward-looking data, but our reserves are set on a prospective basis, based on what we see happening.

And again, a big part of that reserves is reserves not for charge-offs; a big part of that reserve is the reserves for growth that we expect to see coming on the books here over the course of the near-term as well.

So there is a number of different moving pieces there.

So what I would say is that, again, we don't expect the increase in reserves that we expect to see over that 12-month forward period coming as much from losses -- we don't expect to see it coming from losses.

We really expect to see more of it coming from growth in the book.

And with respect to the current reserve, it obviously reflects what we expect charge-offs from loans that are currently on the books.

And as Mark has mentioned, we feel like we are somewhere near the bottom, and so would be forecasting a modest increase in charge-offs over the forward 12-month period, which is why we end up with a 00 what you see as a -- might view as a higher coverage ratio on the current quarter's very low level of loan losses.

Any kind of color on what type of growth is reflected on that?

Because we're still talking about a pretty big build between where the charge-offs are now and where the reserves are.

Well, I would just say that it assumes, as we look at all the variables -- and there is obviously different reserves for different parts of the book, so it is a complicated calculation, obviously, that we work very hard to fine tune -- but reflects what I would characterize as over the forward 12 months a modest increase in charge-off rate.

I would think about the growth being in line really with the model we shared at Investor Day for each of the various and sundry different asset classes.

Okay, thanks.

Rick Shane, JPMorgan.

I think actually Bill has a couple of other little reasons to be congratulated as well, so best wishes on all your good news.

Thanks, Rick.

For those who don't know, Bill and his wife had twins also in the last couple weeks.

A lot going on.

Mark, just one quick question for you.

You had talked about the increase in delinquencies on the student loan book being a function of seasoning.

And it is a little bit out of whack with what you would expect from a seasonality perspective.

Can you -- you also made the comment you see this as in line with your overall projections.

Can you help us understand how long you think that seasoning will go on so that we can have a sense and benchmark this to see how things are going as well?

Yes, I would say the comment really reflects the fact that we've had a significant portion of our portfolio that has been in the deferral phase, where the student has still been in school or immediately out of school, where they have not yet begun repayment.

So obviously during that period of time, they can't by definition be delinquent.

So what happens is you have a larger portion of your book begin to creep into that repayment phase, is when you start to see the delinquencies begin to materialize.

And I think the right way to think about it is we continue to believe this business operates kind of right at or above, give or take, a 1% loss rate, annualized, going forward, is the right way to think about it.

And the delinquencies would be commensurate with that type of a loss rate.

But we can give you some more color going forward on exactly how we kind of expect that trajectory to blend out.

That would be great.

Thank you so much.

Robert Napoli, William Blair & Company.

Two questions.

First, just a little more color on the spend growth through the quarter, and thoughts on spend growth.

I mean, your spend growth on cards for the proprietary portfolio, about 5%, which you (technical difficulty) for comps.

But it is about in line with portfolio growth at 4%.

Do you expect spend growth to track along with portfolio growth from here?

I would expect spend growth to continue to be a bit more than loan growth.

We've seen that in normal periods for quite some period of time.

And I think that since --- we really started getting what I would consider tougher comparable year-over-year comparisons probably in December of this year.

And since December, I've seen a fair amount of stability, bouncing around in that -- right around the 5% to 6% year-over-year, if you look at the months since December.

So I generally expect that kind of growth level to roughly continue.

Okay, and then on your affinity -- discussions on affinity, David, I think that is -- you have some background in the affinity business with MBNA.

MBNA was a massive affinity player, and it is probably a shadow -- it is a shadow of what it used to be.

Do you see a big opportunity here to -- in the market to really re-create the MBNA strategy of sorts?

Or I mean is this a big effort for Discover to move in that direction, or --?

I would view it as not our primary strategy, but an extension of our strategy.

Certainly one of the things that we really have is our own brand, Discover.

We are the leader in cashback bonus.

That will continue to be our primary strategy.

I think that over the last few years, we have gotten an increasing interest in demand from groups who are not currently satisfied with their current providers, whoever that might be.

And I think we have now stuck our toe in the water with Ducks Unlimited.

We are going to focus on doing a great job with them.

And I wouldn't look to have anything overall.

This is not a change in our strategy in any way, but rather a natural extension.

And like our other efforts, we will have controlled -- test and control and grow things as appropriate based on what we learn.

So there is no target to sign a whole bunch of new affinity groups over the next quarter or anything like that.

Great.

Thanks and congratulations, Bill, on all fronts.

Great to see.

Daniel Furtado, Jefferies & Company.

This is Martin Kemnec in for Dan Furtado.

Thanks for taking my questions, and congrats to Bill.

I have two questions.

First, I think you noted in your prepared comments that promotional volumes increased over the prior year, but the APR mix is shifting away from higher balances at a slower pace.

I was wondering if you could give us an update on how that mix now -- how does that mix look now between the three balance types and what would you consider kind of a normalized mix.

I think one of the statistics we've given is what percentage of balances are at a promotional rate.

And it may be slightly higher this quarter at right around 16% or so, but has pretty much remained about in the range that we talked about at Investor Day.

And I think certainly the fact that we've had low attrition and low charge-off rates is contributing to our yield remaining higher than one otherwise might have expected.

Okay.

And then last question.

I think it is well-known you guys have a pretty significant benefit to the funding cost as these kind of higher-priced deposits are repriced.

I'm just curious -- how do you think about pricing 12 to 18 months out?

Like Barclays and some others are [beaconing] to re-engage the online market here in the US.

I think also back in Investor Day, you had a chart that kind of showed how your deposit costs were tracking versus the largest banks.

What is that delta at today, if you can describe it, or what is the kind of convergence we should expect to see there between those two lines?

I guess I would say at this point in time we tend to think about our direct-to-consumer deposits as one of our core funding channels, and it is one that brings us the added benefit of a customer attached to it as well.

So having good-quality, sticky funding relationships, sticky customer relationships associated with that is a real core strength.

And that is really where we are focusing our action and activity in that market right now.

We obviously grew the business as a pretty significant ratepayer.

I would say we've gotten very disciplined in that at this point in time, and still are looking to be a leader in that regard, and are very focused on that.

But some of the other funding channels have of late been a little too enticing to ignore, shall we say, as well.

Going forward, I would say you should expect to see us stay very competitive in the rates business.

And I would expect to see that -- expect that we are monitoring all those competitive actions you alluded to very, very carefully and feel very confident in our ability to respond to those should and if it becomes necessary.

Excellent.

Thank you guys very much.

James Friedman, Susquehanna Financial.

I had two questions.

First, more of a housekeeping nature.

So the rewards are up to 95 basis points from 92.

Mark, could you just repeat what you had said in your prepared comments?

Is that the level we should think about going forward?

Yes, I think that 95 basis point kind of range is really the right way to think about it.

In the current competitive environment, we feel strongly that reinvesting in that program is a critical component of our business strategy, and that is how I'd think about it.

I would tell you on a net available exchange basis, we are kind of flattish, so we think that is -- that rewards rate is paying off for us, shall we say.

So that is what I would -- that is what I would guide you to there.

Okay.

And I know it is a small part of the business, but I wanted to ask about third-party issuance.

It was up about 19%.

That was the fastest growth we'd seen in many years.

Could you talk a little bit about the economics of that business and if that will continue to be a focus area for the Company?

Well, I would say we were very pleased with the third-party growth, and that business has been profitable for us for quite some time.

We don't separately break it out, but it is certainly a contributor towards our Payment segment, and we are very interested in continuing to grow it.

And I think that certainly we've got some significant relationships in there, but we are continuing to diversify out as well with some additional relationships that are also contributing to the growth.

Thank you.

Matthew Howlett, Macquarie.

On the FICO score breakout, I guess the first question -- has there been any change in terms of what you're seeing in terms of (inaudible) that you are putting on.

And as it relates to that question, some of your competitors have talked about going down the FICO score level.

I mean, it depends what you define subprime as, but apparently there is a lot of opportunities for that underserved market.

My question is, is there any plans to sort of reach down to some of the lower credit quality borrowers out there?

We have no intention of becoming a subprime player.

We are a prime card issuer.

We are -- we do continuously fine-tune our credit models and strategies, and the thing that we most look for are people that will have prime performance and that we can be profitable with.

And sometimes FICO -- I would say first on FICO, we have been relatively stable, so you haven't seen a big change on us.

But I think sometimes people overuse the FICO definition.

We turn down a whole lot of people that are over 660, who may have other characteristics that we don't think will lend to the credit performance that the FICO score alone might indicate.

And then there is a small subset of people who have less than a 660, but have other characteristics that we think can be attractive from a credit performance.

So we are continuously fine-tuning our models.

Great.

Thanks, guys.

We have no further questions at this time.

All right.

Thank you, Larissa.

Feel free to reach out to the Investor Relations team if you guys have any follow-up questions.

That concludes the call.

Thanks for joining us.

Thank you.

Thank you, ladies and gentlemen.

This concludes today's conference.

Thank you for participating.

You may now disconnect.