發現金融 (DFS) 2016 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Discover Financial Services first quarter 2016 earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Bill Franklin, head of Investor Relations.

You may begin your conference.

Thank you, Connor.

Good afternoon, everyone.

We appreciate all of you for joining us.

Let me begin, as always, with slide 2 of our earnings presentation, which is in the Investor Relations section of Discover.com.

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 provided to the SEC today in an 8-K report, and in our 10-K and 10-Qs, which are on our website and on file with the SEC.

In the first quarter 2016 earnings materials, 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 today will include formal remarks from 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.

During the Q&A period, it would be very helpful if you limit yourself to one question, so we can make sure that everyone is accommodated.

So now it is my pleasure to turn the call over to David.

Thanks, Bill, and welcome, all of you, to our call.

For the first quarter, we delivered net income of $575 million, earnings per share of $1.35, and a return on equity of 21%.

Our direct banking business continues to deliver solid results.

Discover achieved total loan growth of 4% over the prior year, which now brings us into the lower end of our targeted range for 2016.

Specifically, we grew card receivables by 4%, accelerating year-over-year growth versus the fourth quarter.

This receivables growth was the result of more new accounts and slightly higher customer spending and borrowing on cards, as our overall revolver mix for the portfolio increased.

Our brand, rewards and overall value proposition remained focused on the prime revolver segment, which we believe is the most profitable part of the card market.

Card sales grew by 4% over the prior year.

Excluding the impact of gas prices, sales were up approximately 6%, which shows that the lower gas prices at the pump remain a drag on card sales.

Also, I'll point out that leap year in the first quarter added roughly 1% to sales growth.

Last quarter, we were recognized as highest in customer loyalty in the annual Brand Keys survey.

This marks the 20th consecutive year that we've earned the top spot.

I believe our focus on the customer has allowed us to have some of the lowest attrition rates in the industry and will continue to allow us to grow loans profitably.

Our other lending products are performing well.

The organic student loan portfolio increased 15% and personal loans grew 9% over the prior year.

The strong organic student loan growth was driven by disbursements related to students going back to school for the second semester and our continued focus on increasing awareness of Discover student loans.

On the funding side, I'm very pleased with the 6% sequential increase in direct-to-consumer deposits.

Our consumer deposits grew approximately $2 billion and made up 45% of funding at the quarter end.

We captured the growth as investments in marketing over the last several months delivered positive results, specifically in savings accounts and balances.

Moving to our payments business, total volume for the segment declined, as increases in network partners and Diner's Club volume were offset by year-over-year declines in debit volume at Pulse.

We believe Pulse volumes will stabilize at approximately current levels for the remainder of the year.

Lastly, in payments, we continue to leverage our proprietary network to deliver great returns in our card issuing business and are pleased with the increasing domestic and global acceptance.

Overall, it was a good quarter and we're making progress against our key focus areas for the year.

Now, I'll turn the call over to Mark and he'll walk you through the details of our first quarter financial results.

Thanks, David, and good afternoon, everyone.

I'll start by going through the revenue detail on slide 5 of our earnings presentation.

Net interest income increased $121 million, or 7% over the prior year, driven by continued loan growth and a higher net interest margin.

Total non-interest income decreased $68 million, to $474 million.

The prior year's results included $42 million in mortgage origination revenue, a category that is absent this year as we subsequently exited the business.

Net discount and interchange revenue was up 2%, driven by increased sales, partially offset by a higher rewards rate year-over-year.

Our rewards rate for the quarter was 106 basis points, up 4 basis points over the prior year due to higher promotional and standard rewards.

Sequentially, the rewards rate was down 12 basis points.

The fourth quarter typically represents a seasonal high and also included the Apple Pay rewards bonus.

Protection products revenue declined $10 million, as new product sales remain suspended.

Sequentially, protection products revenue was relatively flat; however, we continue to expect some runoff this year.

Moving to payment services, revenue decreased $6 million from the prior year, mainly due to the previously announced loss of volume from a third-party issuer.

Overall, we grew total company net revenues by 2% for the quarter.

Turning to slide 6, total loan yield of 11.69% was 32 basis points higher than the prior year, primarily driven by a 37-basis point increase in card yields.

The year-over-year increase in yield was primarily due to a higher percentage of revolving card receivables in the portfolio, as well as the impact of the prime rate increase in December.

On the funding side, we grew average direct-to-consumer deposits 9%, and we've completed two ABS deals year-to-date.

Funding costs increased only 8 basis points, partly as a result of fixed rate debt issuances in the last year muting the impact of rising rates.

Overall, net interest margin expanded 25 basis points from the prior year, to 9.94%.

We achieved good acceleration in card loan growth through stronger sales and an increased revolve rate, so we did not feel a need to increase our promotional mix during the quarter.

However, looking forward, we may yet choose to invest some of this NIM benefit to drive continued loan growth.

Turning to slide 7, operating expenses were up $13 million over the prior year.

Last year's results included $37 million in expense associated with the direct mortgage origination business, more than half of which was reflected in employee compensation.

The $14 million year-over-year increase in total employee compensation you see in the table was driven primarily by higher headcount to support compliance activities, as well as annual merit increases.

Marketing expenses decreased $20 million, due in part to the timing of card marketing, as well as the elimination of mortgage marketing activities.

Professional fees increased $33 million, to $160 million, as expenses associated with the AML/BSA lookback project totaled approximately $30 million for the quarters.

We expect the lookback project costs to be largely complete in the first half of this year.

And finally, other expense was lower, as the prior year included a $20 million addition to the legal reserve.

For the quarter, our total company efficiency ratio was about 40%.

However, if you exclude the $30 million lookback project expense I mentioned a moment ago, total company efficiency ratio was roughly 38.5%.

Turning to provision for loan losses and credit on slide 8, provision for loan losses was higher by $34 million compared to the prior year, due to higher reserves and charge-offs, primarily driven by loan growth.

This quarter, we increased reserves $52 million, while last year we had a $30 million reserve build.

The credit card net charge-off rate of 2.34% decreased by 6 basis points year-over-year and increased 16 basis points sequentially.

The 30-plus day delinquency rate of 1.68% increased 4 basis points year-over-year and was down 4 basis points sequentially.

On balance, the credit backdrop continues to remain benign and reserving continues to be driven primarily by the compounding effect of several years of consistent loan growth, a meaningful portion of which has come from new accounts.

Moving to private student loans, the net charge-off rate, excluding acquired loans, decreased 18 basis points from the prior year, benefiting from the benign credit environment, as well as a couple of items that we've discussed in the past, specifically, more effective collection strategies, as well as the introduction of several new payment plans over the last year.

Student loan delinquencies, once again excluding acquired loans, increased 26 basis points to 1.92%, as a larger portion of the portfolio continues to come into repayment.

Overall, the student loan portfolio continues to season generally in line with our expectations.

Switching to personal loans, the net charge-off rate was up 23 basis points from the prior year and the over 30-day delinquency rate was up 21 basis points, to 97 basis points.

The year-over-year increases in the personal loan charge-off and delinquency rates were primarily driven by the expected seasoning of recent loan growth.

Next, I'll touch on our capital position on slide 9. Our common equity Tier 1 capital ratio increased sequentially by 30 basis points to 14.2%, due to the seasonal decline in loan balances from the fourth quarter.

This ratio declined 50 basis points from the prior year, due to capital deployment in the form of loan growth, buybacks, and dividends.

In the quarter, we again repurchased nearly 2% of our common stock.

Lastly, while we did not recognize any material tax benefits this period, there will be a favorable resolution to an outstanding tax matter which will have the one-time effect of lowering the effective tax rate for the second quarter.

In summary, it feels like a good start to the year, with a strong margin and good loan growth and a continued benign credit environment.

We expect to see provisioning driven by loan growth and will continue to work diligently to manage the core expense base as we absorb increasing regulatory and compliance costs.

That concludes our formal remarks.

So now I'll turn the call back to our operator, Connor, to open the line up for Q&A.

Connor?

(Operator Instructions)

Our first comes from the line of Sanjay Sakhrani from KBW.

Thank you.

Good afternoon.

Just had a question on the revolve rate.

Was wondering if you could just talk about what drove that higher.

Was it something that you guys were doing, or was it just a broader consumer trend?

Obviously, in this market, people are jittery about the macro.

Any comments on the macro would be helpful, as well.

Thank you.

Sanjay, it's Mark.

I'll let David pile on, as well, here, but I think the revolve rate was really driven by a continued focus on the revolver in our book.

And I think, as we telegraphed on the last, on the call last quarter, over the course of last year we pulled back a number of activities that weren't driving the kinds of behavior that we wanted to see in the book and had refocused our efforts really along some of the more traditional areas, where we had emphasized growth in the portfolio.

And that's paid very significant dividends over the course of the last quarter.

I would say it's paid dividends not only in the form of growth from balances from new accounts, but also growth in formerly dormant accounts that have reactivated also showed good contribution to growth in that regard.

And the only thing I would add is we have been talking about the continued impact of gas prices on sales, and that has much less of an impact on loans and has the effect of helping the revolve rate a bit.

Okay.

And any comments, David, on just the state of the consumer or on the macro?

You know, I think it continues to be steady, but slow, growth.

And we're seeing sales continue to kind of bump along, increasing from last year.

But the consumers are continuing to be cautious, and that makes it tough on the sales line, but is certainly benefiting the credit line, where the caution is showing up in continuing great credit results.

Okay.

Great.

Thank you.

Our next question comes from the line of John Hecht with Jefferies.

Thanks very much, guys.

Real quick, Mark, can you quantify the tax benefit in Q2, just so we have it for a model perspective?

Yes, I would say with respect to tax benefit, it relates to a matter that's disclosed in our SEC filings.

It's the OID treatment of cash back bonus.

It's for an extended period from 1999 to 2007, and it's a pretty complex matter over a number of years, so we are still in the process of putting a fine point on it.

I guess what I would say is on the tax line itself, it looks to be a mid-8 figure kind of number in the quarter that we would indeed recognize.

So I think that probably gives you a good triangulation for how to think about it.

Okay.

Thanks very much.

And then second question, you got a little bit better margin expansion than we expected from rising prime rate.

Is all that priced in the portfolio, or is there some kind of residual upside as we stretch into the second quarter?

No, I think it really relates to, we talked on the last call about a natural upward bias in the NIM in the book and that we thought we might lean more heavily into promotional activity.

We didn't end up doing that, as it turned out, because we saw growth reaccelerating along the lines of what we hoping for from a cadence perspective.

So I think I would say, as you look forward over this year, I would kind of discourage you from flattening NIM out and just saying, this is where it will be for the rest of the year.

I think there would be relative stability in NIM, but it could be affected by promotional activity, that revolving behavior, Sanjay asked about a second ago, and obviously, any further moves the Fed makes because of that positive bias in positioning.

Okay.

Appreciate the details.

Thanks very much.

You bet.

Our next question comes from the line of Ryan Nash with Goldman Sachs.

Good afternoon, everyone.

David, just following up on one of the questions that Sanjay asked about, could you maybe just talk about how the efforts to accelerate loan growth are going?

Last quarter, you laid out a handful of initiatives.

I was wondering if you could share how they are going, maybe any other metrics you have, account openings, activations, to help us understand what the pipeline could look like for loan growth for the rest of the year.

Sure.

Well, I think that the best indicator that our efforts are working in total is just to look at actual loan growth.

And so we accelerated from just over 3% to about 4% year over year.

And as you know, we had just established a new higher 4% to 6% full-year target, also for total loan growth, also for long-term to be in that target.

So I'm pleased at all of our various actions have moved us into that lower end of the range, and we're certainly taking efforts to continue to move higher in that range, if we're able to, later this year.

And I'd say those efforts include, I mentioned more new accounts.

We are continuing to look for places where we can appropriately increase credit lines or extend credit where we expect good -- and are achieving good results.

Also, some of our new features have been well received, whether it's some of our cash back, Freeze It, continued great take-up of free FICO scores.

So I'd say that we have -- I don't think there's a single home run kind of initiative for loan growth, but a whole lot of singles that we are working on across the franchise.

And Ryan, I'd add on to that, just quickly, the loan growth continues to be close to 50/50 new accounts, as well as existing accounts, which is a really healthy way to see that loan growth coming in.

And if you look at the $2.2 billion in card receivables growth over the course of the last year, over 80% of that is coming in what I'll call the standard merchandise bucket; customers just simply using their cards, exhibiting the behaviors that drive the kind of long-term profitability we want to see out of the book.

Got it.

So it feels very good.

Maybe I could just ask one other question, just on credit.

If I look this quarter, charge-offs were relatively stable.

Delinquencies were relatively stable, up a couple basis points.

I was wondering how do we think about the puts and takes?

And Mark, more specifically, since last quarter there was a wide range on outcomes for reserves for 1Q, could you help us how to think about the pace of reserve builds from here, just given there was a release in the second quarter last year?

I don't think you're anticipating a reserve release this time just want to understand how we should think about reserve builds from here.

Yes, so Ryan, happy to.

I think from my perspective, the $50 million or so we built this quarter, I continue to describe that as essentially noise on a $1.9 billion balance sheet item.

It's never going to be exactly flat.

It's always going to be bumping along a little bit one way or the other.

I would say provisioning from this point forward is going to continue to be a factor of loan growth and the seasoning of that loan growth.

I would not encourage anyone to expect a reserve release in the second quarter.

By the same token, I would not encourage anyone to assume there's going to be some giant take-off in provisioning in the second quarter, either.

It feels, again, it's going to be very much a function of loan growth and the seasoning of that loan growth, and it feels like we're in a good general band.

Thanks for taking my questions.

You bet.

Our next question comes from the line of Henry Coffey with Sterne Agee.

Yes, good afternoon, and thank you for taking my question.

When you look at the network side of the business, obviously Diner's Club has started to show some positive life and your expenses were lower.

What are the next steps forward there?

Well, I think I am pleased with the growth that you acknowledged in Diner's Club, as some of our new partners that have come online in recent years, in places like China and other areas, start to grow more robustly and same with network partners, with the volume up very nicely as other networks around the world increasingly coming online and using our network for global acceptance.

And I'd say the headwind has been quite severe in the largest segment, which is Pulse.

And as I mentioned in my comments, after several years of a downdraft following the [fanth] and paved actions that Visa took, as well as loss of one major customer, it feels like we have reached a plateau with Pulse, and I think after this year what we're looking to do is to go back to growing Pulse.

And we had a bunch of years of very robust growth in market share and volume in Pulse, up until the actions shortly after Durbin, Amendment went in.

And we're working to have that grow as well, while maintaining those newer areas like Diner's and network partners and AribaPay, where we're seeing nice growth add-on, as well.

Great.

And then on the overhead side of the equation, Mark, when does the AMLBSA, when do those extra expenses dwindle away?

So Henry, I'd put it in two buckets.

The lookback project that we continue to call out specifically, I think we see that, in terms of dollars of spend, largely drawing to a close next quarter, at this point in time.

So I think we can say that piece is close to being done with the case work.

I think the other piece of AMLBSA is really what I would call building out the AMLBSA process within the organization.

We're largely covering a lot of that increased expense through finding efficiencies elsewhere in the business model.

So I'd take you back to second of my prepared remarks where I said roughly a 40% efficiency ratio all-in.

But if you exclude that lookback that we expect to bleed off after next quarter, we're printing about a 38.5% efficiency ratio this quarter.

Now I think expenses are never flat.

I think next quarter they may be inflated a little bit as we bring some things across the goal line and all.

But I would stand by the expense guidance we gave at the beginning of the year.

Great.

And congratulations on a good quarter.

Thank you.

Thanks, Henry.

Our next question comes from the line of Chris Donat with Sandler O'Neill.

Hello.

Good afternoon.

Thanks for taking my question.

Wanted to explore on the personal loans business, because we've seen the deceleration of the growth there over the last couple of years and some of that's coincided with the entrance of the marketplace lenders or peer-to-peer lenders.

Are you seeing any changes in the competitive landscape there?

And would you have any hopes of getting the loan growth back up into the double digits in the coming year or so?

Well, I would encourage you to look at the dollars of loan growth, which last year was an all-time record for growth in our personal loan business.

And we continue to grow that very nicely and there was -- the only thing that's really changed is the denominator is getting bigger.

So percentage is dropping because of the denominator, even as the dollars of originations have gotten bigger.

I wouldn't cite market entrants or competition as being the slowdown.

I think going forward, we do think our model is more sustainable, since it's going on our balance sheet.

We have long-term customer relationships.

We are profitable, in contrast to some of the competitors who are printing some more difficult headlines right now.

And so, I think we have a very sustainable business model that we continue to grow, we think, well and appropriately.

Okay.

And just on the marketing side, I guess there were some timing issues that Mark had commented on.

So it's down 11% year on year.

Would you expect, Mark, it to be more flat year on year going forward, or even up?

Or is it just, are we in the ballpark in terms of year-on-year comparisons from here?

So I guess what I'd say is we're continuing to really manage the interplay between marketing spend, as well as rewards rate.

And as we're leaning a little bit more into rewards rate, with our double new account promotion and some of the other things we're doing, I think we're viewing that as interchangeable with the marketing spend.

So to some degree, some of the decline in marketing spend you see is related to that.

The other thing I would say is there's obviously some timing of spend, as I mentioned in my prepared remarks, that occurs throughout the course of the year.

The first quarter was not a particularly high point, from a marketing spend standpoint.

And then the other thing I would just point out is in the year-over-year comparison, we did have the mortgage marketing spend in there last year, which I would remind you, you kind of have to peel back out for comparability.

Those would really be the bits and pieces, puts and takes.

I think ultimately, we continue to have a very disciplined approach to marketing spend.

We want to make sure we're getting the results we see for it.

Again, when we saw we weren't getting some of the results we were looking for through some of the listing sites and other channels last year in the middle of the year, we pulled back on those, because we want to make sure we're driving the kind of growth that's going to drive the right kind of long-term profitability.

Got it.

Thanks very much.

Our next question comes from the line of Don Fandetti with Citigroup.

Yes, Mark, can you talk a little bit about the rewards being so low this quarter and how you're thinking about that in context of the full-year guidance?

And then maybe provide a little bit of color on your thoughts about the industry in general on rewards.

We're starting to see some pretty high offers, in the 5% range.

Want to get your updated thoughts there.

So I'll tackle the rate and dollar questions, then I'll let David talk about the industry trend.

I guess what I would say is we're still very comfortable with the full-year rewards rate at 115 basis points.

Couple things to think about there.

Number one, we are going to continue running our double rewards program for new accounts, at least for the next quarter and maybe beyond.

And I would say from the standpoint of the rewards perspective, it is down a little bit from where we were in the fourth quarter, but there's generally a peak seasonality effect in the fourth quarter.

And in addition, the fourth quarter was elevated because of Apple Pay and the special promotion we ran in the most recent fourth quarter.

So I think we're up about 4 basis points year over year in terms of reward's rates.

So that 115 on a full-year basis still feels like a good place to triangulate.

And I would just say that it's no surprise that competitors are aggressively offering cash rewards programs, because it's what consumers most want and it's just very attractive to consumers.

And I think that we are in a -- we've been at this game for 30 years now -- and I think our combination of 1% cash back, 5% rotating categories, additional value coming from our network partners who add value that doesn't hit our expense line, the elimination of breakage on the back end that we put in place a year ago, consumers still tell us that regardless of top line headline numbers, most consumers, we think, really like our program.

And we think we have the right balance between sustainable cost and great value to consumers.

So David, you don't see -- you're not sensing a big step forward in terms of accelerated reward offers.

It's more of just a continued, steady competitive environment?

I think so.

I think it accelerated a few years back.

Since that time, the competitors have swapped between years.

Two years ago, there was one competitor was heavy.

They kind of pulled back, then another one came in.

And so, I think we're at a fairly steady state, which is an intense environment, but I don't really see it getting worse from here.

And the history of the industry has been when people have something that seems unsustainable, they eventually peel it back.

But my guess is when some of those competitors peel back, someone else will enter the fray.

So we're competing as if this is going to be the -- we think it's the steady state, a lot of competition and we have to win this game.

Thank you.

From a value perspective and profit perspective.

Our next question comes from the line of David Ho with Deutsche Bank.

Good afternoon.

I just wanted to follow up on credit.

Have you seen any, on the margin credit deterioration, related to energy or even some of your lower FICO customers?

And a follow-up on that would be, would credit deterioration potentially come from some of your competitors increasing credit lines or just loosening that up over time?

David, it's Mark.

I'll take the first stab and David can pile on.

I would say with respect to the energy-related part of the question, we have seen some deterioration in the energy-related states, but I would describe it really as, prior to the significant drop in oil prices, all of those markets were performing better than the national average for our portfolio.

They've basically come down to the national average for our portfolio.

So it's something we're watching very closely, but it's not something that currently gives us significant pause or concern.

All the credit metrics we're watching in the portfolio really speak to a continued benign environment with, again, as I said earlier, reserving from here really more a function of loan growth.

David, I don't know if there's anything you want to add to that?

No, I agree.

I think in general, I think about energy exposure as being business loan-related, which we're not in.

And I think on the consumer side, it certainly has to have an impact.

Any time there's loss of jobs or income in the industry, it affects consumers.

But even with the high percentage reductions in employment in that industry, it's just not that huge of a number on a national level, since we're completely national in scope.

It's not going to be, as an example, like the mortgage that hit lots of consumers nationally.

This is a pretty localized impact.

Okay.

And then are you seeing, or potentially expecting, any pressure from more credit lines being offered by competitors?

Servicing ratios have stayed flat.

Mortgage debt has been replaced by a little bit on the consumer side in terms of leverage.

So any thoughts there?

Well, I think that there may be less, if rates slowly rise, there's probably a little bit less refinancing that will go on, particularly in first mortgages.

But I don't see a big impact in the near term.

I think we're in a fairly steady state in terms of the credit card industry growing at a slow rate.

And consumer balance sheets still seem like they're in pretty good shape, David.

When you look at the obligation ratios and when you look at the debt burden that they're carrying, it's a very different scenario now than it was the last time we were at this point in the cycle.

So, not dissuading you from your belief that we are in a cyclical business.

We are.

But it just feels like the consumer debt burden is still really manageable at this point.

Okay.

Thanks, Mark.

And one more question on the interchange relative to volumes.

Interchange fees look like they rose 5% versus volumes closer to 4%, implying a little bit of a higher margin there.

Is that just one-time or is that a mix shift, or how do you see that?

It's really more a function of spend mix.

The fourth quarter tends to see a lot of big box spending around the holiday period.

And in the first quarter, you tend to see a higher percentage of the mix being smaller merchants.

So it's really more mix-driven than anything else, David.

Okay.

Great.

Thank you.

Our next question comes from the line of John Pancari with Evercore.

Good afternoon.

Wanted to just ask on expenses, the other expense line came in lighter than expected, is down quite a bit.

Just wanted to get the color around that line item.

The real big driver in other expense is in the similar quarter.

Last year, we had about a $20 million addition to the legal reserve that was absent this quarter.

Beyond that, I would say it's just generally, back to what I said earlier, that focus on if you exclude the MLBSA lookback, really trying to find ways to look at the expenses that are creeping into the model from a regulatory and compliance standpoint, making sure we're finding efficiencies and ways to cover those.

So I think it reflects the discipline on that front, coupled with the lack of the $20 million addition to the legal reserve.

Right.

So therefore, the -- I'm getting noise on my line here.

Sorry.

So basically that $100 million, or that $107 million appears sustainable at this level?

Yes.

Again, I would say expenses do tend to bounce around quarter over quarter.

So I wouldn't specifically encourage you to cycle to the $107 million.

I think what I would say is we've given guidance for total expenses really being slightly north of $3.5 billion for the year, I think is how we described it back on the fourth quarter call.

And we'll stand by that guidance, and I think I'll stand by the earlier comments on the other line, as well.

Okay.

And then one more.

On the card yield, up quite a bit year-over-year, 37 bips, up 22 linked quarter.

I know it's a function of both higher rates in terms of the Fed move, but also the mix.

Can you just talk to us about how we should think about that going forward in terms of the magnitude of incremental upside we could see there as the mix evolves?

Yes, I think what I would say is, you now have the prime rate increase is already priced into the portfolio.

I'd say that's there.

Obviously, further prime rate increases would potentially have a bearing on it, but assuming the prime rate stays where the prime rate is, I think that whole benefit's baked in.

The other part of it is a much higher component of revolving balances in the portfolio, due to that real strong focus on the revolving consumer and the success we've had there.

I would say given what's happened to revolve rate, I wouldn't expect really significant increases in the revolve rates from here.

So from that perspective, I would go back and just generally say, if you think about it in a NIM perspective, as opposed to specifically a card yield perspective, it feels like you'd have, I'll call it again, a relatively stable NIM from this level, but you'd have some diminuation over the course of a year in a stable environment.

But again, I would point out that it could be impacted by, we still may make a decision to do a little bit of promotional investment that would have a muting impact there.

The revolve rate would have an impact.

And again, further prime rate increases would have an impact, as well.

Okay.

Helpful.

Thank you.

Our next question comes from the line of Bill Carcache with Nomura.

Thank you.

Good afternoon.

I had a couple of questions on CCAR.

First, relating to last year's, is it reasonable to assume that you guys would seek to max out, I think it was the $2.2 billion authorization that you received last year, which I think would imply about $480 million of buyback in the next quarter?

And then separately, relating to the upcoming CCAR, broadly speaking, and certainly at a high level, is it reasonable to expect that you guys are continuing to accrete capital to consumers in good health?

We've got unemployment rate at the same level, although the starting point is a little bit lower, so the delta is higher.

But you put all the pieces together and would it be reasonable to assume that you continue to grind closer to 100% payout ratio rather than move farther away from it?

So if I think about CCAR -- I'll parse it -- there's a bunch of questions embedded there.

I'll try and touch on them all, and if I miss one, just come back with your follow-up.

I think with respect to repurchase cadence, we've never given any specific guidance on that front.

But I would just say, I wouldn't see any reason to expect a radically dissimilar cadence in Q2 to what you've seen, would be the way I would think about it.

In terms of the overall approach to how we think about CCAR, I would say over the course of the last couple of years, we've continued to make what I've described as prudently aggressive asks, and every year they've been slightly more aggressive.

I would assume, that a reasonable person should assume that we don't see any reason to change that.

We recognize we have excess capital today, and we are working diligently within the confines of the CCAR process to be able to return as much of that as prudently possible.

And I might just add on, I think typically we've seen the last few years, the Fed scenarios getting tougher, not easier, which impacts, but also as our processes have matured and there's greater comfort, we have continued to move into a position of actually working towards our targeted levels.

And you've seen our capital.

You see our capital ratios today a bit lower than they were last year.

We bought back almost 8% of our stock in the last year.

And every year, we'd love it to move a little more quickly towards the target levels, and every year we're trying to take steps to do that.

But we also know we just can't get to the target.

We won't get approval to get to the target in one fell swoop.

Think about it like a constrained optimization.

Drove a total yield last year, something on the order of 10%, between dividends and buybacks.

So we feel like we're being respectful of our shareholders' capital and appropriately being prudently aggressive in our asks.

Again, the cadence having been more aggressive every year, I think a reasonable person would assume we wouldn't see a meaningful reason to change that cadence.

Understood.

Extremely helpful.

Thank you.

If I may squeeze one more in, on expenses.

Just for clarification, Mark, I believe that you had said earlier that the lookback project was drawing to a close next quarter.

Should we interpret that to mean that there will be one more quarter with the non-recurring BSA AML cost that would result in a differential between the operating efficiency and the adjusted operating efficiency ratio before they converge, or will they converge starting next quarter?

No, I think you're thinking about it right.

I'd go with your former characterization.

There will be one more quarter where those costs are in there.

And the good news is I think we are comfortable that we're approaching the end of the case review portion of it, which is the big dollar portion of the project itself.

So I would expect to see those yet.

And that's why I alluded to the fact, while we're standing by our expense guidance for the year, we don't expect expenses to be linear across the remaining three quarters, and 2Q may actually prove to be the high point, quite honestly.

Thank you very much.

Absolutely.

Our next question comes from the line of Matthew Howlett with UBS.

Thanks.

Just on the funding side, with the mix shift, can you go in a little more detail what you did with the deposits, how far out you went?

And then on the two ABS [purizations], was there any impact on the cost and with the [lending] that went on?

And what's the outlook if we do get two hikes this year?

Maybe you could comment on that in terms of funding.

I would say the vast majority of the growth in the deposit book has come in the savings product.

To a lesser degree, the money market and the CD books.

So we're very focused on the indeterminate maturities.

Those prove to have the lowest betas over time and also the stickiest customer retention characteristics.

So that's why we're focusing in that particular area and why it has driven it.

With respect to ABS transactions, I would say the answer is yes, there has been some impact, obviously, with respect to what's happened in the marketplace in terms of credit spreads.

Overall, I would say our credit spreads are up, roughly, call it, 30 basis points year over year, in addition to just the base rate changes, if you will, the index rate changes that have taken place over the course of the last year.

That being said, it's still a very robust market.

We were in market last week, did something on the order of $1 billion, give or take, and actually were able to walk pricing in.

So it still feels like a very accessible, very effective channel.

Pricing, a little more expensive than it was, but clearly still very attractive funding.

Could you remind us again in going forward, if we do get a tightening cycle, what's the target in terms of deposits again versus securitization and is there one angle that you'd lean on more than others, more than another if we do get the start of a tightening cycle?

We haven't decided bias for deposits.

There's a couple of reasons for that, the first of which is, as we've talked, we've worked really hard over the last several years to really have a cross sold deposit base, and we always like to use our balance sheet to support our customers.

So I think that's one reason.

The other reason is because of the betas.

Deposits do not reprice at the same rate as any of the capital markets fundings do, so we would have a decided bias to continue leaning into deposit growth, I would say.

That being said, it takes time to grow deposits, especially relationship-oriented deposits.

You can grow them really fast by hanging out the highest rate in town, but that's also got a beta of 1. So we're trying to do it the old fashioned way, where it adds real value.

So I'd look for us to continue leaning into deposits, but I'm not so sure 9% to 12% growth rate is the way to be thinking about it, but mid to high single-digit growth rates sure sound good.

Absolutely.

Thank you.

Our next question comes from the line of Moshe Orenbuch with Credit Suisse.

Great.

Thanks.

On the rewards costs, you had talked, Mark, you had said that you intended to keep the bonus into the second quarter.

What would make you change it in the second half?

And does the 115 guidance include it for the full year?

How should we think about rewards costs relative to that guidance and how it might relate to your plans to grow the business?

So as I sit here right now, I still feel very good, Moshe, about the 115 basis points on the full year.

I think our double program has been very effective.

I think it's driving a big chunk of that revolve behavior that you're seeing out there and is something that we would be probably predisposed to continue.

And I wouldn't change the guidance we've put out there in light of anything happening with respect to that.

Okay, good.

And just a second question.

I recognize and applaud the fact that you brought back 8% of the stock, but the constraint isn't actually the percentage of the stock that you bought back, it's the dollar amount.

So that's basically saying that the share price fell and you were able to take advantage of that, which is wonderful.

But the question is, are you able to push the dollar amount of buybacks a little harder?

And I didn't notice any mention of going after the de minimus exemption that some of your peers have done, and I'm wondering if you can talk about that.

Sure.

A lot embedded in there.

I'll try and tackle all the pieces.

I would say first and foremost, again, I think we've been -- driven the highest yields to investors, between dividends and buybacks, of any of the financials out there.

So I think we've been very focused on it.

And every year, we've gotten more aggressive with that ask.

So from that perspective, I wouldn't dissuade you, Moshe, from, again, thinking we would continue to, as we have comfort with the process and as the Fed has comfort with us, continue to be more aggressive there.

In terms of the 1% de minimus ask, I think it has tended to be utilized by people primarily around, what I would call, unexpected events that weren't contemplated in capital plans, compensation dilution being one that comes to mind that I've seen a few folks do and a number of other things, as well.

We would not be hesitant to use something like that if we had a like type event or similar event of some kind come along.

But I would say it's clearly the 1%, in our minds anyway, is clearly not designed to be your CCAR approval plus 1% every year.

That's really not why it's out there.

But if you were to see that perhaps asset growth was at the lower end or lower end of expectations, couldn't that be a reason to think about it?

I think there could be a lot of reasons to think about it.

The question is in what context do the people who allow you to do it, think about it?

Okay.

So I'm not so sure -- again, I think it's really designed to cover situations that weren't contemplated in a capital plan, as opposed to simply business trajectory issues.

And again, I'd just point you back.

We're in a CCAR submission cycle right now.

We're going to be more aggressive.

And we are driving by far and away the highest total yields of any of the financials with that 10% total yield last year.

And I don't think the exception process is going to move the dial as much as what happens in CCAR itself.

If you think about it, 1% of our Tier 1 combo would be a little north of $100 million, so it's not exactly going to redefine our earnings stream.

Okay.

Thanks.

You bet.

Our next question comes from the line of Rick Shane with JPMorgan.

Thanks, guys, for taking my question.

Look, we've seen the loan growth start to accelerate back into the target range.

And I think that that's, to some extent, a function of optimizing the investments in growth.

And you talked about shifting from marketing to rewards and I think laid out the potential that that will continue into the second half of the year.

When I think about investment in growth, marketing is spending in advance.

Reward is spending concurrently.

And then the last way you can invest in growth, and this sounds a little bit strange, but is on the credit side.

And that's basically investing in growth down the road, paying for it down the road.

Given your outlook in terms of benign credit, does it make sense at this point to make some of that investment down the road and potentially open up the credit bucket a little bit?

Well, I think that we would -- I would agree that those are all three good levers and we are pulling, where we think appropriate, all three.

And in response to one of the earlier questions about what the various causes of us getting back increasing, accelerating our loan growth, I did cite credit as one of the actions we've taken, in line increases, who we're approving, how we're authorizing.

We are working to optimize all of the levers that you just cited.

And the one I would probably add, because I think it's not just about money, the execution, things like new features that may not cost that much money, but maybe move behavior, is a fourth lever that I would add.

And I think if you look at what we've produced in terms of innovation the last couple of years compared to others, like Freeze It and Free FICO and on and on, I think that innovation is one of the best ways to move the dial.

That makes sense.

Look, I think one of the facets of your business is that you have very strong customer loyalty.

And I'm not necessarily sure how you market that, but it certainly impacts the attrition within the portfolio in an environment where things are really competitive.

Well, I think by not having a leaky bucket, we end up with two things.

You don't have to put on as many new accounts to grow a certain rate if you're not losing out the back end, but it also helps us from a credit perspective, because with our average duration of 12 years of customer relationship, compared to industry average around 8 years, we don't have as many, as high of a percentage in those early years that have much higher credit risk.

And that helps explain some of our better credit performance than most of the competitors in our industry.

Got it.

Hadn't thought of that.

That's helpful.

Thank you very much.

Our next question comes from the line of Bob Napoli with William Blair.

Thank you.

Just on some thoughts, David, on industry loan growth, if you could.

We've seen a ramp up in industry loan growth over the last year from 3% to around 6%.

Do you think that is -- and we've seen that with a consumer that's still kind of sleepy.

Is this essentially just the industry itself looking at the profitability of this product and tweaking the credit levers and the incentive levers to drive that growth, such that we're setting the seeds for the next credit cycle, if you would?

Some thoughts around that would be helpful.

You know, I would bifurcate the industry loan growth between lower credits versus higher credits, call it the sub prime business versus the prime business.

We really haven't seen -- I haven't seen much acceleration in the prime space.

It stopped shrinking.

But my best guess is it's growing at 2% to 3% in prime credit scores today.

If you see where the acceleration has come, it's come in the issuers who are in the sub prime space, including private label, which obviously a lot of people get that are new to credit.

So there's a high correlation between the high yield competitors and the higher growth competitors at the moment.

If you just isolate the prime competitors, some are still shrinking a little bit.

And so I think it's been -- and so how that plays out is, we're not a sub prime player, but how does the sub prime credit play out and impact those competitors over time?

I'm not an expert in that, but I'm comfortable that low growth in prime probably is hard to grow in that space, but is probably good from a credit performance perspective.

Okay.

Thank you.

And just to follow up on your deposit quality, you've seen a nice pickup in growth, or steady growth in a direct-to-consumer Infinity products as a percentage of total funding, 44%, up from 42% a year ago.

Where would you like that to be?

Where can that go over the next five years, in an efficient manner, if you would?

Do you have some targets for that?

Well, we like the fact that it's our largest single funding source.

And I'm very comfortable with where it's at.

If it grows a little bit more, I think that would be even better.

I was really pleased this quarter that we really didn't take our rates up, but yet we saw a very nice inflow of deposits.

So that's helpful from a funding perspective, a customer relationship perspective.

And I think over time, we'd like to add more checking accounts to the mix, we'd like to continue to grow the indeterminants in general, on savings and money markets, as Mark mentioned earlier.

So if it was a little higher over time, I think that would be even better.

But we feel like it's at a good level right now.

Thank you.

Appreciate it.

Our next question comes from the line of David Scharf with JMP Securities.

Hello.

Thank you.

My questions are largely answered, but I did want to get a sense for you, back to the consumer spending patterns, this kind of even, rough mix of 50/50 from both new accounts as well as dormant accounts that's been driving the increase in revolving balances, could you give us a sense for how that mix measures up to both what your expectations were earlier in the year?

I'm trying to get a sense for whether 50% of the growth coming from dormant accounts is potentially a bit of a positive surprise from what you would normally expect to see?

Well, I'd say we've been -- our growth over the last several years has been roughly 50/50 base and new accounts.

And so I think that's more of a continuation of a trend.

I think if you think about sales, that probably comes a little bit higher from new accounts.

And I would say generally, loans have performed about at what we expected for the year and targeted.

We had a lot of programs to go into place and we were happy they worked and they produced the result we expected.

Sales, on the other hand, has continued to disappoint.

And while I'm pleased that it was 4%, which matched the 4% loan growth, I would like to see the consumer become a little more -- given the strong balance sheet that they have and their capacity to spend, I'd love to see the consumer in general spend a little more, which would allow us to grow sales a little faster.

Got it.

And the 2 percentage differential on card sales attributable to gas, just given the upward trajectory really since your Q4 call and prices at the pump, should we expect that to narrow considerably this quarter?

I wouldn't say considerably, because remember, it's the year-over-year change.

And so unless we got a dramatic increase in gas prices, it's going to probably be lower than the same quarter last year all year long.

Now it may narrow each quarter, if it stabilizes.

It's certainly not as big of a downdraft as it was last year.

But gas prices were over 10% of our sales 18 months ago.

Now they're 5% or 6%.

And so they're becoming less of an impact.

But it's not going -- the 2% isn't going to go to zero next quarter because of the year-over-year nature.

Got it.

Thank you very much.

Our next question comes from the line of Mark DeVries with Barclays.

Yes, thanks.

Just wanted to drill down on some of the comments again around the guidance and the NIM, in particular.

Going into the year, you guided to relatively stable NIM.

And that's somewhat vague.

But you're up 25 bips year-over-year and even slightly higher, based on the average for 2015.

And it sounds like, Mark, what you're saying is that's kind of biased flat.

It could go a bit lower if you lean into some more of the promotional balance opportunities.

But is it right to say that that guidance no longer holds, that we're looking at a higher NIM year over year than what we had in 2015?

Yes.

If you think back to the fourth quarter call, I think what we said is there is a natural upward bias in NIM, but we were calling for, call it, relative stability because we anticipated we might be doing some more promotional-related activities.

The good news is we saw the reacceleration in growth we were looking for based on some of the things we did back in the middle of last year, and it was coming in the form of good old fashioned utilization of the card, both in the hands of the existing card member base and the legacy card member base.

So I think we are definitely, Mark, saying we have not taken the right, for lack of a better term, to increase promotional activities off the table, which is why I'm saying I wouldn't put just a flat NIM in from here for the remainder of the year, but I think it's a very safe bet to say on a full-year basis, the NIM is not going to approximate the full-year basis of last year.

I think that's a very safe bet at this point in time, based on the current trajectory of growth we're seeing.

Okay.

But given the success you've had with the loan growth so far without the promotional, is it right to assume that if we take our NIM down a little bit because you do more promotional, that's somewhat additive and that maybe we should expect loan growth to accelerate more from here?

We are not calling out that we're going to do any increased promotional activities, nor are we giving out guidance for what we expect the trajectory of loan growth to be from here.

Just to be clear, all we're saying is at this point in time, to this point, we have seen the growth trajectory reaccelerate into our target range and we feel good that we're getting it in a very constructive way that drives great returns through time.

We haven't taken off the table the ability to invest more heavily in promotional activities, but we're not calling that we're going to do it either, just to be clear.

Okay.

I'm just trying to clarify some of the give and take between some of these promotional things I think you indicated, that that you feel good about the rewards rate so you still would look to be doing, I think presumably, a lot of the double cash promotion than if you were to lean into promotional.

I'm just thinking of that as being potentially additive to your growth.

Is that at least a fair way to think about it?

Well, one way to think about it is we're at the bottom end of our range and we might want to take some actions to move it further into the range.

Okay.

Fair enough.

And just to clarify, Mark, you understand promotional comment could be on the balance side in terms of balance transfers or sales promotion, not just--

Yes, absolutely, yes.

Okay.

Yes.

Thank you.

Absolutely.

Thank you.

We have no further questions at this time.

At this time, I'd like to turn the call back over to Bill Franklin for final remarks.

So actually, this is Mark Graf.

I'm going to jump in before I let Bill prepare his final remarks.

To show that we are committed to timely and accurate disclosure, my controller just passed me a note and said he's comfortable with me pointing you to a $40 million benefit on the tax line in the second quarter.

So to the extent there was any lack of clarity around my prior guidance, I would just say the number to think about for the second quarter tax benefit we discussed earlier is about $40 million, give or take.

Bill, sorry to preempt you there.

So thank you, everyone, for joining us.

If you have any other follow-up questions, feel free to call the Investor Relations department.

Have a good night.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude the program and you may all disconnect.

Everyone have a great evening.