發現金融 (DFS) 2018 Q1 法說會逐字稿

Good afternoon.

My name is Sarah, and I'll be your conference operator today.

At this time, I would like to welcome everyone to the Q1 2018 Discover Financial Services Earnings Conference Call.

(Operator Instructions) Thank you.

I will now turn the call over to Mr. Craig Streem.

Please go ahead, sir.

Thank you, Sarah.

Welcome, everybody, to our call this afternoon.

I will begin on Slide 2 of our earnings presentation, which you can find in the financial section of our Investor Relations website, investorrelations.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 in an 8-K report and in our most recent 10-K, which is on the website and on file with the SEC.

In the first quarter 2018 earnings materials, we've provided information that compares and reconciles the company's non-GAAP financial measures with GAAP financial information, and we explain why these measures are useful to management and investors.

And we urge you to review that information in conjunction with today's discussion.

Our call today will include remarks from David Nelms, our Chairman and Chief Executive Officer, covering first quarter highlights and developments; and Mark Graf, of course, our Chief Financial Officer, who will take you through the rest of the earnings presentation.

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

(Operator Instructions)

Now it's my pleasure to turn the call over to David, who'll begin his remarks on Page 3 of the presentation.

Thanks, Craig, and thanks to all of you joining the call today.

In the first quarter, we delivered net income of $666 million with earnings per share of $1.82 and the return on equity of 25%.

Very solid performance, which reflects our success in driving outstanding growth in receivables, preprovisioned net revenue and shareholder returns.

Our strong profitability is the result of consistent execution of our Direct Banking strategy buoyed by positive macroeconomic conditions.

The environment for prime consumers remains healthy, supported by a robust labor market and rising home prices, both important indicators of credit performance on our target segment.

In addition, data suggests that U.S. consumers generally continue to feel positive about future prospects for their personal finances.

We believe our positive business momentum will continue to be supported by the growing economy and higher take-home pay as a result of tax reform.

Credit performance across the industry continues to normalize after several years of historically very low net charge-off rates, including in our portfolio.

This trend has been driven by the increasing supply of credit from lenders and greater usage of credit by consumers.

Against the backdrop of low unemployment, rising wages and low -- lower consumer tax burdens, we view recent credit performance as the natural result of this greater availability of consumer credit and not as the first sign of a downturn.

The other factor playing a role in higher provisions is the seasoning of our loan growth as recent vintages make up a larger percentage of our portfolio.

These vintages are performing in line with our expectations, and we will continue to pursue quality loan growth because the economic and competitive environment remains conducive to creating long-term shareholder value.

Receivables grew 9% in the first quarter led by strong growth in the card business.

Card loan growth continues to come from a balanced mix of new accounts and existing customers, and is supported by sales growth acceleration.

The origin of sales growth includes strong customer acquisition, low attrition and economic growth.

It is clear that the Discover brand as well as the features and benefits of our card continue to resonate with consumers, driving growth in new account acquisitions.

Our consistent focus on prime revolvers and discipline in pricing and rewards drove 10% revenue growth in the first quarter.

Operating expenses also rose as we continued to invest both for growth and an enhanced customer experience as well as to advance our analytical capabilities.

Our efficient operating model helped keep expense growth lower than revenue growth, driving positive operating leverage again this quarter.

In Payment Services, our PULSE, Diners Club and Network Partners businesses each delivered double-digit increases in volume.

I'm pleased that volume for the segment was up 19% year-over-year, which drove a healthy increase in revenue while prudent expense management held operating expenses flat.

Before I turn over the call to Mark, I want to take a minute to highlight an initiative that we believe is an important element in our long-term strategy.

In February, we announced our new debit rewards program for our Cashback Checking product.

This program allows our checking customers to earn 1% cashback and up to $3,000 of eligible debit card purchases each month.

Despite only minimal promotion to date, the checking product has received a positive reception in the market, particularly among millennials with an average age of 35 for new checking account customers in the first quarter.

Importantly, for more than 40% of the new checking accounts opened in the first quarter, this represents the customers' first relationship with Discover.

This demonstrates the checking products potential to serve as an important new entry point to the Discover franchise.

In summary, our consistent focus on the customer, good momentum across our businesses and favorable economic conditions continue to drive strong risk-adjusted returns.

Now I'll ask Mark to discuss our financial results in more detail.

Thanks, David, and good afternoon, everyone.

I'll begin by addressing our summary financial results on Slide 4. Looking at key elements of the income statement, our 10% revenue growth in the first quarter was driven primarily by a combination of strong loan growth and margin expansion.

The increase in provision is largely consistent with ongoing supply-driven normalization in the consumer credit industry as well as the seasoning of our last several years of loan growth.

Operating expenses rose 9% year-over-year as a result of investments to support growth and new capabilities.

Turning to Slide 5. Total loans increased 9% over the prior year, the result of 10% growth in credit card receivables.

Growth in standard merchandise revolving balances drove much of this increase spurred by stronger sales growth from both revolvers and transactors.

Promotional balances were a more modest contributor to our strong performance.

Looking forward, we believe that the first quarter will represent the high watermark for receivables growth.

This is due to a combination of tougher comparisons, the continued slowdown in personal loan originations and our expectation for lower balance transfer activity in card.

Looking at our other primary lending products.

Year-over-year growth in personal loans slowed to 10%.

Private student loan balances rose 3% in aggregate, but our organic portfolio increased 11% year-over-year.

Moving to the results from our Payments network.

On the right-hand side of Slide 5, you can see the proprietary volume rose 8% year-over-year, driven primarily by an increase in active Discover card accounts.

In our Payment Services segment, PULSE volume growth continued to increase, with 20% higher volume compared to the prior year as a result of merchant and acquirer routing decisions as well as incremental volume from existing issuers.

Diners Club volume rose 14% from the prior year on strength from newer franchises, and Network Partners volume increased 24%, driven by AribaPay volume.

Moving to revenue on Slide 6. Net interest income increased $208 million or 11% from a year ago, driven by a combination of higher loan balances, market rates and our balance sheet positioning.

Total noninterest income was up $28 million, driven by Discover card sales volume, which grew 6% this quarter despite a smaller number of processing days when compared to 2017.

If we adjust for the number of processing days, sales growth would be closer to 8%.

As shown on Slide 7, our net interest margin rose 16 basis points from the prior year and was down 5 basis points sequentially, ending the quarter at 10.23%.

Relative to the first quarter of last year, the net benefit of a higher prime rate and a favorable shift in funding mix were partially offset by an increase in promotional balances and higher interest charge-offs.

Relative to the fourth quarter, the net benefit of a higher prime rate was more than offset by higher interest charge-offs as well as some minor shifts in portfolio and funding mix.

Total loan yield increased 27 basis points from a year ago to 12.21%, resulting from a 20 basis point increase in card yield and a 60 basis point increase in private student loan yield.

Prime rate increases, partially offset by the impact of somewhat larger promotional balances and higher charge-offs, drove card yields higher.

Higher short-term interest rates drove the increase in student loan yields.

On the liability side of the balance sheet, we once again generated robust growth in our consumer deposits, which ended the quarter above $40 billion.

Consumer deposit rates rose during the first quarter, increasing 15 basis points sequentially and 34 basis points year-over-year.

As one would expect as we get further into a rising rate cycle, deposit betas are rising, and we expect that trend will continue in 2018.

Turning to Slide 8. Operating expenses rose $83 million from the prior year.

Employee compensation and benefits was higher, the result of increased headcount to support business growth and higher average salaries.

Marketing expenses were up as a result of higher account acquisition costs and increased brand advertising.

Other expenses also grew as we increased our philanthropic commitments.

I'll now discuss credit results on Slide 9. Total net charge-offs rose 49 basis points from the prior year and 24 basis points sequentially.

As we've talked about over the last year, supply-driven credit normalization, along with the seasoning of loan growth in the past few years, have been the primary drivers of the year-over-year increase in charge-offs.

Credit card net charge-offs rose 48 basis points year-over-year, with this quarter representing the second consecutive quarter of slowing year-over-year increases in card charge-offs.

I'm also pleased to say that for the month of April, we've seen improving credit performance, showing up both in payment rate as well as delinquency formation.

Personal loan net charge-offs increased 87 basis points in the prior year and 41 basis points sequentially.

As we indicated last year, we stopped booking loans in several segments of the broad market personal loan book that were not performing in line with our expectations.

Losses on these segments continue to rise as the loans season, but the performance of the rest of the portfolio is consistent with our expectations.

Remaining incremental exposure over the lives of the loans in the discontinued segments is expected to be approximately $20 million.

Private student loan net charge-offs rose 32 basis points year-over-year and fell 11 basis points sequentially.

Total company 30-plus day delinquency rates were largely flat sequentially and up 26 basis points on a year-over-year basis.

This increase is fairly consistent across credit cards, student loans and personal loans, and is similar to what we saw in the second half of 2017.

As with net charge-offs, increasing delinquencies are driven by normalization and seasoning.

Looking at capital on Slide 10.

Our common equity Tier 1 ratio increased 30 basis points sequentially as loan balances declined.

Our payout ratio for the last 12 months was 120%.

Before I move on, I want to say a few words about capital stress testing.

As you remember, last month, the Federal Reserve announced that it was introducing a new model that would likely increase stress losses on credit card receivables.

In addition, this year's CCAR process incorporates both a more severe stress scenario as well as the impact of tax reform on stress capital consumption.

These factors were taken into account in our recent capital plan submission.

And while we can't provide specifics prior to receiving regulatory feedback, realistically speaking, we expect to pay out for the next CCAR cycle to be somewhat below 100%.

To sum up the quarter on Slide 11, we generated 9% total loan growth and an overall 25% return on equity, with significant contributions from all 3 of our primary lending products.

Our consumer deposit business posted equally strong growth of 10%, while deposit rates increased 34 basis points year-over-year.

With respect to credit, while our charge-off rates have risen as credit conditions normalize in loans season, they remain consistent with our expectations as well as our return targets.

And we are continuing to execute on our capital plan with strong loan growth and a leading payout ratio helping to bring our capital ratio closer to target levels.

In conclusion, we're pleased with our performance this quarter and are confident in our outlook for the balance of the year.

That concludes our formal remarks.

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

(Operator Instructions) Your first question will come from Sanjay Sakhrani from KBW.

First question is around credit quality.

Mark, intra quarter, you talked about the provision being a little bit higher than the consensus estimate for the first quarter.

As you look out for the remainder of the year and considering some of the comments you had on the April statistics, I mean, do you think the provisions are appropriate across the Street?

And then maybe just specific to the April numbers, relative to the guidance that you've given for the year in terms of the charge-off rate, does that favorably influence that range?

Absolutely.

So Sanjay, I would say with respect to provision, we don't typically guide provision.

The only reason we made those comments at your conference actually back in January was we saw folks coming in a little bit high.

I guess what I would say is if we saw a need as models come out for the next quarter to adjust provision guidance, we'll give a soft nudge then at that point in time.

But right now, I guess what I would say is we feel very good about that 2018 charge-off guidance that we did give at the beginning of the year of 3% to 3.25%, and all the performance continues to be in line with those expectations.

Okay.

And I guess on CCAR as a follow-up, the amount -- the little under 100% that you mentioned, do you feel like that fully contemplates the spirit of what the Fed is suggesting across all the data points we have on what they've said about the new models?

Or is there some variability to what that might end up being after the process and what you might be able to do there?

I think it's fair to say, there clearly could be some variability.

We don't have insight into exactly what the Fed's new model shows.

I think that letter you guys all had a chance to see it, it was a public record document.

It just said it's going to produce materially higher losses.

We have no way to calibrate, Sanjay, whether materially higher is 10% higher or 30% higher, right?

So I think we took a very thoughtful approach to how we worked our way through it.

And my comments today reflect the spirit of our submission.

How it actually works its way to the Fed, we'll have to wait and see.

Your next question comes from the line of Moshe Orenbuch from Crédit Suisse.

Mark, you had kind of pointed out that you thought that the first quarter would be the best quarter for growth and outlined some of the reasons.

Maybe if you flip that around and talk a little bit about the competitive environment, what other things might be going on and how you think about that and also your use of promo rates in that and how you're kind of thinking about that for the balance of the year.

Yes, so this is David.

Maybe I'll kick off and Mark may want to add something.

I think if you look over the last couple of years, 2 years ago, our -- we -- our growth slowed a bit more because there were some competitors who were really aggressive and we saw some maybe fewer profitable opportunities.

We talked last year about the fact that some of those competitors pulled back, and that allowed us to put up accelerated growth.

This year, I'm seeing that it's starting off feeling a lot like last year in terms of the competitive environment.

Competitive but not overly competitive -- not crazy, not as many crazy offers out there.

And -- but we're now looking back over a comparable period where we had high growth.

So I think if you look at the guidance we gave for the year of 7% to 9%, this quarter, we were actually a little bit above that.

So I think consistent with that guidance, we expect it as we lap and we continue to see great opportunities for it to grow value and profitability, that's allowing us to put on really good growth.

But the year-over-year change, we would expect to fall somewhat.

And -- but at least maybe into -- into the range of the 7% to 9% that we guided.

Yes.

I would, Moshe, what I would tack on to that would be a couple of things.

And I guess, number one, really underscore David's earlier point about our approach to growth really hasn't changed over the last number of years.

It's really just competitors surging and then pulling back and other things that have impacted the rate of growth because we stayed consistent in the return thresholds we look for and what we'll actually book.

So it's a pullback of others that has allowed our growth rates to rebound a little bit.

But I think the tougher comps that I referenced earlier to, our growth rate really accelerated as a result of that pullback through 2017.

I think also the pullback in the DPL originations that we have talked about a few different times will have a meaningful impact on that overall loan growth as well.

So I wouldn't expect -- we're not calling out that we expect loan growth to fall dramatically.

I think we're just kind of saying, what's on the margin, it's probably going to be somewhat lower as we look forward than what we're looking at right now.

Got you.

And maybe to kind of relate that to the fact that you had positive operating leverage with 9% expense growth, which is a pretty good feat.

How do you think about expense growth in that context for the balance of the year?

I mean, I think at the end of the day, expense growth, Moshe, is really a function of business growth.

And it's naturally going to fluctuate as we invest in the business and look for ways to capitalize on great growth opportunities as we see them.

We've talked in the past, there's tremendous leverage in the model in marketing costs, in absolute levels of marketing, lots of different levers that when you hit an environment where really shifting to focus on pulling back on expenses as opposed to building the franchise makes sense, we feel very comfortable in our ability to do that.

So I think it's a conscious decision.

Long story short, that got us to the 9% growth.

And I wouldn't think about all that as interest run rate kind of numbers.

It's conscious decision-making quarter-over-quarter.

Your next question comes from the line of Don Fandetti from Wells Fargo.

Mark, so the NIM was down a little bit Q-over-Q.

I assume that the full year '18 guidance still holds.

I think it was 10.3 to 10.4.

And then can you talk a little bit about the card yield progression?

It sounds like credit was a factor on a quarter-over-quarter basis, but would you expect to see that sort of pop a little bit more?

Yes.

In terms of the full year guide, Don, I would say if we kind of saw a need to revise that guidance, we'd revise the guidance.

So I wouldn't worry about that one.

I would say in terms of quarter on a sequential basis, I would say what we said is expect about 7 to 8 basis points of upside from every 25 basis point Fed hike.

Based on our asset-sensitive positioning, I would say that is consistent with what we saw this quarter.

I think sometimes people forget there's a seasonal uptick in charge-offs in the first quarter, so that really kind of increases your revenue suppression.

We also saw a little bit of an increase in promotional balanced mix this quarter.

And I think you heard me say in our prepared remarks, we're going to see a little less promotional growth in the mix going forward.

So I think those 2 things really combined to offset the goodness that we saw on the rate side.

Feel good about our continued positioning.

Think again about the comments we made in what we're seeing around credit in the month of April.

So again, I'd -- if we saw a need to revise that NIM guidance, we would have revised it.

And just a clarification.

I know CCAR doesn't incorporate CECL, but are you sort of thinking about that as you set your payout ratio or your capital level today?

And do you have any initial thoughts?

I mean, obviously, there'll be some impact to the card lenders.

Do you have any sort of commentary on how we should be thinking about that at this point?

Yes.

No, I mean, it's preliminary.

We're working our own way through it at this point in time, Don.

I guess what we have said is, make no mistake, reserves will go up in a CECL environment given our product and our business mix, right?

So I think that's definitely the case.

I think the thing I'd remind everybody is it really affects accounting earnings.

It doesn't really affect cash flows the same way.

And so if you think about it from a held-to-maturity perspective, the economics of our portfolio don't change one iota from pre-implementation to post-implementation.

So I think sometimes, it's a little bit of rearranging deck chairs.

That having been said, it's a very complex rearranging of deck chairs, and there's a number of issues.

We're still trying to get our arms around such as how do you define the life of a card well, right?

Do you do it on a FIFO basis where the first dollar borrowed is the first dollar repaid?

Do you think about it in a CARD Act hierarchy?

How do you think about it?

So I think there's a lot of work needs to be done defining those things.

So clearly, reserves will go up under CECL.

And it's clearly our intent as we have a good sense of where that's going to be, we obviously will telegraph that to you guys.

It's preliminary at this point, though.

Your next question comes from the line of John Pancari from Evercore.

Wanted to see if you could talk a little bit about the trend and rewards costs.

I know you -- it ticked down a bit this quarter.

And are you still expecting maybe in that 128 to 130 range in terms of basis points as you look out for the year?

Yes, I think that's the way to think about it.

Again, if we had felt the need to revise guidance, we'd be doing that.

To the extent you're looking at year-over-year and wondering about that, I think the big change is it is up year-over-year.

A big chunk of that is we ran gas in the first quarter as our 5% -- one of our 5% rotating categories.

Whenever you run gas, it's extremely attractive to people, and they jump on that.

So I would say that would really explain the year-over-year number.

But full year, we feel very good about that earlier guidance.

Okay.

I figured that was the year-over-year driver.

And then separately -- and to just -- getting back to the receivables growth discussion again, I hear you about the potential ticking back a little bit or moderating a bit.

Are you seeing any signs yet just in terms of your -- the transaction volumes and card volumes around any pick up in spending that's evident with your customers post-tax reform?

Is that something that's clearly becoming evident?

Well, so it's David.

I would say that the days -- number of days in the quarter, processing skewed our numbers a little.

If you look at a day, like-for-like days, we had about 8% year-over-year growth in volume for the first quarter, which was stronger than it's been in the past.

Now I can't say yet if that is attributable to tax reform or whether it's just attributable to our value proposition and us gaining share.

Because it's a little bit -- some of the retail reports I've seen have not suggested so much of a pickup yet in the first quarter.

I do think that given that some of the withholding has just kicked in, in the last 6 or 8 weeks for people that people are going to do one or 2 things with a couple percent extra money in their pocket.

They're either going to save it more or they're going to spend it.

And I suspect consumers will do some of each.

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

David, maybe just to follow up on, I think, the comments that Mark had made regarding promotional balances.

Can you maybe -- I know this is a channel that historically, you guys have come in and out of.

Can you maybe just talk about competitively what you're seeing there that's causing you to -- us to potentially see some slowing growth in that channel?

Well, I think he mentioned specifically balance transfer pulling back a bit.

And one of the factors is obviously the economics change a little bit just with higher interest rates.

And also, we're constantly adjusting our models.

We use promotion -- promotional rates to drive better profitability if we can -- if it's cheaper to invest in promo rates than higher marketing costs, we look at that as almost another marketing cost, as you will.

So I wouldn't say -- we don't tend go guardrail to guardrail on anything, but it's -- we're always making adjustments as we review the data and find opportunities.

Got it.

And Mark, maybe I can ask Sanjay's question a little bit of a different way given that we needed your assistance to get us into the right place for the first quarter.

I guess when I think about what's transpired over the last couple of quarters, the reserve as of the end of the year was running about 40 basis points above last year's charge-off level.

Given that you're growing at a nice clip, but delinquencies are increasing at a stable to improving pace, you highlighted what's been happening with charge-offs.

Would you expect us to start to see more convergence between charge-offs and the reserve level?

Or given the normalization that's going on, would you expect that gap to kind of remain in a similar range like it's been the last couple of quarters?

Yes.

I got to be really careful with that one, Ryan, because that could be back -- back into provision guidance on that one.

So I'm going to be careful.

How about if I tackle it a little differently and just kind of say from my perspective, we continue to feel really good about the way credit is seasoning.

If you look at it this quarter, it's about 40% driven by the seasoning of new accounts.

It's about 60% the normalization on the back book.

Roughly speaking, that continues to be in line with our expectation.

It also continues to be in accordance with all of the return metrics under which we're underwriting this credit.

So we feel very good about the nature of the credit we're putting on the books.

We talked the last quarter about potentially directing some incremental growth dollars towards some segments.

We haven't fully deployed all that at this point in time.

And at the end of the day, we may not end up fully deploying all of it.

Just to be clear, if we can't find return -- risk-adjusted returns and ways to deploy that, that are consistent with our models, right?

Again, we're not going to bend from the discipline in terms of how we grow.

So continue to feel really good about what we're putting on the books, continue to feel very good about the trajectory of credit.

Appreciate your comment about delinquency rates basically, 27, 24, 27 basis points, I think, they'll up the last couple of quarters.

They've really flattened out to a large degree, and we feel good about where we are.

Your next question comes from the line of Mark DeVries from Barclays.

David, to what extent do you attribute to the above industry receivables growth to the Cashback Match offer, which really was kind of unique in that it provided upfront incentives that encouraged customer to engage for a full year rather than 3 months?

And what impact, if any, do you think you'll see in that growth with probably one of the most direct competitors, the Freedom Unlimited, effectively matching that in the last week?

Well, Mark, I think that it's a combination of differentiating features and strong execution that have allowed us to grow faster than the industry average the last 1.5 years or so in particular.

Certainly, Cashback Match is one of those things, but Social Security numbers on the dark web and on/off freeze, functionality and the fact that we have our own brand at point-of-sale that is differentiating from the Visa Mastercard issuers, one of which you mentioned.

Yes, I think it's the cumulative impact of a bunch of stuff.

It's no one thing.

I guess the second thing I would say is imitation is flattery and -- but this is, while an important competitor, it's one program.

It'll be x percentage of total marketing that we're up against.

And overall, we think the package that we offer is what's attractive to consumers versus any one thing, even Match.

Got it.

And a second question, David, are you prepared at all yet to comment on kind of what your expectations and objectives are for growing the new checking product over the next couple of years?

I'm sorry.

You said the -- you asked about what you could expect...

The new checking product that you guys (inaudible).

Yes.

We're really excited by it, but I think it's going to be a gradual build because this is a long-term play.

By nature, checking accounts tend to be sticky.

It's what makes them attractive to financial institutions.

But that means we'll probably ease into it and focus on testing new things.

We're going to be adding some more features mid-year this year.

I expect the second half of this year to have more promotion -- more promotional activity than we had the first half of this year.

But to put a point on it, I'm not sure you'll see a TV ad in the second half of the year.

But we think that we're going to report our progress as it becomes more material.

But I think you should think about over, say, a 5-year period, this sort of turning into something material in terms of first-time customers, lower cost funding, stickier relationships, and we're starting off to increase the franchise.

Your next question comes from the line of Betsy Graseck from Morgan Stanley.

A couple of follow-ups.

One on capital.

I know you mentioned somewhat below 100%, and I'm sure Mark you're not going to tell us what that's defined as numerically.

But maybe you can help me understand, is it somewhat more or less than modestly?

Maybe you could ask the Fed for us, Betsy.

Look, I think, Betsy, one of the things we talked about earlier was in the first quarter when we saw provisions coming in a little bit high and sort of some of the models we gave a little bit of a nudge just to make sure that folks kind of recalibrated.

I guess really sort of what we're trying to do in part based of what we're saying here is that for those folks who were thinking in their modeling currently something north of 100%, maybe the thought process is removing the thought of north of 100% more so than it is how much below 100% should you be.

How about that?

Okay.

That's helpful.

And then as I'm thinking about that, is there anything you can tell us with regard to dividend versus buyback?

Like does it make more sense to keep the divi flat and not flex the buyback as much?

Or do you want to see that growth in dividend year in, year out and flex it into buyback?

So I would say, I think we've been pretty consistent over the last 4 or 5 years that we do have a goal of being an S&P dividend achiever.

That requires dividend increases.

I wouldn't change or dissuade anybody from thinking that remains a piece of our thought process.

That being said, the magnitude of increases can vary, obviously, too.

So we'll -- as we went through our submission, we looked and we recalibrated some of those things, and in terms of exact detail, have to wait until we get result back from the Fed, and we can share it with you then.

Your next question comes from Eric Wasserstrom from UBS.

Just a couple more questions about provision.

I know it's a topic we've labored over.

But first, Mark, historically, April -- March or April tended to be a low for credit experience just because people use tax refunds and things to get a little bit caught up and that kind of thing.

Is that something that you continue to expect to be true?

Or is something changing in terms of the seasonal nature of losses?

No.

I think there's definitely the tax refund impact that comes in.

I would say they're delayed a little bit this year is one thing to keep in mind.

And the other thing I would point out in this construct, it's not -- I want to be abundantly clear, we don't have data that supports causality.

But simply, correlation, we saw a pretty significant improvement in our payment rates, and our delinquency trends start at the very week when the payroll processors adjusted withholdings.

So I do think there's something going on here as we talked earlier briefly with that additional discretionary income that folks have seen as well.

Got it.

Got it.

And then just in terms of -- I know this has been asked a couple of different ways, but I just want to make sure I'm fully understanding how to reflect your commentary about growth in terms of the provision as well.

So all else equal, if growth is tailing a little bit, I recognize that you're talking about a moderate extent, but if growth is tailing a little bit, would that, all else equal, suggest that the provision increment should also be diminishing in line?

So I would say in an all-else-equal environment, yes with one exception, and then there's a lag associated with that portion of the reserve build that is associated with the growth in new accounts, right?

So if you think about the way a new account seasons, it peaks -- takes peak seasoning 24 months after you originate it.

So if its growth that I put on the books today, I don't have a lot of reserves set up for that yet.

That'll come as we roll forward on the calendar.

So yes, but with a modest lag.

Your next question comes from the line of Ashish Sabadra from Deutsche Bank.

A question around MDR.

I see -- if my calculation is correct, I see a 4 to 5 basis point improvement year-on-year.

Can you just talk about what's driving it and how should we think about it going forward?

So the big driver there, Ashish, is going to be mix of merchants.

Particularly quarter-over-quarter, the fourth quarter is heavy spend at big-box type retailers and larger online retailers that typically tend to have lower discount rates.

As you move into the fourth quarter, the spend mix shift's more balanced.

It's not as heavily concentrated than the big ones.

So that tends to drive a little bit of an uptick in the MDR.

Okay.

That's helpful.

Because I also saw it on a year-over-year basis, so that's why I was -- that was positively surprising.

So that was positive.

So just maybe on...

The one -- just the one thing I would caution on is that I think that it's more likely that, that could have modest pressure over time.

The merchant discount rates, in general, have had some upward pressure as more -- as there's been a mix movement towards more card not present, but some of the card-not-present merchants are getting much better at antifraud kind of capabilities and are able to then earn somewhat lower discount rates.

So I would just be cautious not to extrapolate that increase.

Sure.

And maybe just a quick follow-up.

On the funding side, the securitized borrowing, in particular, that showed a 24 basis point sequential increase in rate from 2.19% to 2.43%.

I was just wondering if there's any particular call out there and how we should think about that -- those rates going forward?

No.

I would say it's just a function of maturities rolling off that were put on several years ago being replaced by new issuances.

Some of those new issuances being fixed rate and further out the curve.

So I wouldn't think about it as anything other than just positioning the balance sheet the way we want to see it going forward.

Your next question comes from the line of Ken Bruce from Bank of America.

My question also relates to credit.

And I just want to square a few things here that have been said, both this evening and as well as in prior calls.

But I understand you've got a healthy consumer and there's plenty of confidence in the consumer remaining strong for a variety of reasons.

You've noted that you've got seasoning in the normalization of credit impacting credit results, which I guess kind of given the nature of the beast.

You've kind of pointed to supply availability as being one of the big drivers of that, and you seem to be one of the marginal providers of credit, so I guess I'm a little kind of questioning as to whether the results that you're going to see in the future actually do kind of live up to your expectations just given that your loss rates are actually higher across the board on a year-over-year basis than anybody else in the sector.

So it seems that things are changing here a little bit more quickly.

So if you could just help us understand kind of that vector, that would be quite helpful.

Well, I guess if you look at the data, we have had somewhat of a higher increase than some others because we were the lowest of the players.

And I'd say that if you look at the prime-related large issuers, it's actually very tight now.

And I think that of the 4 big prime issuers, we're all within about 10 or 20 basis points, which is the closest we've been in years.

And so when we talk about normalization, I think some of the other players had to normalize from abnormally high things -- charge-offs as they continue to work off the problems of pre-downturn loose credit whereas we had the benefit of having a very fantastic credit.

But we are -- we're at a range where being in the low 3% charge-off rate for a prime credit card is great, and our underwriting assumptions assume higher than that through the cycle.

And so I think what -- the way I think about it is if we had expected to be close to 2% charge-off rates indefinitely, we would have been leaving a lot of money on the table and would have been under extending credit.

So to me, this is kind of a more natural move.

Yes, it's painful because we have to put up those reserves that we had to release on the way down.

And I do expect if unemployment rate stays at 4%, housing prices continue to rise, everything continues to be nice, things ought to stabilize here at some sort of new normal rate level.

And what we're seeing so far is consistent with that.

Okay.

And is there -- would you be willing to share what the tenor of the charge-off accounts are?

Are these new accounts that have been acquired that just didn't work out?

Or are these somewhat aged that are being charged off after being long-term customers?

Can you give us some sense as to the nature of the charge-offs?

Hey, Ken, maybe the best way to think about it, as I said, if you think about the reserve build, 40% of it was related to new accounts, 60% of it was related to the back book.

So I think that's already been asked and answered.

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

First question for me just on the comment you made, Mark, about that compensation and any growth there will be a function of growth elsewhere in the business.

Are you feeling any pressure on the compliance side to bring in more people or increase dollars there?

Sort of have we reached the end of that process or even are we at a place where we think we'd take -- see some shrinkage and some compliance related and consultant-like spending?

Yes.

I would say I wouldn't attribute the increase in the 9% year-over-year growth to compensation.

I would say the vast majority of the increase would be coming in other categories more broadly.

Compensation in and of itself was a chunk of it.

I would say that was more broad-based across the company as opposed to really being focused in the regulatory side of the equation.

I do believe we are encouraged by what we see being discussed in Washington on [tearing and tailing] and regulatory reform.

We do believe that there's sincerity in Washington that folks really want to advance and move this forward.

To this point in time, I would say we've seen glimmers, but think about this, your CCAR, where I think we just telegraphed, it's a tougher CCAR this year than we've seen in years past.

So what I would say is right now, it feels like we're in that awkward period of time where the pendulum on the grandfather clock is swinging and it hangs there for a second before it swings the other way.

So I would think about compliance spend really as being more stable now as opposed to being on either an increasing or a decreasing trend.

And I might just add -- I might add more broadly that we're pleased to be at around 38% efficiency ratio, pleased that again we've been achieving positive operating leverage growing expenses faster than revenues.

And that operating leverage being one of the best in the industry doesn't mean that we don't have other opportunities to, maybe over a multiple year period, to push that a little bit lower.

And I think compliance-related expenses, can we automate some things and can we mature some things, regardless of any regulatory changes that may or may not happen, we view as an opportunity.

But artificial intelligence, technology, there's a lot of -- our direct business model does lend itself to really taking advantage of new technologies to drive more and more efficiencies.

And so we're focused on that.

Okay.

And then just thinking about one of the conversations earlier in the call about how competition affects your growth rate loans and thinking about the 10% year-on-year growth in credit card loans this quarter.

Can you give us a little commentary around the actions you like -- when did you take the actions that generated that 10% growth?

Because I think about some of the issues with Discover It, that ultimately caused spending and then caused loan growth, some of these things seem like they're multiyear efforts that result in loans now and then some are like balance transfers that are more near term.

Anyway, you guys are always tracking a balance, can you just give us a comment on your thoughts there?

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

I guess I'd start by reminding you that one of the things we said is we really haven't changed over the course of the last several years, our approach to the business.

We were willing to underwrite to a loss rate that is higher than where we are today, that continues to be the case.

With a certain cost to acquire the account and then think of that card acquisition model like an NPV calculation essentially is how you think about it.

And I think we said before, we target a return that's greater than the return on the buyback program, plus a risk premium, plus a credit premium.

And then we also want to see breakevens generally speaking inside of 5 years, right?

So that's the rubric we have used going back for a number of years now.

And what we saw is if you go back 4 years ago, I might be off by a year or so, we were outgrowing the prime market by about 400 basis points using that same general rubric, then others came back into the market surging or just consistently back in the market in the case of some players.

What we saw is they were willing to pay acquisition costs we weren't willing to pay.

So candidly, our growth rates fell not because we chose to peel back on growth, just because others were willing to pay more to get the accounts.

Now that those others have backed out of the market more, what you see is that same underwriting model is producing the higher levels of growth.

So I wouldn't think about it as so much what we're doing differently as opposed to really the market dynamic itself has shifted.

And I would say, that's essentially what I was going to say.

I would just summarize that, that we tend to be consistent, but we are impacted by less consistent competitors.

Your next question comes from the line of Chris Brendler from Buckingham.

So Mark, if I look at the card yield, up about 20 basis points year-over-year.

Can you help me think about the factors that are weighing on that?

I feel like there's a little bit of a missing link between the increase in the prime rate and the increase in your card yield.

I understand there's some mix issues, also interest charge-offs.

I guess the one piece I don't know is to the extent that consumers are paying off their balances more in full as you shift more to a spend-centric model with some of your advertising.

Is that a big factor?

Is there anything else I'm missing?

And related question, as the promotional activity fades a little bit as you discussed and also potentially charge-offs level off, can we see that card yield do a little better in the second half of the year?

Yes, I'm not going to prognosticate on the card yield trajectory, but I'll go ahead and talk about the bits and pieces that have affected it heretofore.

I think you are correct, there is an element of charge-offs of accrued interest that are flowing through there that are a piece of it.

And I think you've seen the uptick in charge-offs over the course of the last year.

A piece of that obviously is going to be mirrored on the interest and fees side of the equation.

Promotional balances, the other component you called out, promotional balances right now are sitting at about 21% of the total book.

That's not all balance transfers.

Some of that is other things as well.

Those balance transfers, obviously, have an impact, though, because they carry a yield, which is equivalent to the fee being accreted in the yield over the life of the BT if there's a fee associated with it.

0 all the way if there isn't.

So that higher level of promotional activity has had some muting effect as well.

I would say, those would be really the 2 big pieces.

And then of course, you have the piece of the book that's just transactors, right?

So you're not going to see the transactors -- the bigger your transactor book is obviously, the more of a muting effect that has on your overall card yield of the book as those books don't revolve.

So those would really be the component parts and pieces.

Okay.

A related follow-up question.

Really excited about this deposit product.

Seems like it could be a little bit of a game-changer for the company.

What's the hesitation?

It doesn't seem like there's a lot of risk, from a credit perspective on doing more of a fuller rollout of a checking product.

Why the caution on rolling out what could be a pretty unique differentiated product in today's market?

Well, I would just say, while there's not credit risk, there's certainly fraud risk.

And so we have to be cautious there.

And secondly, the traditional distribution for checking accounts has been branches.

And I think that consumers increasingly will acquire their checking accounts in a digital fashion, but we are a pioneer in that.

And so I believe that it -- as a pioneer, it will take time to literally change consumer behavior in the country.

But long term, I believe we're best positioned of any one I can think of to revolutionize that, but I think it will take time.

(Operator Instructions) Your next question comes from the line of Bob Napoli from William Blair.

A question on the Payments businesses, the PULSE and the Network Partners continue to show strong growth.

And the income, the net income in that segment, you mentioned some things for the $45 million.

Is that a real number, a sustainable number?

I mean it was a pretty significant increase over the trend.

And what is your outlook for the growth of those businesses?

Can -- do you want payments now that you have some momentum to become a much bigger part of the business over time?

So I'll speak to the numbers themselves and David can speak to the vision for Payments here.

I guess what I would say, Bob, is I feel good about the numbers, I feel good about the trajectory of the numbers that we're looking at, at this point in time.

The PULSE put up some very strong growth.

In that particular case, I would say they were -- there were no particular elephants who presented -- there are no giant wins in the quarter or anything like that, that really drove that growth.

It was far more granular across the board in our traditional marketplace of smaller FIs and some mid-tier FIs as well.

So I would say, I feel very good about what the team has done there.

I would say the AribaPay volume continues to pick up nicely.

Feel very good about the trajectory we've got there as well.

So if I think about the business more broadly, it feels like there's a number of things that are really beginning to fire on a number of different cylinders, and really feels like we've turned the corner from a couple of years ago when we were facing what we thought were some pretty anticompetitive actions on the part of some of our competitors.

And David, do you want to speak to the vision?

And I would just say that, I'm not sure I -- 19% growth is awesome but hard to maintain for very long.

But if we can maintain 10% plus double-digit growth, we did that in the early years of PULSE, and I'm glad we're back in double digits.

And I would just say that we are looking very hard at opportunities in the U.S. and around the world to really capitalize on this very scarce and, in our view, very valuable network that has the ability to scale to a whole lot more volume.

But most of that volume today is locked up by Visa and Mastercard, and we're looking for nontraditional ways to unlock it.

The AribaPay business, I mean, is that -- the B2B payments business, are there other partners?

Is that -- I mean, that is a massive market.

I'm not sure if you're looking to become a much bigger player in the B2B payments market or not, but Ariba, I mean, it's nice.

It's one partner, and it's starting to be some real volume.

But what else -- what is the rest of the game plan in that business?

I'd say that Ariba is just one of the places that we're placing bets.

We're seeing some continued good volume growth, but it is a very skinny margin business.

So we -- I would not say that we're staking our whole payment strategy on AribaPay or staking our strategy on placing a bunch of bets.

I'd say the one that I would point out is the net to net.

We're up to about 14 global players that we partnered with, and we continue to sign a few more every year.

And in the long term, the nice thing about that is it comes with some cross-border business.

And as you know, that is the highest margin business in Payments.

And so it's maybe a little easier for me to see us monetizing and making -- having that contribute to the profit, sitting here right now today than what I would say on AribaPay.

But we'll keep looking at AribaPay.

Your next question comes from the line of Jill Shea from Citigroup.

Just following up on CECL, realizing that there's a lot of moving parts and it's still in proposed form.

But could you touch on your views and potential implications of CECL on regulatory capital ratios?

Yes.

So it's hard to know what the impact of the ratio is going to be until we know what the absolute impact on the reserve level is going to be because obviously, that initial hit is going not be a P&L event.

It's going to be a capital hit as you adopt CECL.

So what I would say is the regulators did come out and make a statement that I think it was -- it might have been that they're leaning towards, I'm sorry I don't remember if it's they're leaning toward or if they actually have agreed now to allow for a 3-year phase in of the regulatory capital impact to CECL, so that obviously eases the transition there to the extent the numbers are large.

But I would say that really being able to triangulate more on the reg cap impact itself requires us to be able to triangulate more on the absolute magnitude of the delta in reserves that I think we're still working through a number of issues.

So looks like maybe no more questions?

Am I right about that?

Yes, there are no further questions at this time.

I turn the call back over to do Craig Streem for closing comments.

Thanks, everybody, for your attention.

And of course, any follow-up we're available whenever you need us.

Thanks.

Bye.

This concludes today's conference call.

You may now disconnect.