發現金融 (DFS) 2019 Q4 法說會逐字稿

Good afternoon. My name is Erica, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter 2019 Discover Financial Services Earnings Conference Call. (Operator Instructions) I would now like to turn the call over to Mr. Craig Streem, Head of Investor Relations. Please go ahead.

Thank you, Erica. Welcome, everybody, to our call this afternoon. We will begin, as usual, on Slide 2 of the earnings presentation, which you can find in the Financials section of our Investor Relations website, investorrelations.discover.com.

Our discussion today contains certain forward-looking statements that are subject to risks and uncertainties that may cause actual results to differ materially. Please refer to our notices regarding forward-looking statements that appear in today's earnings press release and the presentation. Our call today will include formal remarks from our CEO, Roger Hochschild, covering 2019 full year and fourth quarter highlights, and then John Greene, our Chief Financial Officer, will take you through the rest of the earnings presentation. And when John completes his comments, there will be plenty of time for a Q&A session. And please limit yourself, if you don't mind, to 1 question and 1 follow-up so we can make sure that we accommodate as many participants as possible. Now it's my pleasure to turn the call over to Roger.

Thanks, Craig, and thanks to our listeners for joining today's call. I'll begin by reviewing the highlights and key performance metrics for the full year, then turn the call over to John to review fourth quarter results as well as our guidance elements for 2020.

2019 was another very good year for Discover with net income of $3 billion after tax or $9.08 per share and a healthy return on equity of 26%. These results reflect our business model that brings together the positive attributes of high-return consumer lending and Direct Banking with the benefits and long-term potential of owning our own global network. Our robust returns allowed us flexibility to return excess capital to our shareholders, while continuing to make important investments in the Discover brands, advanced technology and expanding our acceptance globally. These investments have further strengthened our competitive position in 2019 and set us up for continued strong returns in 2020 and beyond.

Looking at some of the specifics. Total loans grew 6%, in line with our expectations, and credit performance was also on target, as we benefited from the continued strength of the U.S. consumer and ongoing advances in our risk management and servicing capabilities. We achieved a robust net interest margin of 10.41%, and operating expenses remained in our targeted range.

Economists are forecasting continued growth in the economic environment in 2020. However, given the unprecedented duration of the economic expansion, we will manage credits with that in mind. We continue to invest in our global payments business in 2019, focusing on expanding acceptance by adding network partners and relationships with acquirers in key markets like the U.K., New Zealand, France and Spain.

Our Payment Services segment generated a 24% increase in pretax income, primarily driven by strong volume gains from our PULSE business. The team at PULSE had a great year, adding volume from acquirers and both existing and new issuers.

Turning to Slide 4. We had solid loan growth in all our products, with total loans and card loans, both up 6%. In our card business, the majority of this growth was in higher yielding merchandise balances as opposed to promotional activity, reflecting strong card member engagement. We continue to introduce features and service enhancements that are relevant to customers and prospects, including, for example, leveraging merchant partnerships to provide even greater value to our card members.

We also had a good year in our student lending business with organic receivables up 9%. Loan growth is benefiting from increased awareness of the Discover brand, enhancements to acquisition models and improvements in the conversion process. We continue to benefit from our strong position as the second largest provider of private student loans. Our personal loan portfolio grew 3% in 2019, a touch above our expectations. Our investments in analytics and modeling have had a significant impact on our personal loan credit performance, enabling us to increase originations, while maintaining an acceptable level of credit risk.

Turning to Slide 5. Credit performed very well in 2019, and it was in line with our expectations. The seasoning of loans from recent vintages was the primary driver as the impact of normalization in the consumer credit industry continues to abate. As I said earlier, we feel good about the underlying economic and credit trends as we enter 2020, and we'll have more to say about the overall credit environment when we discuss fourth quarter performance and 2020 guidance later in the call.

Before I turn the call over to John, I want to wrap up by saying how excited I am about our prospects for continuing to create value for Discover's customers, team members and shareholders. We finished 2019 on very solid footing, generating outstanding returns by combining solid loan growth and effective credit risk management.

I'll now ask John to discuss our financial results in more detail.

Thank you, Roger, and good afternoon, everyone. I'll begin by addressing our summary financial results on Slide 6. Looking at key elements of the income statement. Revenue net of interest expense increased 5% this quarter, driven primarily by a 6% increase in average loans. Provisions for loan losses increased 5%, mainly driven by loan growth, and to a lesser extent, by ongoing supply-driven normalization in the consumer credit industry. Operating expenses were up 7% due to higher compensation expense and continued investments to support growth in collections, digital platforms and advanced analytics.

Moving to Slide 7. Roger already covered the key loan metrics, but I wanted to emphasize that the majority of the growth in card receivables came from standardized merchandise balances with a smaller contribution from promotional balances. We expect merchandise balances will continue to be a primary driver of card growth in 2020. Just under 70% of the increase in receivables was from new accounts with the remainder from existing cardholders.

Looking at student loans. Total receivables were up 3% from the prior year with the organic student loan portfolio increasing 9% year-over-year.

Turning to Slide 8. Volume on the Discover Network rose 5% from the prior year, in line with growth in the Discover card spending. Within our Payment Services segment, PULSE volume increased 6% over the prior year, driven by strong performance in key products.

Moving to Slide 9. Net interest income of $2.4 billion increased $122 million or 5% from the prior year. The increase was driven by higher loan balances, a higher revolve rate, lower promotional balances and a favorable funding mix as we continue to grow lower cost direct-to-consumer deposits. This was partially offset by the impact of a lower average prime rate in the quarter; an unfavorable funding rate, reflecting maturities of lower coupon brokered and direct-to-consumer deposits; and higher interest charge-offs. Total noninterest income was $520 million for the quarter, up $15 million or 3% year-over-year. The primary drivers of the increase were higher loan fees and an increase in transaction processing revenue. Net discounts and interchange revenue was up $281 million or 1%.

Turning to Slide 10. Our net interest margin was 10.29% for the fourth quarter, consistent with our expectations. This was down 6 basis points year-over-year and 14 basis points sequentially. Relative to the prior year quarter, the decrease in NIM was due principally to 3 factors: first, the unfavorable funding rate, I just mentioned; second, the impact of a lower prime rate; and third, higher interest charge-offs. These were partially offset by a higher revolve rate, BT fees and a favorable promotional balance mix. Relative to the third quarter, NIM decreased 14 basis points due to the impact of lower prime rate and an unfavorable funding rate, partially offset by a higher revolve rate and BT fees. Total loan yield decreased 7 basis points from a year ago to 12.52%, primarily driven by a 12 basis point decrease in card yield, reflecting prime rate decreases and higher interest charge-offs. This was partially offset by a higher revolve rate, BT fees and lower promotional balances.

On the liability side of the balance sheet, average consumer deposits grew $3 billion in the quarter and now make up 55% of total funding. Consumer deposit rates decreased 13 basis points from the third quarter as we actively manage our funding cost lower. Although market observers expect a stable Fed funds rate this year, we'll remain vigilant for opportunities to prudently manage our deposit and other funding cost.

Turning to Slide 11. Operating expenses increased $74 million or 7% from the prior year. Employee compensation was $33 million higher, reflecting staff increases in technology as well as higher average salaries and benefit costs. Professional fees were $24 million higher, mainly driven by third-party recovery fees. Cost to support investments in analytics also contributed to higher professional fees. The $20 million increase in information processing was driven by our continued investment in advanced analytics and infrastructure costs.

Turning to credit on Slide 12. The takeaway here is that overall credit performance remains stable and well within our risk and return expectations. Total net charge-offs increased 11 basis points from the prior year with the primary driver continuing to be the seasoning of loan growth, and to a lesser extent, the supply-driven normalization in consumer credit. Credit card net charge-offs increased 18 basis points from the prior year and 9 basis points from the prior quarter. The credit card 30-plus delinquency rate was 19 basis points higher year-over-year and 12 basis points sequentially. This was another solid credit performance in our card business, reflecting our disciplined underwriting and line management. We saw a modest uptick in student loan charge-offs as the portfolio seasoned. Student loan credit performance continues to be aided by efficiency gains in collections, including expanded outreach to cosigners. In personal loans, charge-offs rose in the quarter, consistent with typical seasonal patterns. The 30-plus delinquency rate was down 23 basis points from the prior year and 12 basis points compared to the third quarter. We continue to see credit improvement as a result of our prior credit tightening and improved fraud detection.

Before leaving the subject of credit, I wanted to preview an additional disclosure on troubled debt restructuring, you'll see in our 10-K. To provide greater clarity on the growth in our TDR receivables, we will now report the balance of receivables that have successfully completed programs. At December 31, we had total credit card TDRs of $3.4 billion, up $1.1 billion from the prior year, but, in fact, over half of the $1.1 billion increase was from customers who had successfully completed a program. In account number terms, this equates to about an 80% success rate. This demonstrates that our modification programs are an important aspect of helping customers through temporary hardship and also benefit discovered by reducing overall credit cost and enhancing revenue.

Let's turn now to Slide 13. Our common equity Tier 1 ratio decreased 20 basis points sequentially, reflecting loan growth and capital returns, partially offset by strong earnings. Our payout ratio, which includes buybacks, was 77% over the last 12 months. And as we noted earlier, average consumer deposits now make up 55% of total funding.

Slide 14 provides a summary of 2019 business performance compared to our guidance for the year and against 2018 performance. You will see green check marks against each of the metrics, and I want to congratulate the team for its solid execution against all of our key financial objectives for 2019.

The following slide provides a summary of our outlook and guidance for 2020. First, we share the consensus view that the macroeconomic environment will remain stable. We do not see any indicators that point to a recession in the next 12 months. We expect the U.S. consumer to remain healthy and unemployment remaining near the current levels. We also note that household debt service levels are at a 40-year low, an indication that consumers remain financially resilient. Based on these factors, we have assumed no Fed rate changes in our 2020 business plan. This backdrop sets us up for another year of profitable growth and strong returns.

Now turning to the specific guidance elements. First, we expect loan growth to be in the range of 5% to 7%. Next, we expect operating expenses to be in the range of $4.7 billion to $4.9 billion as we continue to invest for future growth with incremental spending on our brand to increase awareness and consideration. We expect net charge-offs to be in the range of 3.3% to 3.5% this year, reflecting a stable credit environment and the seasoning of our growing portfolio. Our target CET1 ratio continues to be 10.5%, which remains an achievable target under CECL due to the phase-in for regulatory capital purposes and our capital-generative business model. I'm sure you've noted our list of guidance elements for 2020 is a bit shorter. In fact, we've taken a fresh look and decided to no longer provide specific guidance on the rewards rate or NIM. The rewards rate can vary quarter-to-quarter depending on the 5% category. The annual rate has been increasing by around 2 to 3 basis points due to the ongoing shift from the more card to the it card, and we expect this trend to continue. In terms of NIM, the single largest driver of changes in net interest margin has been Fed actions. Given this, we've elected not to provide specific guidance but will comment on the other drivers, such as deposit beta and spending patterns as part of our quarterly earnings calls.

So with that, I'll move on to the topic of CECL. On the last earnings call, I indicated the day 1 adjustment would be towards the north end of the 55% to 65% range we had guided to. We now expect our adjustment to be approximately $2.5 billion or 75% above the year-end incurred basis. In terms of the day 2 impact, the reserve change will depend upon the mix of the business, economic outlook, overall credit performance at the point in time, in which quarterly estimates are determined. Additionally, the seasonality of our business will impact quarterly reserve changes and could introduce some volatility from one quarter to the next. As you've seen, our business model is capable of generating high returns, which should enable us to largely offset the capital implications of CECL over time.

Wrapping up on Slide 16. In 2019, we generated 6% total loan growth and delivered a robust 26% return on equity. We had a very strong year in our consumer deposits business with growth of 22%. Credit remained in line with our expectation and return targets, and we executed on our capital plan by allocating capital to loan growth and share buybacks. In conclusion, 2019 was a strong year, and we're very pleased with our performance and positioning for 2020.

That concludes our formal remarks. So I'll turn the call back to our operator, Erica, to open up the line for Q&A.

(Operator Instructions) We'll take our first question from Ryan Nash with Goldman Sachs.

So John, thanks for the updated day 1 outlook on CECL, where you said 75% increase. I guess, first, what is driving that higher from the initial guidance? And then second, on last quarter's call, you mentioned the day 2 impact on the reserve build could be higher than day 1 since you're adding new accounts that don't have any incurred loss. The message is slightly different from what we've heard from others. So I just wanted to get a sense, one, how should we think about -- is that the fact that you're growing faster and adding more accounts factor into that faster day 2 impact? Or is there something else that's impacting it? And I have a follow-up.

Okay. Thank you, Ryan. Thanks for the question. So let me start with day 1 impact. So I think as I said on the last call that my take was the team did a fantastic job in terms of modeling and preparing for CECL implementation, and that view still holds very, very strongly. The initial guidance of 55% to 65% included a number of factors. And as we came through the fourth quarter, we took a look at the modeling, the performance of the portfolio and specifically, recovery assumptions. And we ended up revising a recovery assumption that had to do with overall recoveries, taking a look at most recent history, which was certainly a stellar performance, and we've moved it back to the middle point of the observable history on recovery. So that was the primary driver of the change in day 1.

In terms of day 2, I said on my first call, third quarter, that day 2 would be higher. And certainly, in the third quarter, it was higher as we modeled and that increase had to do with the amount of volume we put on the books related to our student loan products, which, in terms of day 2 impact, has a significantly higher impact than day 1 would under an incurred basis.

Now that actually points to some of the volatility that we're seeing in CECL. So as you -- as we take a look at all our product and the relative mix throughout the year, I would say, a good proxy for day 2 would be that range around 75%. So it's a slight nuance on the initial message that I provided. But I would also caution that, that's a preliminary number, and we're working through it. And there's a bunch of dynamics that impact CECL, including the macroeconomic outlook, portfolio performance, mix of products that we're putting on the book in any one quarter. And obviously, the delinquency and roll rates that we're observing. So a lot to consider there. But I hope I've provided enough specificity to be helpful as you think about how to model this business.

Got it. And then, I guess, a follow-up for the both of you. So if I look at the expense guide, it implies about 7.5% to 12% expense growth, which is ahead of, I guess, expectations and where you are running. So first, John, can you maybe size some -- what are some of the incremental investments?

And Roger, are there any one-off investments in here that you feel you need to make for this year? Or are we entering into a new phase of elevated investing? And then second, how should we think about seeing the paybacks from these investments?

Okay. Ryan, I'll start, and then Roger, I'm sure, will have a follow-up. So I'm going to start with -- by editorializing a little bit here. So if you look at the efficiency ratio that this company has generated over time, it's among the lowest in the industry. And then if you also look at the returns, in terms of return on equity, we are among the highest in the industry. And one could use those 2 data points and make a simple argument that perhaps we've underinvested over time given how much -- given the returns that we're generating. So as we put the plan together for 2020, we looked at where it was appropriate to invest, where we thought we'd generate the best long-term returns for our shareholders. And there was 2 items specifically: so investments in brand around awareness and consideration. And that's a meaningful number around $100 million, believe it or not; and then also continued investment in our infrastructure to add functionality and ensure it's appropriate from a scale and resiliency standpoint going forward.

Yes. And maybe just to build on what John said, in terms of the payback, some will be more immediate to drive our continued strong loan growth, but others, we also expect multiyear returns. And as you think more broadly about our expenses, I'd say, it's sort of a dual story of efficiency but then also investments. And so the vast majority of the expense lines are close to flat year-over-year. As John and I look across the P&L, we're looking for efficiencies in terms of our marketing expenses. So our CPAs that we're targeting across the different products, but we are investing significantly around building the brand, and also building brand awareness of some of our non-card products, as well as some investments in technology that we think will be very helpful in driving growth in the future.

Yes. And then just one follow-up comment. So this company has a rich tradition of effectively managing cost. And certainly, my background, I've had my share of cost management and analytics to ensure we are -- we're going to get a payback on these investments. So as Roger said, some of these are longer term, some of these are shorter term. We'll continue to monitor and ensure that for every dollar we're spending, we're getting appropriate paybacks for our shareholders.

We'll take our next question from Sanjay Sakhrani with KBW.

I guess I wanted to dig in, again, on day 2 impact related to CECL. I was wondering, John, if you could give us a little bit more to help us sort of triangulate on how we should think about the provision for 2020?

Yes. So I've guided around that 75% figure as, call it, a post or an anchor as you think about day 2. It's still early, as I mentioned on my last comment, Sanjay. So I would say, for the year, that's a decent way to think about it. Might be a little higher, might be a little lower. And in terms of quarter-over-quarter, in the third quarter, we originated a lot of student loans. And that day, too, will certainly exceed the 75% number that I just mentioned. So mix will be an important factor on it. But beyond that, I don't know if I'd be doing anyone a service by being more specific.

Okay. Fair enough. And then on the other guidance data point around loan growth and not getting a whole lot on NIM and rewards rate. I was wondering, if we think about loan growth and what revenue growth might do in relation to loan growth, is it fair to assume that it should be fairly commensurate, i.e. there's not significant factors that would lead to a different direction than what loan growth would suggest? Or am I thinking about it incorrectly.

No, no. I think you're definitely in the right direction. So there's a couple of things that I just want to point out. So as I said in my prepared remarks, we assume no Fed rate changes in our planning assumptions. So if that changes, that certainly, as it has done historically and been a problem from a forecasting standpoint, that would impact NIM. We're also -- I alluded to this in the prepared remarks in terms of our focus around deposits and increasing the level of overall funding from a direct-to-consumer deposits, which are a cheaper funding source.

I also mentioned that I think there's -- over time, we will continue to work to see what we can do in terms of the cost of deposits making sure that we're originating the deposits at an appropriate level to fund the balance sheet towards our longer-term target, but also being very mindful of the cost of funding. So if things went well, there could be 1 basis point or 2 on the deposit side. That's your call, whether you want to put that into your models. And then in terms of pricing action, the company has been pretty stable, but we'll continue to look for opportunities on the pricing side.

We'll take our next question from John Pancari with Evercore.

I just have a question on the TDRs. I know you'll be giving us more disclosure in the K. But I wanted to see if you could give us the -- of the $85 million loan loss reserve build that you recorded for the quarter, how much of that was related to TDRs? And then separately, do you have what the delinquency ratio was for the TDRs for the quarter?

So for the quarter, we've previously said this, and it's -- it remains consistent that, from a TDR standpoint, only 5% are more than 90 days delinquent. So that's remained consistent. So performance there, no major change. In terms of reserve provisioning, we're probably not going to break that down on this call. I don't know that it would be super-helpful. And if I did, it would take the balance of the call to kind of walk through the nuances of it. So we'll pass on that one, if you don't mind. Sorry, I can't be more specific, John.

No, no, I get it. That's fine. I guess, one more on the TDR topic. Just given the increase that you cited, the up $1.1 billion year-over-year, that's about just under a 50% increase. And then TDRs were up 9%, linked quarter. It looks like -- I mean what are you seeing differently in your -- the makeup of your card base that you -- that Discover is seeing a much larger increase in the usage of TDRs versus a lot of your peer institutions? I know you can't really talk too much about what the peers are seeing, but the increase in TDRs has certainly outpaced that of other lenders in the space?

Yes. So let me start off by saying that we have some really solid analytics around our TDRs. And we test populations. And then once those tests come back and show that, indeed, cash flows are improving, we'll open it up to a certain population and then we'll observe that, and then we'll adjust accordingly based on any differences we see between the test populations and when the TDR-specific program is in process. So I'm not really going to talk about what other folks are doing. There is -- there also is an approach that we take, where we think that -- and we've seen real differences in terms of outcomes for our customer base in terms of helping them work through some difficulty and they end up -- some 80% of them end up sticking with us, have their credit lines open back up and continue to be very, very satisfied customers. So what -- around the edges, we're going to take a look at smaller accounts and see if the effort to make a TDR is worthwhile based on our belief in terms of what's going to happen in those particular populations. But these are good programs. They're -- the financial impact is taken as soon as we TDR them. They remain in the delinquency buckets that they're in, unless they've made 3 successive payments. So what you're seeing flow through the financials is exactly what you would hope in terms of overall good credit performance and a solid book. And TDRs is an approach to work with customers and help cash flows.

And maybe just to build on that. There has been a lot of noise around this. And so that's part of why we decided to add the disclosures to help provide you more information and kind of give us more insight to the way we see it. A better way to classify it might be, not just TDRs, but customers who have ever been in a TDR. And so the growth really, some of them will have returned to prime, we'll be getting line increases, et cetera, and are well into the book. It just happens to be the way we account for these is once a TDR always a TDR. So that's why we think these new disclosures that you see in the K will be very helpful.

We'll take our next question from Mark DeVries with Barclays.

Yes. My question is, what are the implications of the 10.5% CET1 target for the end of 2020, which I believe is kind of where you guys have indicated, you think you should operate longer term on the payout ratio as we look beyond 2020 and sort of factor in the continued phase-in of the CECL impacts along with continued loan growth?

Yes. Okay. So I'll take this and maybe Roger will have a comment if appropriate. So when the team set up the original target for CET1, they did that with the idea that, indeed, CECL would be implemented and would impact the overall capital plan for the year 2019 through the first half of 2020. So we are going through our beginning -- our CCAR work, and we're going to make the submission, and we'll get some feedback likely in June, and we'll use that, coupled with our overall plan around capital allocation that we'll review with the Board to make a determination of what the future dividend payout ratio and buyback programs will look like. I would say this, so as we look at CECL for 2020 and our capital-generative business models, we can likely absorb over the short term, based in the phase-in and long term, the impact of CECL. Now there's questions regarding our regulators and how CECL will impact the consumer finance industry, especially given its pro-cyclical nature and the fact that products with longer lives, such as student loans and certain home equity products, and even to a lesser extent, personal loans in a tough economic environment, certain lenders might not look -- like the profile of that, and that will impact the availability of credit. I will say this, we like our products under CECL and under the current FAS 5 methodology. So it's based on the cash flows. CECL's not impacting the cash flows. And we like the return profiles that we've generated historically and will in the future.

Yes. And to build on that, from our discussions with regulators, I wouldn't interpret the phase-in as just delaying the pain. The Fed has indicated to us that it's designed to give them time to see how CECL is impacting different financial institutions. And that actually, they feel like the amount of loss absorption in the system currently, i.e. pre-CECL, which is capital plus provision, is appropriate. So we'll see how that comes out. But again, I wouldn't just necessarily view it as something that's going to phase-in, and that's that.

Okay. So -- sorry, Roger, does that imply that there's some room for the Fed to potentially say now that you've got greater loss absorption capacity kind of post-CECL that maybe the 10.5% isn't the right level that maybe you could go a little bit lower?

I would not predict what the Fed is going to do. I can just say what I've heard directly from them, which is they feel like pre-CECL, the loss absorption is right for the system as a whole. And that the phase-in is not just to spread it out over time, but to actually give them time to figure out what they want to do. So I would say we're all going to have to stay tuned.

Yes. And then the other kind of party that we'll -- help form this with the rating agencies, right? And we've spent some time with the rating agencies in December, and the view there is, at least, my personal takeaway is that they're going to take a look at equity and reserves in the aggregate. So I don't see any major implications, at least in the short term there.

We'll take our next question from Eric Wasserstrom with UBS.

Gentlemen, I have a question just about credit. I heard your commentary about broad-based stability but also, we're seeing a few other trends, too, such as higher interest charge-offs and investment in collections, higher late fees, the TDR experience that you cited, the success rate seems high, but as others have pointed out, just the growth in TDRs is also very large. So I'm just trying to put all of those pieces together to understand kind of how to really think about the credit experience over the near-term horizon?

Yes, I would worry about stringing a bunch of things together. I think we've talked about the TDRs and are adding more disclosures, so that, hopefully, that will help you see them the way we do. In terms of investing in collections, I think, that's something that makes a ton of sense just about any time, but certainly, late cycle. But that's something we've talked about, I think, pretty consistently for multiple years there. So if you're trying to string those kind of data points into a bigger story, I'm not sure that's something I would agree with.

Okay. And maybe just transitioning topics for a moment. The -- in terms of the investment expense that you've highlighted, is this an expense that you're thinking about over a specific horizon? Or should we just think about the overall efficiency ratio of Discovery is just being a little bit different going forward than maybe what the recent historical experience has been?

I think we've provided guidance for what to expect for 2020. My guess is, going beyond that, we'll continue to invest in growth. But I'm also optimistic about our ability to find efficiencies as well, especially leveraging some of those investments on the technology side, around robotic process automation, around advanced analytics. So we're not prepared to really give guidance beyond 2020. But you can rest assured, we'll be looking to see what we can find on the efficiency side to help fund investments in growth.

We'll take our next question from Moshe Orenbuch with Crédit Suisse.

Great. Just sort of following up, and I appreciate, Roger, that you're not interested in giving guidance beyond that. But if you put together the comment that you do expect a payback from those investments and obviously, the efficiency ratio, given you're likely to see revenue growth in the -- between 5% and 6% at most there, is going to deteriorate in 2020. I mean is -- should we take from that the inference that at some point, it should be improving? Or I mean can you kind of discuss that a little bit?

So it sounds like you're asking for long-term guidance. No -- again, as I said earlier, we're not giving guidance beyond next year. But I did want to make it clear that you shouldn't necessarily take that as a run rate number. And we do believe, to the point John made, as efficient as our model is compared to the rest of the financial services industry, we believe, there are further efficiencies to be gained by deploying some of these advances in technology. So we're not also saying that you can just continue to print the number for 2020.

Right. And maybe just to take that idea because I'm not a huge fan of the idea that, well, because it's lower than others, we should want it necessarily to be higher for some period of time. I mean you talked about the high level of returns, but it's not like we're seeing a degradation in that, right? It's not like that was running down. So maybe talk a little bit about what are the things you saw that kind of made this the right time to take that stand on expenses?

Yes. No -- I think it's a very good point, Moshe. We don't manage the business to an efficiency ratio. We manage our expenses to be as efficient as possible, but then also look to invest and drive growth. And the sum of those 2 really is the entire expense base and drives the calculation of the efficiency ratio. But to the extent we see opportunities to make investments to drive accelerated growth, and we feel good about the payback, as John talked about, we will do that and communicate that as appropriate. But I think your point is a good one. You don't want necessarily just manage the business to an efficiency ratio.

No, I don't think so. And I guess, I look forward to having a future discussion about seeing some of those gains coming in there on the revenue side.

Sure.

We'll take our next question from Jason Kupferberg with Bank of America.

This is Mihir, for Jason. I just had a -- maybe we could start with just CECL. I just want to make sure we understand. Given -- I think you'd mentioned, like, CECL has a differential impact on some of your products, particularly on day 2 and as we go into the quarters. Has that changed your -- the way you think about those products? And also just relatedly, in terms of just the disclosures you'll be providing, are you going to provide disclosures for the next several quarters, so we can compare results on a more apples-to-apples basis?

So yes, thanks for the question. So in terms of how we think about our products, we think about them from a cash flow standpoint and a risk and return -- on a risk and return basis. And we continue to like all our products, whether we are on an incurred basis or under this new regime, CECL. So no change in the thinking there. Now in terms of disclosure, what we've said previously, and we continue to be in the same spot, that we will provide disclosures that will create transparency between CECL incurred for the next 4 quarters.

Got it. That makes sense. And then just real quick, if I can go back to just the OpEx guide. Maybe, I guess, clearly, it's the topic in de jure on this call, but maybe we could get -- if you could give us a little bit of more color on just the kinds of investments you're making and just maybe just help us understand. Your loan growth next year is 5.5% to 7% is a little -- I guess, in the range similar to this year. And it sounds that like some of these investments have a little bit longer payback period. But is it also supporting that 5% to 7% loan growth this year? And would -- do you need to make those investments to achieve that growth, I guess? Is that so?

So here's how we think about it. So there is the investment in brand to drive awareness and considerations. We haven't actually baked it in. But we think that, over time, we'll lower our acquisition cost, our per unit acquisition cost as people find greater awareness of Discover, the product offerings, the customer experience, and frankly, a fair value exchange. So that is one aspect, but that is over time and to be determined. The other piece around technology investments, we're going to be very judicious about those. And with those to make sure that we are deploying functionality that help make a difference to either our growth trajectory or expense profile. So over time, I would expect that, indeed, we'll see efficiency gains, either top line or through the expense base. And some of them, as Roger said, longer term, some are shorter term, but there is a thorough process to make sure we're getting the bang for the buck.

We'll take our next question from Rick Shane with JPMorgan.

When we think about the sort of normal factors that cause hardship, loss of job, death, unemployment or illness and divorce, is there anything idiosyncratic that you're seeing that's changing in the portfolio? Or is there a policy shift that's driving this?

Yes. No, there is no change what -- in terms of, I would say, customer behavior. What you're seeing here is, frankly, the benefit of, frankly, some solid analytics by our collections team in terms of when a customer is experiencing difficulty and helping that customer manage through it. The only process change we've made is, it used to be someone had to call in and talk to a rep. For large balances, that continues to be the case. For certain customers who meet certain criteria, they can do it online on their mobile app. And we've tested those populations versus the call-in populations and actually the mobile app populations are performing as well or better than when someone talks to a rep. So what you're really seeing here in the growth is a couple of factors: one is that, I think, there is a difference in reporting that -- versus some competitors; two is we've had -- we've done an analytical exercise to make sure we understand paybacks and where it can make a difference to cash flows positively and we've opened those up. So it's a combination of those factors. And we're going to keep doing them as long as they're cash flow positive.

Got it. And to the extent it is constructed from an NPV perspective, does the transition to CECL and the lifetime reserve make it easier because there's less accounting, sort of, penalty to doing this?

Yes. You know what, in terms of the P&L impact, right, when you take a TDR, you basically take the net present value of the cash flows and compare it to your balance and that's the P&L impact. CECL, you basically do the same thing on life of loan losses. So yes, the relative kind of decrement to the P&L. And if you were growing TDRs, it's smaller under CECL. But that's not how we make decisions here.

We'll take our next question from Don Fandetti with Wells Fargo.

A couple of follow-ups on the day 2 conceptual accounting. Can you clarify what you mean by the 75%, not on the day 1, but on day 2? Are you talking about incremental provision of just the loan growth? And then also, can you talk, once your allowance rate sort of is set, will it remain relatively stable through the year, if there's no change in sort of mix or economic outlook?

Yes. So in terms of the 75% on day 2, it would be relative to what they would be on an incurred basis. So an incremental 75% versus incurred. Now loan growth will create incrementality versus an incurred basis. It's just the nature of taking a lifetime loss upfront in a provisioning standpoint. And we -- the team did a really good job in terms of modeling. And we feel like we're appropriately reserved and -- from a day 1 standpoint. And going forward if we're seeing better recoveries through a cycle or better performance from an overall portfolio standpoint, then we'll adjust. And if -- correspondingly, if we're challenged somewhere, we'll adjust the other way.

But conceptually, what do you think about sort of the reasons, all else equal, that the allowance rate would remain relatively stable throughout the year despite mix or economic change? And are we talking about sort of CECL being an incremental couple of percent GAAP EPS impact, all else equal?

So I'm not sure I'm totally clear on the question, but I'll try to answer. And if I missed, we can come back. So in terms of -- if we're seeing a change in the economy or outlook of the economy or a change in the performance of our portfolio or a change in mix, all those will have an impact on the CECL reserves.

So -- no, that I understand, but I'm saying, if those were not to change, would the allowance rate, all else equal, kind of stay the same throughout the year?

Yes. So -- yes, so it would build for loan growth at that rate. But in terms of kind of relative difference to incur, it'd to be fairly consistent.

We'll take our next question from Betsy Graseck with Morgan Stanley.

A couple of questions. So Roger, I just wanted to swing back to the investment spend. I think during the -- some of the comments you were mentioning that with the investment spend, you're expecting to be able to enhance the brand awareness, maybe used the words in particular or especially in non-card product. I'm wondering if you're messaging to us that you think that you're underrepresented in either the personal loans or in the student loans or if there's other products that you're looking to get into? Maybe you could touch base on what the implications for that is? And if the payback for the investment should come in the form more in loan growth and NII? Or should it be more -- should there be any fees associated with it as well? Just I would like to understand how you're thinking about that?

Okay. So the investment in brand, there are 2 parts, right? Part of it is just increasing consideration on the card side. You've seen some work around building awareness that we offer products other than just cash back. So we'd put -- add money behind miles as well. But we do -- as we look at consumers out there, there is a gap in terms of, what I'll call, top of funnel, right? People who consider Discover and have us top of mind, so that's why -- as we think about our marketing mix, we're going to heavy-up a bit on top-of-funnel brand-type advertising.

There also is an opportunity for our non-card products, in particular, some of the deposit products. We've made great strides in terms of the products themselves, went out with sort of no fees across any of our deposit products. But there still are huge amounts of consumers that don't understand, for example, we're even in the student loan business, let alone, we are the second largest originator of private student loans. And the same holds true with understanding that Discover offers the savings account, the checking account. So it's a mix of both of those. Building and enhancing consideration on the card side and building awareness for our non-card products.

And then this investment spend should kick off in 1Q, like, should I take this $100 million and just divide by 4 and throw that through the model linearly? Or is this going to be back-end loaded kind of in the 4Q environment? How should I think about the pace of that spend throughout the year?

We tend not to comment on the seasonality of the spend, sorry.

We'll take our next question from Bill Carcache with Nomura.

Roger and John, I had a high-level question on the guidance for you. I think everyone would agree with your earlier point that you guys have a rich history of generating high returns and industry-leading operating efficiency. But within that, there's also been a commitment to positive operating leverage that we're not seeing in this year's guidance with your revenue growth and expense guidance suggesting that you're explicitly guiding to negative operating leverage. And so when we think about what's changed, it seems like in the past, what we've seen from Discover, is a commitment to managing expenses for the revenue environment and achieving positive operating leverage by finding cost improvement opportunities in one area to the extent that you need to make investments in another as opposed to the approach that you guys seem to be taking now, which is more along the lines of making the investments upfront with the expectation that you'll get the efficiency improvements later. So is that an accurate way to think about it? I was just hoping if you could comment on that and just share any high-level thoughts? And that's my only question.

Yes. So first, I'd say it's -- by and large, John is new, but you've got the same team that's been here for decades, making the investment decisions. And I think you've seen a lot of discipline from us over the years, whether it's on the credit side or the expense side. It isn't necessarily a trade-off where we sort of managed to an expense budget. And then sort of if we can generate more efficiencies then that frees up more money for growth. We try and be disciplined and consistent. So our investments in growth are really more driven by the opportunities we see to put our shareholders' money to work to drive good organic growth with strong return profiles for that.

And I mentioned that we expect our unit costs on the investments and account acquisition to be coming down next year. But we do feel like there's an opportunity to put some money to work with a bit of a longer payback on the brand side, in particular, sort of, top-of-funnel brand advertising, driving that awareness and consideration. And on technology, that reflects some specific decisions we are making for 2020. I would not read into it any change in discipline or philosophy from the team here at Discover.

We'll take our next question from Bob Napoli with William Blair.

I guess, trying to follow up on just on the revenue growth -- the loan growth and revenue growth. Is there the potential through some of the deposit products or the consumer banking products, the growth of AribaPay, B2B, that you could get revenue growth higher than loan growth over time? Is that a goal? Or -- and is there a potential to do that? And it seems you've made a lot of investments in the network and in B2B payments over the last several years?

Yes. B2B payments have benefited. It's probably so far more in terms of volume than profitability, the margins can be very thin. But we've been clear that we would love to see more of our earnings come from the payments segment and are very focused on driving that. That can be a multiyear initiative. So I wouldn't necessarily expect something transformational in 2020. But we have a unique collection of payments assets. If you look at PULSE and Diners Club and sort of the fact that we've built the third largest global network in terms of acceptance. So the team is very focused on monetizing that. But again, you're talking about the B2B sales cycle, and so that will take some time.

Okay. Maybe a follow-up on the competitive environment and with the -- maybe with the entrance of the Apple card, which, maybe, is going after the -- your demographic, the growth of neobanks, probably going after the deposit space. In your target segment, several of them -- some of those companies getting super-high valuations as private companies. What are your thoughts on the Apple card, on the neobanks and on some of your investment in brand in response to the competitive environment?

So our investments in brand are much more driven by our traditional competitors and as we've seen, those super-high private company valuations appear to come and go. As I think about competition, competition in the card space is always intense. Right? It tends to be rational, but you have some large, sophisticated players. It's a high-return business. It's challenging, but always intensely competitive. So I would view the Apple card as -- you can't underestimate anything that Apple does. It's a new competitor and one that I'm sure will be formidable. But I don't think it's transforming the overall competitive environment in the card space.

On the deposit side, it's a different decision in terms of who you take a loan from, from who you give your money. And so brand and trust remain key elements of that, I think, as you saw from the very strong direct-to-consumer deposit growth we've posted. We feel like we have the product set, the ability to compete. We really just need to build awareness.

And a lot of the focus is on moving deposits from some of the traditional branch-based players as opposed to necessarily going head-to-head with some of these emerging online players.

We'll take our next question from John Hecht with Jefferies.

Actually, most of my questions have been asked, but a couple of those are out there. Number one is, you mentioned some unfavorable funding triggers in the quarter. And I'm wondering, are those -- are you able to unwind those? Are those kind of permanent aspects of the funding going forward?

Yes. So actually, what that was is, if you go back about 1.5 years ago, we had some really cheap CDs on the books. And then there was Fed rate actions and more expensive deposits came on the books. And over time, if there's no Fed action, you'll see favorability come through into the P&L on that. So -- and if you look at...

And like what duration should we expect that and -- where you'll get that favorable outcome on the deposit costs?

Yes. So it's -- throughout this year and into next year.

Okay. And then follow-up question would be, you've taken deposits as a percentage of funding up a couple of hundred basis points in the 2019 period. How should we think about funding mix over the course of 2020?

Yes. So our -- we enjoyed great growth there. I think it's a testament to both the team and the products and Discover, in general. We have a longer-term target of 70% direct-to-consumer deposits, thereabouts. And I would say, next 3 to 5 years on that. So one way to do it would be to draw a line and plot it accordingly.

We'll take our next question from David Scharf with JMP.

And once again, pretty much all my questions have been answered except I did want to just follow-up on what I hope is not a repetitive topic. On the investment spend, it seemed like collections was highlighted a couple of times. I think backward, looking in the fourth quarter, I have written down that you had more third-party professional fees and then going forward, it was more of a broader investment late cycle. I'm just curious, I mean, should we be thinking about sort of undercapacity with in-house collectors? Is that why you defaulted to more third parties? Or are you finding any challenges with recovery rates internally? Can you give us a little color besides just the cyclical factors?

Sure. So just to be clear, in terms of collections, which we define as sort of prior charge-offs, we do 100% of that in-house. And so that's with our own U.S.-based employees. It is very scalable. A lot of our investments have been in the area of analytics. As well as if you think about collections is marketing. We've seen great impact from sort of building out digital collections. There are a lot of people who may not want to talk about the situation they're in but like seeing the options they have online. And so I think collections is an area where you can achieve competitive advantage. So it's been something that -- there hasn't been a change in our investment strategy there. It's been a multiyear journey, and we expect to continue.

On the recovery side, we do work with third parties, and so to the extent recoveries are more successful because of the commission structures, we will pay more in recovery fees, but that usually means there's a net benefit.

Right. And just adding on to that. So the recoveries are up year-over-year about 28%. So what you're seeing is that, that's, I think, a factor of portfolio, but probably more reflective of where we are in the economic cycle and the fact that the consumer strength is probably, and frankly, increasing and as wealth distribution is also improving mildly. So not a bad story there on the professional fees, whatsoever.

And just one thing I'd point out, on the recovery side, we do not sell any of our charge-off paper. And so -- and haven't for well over 10 years. So you do enjoy a stream from those recoveries as opposed to people who would just sell and take the NPV.

Right. And as far as just as a quick follow-up. And I assume embedded in your net charge-off range you provided for 2020 is a consistent recovery rate as a percentage of gross charge-off rate? Or is there any modification or conservatism built in there?

So overall charge-offs, I mean, we gave the range. That's a net range. And I think we're pretty comfortable with that as guidance.

We'll take our next question from Meng Jiao with Deutsche Bank.

Most of my questions have been answered already. I just have 2. One quick question, I guess, on the deposits. It looks like, I guess, the brokered deposits were pretty down this year. Is that the -- I guess, the run rate going forward or we should see more, I guess, runoff in the brokered deposits range as well as continued expansion in the direct-to-consumer?

Yes. In general, that's the plan. We're going to keep that open as a channel. But in terms of our funding stack, that should continue to decrease as an overall percentage of the funding stack as the DTC increases.

Got you. Okay. And then I guess the second question is, in terms of M&A, I know you guys are focused on B2B partnerships and noting that less interest in a bank deal. Has that changed materially from -- in prior quarters? Or is that still the same message going forward?

Yes. I think we feel good about the businesses we're in and our ability to grow organically. And I think if you look on the banking side, I don't see any gaps in our model that we would need to fill.

We'll take our next question from Bill Ryan with Compass Point.

A question on student lending. If you could maybe give us some idea what your origination volume was in 2019 versus 2018 dollars and/or percent? And maybe what your outlook is for 2020? And maybe a little bit of color what you're seeing in terms of pricing, your market share and borrower profile?

So in terms of growth, we said organically, we had 9% organic growth in student loans, not on originations, but the loan balance. And we've provided overall guidance on loan growth, which is inclusive of student loans. So we're not going to get into kind of origination levels. We just don't think that's probably the most helpful information.

Okay. And any color on pricing or where you think your market share is and things like that?

Yes. I think, we feel good about the season of originations we've had. So again, a little harder to get market share data, but we certainly feel like we held our position as the second largest originator, even in an environment where there were some new entrants. And in terms of kind of who we target and credit, we remain very disciplined.

We'll take our next question from Dominick Gabriele with Oppenheimer.

When you talk about the investment spend, how much of the investment spend? Or are there plans to use this period of time to significantly invest in the global network, in particular? And how much is the focus there, given what you've talked about on investment spend?

Yes. I think we highlighted the 2 areas where we want to call out a significant increase. One was around the brand and advertising, the other one was on technology. We did not highlight a significant change in spending. And again, as we look at building our global acceptance, some of it is working with acquirers, some of those are very cost effective. We've built through these network-to-network agreements, and that will remain a core part of the strategy.

And there are no further questions at this time. Mr. Streem, your closing remarks, please.

Thanks, Erica. And thank you, everybody, for your attention and for staying with us through this long call, but we wanted to make sure that we took care of everybody's questions and didn't cut anybody off. But if you have any follow-ups, please come back to me, and we will take care of it. Thank you.

Thank you.

Ladies and gentlemen, this is -- this does conclude today's conference call. Thank you for participating. You may now disconnect.