發現金融 (DFS) 2013 Q4 法說會逐字稿

Welcome to the fourth-quarter 2013 earnings 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, Investor Relations.

You may begin.

Thank you, Alexandra.

Good afternoon, everyone.

We appreciate all of you for joining us on this afternoon's call.

Let me start on Slide 2 of our earnings presentation, which is on our website, and we will be referencing during the call.

Our 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 today in an 8-K report and in our form 10-K for the year ended November 30, 2012, and in our form 10-Q for the quarters ended March 31, June 30, and September 30, 2013, which are on our website and on file with the SEC.

In the fourth-quarter 2013 earnings materials, which are posted on our website and had 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 by David Nelms, our Chairman and Chief Executive Officer, and Mark Graf, our Chief Financial Officer.

After Mark completes his comments, there will be time for a question and answer session.

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

Thanks, Bill, and welcome to all of you for joining the call with us today.

After the market closed, we reported fourth-quarter net income of $602 million, or $1.23 per diluted share, up 16% over the prior year, driven primarily by loan growth and share repurchases.

During the quarter we generated a return on equity of 22% and returned nearly $450 million of capital to shareholders through repurchases and common dividends.

For 2013, we had two main priorities for the direct banking segment.

First, we wanted to continue growing our card receivables while maintaining our leading credit performance.

Second, we wanted to expand our non-card assets by growing personal and private student loans, as well as to broaden our product offerings.

I am very pleased with the progress we made on both of these priorities last year.

For the full year, we successfully grew card sales and receivables by 4%, as we continued our focus on the prime revolver segment.

This growth was driven both by increasing wallet share with existing customers and by acquiring more new accounts.

We drove new card account growth by nationally launching Discover It, which is built upon our leadership in cash rewards and customer service, and includes a number of new consumer benefits.

Recently we started offering Discover It card members free FICO scores on their monthly statements, because of our commitment to helping people achieve personal and practical financial goals.

Discover is currently the only major credit card issuer to do something like this.

We grew non-card assets by continuing to leverage our expertise in unsecured underwriting, and by maintaining a customer centric focus.

In 2013, we originated roughly $2.5 billion in personal loans and over $1 billion in private student loans.

In 2011 and 2012, we had the benefit of originating private loans under two brands, Discover and Citi, as we had a two-year agreement with Citi.

Our student loan origination's in 2013 were all originated under the Discover brand, and yet we originated even more private student loans than we did in 2011 or 2012.

During our first full year offering home loans, we originated approximately $4 billion of mortgages, despite the significant decrease in refinance volumes in the second half of the year caused by rising interest rates.

We further broadened our direct bank product offerings by launching cash back checking, which has the potential of representing an important funding source for us over the long-term.

Additionally, because of the housing recovery and rising first mortgage rates, we felt it was the right time to launch our home equity installment loan product, which we did in the third quarter and fourth quarter of this year.

For our payments business, 2013 was a challenging year, but we continued to plant seeds for future growth.

PULSE [drawings] were flat year-over-year and margins were stressed as we responded aggressively to an intensely competitive environment and expanded our focus to target volume historically run at over signature debit networks.

At Diners Club, while the European environment remains challenging, we believe we have put the most significant challenges behind us from a financial point of view.

Additionally, we saw the launch of some very exciting new franchises in China, Russia and India.

In network partners, we were notified in the quarter that we would be losing the third-party issuing deal in the middle of 2014.

However, we remain excited about our growing portfolio of payment partnerships and our increasing global acceptance.

While these newer partnerships will take time to ramp up, they position us well as a flexible payment partner.

Lastly, one of our top core priorities was to drive shareholder value through effective Capital Management.

During the year, we repurchased 5% of our shares and increased our dividend in April, all in deploying more than a $1.5 billion of capital.

We also completed our inaugural CCAR filings and are looking forward to receiving the results in March.

Our fourth-quarter provided a strong finish to a record year, as our card business grew receivables by 4% versus the prior year, despite tougher comps.

We achieved 11% growth in other consumer lending products, broadening our direct banking product offerings, and we drove outstanding credit performance across all asset classes.

That concludes my prepared remarks on our fourth-quarter and full-year performance.

I look forward to providing you with an update on our business strategy and priorities at our annual financial community briefing on February 27.

Now I will turn the call over to our CFO, Mark Graf.

Thanks, David.

Good afternoon, everyone.

I will start by going through the revenue detail on Slide 5 of the earnings presentation.

Net interest income increased $141 million or 10% over the prior year, driven by loan growth and a higher net interest margin.

Total non-interest income decreased $28 million to $560 million, primarily due to lower direct mortgage related income, as well as lower protection product revenue.

These items were partially offset by higher net discount and interchange revenue, which increased by $38 million year over year, due to a lower rewards rate and Discover card sales volume growth.

The rewards rate for the fourth quarter of 2013 was 11 basis points lower than the prior year.

You may remember that in the fourth quarter of 2012, we had two 5% cashback categories, as opposed to the most recent quarter's single category.

Payment services revenue decreased 2% year over year, mainly due to lower transaction processing revenue for PULSE.

Overall, we grew total Company revenues by 6% for the quarter.

Turning to Slide 6, total loan yield of 11.38% was nine basis points higher than the prior year, as interest yield for card, private student and personal loans all increased.

The year-over-year increase in card yield reflects lower interest charge-offs, and a higher portion of balances coming from revolving customers.

This higher total loan yield, combined with lower funding cost, resulted in a 41 basis point increase in net interest margin over the prior year to 9.81%.

Looking forward, net interest margin is expected to remain elevated above our long-term target for some time to come.

Turning to Slide 7, operating expenses were up $35 million or 4% over the prior year.

The increase in employee compensation was primarily related to higher headcount to support growth in new product initiatives, as well as compliance with increased regulatory requirements.

Information processing expenses were up $12 million or 16%, largely due to a reclassification of expenses that were previously included in employee compensation and benefits.

Turning to provision for loan losses and credit on Slide 8. Provision was lower by $16 million compared to the prior year, due to lower charge-offs and a smaller reserve build.

Our $50 million reserve build during the quarter remained reflects two things.

First, a $28 million build driven by the accounting treatment for a portion of the purchased private student loans, and second, overall loan growth.

Regarding the purchase student loans, certain pools are performing better than our original expectations, and a few are performing below our original expectations.

PCI accounting requires pools that are performing better than expected to be accounted for by increasing the yield on the underlying loans, while a reserve addition is recognized for those pools performing below our initial expectations.

I will point out that the full effect of the increasing yield for pools performing better than expected isn't reflected in the fourth quarter.

So student loan yield will tick up again this quarter.

The key takeaway here is that, in aggregate, the acquired student loans are performing slightly better than we expected at the time of purchase.

Continuing on to Slide 8, sequentially, the credit card net charge-off rate increased by four basis points from a record low last quarter to 2.09%.

And the 30 day delinquency rate of 1.72% increased five basis points from the prior quarter.

Our credit outlook for cards continues to remain relatively benign.

The private student loan net charge-off rate, excluding purchased loans, increased 41 basis point in the prior year, and eight basis points sequentially, due to more of the organically originated portfolio entering repayment.

Student loan delinquencies, excluding acquired loans, increased six basis points sequentially to 1.66%.

Switching to personal loans, the net charge-off rate remained relatively unchanged sequentially, and the 30 day delinquency rate increased by 5 basis points to 70 basis points.

Turning to Slide 9, in 2013 we repurchased $1.3 billion of our common shares, paid almost $400 million in dividends to common shareholders and grew total loans by 5%.

Despite these actions, the strong performance of our business resulted in us accreting more capital, as our Tier 1 common ratio increased by 70 basis points over the prior year to 14.3%.

Sequentially the Tier 1 common ratio was down a bit due to seasonal loan growth.

We are in a very strong capital position as we enter our inaugural CCAR review, and we continue to generate greater returns that support the capital actions we submitted to the Fed earlier this month.

One item I would note is that this quarter's share repurchase activity will still be guided by last year's CAPR submission, which has us repurchasing closer to $300 million for this quarter, as opposed to our recent cadence of about $350 million.

While not related to capital, one final call out for the quarter is our lower effective tax rate.

This was driven by a favorable resolution of a state tax matter.

To sum up, 2013 was a great year.

We grew top line revenue by 7% through loan growth and a higher net interest margin.

This combined with a strong credit performance and focused expense management drove record net income.

Despite challenges in our payments business, we continue to successfully lay the groundwork to drive future volume and profits for this segment.

And finally, we effectively deployed capital and repurchased over 5% of our net shares in 2013.

Looking forward, we expect the credit environment will remain benign, NIM will remain elevated, and we will continue to remain disciplined with our expenses and investments for growth.

More to come on all of this and more at our financial community briefing next month.

That concludes our formal remarks, so now I'll turn the call back to our Operator, Alexandra, to open up for Q&A.

(Operator Instructions)

Our first question comes from Sameer Gokhale from Janney Capital Markets.

The first question was just on operating expenses.

I know you've given some year-over-year comparisons, but I was looking at the sequential increase in the other expense category, other other, going to $133 million from $118 million last quarter, and I was just wondering what was responsible for that sequential increase in expenses?

I think there was a little bit of a catch-up on depreciation of some technology investments, and that made up a good portion of the $11 million increase year-over-year

Very specifically, Sameer, what it was is we changed the way we are accounting for certain technology investments.

Previously we had been capitalizing web development expenses.

We are now going to be expensing those going forward, and that's the first quarter you see that reflected.

Sp the run rate will be off of the Q4 number?

I don't think Q4 is exactly going to be the run rate to build off of because that did include some catch-up, as Bill alluded to, but I think it is fairly close.

Okay.

That's helpful.

And then just the other thing on the NIM dynamics, net interest margin and you look at your funding cost it looks like you got a sequentially again, significant benefit from a declining year broker deposit cost.

And I know overall they've been trending lower, but it seemed like the decline from Q3 to Q4 was a little bit bigger than you've seen in previous quarters.

So can you just help us walk through just the sequential decline in your brokered deposit cost and if there's anything unusual going on there?

No, I don't think there's anything unusual going on there, because we've actually done two different things, Sameer.

Not only have we effectively brought down the rate we are paying on our deposit book across the board.

I would point out the direct consumer deposits in addition to the broker deposits, we've also been pushing out maturities as we've been doing that so I'll call it a both/and benefit.

We've brought down the effective rate we are paying as we've seen high rates longer dated maturities rolling off, and we've been able to replace those with similar or longer-dated products at much lower rates in the current environment.

We are doing that in the CD book on the direct to consumer side.

We are also doing that in the brokered deposit side.

Okay.

That's helpful, thank you, and I will get back in the queue.

We have Betsy Graseck from Morgan Stanley with a question.

Hi.

A couple of questions.

One on -- while we are on the broker deposits, I'm just wondering what that decisioning was behind increasing year on -- Q on Q. You had about a $1.8 billion increase in the brokered deposits -- or I'm sorry, $2.3 billion in the brokered deposits.

Yes, I would say it is couple things, Betsy, but the primary driver there is our funding strategy overall is what we like to describe as a constrained optimization.

So we want to make sure we are accessing all of our channels all the time, and tapping out none of our channels at any time, to have a balanced profile from a risk perspective and a funding standpoint, and subject to that overall constraint, we target the lowest cost to funding at specific duration points out the curve, and in the fourth quarter it was a very attractive source of longer dated funding.

So do see that as an opportunity to kind of pre-fund loan growth in 2014?

Yes, I think that was an attempt to not only pre-fund the growth but extend out the maturity on the book overall.

I think we also took down some ten year bank note money in the fourth-quarter that I would put in the same category.

We didn't have a need for it at the time, but it was really managing the complexion of the balance sheet as well as pre-funding loan growth earlier this year.

So we should expect to see, all other things equal, the securities portfolio tail -- trend down as you grow loans into the next couple of quarters?

Yes, I would say generally speaking that's correct, but we are going to be looking at other maturities we have upcoming as well as other obligations, and making sure we are carrying enough on balance sheet liquidity to meet our needs.

So as a general rule, I think what you said is correct.

Okay, thanks.

We have said Sanjay Sakhrani from KBW online with the question.

Please go ahead.

Thank you.

I've also got a couple questions.

I guess first could you, Mark, maybe help us think about the yield benefit from student lending PCI accretion in the first quarter?

Is it fair to assume that it is a comparable step function up in the yields, as we saw in the fourth quarter?

And then secondly, David, you mentioned a loss in the third-party issuing area Could you just talk about the materiality of that and some more color on that?

Thank you.

With respect to the PCI loan yield, Sanjay, what I would say is essentially 100% of the increase you saw in student loan yield in the fourth quarter was driven by the movement in the accretable yield on the pools that are performing better, and that reflected that being in place for one month of the fourth quarter.

So you will get it for the full three months in the first quarter, and that should give you a pretty good idea how to range it in, I think.

Sanjay, on your second question, this is the third party issuing deal that we've been calling out as a risk for the last couple quarters, but we actually received notice this quarter.

And in terms of materiality, I'd say we expect to have a meaningful impact on network partners' volume and profits but immaterial to EPS overall.

Okay, great.

Thanks.

We have Ryan Nash from Goldman Sachs online with a question.

Please go ahead.

Good evening, guys.

Just a question on credit.

How should we think about the pace of loan-loss reserve builds in 2014?

If you take out the PCI charge this quarter, I think you built about 22, is that a good estimate for growth as well as seasoning of the portfolio?

And just on the reserve, do you think we're at the bottom in terms of the reserve level?

How should we think about those two items?

Yes, I think it terms of the environment overall, Ryan, the right way to think about things is we are somewhere at or near the plateau in improvements.

I think what we've been saying for some time is we do expect this environment will continue for a while.

We don't see any kind of inflection point in the credit environment in the 12-month forward planning cycle we use to set our loss reserves.

So provisioning is really principally going to be driven from this point forward by growth in the loan portfolio, and to a lesser degree I think a bit of a tapering affect continuing on recoveries on the aged charge-offs kind of from the recession period of time.

I guess what I would say is they won't be while I say they are relatively stable, I wouldn't have an expectation they are exactly flat.

I think quarter-over-quarter, economic factors and other inputs the models are going to cause them to tick up a little bit or to tick down a little bit, as the case might be, but think about it as in general terms somewhat flat.

Great, and if I can just ask one follow-up unrelated.

If you look at your marketing expense, it was basically flat in the back half of the year in 2012 versus 2013.

So, given that I believe a lot of the marketing budget for 2013 was driven by the launch of the It card, so given that how do we think about the trajectory of marketing expense from here?

Could we actually see a decline, given that a lot of the spend was put into the It card?

Ryan, I would expect that you probably won't see a decline in the marketing expense.

As we've said in a couple forums recently, we continue to see great returns on the investments we're making in the It card, both in terms of not only the cost per account acquired being very low, but the engagement we are seeing out of those It card member being very, very strong.

In other words, they are using the card sooner and more frequently than our traditional More card members have.

And I think you've heard me say before I grew up on a farm, so I believe and David believes in making hay while the sun shines.

So while those great returns continue and those great opportunities are there, we are going to keep investing into that.

Great.

Thanks for taking my questions.

We have Mark DeVries from Barclays online with a question.

Please go ahead.

Yes, thanks.

First question, Mark, I was hoping you could give us a little more detail about what you mean by margin remaining elevated for some time to come.

Based on what you know and you're seeing on asset yield trends and your CD repricing opportunity, is there a potential for a little bit more expansion in the NIM over the next couple of quarters before we see that eventually trend down?

I would say the very quick answer to the last part of your question is yes, there is opportunity for a little bit more improvement.

What I would say is I think we're going to provide a greater degree of insight to that at our financial community briefing next month.

So to keep the anticipation, up I think I'm going to say more to come on that front come February.

Okay, fair enough.

And then a separate question, Sallie Mae took a $70 million charge this past quarter on expected compliance for mediation efforts relating to ongoing regulatory [pleas] which we assume is tied to that CFPB's ongoing review of student loan servicing.

Is that something we should potentially expect to see from you in the coming quarters?

I don't really have any good visibility as to what their practices are or what the CFPB may or may not be suggesting to them.

I would just say that we are obviously under a continuous supervision by the CFPB in our student loan business and our other consumer businesses.

So we will remain vigilant to make sure we are doing the right thing, and -- but I couldn't comment on Sallie

Okay, but has there been any kind of intensification of level of activity you are seeing in interaction with them?

As I say, it is ongoing so there's not -- we have interaction with them and have had pretty continuous level of interaction with them since they were stood up, and we would expect to continue to have that level of activity and scrutiny.

Okay.

Appreciate the color.

[David Hall] from Deutsche Bank is online with a question.

Please go ahead.

Good afternoon, guys.

Just a question on capital.

With CCAR around the corner board, one of your competitors has been out warning of potential wide gap between its internal stress modeling scenarios and that of the Fed's.

Can you talk about how you're tackling this potential risk and potentially narrowing the gap and the work you've done over the past year?

Sure.

It is hard for me to comment quite honestly on what the Fed's model is going to produce until we actually have a chance to see with the Fed's model is going to produce, so I think that part of the question I can say better directed at them.

I think if you look back at the actual results from last year, I think last year there was a pretty meaningful disconnect between the submitted stress losses and the calculated stress losses that came back from the Fed.

Just extrapolating that forward, I think there's probably a high degree of probability that that situation persists.

With respect to our CCAR filing on balance, we filed what I would say we believe to be an appropriately aggressive ask a few weeks ago, David, and I think we've been pretty transparent with the market about where we believe the orange cones are said with respect to payouts in this environment.

And we've also tried hard to keep front and center of the fact that we are required to submit our request in terms of payout dollars, and aren't allowed to submit a request for a payout ratio.

So we along with a number of our competitors, who received approvals for some pretty high theoretical payout ratios last year, didn't really approach those percentages due to the strong year we both -- or several of us turned in relative to what's forecast by some pretty lockdown quantitative models.

I guess what I would say is there's no way for me to handicap exactly what the Fed's models are going to say, but we think we made an aggressive ask.

We understand our shareholders want us to increase the already high levels of capital distributions we've got, and within the current environmental constraints we are working hard to achieve that goal.

That's helpful.

Switching gears a little bit, obviously you are getting good growth in personal loans.

Can you talk a little bit about where in the credit spectrum you're seeing the most growth, and maybe the competitive landscape?

You obviously have a very strong market share in prime space, is that where you are seeing a lot of competition, and then how about your prime?

I would say it is very focused on the prime space.

In fact, the FICO scores that we see in our originated personal loans are significantly higher than what we have even in the credit card space, where as you know we are a prime lender there as well.

There is a good amount of it that's cross-sell, and so that is very helpful.

And I think in terms of competition, I'm not -- I think that we have focused may be more on this opportunity than others.

Some others were not in the prime space a number of years ago and got burned, and so I think that means we are one of only a few that are really focused on this, and especially when you look at the prime space.

Is there any risk of competition heating up any time soon, or is it basically a vacuum at this point?

You know, there's always competition, and I think if you look at our growth, you can see that we are doing well in the face of the competition we are seeing.

So I think I'd leave it at that, other than we are continuing to evolve the product and to offer more options for customers, more value for customers.

And so, even as more people maybe get back in the water, I would think we could hold our own, because we are continuing to improve the segmentation, the marketing, and the products themselves.

Great, thanks a lot.

Bill Carcache from Nomura is online with a question.

Please go ahead.

Thanks.

You've touched on this will bit, but I wanted to follow-up, you guys -- on loan growth -- you guys are continuing to put up industry-leading credit card loan growth, but it is decelerated a bit.

At this time last year, the year-over-year growth rate was well above 5%, but now it's gradually fallen to -- last December, I think it was 3.9%.

I realize that you're comping against tougher numbers, but could you talk a little bit more, is it really just the segmentation that you talked about just now, or are there other things that perhaps you would expect to kick-start that growth back towards the 5% range?

Well, as you have said, the comps are getting a bit tougher, being right at the top end of our 2% to 5% range wasn't necessarily something we thought we could hold forever.

But that being said, we are absolutely looking at opportunities to stay as close to the top of that 2% to 5% range as we can, and if we can find additional opportunities to accelerate the growth, Mark talked about the marketing spend, that's certainly one of the levers that we are going to continue to look at.

We are continuing to add features.

I would note the new FICO score is unique and has been well received so far.

So we will do everything we can to maintain our industry-leading loan growth in the prime credit space.

Okay.

And a follow-up on your outlook, can you give an update on your interest level in general-purpose reloadable prepaid space and also perhaps discuss your outlook for transaction processing revenue growth from PULSE?

I would say that most of our involvement with prepaid has been as a network to some of the leaders in prepaid.

It's still a evolving market.

You've seen some new people make big moves in it.

You've also seen people announce they're withdrawing from it.

So I would say we are being cautious.

I think it's -- there's -- the thing that we are most interested in is doing sort of nonstandard things that are really maybe out-of-the-box, maybe with partners.

And if we can find the right opportunities, we would maybe expanded in the future.

But we don't have -- we don't have a big interest of just being 1 of 100 cards on a rack in a retailer right now.

We are more interested in doing things that are really going to help consumers.

Okay, and the transaction processing revenue growth outlook for PULSE?

That's it.

I think what you are seeing is that we've somewhat stabilized a bit.

We are still facing some challenges both in -- on the PULSE volume and margins, which we've talked about numerous times before, as well as continuing challenges in Europe, in particular on Diners Club.

But we are working on additional opportunities to try to really get back to more of the level of growing profits and revenue, more like the numbers we put on the board for five years before this recent difficult patch.

Okay, that's helpful.

Thank you very much.

Craig Maurer from CLSA is online with a question.

Please go ahead.

Good evening.

Regarding your spend growth on your proprietary cards, it looked fairly anemic to the better players we look at in this segment.

So wondering, do think this is a demographic issue, or what would you attribute that to?

Secondly, you discussed you had trimmed the categories of 5% cashback year-on-year in half from two to one.

Was there less opportunity to go after spending so you trimmed what you were willing to spend to go after that?

I'm curious, because again the spend growth on the proprietary cards looked weak.

You know, what I would say is that our spend growth was still a little bit higher than retail spending, so we are continuing to grow with merchants.

You are right that there are a number of competitors who are putting up much bigger numbers on sales volume.

One of the things we look at is sales volumes with revolvers versus the high transactors, and one of the things that's happening in today's economy is that the big spending transacting -- transactor volume is growing a lot, and the prime revolver sales are not growing a lot.

But we are actually doing very well compared to our competitors in that segment that we are focused on.

And so corporate spending, high TN&E, high NT&E, we just don't participate in some of those segments the way some of our competitors are.

We think that our model is more sustainable in the long run, especially when cost of funds return and flow returns tomorrow normal levels and especially if there's any downward pressure on interchange, we think we are in a more sustainable place.

I didn't exactly understand the rewards question.

And, Craig, the second part of your question was around the rewards, the amount of expense we had --

It was the decision to trim the categories that had high cash back levels.

I would think about the fourth quarter of 2012 as being the more unusual time.

We normally would have one big promotion each quarter.

That particular year we had two.

That drove some incremental sales last year, and we didn't repeat it this year.

So you've seen a nice benefit on the cashback bonus expense, but as you'd expense especially looking at that high comp last year, we didn't repeat the extra sales burst that we had a year ago.

Yes, Craig, what I would say is that going forward I would expect continued variability in the rewards line, because quarter-over-quarter we are going to tackle different things to drive the result we are looking for at that particular time and make sure we are getting the customer engagement we are looking for.

I think over the long haul, kind of a 1% rewards rate is still the right way to think about what we are targeting, but you are going to have some degree of variability around that number quarter-over-quarter.

Okay.

Thank you.

Don Fandetti from Citigroup is online with a question.

Please go ahead.

David, thanks for the color on the loan growth for Discover.

I was curious if you wouldn't mind maybe talking about the industry in card loan growth in general, what your general outlook is?

It seems like if you look at some of the data, it might suggest a slight improvement in the trajectory, but I'm not sure if you are seeing that or what you think the pluses and minuses are for industry growth?

Don, I'm expecting a pickup in loan growth.

I have not very many data points that support it.

If I look through our competitor results recently, I didn't see really anyone besides us and American Express that grew loans.

And so I think that it is -- the industry as a whole is just kind of flat, with a couple of us growing and more people shrinking.

I think that as we go through this year, I still expect that loan growth in the industry ought to return to more like at least GDP growth.

And I think that if that happens, and that would obviously be good for us, because I would hope to participate in some of that faster industry growth, because right now all of our growth is from taking share.

The industry is generally flat now, so I guess GDP may be 2% or 3%, that's actually a decent little pickup.

That would be a decent pickup.

I don't -- I'm not -- our plans across the next few years don't have the industry returning to rapid industry growth.

I think there was a period of time when there was rapid growth, product innovation, balance transfer, all kinds of innovations, big reset, big deleveraging after the financial crisis, three years of down in the industry, three years of flat.

I think it probably returns to slow single-digit growth as an industry, and what our strategy is to continue to grow faster than the industry.

Thank you.

Ken Bruce from Bank of America Merrill Lynch is on the line with a question.

Please go ahead.

Thank you, good evening.

My question really picks up where you left off with Don's question, I guess.

As you look forward into this slow growth environment, you've commented that you expect to keep the marketing spend high in terms of driving your growth.

This is all about card acquisitions I suppose, and certainly it is what you've been driving with Discover.

Can you give us some sense as to how you think you can continue to gain share in what the competitive backdrop is doing within the revolving credit space, since that's really where you're going to take share?

When I think, Ken, about growth, I think about it in three ways.

One of those ways is putting on new accounts, as you say, and having strong products, and I'm very proud of Discover It.

I'm proud of our marketing, our commercials, our online digital presence, and that's very important.

I would say that maybe an even bigger share of our growth will actually come from our existing base.

We still have a very loyal customer base.

We still have our customers who have a lot of spend and balances elsewhere, and we've been making good inroads to gradually move them over with our better service and value.

But that's the best place to pick up growth.

The third area is retention, and as long as we can maintain lower charge-offs and lower attrition, because we are keeping our customers happier, we are not having as much of a leaky bucket as the rest of the industry has.

And so I would think about those three together, and growing an extra 1% faster, 2% faster, 5% faster, obviously really adds up and will, in conjunction with the new products that we put on which are going much faster than credit cards, help offset the credit tailwind that will eventually become a least somewhat of a headwind at least from a -- especially from a provision and reserves perspective.

Okay, and just following on with that, you pointed out in a number of occasions that the Discover It product is slightly different than some of your prior products just from the standpoint of how you would expect loan growth to come into the portfolio over time.

Is there any way to dimension that, in terms of how much back-loaded that might be, in terms of the embedded growth that's actually come into the portfolio through Discover It?

I'm not prepared to address that on this call.

We will think about what we might be able to share at Investor Day on that, Ken.

Okay, thank you very much, and look forward to Investor Day.

It sounds like it is going to be a good one.

We hope so.

Thank you.

Brad Ball from Evercore is online with question.

Please go ahead.

Thanks.

Regarding the PCI private student loan pools that were underperforming, Mark, I wonder if you could talk about what was -- what drove that under-performance relative to your expectations, and are you seeing any of those factors impacting your non-PCI private loan book?

The quick answer, Brad, is that the pools are stratified based on origination vintage, and it is one pool in particular from one particular vintage year of origination that is underperforming the expectation there.

So it is not -- the under-performance issue doesn't bleed across shall we say the other pools at all.

And with respect to whether or not we are seeing the same impact in our own organically-originated book, the answer is no.

We are not seeing the same impact in our own original -- organically-originated book.

So is the under performance then related to the structure of the loans in that pool, or whether they were co-signed, or is there some other factor there?

I think it relates to the origination criteria, for lack of a better term, that were utilized in that particular year of origination.

And I think it just relates to the fact that that particular year the market was a little bit more heated, shall we say, than it was in subsequent and prior years.

Remember that it's versus our expectations that were made at the time of the purchase as well.

Correct.

So if our expectations -- it may be different on an absolute basis even, but if our expectations were off from actual, that's what causes the accounting.

So if you think about it, if you look across the pools that are a couple that are performing better than expectations when we acquired them.

There are a couple that are performing worse, one of which is really the driver here, to be honest.

And there are several that are performing right in line with expectations.

So if you look at the portfolio in aggregate, overall it is performing better than we expected at the time we acquired it.

So a one-time impact, no reason to expect that there will be future reserve adjustments related to that one pool?

I wouldn't say it is one-time.

I would think about it the same way as I would think about it -- you've got to bifurcate it, so it is a unidirectional kind of issue, if that's a real word.

Basically if that pool's performance gets worse from here relative to our expectations, you would see us post additional reserves against that pool.

If the pools that are performing better than our expectations get even better yet, you'll look to see as post further accretable yield on those portfolios going forward.

So it's a -- you have to bifurcate, because the accounting for deterioration is reserves, the accounting for improvement is yield accretion.

Okay, fair enough, and then if I may on the personal loan book you grew 27% this year I think over 20% last year.

What are the constraints on growth, or are there any?

Could you grow that even greater than you have?

And are you seeing a distinct pickup in demand for debt consolidation loans in the current environment?

I would say that we feel like we are growing it appropriately, and at some point the growth rate will start to slow down, just by the law of large numbers, but I've been very pleased that we've maintained those kind of growth rates.

I think that -- if I look longer-term the personal loan market is a lot smaller than the home equity market.

So if you think about it, one of the reasons we strategically entered the home equity market this year was A, we think the timing is right from an interest-rate perspective and the fact that home equity is being rebuilt for a number of consumers, and secondly, because we think there's good growth over time in a market that's much larger which is home equity being much larger than personal loans and certainly than student loans as well.

-- private student loans.

And you see the home equity product playing a debt consolidation role in the future?

Yes, I think that it is a combination of home improvement as well as debt consolidation, but to some degree it gives us a more continuous product line.

If someone is just doing a small consolidation, maybe a balance transfer on the credit card is fine.

If someone is doing a moderate consolidation, that's what our personal loans are for, generally $15,000 -- $20,000 kind of range.

If someone has a larger amount that they are consolidating or they are doing a major improvement, that's where the $20,000 to $100,000 line secured by -- it's a secured loan, and home equity kicks in.

Great, thank you.

David Hochstim from Buckingham Research is online with a question.

Please go ahead.

Thanks.

Could you give us any update on what's happening with the Paypal and Ariba partnerships in payment services?

Is there anything in revenues or expenses there this quarter that's meaningful?

I'd say that they are continuing -- there's nothing unusual in terms of expenses this particular quarter on either of those.

Obviously, we have a lot of work to do.

We've made really good progress on both, especially Paypal, we've signed a lot of acquires and put up some merchants.

Ariba is still in the development phase, and then we will go into the pilot phase.

So it is not going to be -- neither one of them have really -- have launched.

So we are continuing to make progress with our partners towards an ultimate launch.

Okay, maybe just related to the $2 million provision for losses in payment services as far as that -- any where -- we are familiar with?

I'm sorry, David, you faded out there.

In payment services this quarter, you had another very tiny reported provision for losses.

Yes.

Wondering what that is.

Yes, that's related to the Diners Club line of business.

And it is specifically a provision related to a loan that we have outstanding to a European franchisee.

Okay.

Can you tell us what we should think about for a tax rate for 2014?

Yes, I would think about really our more normalized tax rate to be in the 37% to 38% range.

We will give you some more guidance on that at Investor Day, but right now I think that's pretty good way to range it.

Okay, great, thank you.

Moshe Orenbuch from Credit Suisse is online with a question.

Please go ahead.

Great, thanks.

David, I was struck by your comment about cost per account being low, and I'm sure that's going to be a significant competitive advantage.

Can you talk a little bit of what you ascribe that to?

Is it the fact that everybody else is beating one another over the head to issue Visa cards or MasterCards?

Or is it product design?

How do you think about that, and how do you think about using that going forward?

First, I would say we don't have great visibility as to what our competitors cost per account are, and I think they vary all over the place.

They might ascribe incrementally low costs for a branch originated account as an example, and we obviously don't originate through bank branches.

When we think about cost per account, I'm thinking more compared to our historical averages, and ours are lower than they have been as -- because we've got a differentiated product with a large number of unique features in Discover It.

And I think we've also gotten better at marketing it as we strengthen our brand, strengthen our acceptance, leverage some of our major sponsorships, and so I think that we need to continue to go to market as a differentiated brand.

We are Discover, we are not just another Visa or MasterCard.

We've got unique features; we keep adding to them.

And then we provide -- increasingly, people know that we stand for great service as well as value.

The Internet and the move to digital I think is another thing that I would point you to, because I think that we face a lot of rejection in direct mail, and increasingly we are finding ways to leverage the Internet to be the account generation machine.

Just to follow-up on the discussion of the difference between the growth rate -- your growth rate in spending volume versus balances and compared to the industry, one of the things we've talked about in the past is that obviously you could get there by increasing balance transfers.

The numbers that I would look at suggest that actually you are doing less balance transfer than in prior periods.

Is that a fair characterization?

That is correct.

We are more -- it is a little difficult to parse through, because what you don't see is the mix.

We just backed off from balance transfer, and if that was the only change, then you'd see maybe sales going faster than receivables.

But as I say, we kind of looked at revolvers versus transactors, and we are fundamentally giving up share purposely in transactors, and we are gaining shares on prime revolvers.

And that's why the numbers are -- our sales in receivables for the year were both up by about 4%, and that's pretty well matched up.

Great, thank you.

If you look at the growth on the quarter about two thirds of it comes from what I would call regular way spend, and only about a third of that is going to come out of any type of promotional activity, of which BT is only a subset of that third.

The nature of the growth in the quarter from my perspective feels very, very healthy.

We have a healthy payment rate, but it is pretty stable.

If you get look at most of our competitors, their payment rates are continuing to rise, so they are basically bringing money in, and it is being paid off at a faster and faster rate, and we are not doing that.

Great, thanks.

Chris Donat from Sandler O'Neill is online with a question.

Please go ahead.

Thanks for taking my questions.

Mark, just wanted to ask one more question on the private student loans, and the timing of the recognition on the accretable yield.

Is that safe to assume we are talking a number that's a little north of $28 million that gets spread out over something like 5 to 10 years?

It is going to be spread out over about five years or so, in terms of timing in terms of the way to think about it, and from the standpoint of a more or less a specific number, what I guide you back to is essentially 100% of the increase in yield in the fourth quarter was driven by that accretion, and that represented only one month's worth of inclusion of that accretion.

So you can calculate what a full month's worth of that would look like, and extrapolate that over five years with a slightly declining balance due to payoffs, and you'll get to your number.

Got it, okay.

That helps me on that.

And then just to ask a hypothetical with the news on Paypal, there's nothing as far as Paypal separating from eBay that would trigger any changes in your current relationship and plans, right?

You're steady as you go with Paypal, I imagine, right?

I think you'd be jumping to a conclusion that they are going to separate in the first place.

We certainly we are seeing a lot more well-run large companies with activists in the stocks, and so I personally would be really surprised if we saw a change there.

Okay.

Just thought I'd throw it out there.

Thanks.

Bob Napoli from William Blair is online with a question.

Please go ahead.

Thank you.

Just like to get some insight on your thoughts about the economy, David, where you -- your view on whether the economy in the US is getting a little bit better or stable, from your view?

I'd say the numbers I'm seeing at the moment suggest stability.

I think that we have the potential to accelerate, and we need to get that past this debt limit without self-inflicting wounds to ourselves.

But if I look at a whole number of things, the less fiscal constraint, as we saw last year with tax increases and reduced spending, that certainly reduced GDP growth.

That shouldn't occur nearly as much this year, so that's helpful.

The unemployment rate continues to tick down.

We've seen some mostly better numbers coming out.

I don't think it has really translated into sales growth that's sustained, and we went through three years of feeling better in the first quarter and then things deteriorated.

I'm hopeful that this year, they will actually maintain or even get better through the year.

So I'm hopeful, but I don't really have -- we need a couple data points of GDP growth and unemployment that keep going in the right direction before we can, I think, declare a strong upward trend.

On the growth side, you talk about hoping to get a little bit of a pickup in the card loan growth, the personal loans still very strong growth.

The student loan market seems to have slowed a little bit, looking at your growth this quarter, Sallie Mae's growth, and I think there's good news that maybe college prices are going up a little less than they have been in prior years, but maybe there are less people going into college.

I was just wondering what you felt like on outlook for loan growth on the student loan side, and then how quickly will the home equity loan become material to you?

Is this a material product in '14, or are we looking a few more years down the road?

I guess I would be hopeful that we could achieve a little bit higher loan growth this year than last on private student loans ourselves, because last year we had the headwind of going from two brands to one, which we overcame, but this year we don't have that same headwind, but we are not looking for anything quite dramatic.

As you mentioned tuition cost finally seem to at least slow down their increase, and I think that is a good thing., but that impacts the size of the market.

In terms of the personal loans, I think that --

Home equity.

I'm sorry, equity.

In terms of home equity, I think that this is our first year, and I think just like when we entered student loans and personal loans, our first year was pretty modest in terms of easing into a new business.

So I think we will err on the side of being cautious at year one, and then I think in subsequent years we would hope to accelerate it as we have more testing under our belts and understand in particular what marketing sales work better versus less well, what's the best marketing pitch, our operations are starting to scale up, and so I would think modestly about this first year.

If I can sneak this in, on the capital side, you've grown capital this year even while aggressively buying back stock, and the Fed -- to the CCAR, it doesn't seem like they will let you buy back more capital than what you generate in the current year.

Are there any thoughts on more maybe looking at acquisitions?

It is a great problem to have, and where your stock is, it is very accretive buying back that stock.

But what are your thoughts -- you don't want to continue to see the capital level build, I'm sure.

Yes, I would -- we've noticed that as well.

We are doing what we can to be good stewards of our shareholders' capital.

But I guess it is a nice problem to have that we are so profitable that we still build book value, I think 15% this year despite buying back and having dividends of about $1.5 billion.

We will -- I think there's the potential, because we submit the capital request on a dollar basis, not a percentage basis, and we really can't adjust easily.

We would be a lot closer to paying out our full earnings in a year, if we didn't exceed our earnings by so much.

I don't know which one you'd rather have, probably exceeding earnings and accreting capital is probably the better problem to have, but it does result in putting pressure on our ROE.

The fact that we've got a 22% -- achieved a 22% ROE even with the higher capital, though, I think you should for good about this quarter.

Thank you.

Eric Wasserstrom from SunTrust Robinson is online with a question.

Please go ahead.

Thanks, just a couple of quick follow-ups.

The first is, I'd be interested to understand, in your process of going through the CCAR exam for the first time, what you thought the most meaningful differences were from your former CAPR experience?

Sure.

I would say the cases we look at and the stresses we are required to run, I would say are essentially the same.

The big difference between the CAPR and the CCAR is we have to ship a significant amount of raw data to the Fed measured as in hundreds of billions of dollars -- billions with a b -- hundreds of billions of fields of data actually get shipped to them, so that they can run there own models on us and come up with the independent perspective there.

So I would say the differences are really more in terms of in the CAPR process, they come and pressure test your submission, your models, and your stresses.

In the CCAR process they do all of that, but then they also come in on top and run their own models.

And I think our first year through, the most telling thing will come out in a couple months, when we get a sense for how their are models view the loss rates that our data produced under a stressed scenario.

What I would say is hold that question to the next quarter's Q&A, and we will be able to give you a pretty clear perspective on the deltas between how we are looking at our loss picks and how the Fed is.

The other thing I would add is just the process itself is even more rigorous, with more Board involvement, and more validation of models and so on.

And so not so much the varying of the cases, but the strength of the process, which we have made major investments on and have dramatically enhanced this year versus last year.

Yes, I think one of the things I've said in a couple settings is that we've not been shy about spending money to make sure we are ready for the CCAR process this year.

It is our first year, we are lucky, we acknowledge that, and for us not to bring in external resources who have helped others through this process in the past and have the benefit of those learnings, I think would have been shortsighted.

We've not been shy about making sure we've invested to be prepared.

Then if I can I can just sneak in a couple follow-ups.

What should we think about terms of your go-forward tax rate from here?

I think about it as 37% to 38% range, is the right approach.

Okay.

And the other income that was up sequentially, I was surprised to see that, just given the continued decline in margin origination.

What accounted for that small sequential uptick?

Are you referring to the $3 million in other other income?

Correct

I think it was a bunch of cats and dogs --

It is cats and dogs, is the answer to the question.

There's nothing specific to call out in there.

Got it.

Thanks very much.

You bet.

Daniel Furtado from Jefferies is online with a question.

Please go ahead.

Good evening, everybody.

I have one question, and I don't know if you'll be able to answer or not, but how meaningful do you anticipate rewards checking product to be for your funding base, and what type of impacts broadly speaking would you anticipate this product to have on your funding costs?

Danny, I would think about it as not being meaningful in the short term.

In the long-term, we certainly expect it to be meaningful.

I am really excited about it, because it is uniquely valuable to consumers having cash back bonus, no fee, no monthly fees, and very feature-rich product.

So far we've only sold it through cross-sell this year.

We are on track for launching it broad-market.

The good news is it is a great product.

The bad news is that it is a very sticky product, and so we think it is going to take a long time to get people aware of the savings that they can have from this product, as well as to wean them from what they are used to, which is the bank down the street.

I think we have modest growth plans in the near-term as we launch this, because it is new and different.

Got you.

Thank you for the commentary there.

You're welcome, Danny.

Brian Foran from Autonomous is online with a question.

Please go ahead.

At the Investor Day last year you had laid out the six strategic initiatives, and you have touched on most of them.

I was wondering maybe just to clean up, if you could remind us where the core banking system replacement or upgrade stands.

And then more broadly, the It card clearly has been a big success, the mortgage business, notwithstanding recent refi slowdown, has been a success, and you touched on home equity.

When you think about the other four you had laid out, clearly there have been some headwinds.

And I wonder of those other four, the deposit, the checking, the PayPal, et cetera, is it just a delay in the ultimate opportunity, or is there anywhere where you've kind of downgraded your internal thinking on what the opportunity actually is?

Sure.

I don't want to go through all of those, because we will have to cancel our Investor Day, because, as you know, we always do a report card on how we did and then talk about our priorities for the coming year.

But I'd say generally the ones that we had hoped to launch but didn't are all delayed as opposed to -- I don't think any of them have been canceled, so you started off by asking about the core banking system.

We had originally hoped to get that live at the end of last year, and that's moved move into this year, but we are on track for putting it in.

But obviously it is more important, a lot more important to put a system in right with low risk, as opposed to getting it in fast, and I think that's true with some of the other priorities.

Many of them we nailed during the year, and some others have slipped from '13 into '14.

Then just circling back to the acquisitions question.

Clearly, you guys have always been very low risk, very conservative and thoughtful over time doing acquisitions.

But I wonder specifically on the topic of portfolio acquisitions, if there's anything floating around out there that is worth looking at and interesting to you at this point?

You know, you mentioned portfolio acquisitions and that's not really -- I think if you look at what we've done it has been more business acquisitions.

If you think about student loans or mortgages, or even PULSE and Diners Club over the years, and we continue to look at potential acquisitions, but I just wouldn't count on anything, because as you say, we are cautious.

It is a lot more difficult making acquisitions with the regulatory environment, and we want to make sure that we don't buy something that then has problems or what have you.

So we're -- maybe in this current environment, we are even more cautious than we normally are.

But that being said, if it is the right fit, the right financials and unique for us, we would love to put some of our capital to work.

Thank you.

Matthew Howlett from UBS is online with a question.

Please go ahead.

Yes.

My question has been already asked.

Thank you.

Thank you.

We have no further questions at this time.

Thank you, ladies and gentlemen, this concludes today's conference.

Thank you for participating.

You may now disconnect.

Thank you, all.

Thank you.