Q4 2019 Earnings Call
Good afternoon. My name is Erica and that 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. All lines have been placed on mute to prevent any background noise.
After the speaker's remarks, there will be a question answer session. If he would like to ask a question at that time. Please press star one on your Touchtone phone. If you should need operator assistance. Please press star zero. Thank you I would now like to turn the call over to Mr., Greg strain head of Investor Relations. Please go ahead.
Thank you Eric welcome everybody to I recall. This afternoon, we will begin as usual on slide two of the earnings presentation, which you can find in the financial section.
Our Investor Relations website, Investor Relations Dot discover dot 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 two.
Thousand 19 full year and fourth quarter highlights and then John Green, Our Chief Financial Officer will take you through the rest of the earnings presentation.
And John completes his comments there'll be plenty of time for QNX session and please limit yourself. If you don't mind to one question and one 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, Greg and thanks to our listeners for joining today's call.
Ill 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, an eight cents 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 in 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.
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 as the us consumer and ongoing advances in our risk management and servicing capabilities.
We achieved a robust net interest margin of 10.41% and operating expenses remain 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 credit 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 UK, New Zealand, France, and Spain, our payment services segment generated a 24% increase in pre tax.
Income, primarily driven by strong volume gains from our pulse business.
The team at Paul's had a great year, adding volume from acquirers and both existing and new issuers.
Turning to slide four 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 merchandised 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 on 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 expectation 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 five credit performed very well in 2019 and was in line with our expectations.
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 discovers 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 six.
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.
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 seven.
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 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 eight.
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 nine.
Net interest income of 2.4 billion increased a 122 million were 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 continued to grow lower costs direct to consumer deposits.
This was partially offset by the impact of a lower average prime rate in the quarter.
And 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 to primary drivers of the increase were higher loan fees and an increase in transaction processing revenue.
Net discounts in interchange revenue was up 281 million.
From the or 1%.
Turning to slide 10.
Our net interest margin was 10.29% for the fourth quarter consistent with our expectations.
This was down six basis points year over year, and 14 basis points sequentially.
Relative to the prior year quarter. The decrease in NIM was due principally to three 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 as for 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 seven basis points from a year ago to 12.52%.
Primarily driven by a 12 basis points decrease in card yield reflecting prime rate decreases in higher interest charge offs. This was partially offset by 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 costs lower.
Although market observers expect a stable fed funds rate. This year will 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 higher average salaries and benefit costs professional fees were 24 million higher mainly driven by third party recovery feed 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 advance 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 in nine 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 perform performance in our card business, reflecting our disciplined underwriting in line management.
We saw modest uptick in student loan charge offs as a portfolio seasons student loan credit performance continues to be aided by efficiency gains in collections, including expanded outreach to co centers.
In personal loans charge offs rose in the quarter consistent with typical seasonal patterns.
That 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 improve as a result of our prior credit tightening and improved fraud detection.
Before leaving the subject of credit.
I wanted to preview and 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 30, Onest, 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.
And 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 discover by reducing overall credit costs and enhancing revenue.
Let's turn now to slide 13.
Our common equity tier one 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 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 checkmarks against each of them metrics and I want to congratulate the team for 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 macro economic environment will remain stable, we do not see any indicators that point to a recession next 12 months.
We expect the us 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've assumed no fed rate changes in our 2020 business plan.
This backdrop sets us up for another year 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 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 CE T. One ratio continues to be 10.5%, which remains an achievable target under Cecil 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 rewards rate for NIM.
The rewards rate can vary quarter to quarter, depending on the 5% category.
The annual rate has been increasing by around two to three 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 weve elected not to provide specific guidance, but will comment on the other drivers such as deposit beta in spending patterns as part of our quarterly earnings calls.
So with that.
Ill move onto the topic of Cecil.
On the last earnings call I indicated the day, one 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 to impact the.
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 Cecil overtime.
Wrapping up on slide 16.
In 2019, regenerated, 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 in positioning for 2020.
That concludes our formal remarks, so I'll turn the call back tour, operator, Erica to open up the line for QNX.
At this time I would like to remind everyone.
Star one youre touchtone phone.
Your question.
He was jeremys yourself from Q2 by pressing the bomb key.
Thank you please pick up your handset for optimal sound quality.
We'll take our first question from Ryan Nash with Goldman Sachs.
Hey, good evening guys.
Hey, Ryan good evening.
Hey, John Roger.
So John .
Thanks for the updated.
Okay. One outlook on C.. So are 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 to impact on the reserve build can be higher than day, one 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 the you know.
It does the fact that you're growing faster and adding more accounts factor into that.
No faster day to impact or is there something else that's impacting it thanks have a follow up.
Okay. Thank you Ryan Thanks to the question. So let me start with day one impact so.
I think as I said on the last call that by my take was the team did a fantastic job in terms of modeling and preparing for Cecil implementation and that few still holds very very strongly the.
The initial guidance, 55% to 65% included a number of factors and as 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 them.
Overall recoveries, taking a look at most recent history, which was.
Certainly stellar performance and we moved it back to.
Middle point of the observable history on on recovery. So so that was the primary driver of the change in day one.
In terms of day to I said on.
My first calls third quarter that day too.
Would be higher.
And certainly in the third quarter it was higher as we as we modeled and.
That increase had to do with the.
With the amount of volume, we put on the books related to ours, our student loan products.
Which.
In terms of day to impact as a has a significantly higher impact then day, one would under a incurred basis.
Now.
Now that actually points to some of the volatility that we're seeing and Cecil so issues as we take a look at all our product and the relative mix throughout the year I would say good proxy for day too.
I 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 thats, a preliminary number and we're working through it and there's a bunch of dynamics that impacts Cecil, including the macroeconomic outlook portfolio performance mix of products that we're putting on the book in any one quarter and obviously the.
Okay.
The delinquency and.
Roll rates that were observing so.
A lot to consider there, but I hope that provided enough specificity to be a to be helpful issue as you think about.
Although on a model this business got it thanks for all the color and then I guess a follow up for for the both of you. So if I look at the expense guide implies about seven and a half that 12% expense growth, which is ahead of I guess expectations and where you are running so first John can you maybe size from what are the 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 seem to payback from these investments. Thanks.
Okay.
Ryan I'll I'll I'll start and then Roger I'm sure we'll.
A follow up so I'm going to start with.
By editorial editorializing, a little bit here.
So if you looked at the efficiency ratio that this company has 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 one could could use those two data points and make a simple argument that perhaps we have under invested over time, giving how much.
Given the returns so we're generating so as we as we put the plan together for 2020, we look at where.
Where it was appropriate to invest where we thought we generate the best long term returns for our shareholders and there was there was two items specifically so.
Investments in brand around.
Awareness and consideration and the that's a meaningful number be.
Around $100 million believe or not and.
And then also continued investment in our infrastructure to add functionality and ensure its.
It's appropriate from a.
Scale and resiliency standpoint going forward.
GAAP and maybe just to build on what John said in terms of the payback.
Some will be more median and so drive our continued strong loan growth for but others. We also expect multi year returns and as you think more broadly about our expenses I'd say, it's sort of a duals story of.
Efficiency, but then also investments and show the vast majority of the expense lines are close to flat year over year as John and I look across the PM now we're looking for efficiencies in terms of our marketing expenses. So RCP AIDS that we're targeting across the different products, but we are invest.
Staying 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 we'll be very helpful and driving growth in the future.
And then just one follow up comment so.
This this company has a rich tradition of.
Effectively managing costs.
And certainly my background I've had my share of.
Cost management and.
And analytics to ensure we are.
We're going to get a payback on these investments. So it's Roger said some of these are longer term. Some of these were shorter term we'll continue to.
Monitor and ensure that.
For every dollar spending we're getting appropriate paybacks for our shareholders.
Thanks appreciate the color.
We'll take our next question from Sanjay Sakhrani with KBW.
Thanks I.
I guess I wanted to dig in again on day to impact related to see so I was wondering John if you could give us a little bit more to help us. So triangulate on how we should think about the provision for our 2020.
Yes so.
Guided around that 75% figure.
As as a as a call it a poster and anchor as you think about.
Okay to it it's still early as I as I mentioned on my last comment Sanjay So.
I would say for the year Thats, a decent way to think about it might be little higher might be little lower.
And.
In terms of quarter over quarter.
The third quarter, we originate a lot of.
Lot of student loans, and and that day to we'll certainly.
Exceed the 75% number that I just mentioned.
So.
Mix, what will be an important factor on it.
But beyond that.
No I don't know if I'd be doing any one as 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 E.
There is not significant factors that would lead to a different direction than one loan growth would suggest or or am I thinking about incorrectly.
I think you're definitely in the right direction. So theres a couple couple of things that.
Just want to point out so as I said in my prepared remarks, we assume no fed rate changes in.
In our planning assumptions.
So if that changes that certainly as it has done historically, it's 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 in crude and increasing the level of overall funding.
From a direct to consumer deposits, which are cheaper funding source.
I also.
Mentioned that I think theres. Some overtime, we will continue to work to see what we can do in terms of the.
The cost of deposits, making sure that we're originating the deposits add at an appropriate level to fund the balance sheet towards our longer term target, but also being very mindful of that cost of funding.
So.
You don't if things went well you know there could be a basis point or two on on the deposit side.
The tier call, whether you want to put that into your 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 on the pricing side.
Thank you.
We'll take our next question from John Pancari with Evercore.
Good afternoon.
Hey, John .
I would just have a question on the on the TV ours, I know, you'll be giving us more disclosure in the in the K, but I want to see if you give us the of the 85 million loan loss reserve build that you recorded for the quarter. How much of that was was related to TD ours, and then separately do you have what the.
Delinquency ratio was for the TDR as for the quarter.
So for the quarter.
We we previously said this and it's.
It remains consistent that.
From a TDR standpoint.
Only only 5% are are more than nine delay 90 days delinquent. So thats remain consistent so performance there.
No major change in terms of reserve provisioning.
We're probably not going to break that down on that 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 the kind of walk through the nuances of it so.
We will.
We will pass on that one if you don't mind, sorry, I can't be more specific John 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 that's about to just under 50% increase and then tdrs were up 9% linked quarter it looks like what.
Are you seeing differently and Youre. The makeup of your card base that you 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 increasing CDR is 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 you know we test populations and then once those tests come back and show that indeed cash flows are improving we'll open it up to certain population and then we will observe that and we'll adjust accordingly.
Based on.
Any differences, we see between the test population and.
When when the TDR specific program is in process. So.
I'm not really going to talk about what what other folks are doing there is there also is a 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 in may end up.
Some 80% of them and up.
Sticking with us have their 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 AD.
Smaller accounts and see if STI effort to make it TDR is worthwhile based on our belief in terms of what's going to happen in those particular populations, but these are good programs there.
The financial impact is taken as soon as we TDR and they remain in the delinquency buckets that there that are in unless they've made three successive payments. So.
What youre seeing flow through the financials is exactly what you would hope in terms of overall, good credit performance and a solid book and.
It appears as 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 thats part of why we decide to add the disclosures to help provide you more information and kind of give us more insight into the way we see it.
A better way to classify it might be modest tdrs with customers, who have ever been in a TDR and show the growth really some of them. We'll have returned to prime will be getting line increases et cetera, and are well into the book, which is to happens to be the way. We account for these is once a TDR.
Always at TDR. So thats why we think these new disclosures that you see in the K will be very helpful.
Got it okay. Thank you.
We'll take our next question from Mark Devries with Barclays.
Yes. Thank you.
My question is.
One of the implications of the 10% of CPT, one target for the until 2020.
Which I believe is kind of where you guys have indicated.
So you should operate longer term on the payout ratio as we look beyond.
2020, and start to factor and the continued phase in of the seasonal impacts along with continued loan growth.
Yes, Okay. So I'll take this and maybe maybe Roger will have a comment if.
Appropriate so.
When the team set up the original target.
For the one.
They did that with with the.
Idea that indeed Cecil would be.
Implemented and what impact the overall capital plan or.
2000, the year to 2019 through the first half of 2020. So we are we're going through our.
Beginning RC car work and we're going to make the submission and we'll get some feedback.
Likely in June and we'll we'll use that coupled with our overall plan around capital allocation that will review with the board do.
But to make a determination of what the.
The future dividend payout ratio and buyback.
Buyback programs will look like I would say this so as we look at AD.
Cecil for 2020.
And our capital generative business models.
We can likely absorb.
Over the over the short term based into phase and long term.
The impact to seasonal.
Now.
There is theres questions regarding.
Our regulators and how how Cecil will impact the consumer finance industry, especially.
Given its pro cyclical nature and the fact that.
Products with longer lives such as.
As student loans, and certain home equity products, and even to a lesser extent personal loans.
And in a tough economic environment.
Certain 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 Cecil and under under the current Fas five methodology. So.
It's based on the cash flow cecil's not impacting the cash flows and.
We like we'd like to return profiles that we've generated historically it will in the future, yes and to build on that product 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 cecil is impacting different financial institutions and that actually they feel like the amount of loss absorption in the system. Currently I received so which is capital plus provision.
He is appropriate.
So we'll see how that comes out but again I wouldn't just necessarily view it as something that is going to phase in and that stat.
Okay. So.
Sorry, Roderick does that imply that you know there's some room for the said to potentially say now that you've got greater loss absorption capacity kind of post resultant maybe maybe the 10% isn't the right level that maybe you could go a little bit lower.
Yes, I would not predict what the fed is going to do I can just say, what what I've heard directly from them, which is they feel like pre see sold the loss absorption is the right for the system as a whole and that the phase in is not just to spread it out over time, but actually give them time to figure out.
What they want to do so I would say, we're we're all going to have to stay tuned yes.
And.
The other the other.
Kind of party that will help form this will be the rating agencies right and.
Yes.
We spent some time of the rating agencies in December and that the view there is.
At least my take my personal takeaway is that they're going to take a look at.
Equity and reserves as as in the aggregate so.
You know I don't see any major implications at least into short term there.
Okay. Thank you.
Well take our next question.
Wasserstrom with.
Thanks very much.
Gentlemen, I have a question just about credit.
I heard your commentary about about broad based stability.
But also we're seeing a few other trends to such as.
Higher interest charge offs and investment in collections higher late fees.
The TDR experienced that you cited others to assess rate seems high but.
As others have pointed out just the growth in TD ours 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 over the near term horizon.
Yes, I wouldn't worry about stringing a bunch of things together.
I think we've talked about the TDR is under our adding more disclosure so that hopefully that will help you see them the way we do.
In terms of investing in collections I think thats something that makes a ton of sense just about any time thats certainly late cycle, but that's something we've talked about I think pretty consistently for multiple years. There. So so if you're trying to spring those kind of data points into a bigger stores.
Great.
I'm not sure that's something I would agree with.
Okay and.
Maybe just transitioning topics for a moment.
In terms of the investment expense that you've you've highlighted is this a an expense that.
That you're thinking about over a specific horizon or should we just think about the overall efficiency ratio of the of discover as just being a little bit different going forward than than maybe what the recent historical experience has been.
You know I think we provided guidance for what to expect for 2028.
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.
Great. Thanks very much.
We'll take our next question from now till Orenbuch with credit Suisse.
Great Thats sort of following up and I appreciate Roger that youre not interested in giving guidance beyond that.
But if you put together the comment that.
That you do expect to payback from those investments and obviously deficiency ratio given that you're likely to see revenue growth and the between five and 6% at most there.
He is going to deteriorate in 2020 I.
It is is should we take from that the.
The.
The in for instead at some point should be improving or.
I mean can you can you kind of discussed that little bit.
How should it sounds like you're asking for long term guidance.
No I again as I said earlier, we're not giving guidance beyond next year, but I.
Did want to make it clear that you shouldnt 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 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 different the number for 2020.
Right and maybe just to take that idea.
I'm not a huge fan of the idea that well because it's lower than others.
We should want to necessarily to be higher for some period of timing you talked about the high level of returns but yeah.
It's not like we're seeing a degradation in that right. It's not like that was running down so maybe maybe talk a little bit out 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 some of those two really is the entire expense base in drives the calculation of the efficiency ratio, but to the extent, we see opportunities to make investments to drive accelerate.
Hi, good growth.
And we feel good about the payback as John talked about we will do that and communicate that.
As as appropriate, but I think your points. It did one you don't want initially 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.
Games coming in there on the revenue side.
Sure.
Thanks.
We'll take our next question from Jason Kupferberg with Bank of America.
Hi, This is my hair Jason.
Just had up maybe we could start with just before I just wanted to make sure. We understand given I think you mentioned, we can have seasonal has a differential impact on Sofia products, particularly.
In Colombia, too and as we go into the Kratos does that change all the way you think about those products and also just related lead in terms of just the disclosure as you will be providing you're going to provide disclosure for the next several calls so we can compare results on an apples to apples basis.
So.
Yes. Thanks for the question. So in terms of how we think about our products, we take about them from.
Cash flow standpoint, and.
A risk and return.
On a Rick risk and return basis, and we we continue to like all our products, whether we are on an occurred basis or under this new regime Cecil so.
No no change in that into thinking there now in terms of.
Disclosure.
What we said previously we continue to be in the same spot that we will provide disclosures that will create transparency between cecil incurred.
For.
For the next.
Four quarters.
Got it so that makes sense. Thank you and then just real quick if I can go back to just get off the opex.
Maybe I.
I guess, you're clearly it's a topic that you're on this call, but maybe we could get if you could give us a little bit of small Carlo and just kind of investments, you're making and just maybe just help us understand.
Yes, the whole growth next year Rose 5.5 to seven as a little I guess in the range similar to this year.
And it sounds like some of these investments have a little bit longer payback period, but is it also supporting that five to 7 million group this year and would you.
Do you need to make those investments to achieve that growth I guess that so thank you. So here's how we think about it. So there is the investment in brand to drive awareness and considerations.
We have we havent actually baked in but we think that overtime will lower our acquisition cost our per unit acquisition cost as as people find.
Greater awareness of discover the product offerings.
Customer experience and.
And frankly.
Fair value exchange so.
That is one aspect, but that is overtime and to be determined the other the other piece around.
Technology investments we.
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 to either our growth trajectory or expense profile. So overtime.
I would expect that indeed, we'll see.
Efficiency gains.
Either topline or through through the expense base and.
You know some of them as Roger said longer term summer shorter term.
But there's a thorough process to make sure we're getting the bank for the Buck.
Thank you.
Well take our next question from Rick Shane with JP Morgan.
Hey, guys. Thanks for taking my question.
Well, we think about the sort of normal factors that clause.
Hardship.
No loss of job gas unemployment.
Illness and divorce.
Is there anything good idiosyncratic that youre seeing that is changing in the portfolio or is there a policy shift.
Thats driving us.
Yes, no there is there's no change.
In terms of.
Lets say customer behavior what.
What we're seeing here as frankly, the benefit of frankly, some some solid analytics buyer our AR collections team.
In terms of when a customer is experiencing difficulties in helping that customer managed through it.
Right.
The the.
Only process change we've made is used to be someone had to call in and talk to a rep.
For large balances that continues to do the case or.
Certain customers, who are made a certain criterias that can do it online on their mobile app.
And we've tested those populations various is the colon populations and actually the mobile app populations.
Our 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 the.
I think theres a difference in reporting that versus some competitors to is we've had we've done an analytical exercise bench and make sure we understand paybacks and where can make a difference to cash flows positively and weve opened those up so it's a combination of those factors and.
We will.
We were going to keep doing them as long as their cash flow positive.
Got to an end to the extent is constructed from an NPV perspective.
Does the transition to see soul and the lifetime was zero make it easier because there's less accounting.
You know sort of penalties could you weakness.
Yes.
You know what in terms of the pain L. impact right. When you when you take it TDR you basically take the net present value the cash flows and compared to your balance and and that's the.
The piano impact.
See so you basically do the same thing on life of loan losses. So yes, the relative kind of detriment to the piano. If you were growing tdrs is smaller under Cecil but.
That's not how we make decisions here.
Yeah, all right. Thank you so much.
We'll take our next question from Don Vendetti with Wells Fargo.
Okay.
Hi, John couple follow ups on that day to.
Conceptual accounting.
Can you clarify what you mean by the 75% Dalembert day, one but on day to are you talking about incremental.
Yes from just the loan growth and then also can you talk once your allowance rate.
There is set will remain relatively stable through the year, if there's no change in.
Sort of mix or economic outlook.
Yes so.
In terms of 75% on day, two it would be relative to what they would be and incurred basis.
So.
An incremental 75% on versus incurred now loan growth will create.
Incrementality versus an incurred basis.
Just the nature of taking a lifetime loss.
Front end of provisioning standpoint.
And what we've.
The team did a really good job in terms of modeling and.
We feel like were appropriately reserved and.
From a day one standpoint.
And going forward, if we're seeing.
Better recoveries through a cycle or.
You know better performance from a overall portfolio standpoint, then we'll adjust and if correspondingly if we're we're challenged somewhere it will adjust the other way.
But conceptually what do you think about sort of the reasons are all else equal that the allowance rate remained relatively stable throughout the year, despite mix or economic change and are we talking about sort of see sold being an incremental couple of percent GAAP EPS impact all else equal.
So.
So.
I'm not sure.
Totally clear on the question, but I'll try to answer and if I Miss we come back. So in terms of if we're seeing a change in the economy or our outlook of the economy or a change in the performance of.
Of our our portfolio or a change in mix all those will have an impact on the c. so reserves.
So no I would add on that but I'm, saying, if those were not to change with the allowance rate all else equal kind of stay the same throughout the year.
Yes, so so.
Yes, so it would build for loan growth.
At that rate, but in terms of kind of relative difference to incurred it'd be fairly consistent.
Okay.
Well take your next.
It.
We'll take our next question from Betsy Graseck with Mike with Morgan Stanley .
Hi, good evening.
Could you questions Hey.
So Roger 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 I'm wondering if.
Your messaging test that you think it you're under represented eight of personal loans or in the student loans or if there's other products that you're looking you get into on a touch base on what the implications for that isn't and if the.
You know if the if the payback for the investment should come in the form more and loan growth and Eni or should it be more should should there be any fees associated with it as well just like to understand how you're thinking about them.
Okay. So.
The investment in brand there two 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 put add money behind miles as well, but we do as we look at consumer.
Is out there there's a gap in terms of what I'll call. It top of funnel right people, who consider discover and habits top of mind. So thats 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 no fees across any of our deposit products, but there's still are huge amounts of consumers. They don't understand for example, we're even in the student loan business. Let alone. We are the second largest originator private student loans in the same holds true with understand it discover offers the savings account.
I can't count 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 Q1 like should I take the 100 million and just divide.
Hi, foreign and throw that through the model linearly or is this can be back end loaded kind of in a for Q environment, how should I think about the pace of that spend throughout the year.
You know we tend not to comment on the seasonality of the spent.
Sorry.
Okay.
We'll take our next question from Bill Carcache with.
Thank you good evening, Roger and John I had a high level of 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 industry, leading operating efficiency, but within that Theres also been a commitment to positive operating leverage debt, we're not seeing.
In this year's guidance with your revenue growth in expense guidance, suggesting that you're explicitly guiding to negative operating leverage.
Well, 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 and another as opposed to the approach that you guys seem to be taking now which is more along the lines of making dinner.
Switch upfront with the expectation that you will get the efficiency improvements leader. So is that an accurate way of thinking about I was just hoping you could comment on then to share any high level thoughts and that's that's my only question. Thanks.
Yeah. So first I'd say, it's Bilardo 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 manage to an expense budget and then sort of if we can generate more efficiencies and that frees up more money for growth, we try and be disciplined and consistent so our investments in growth there really more driven by the opportune.
Ladies 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 our unit costs on the investments and account acquisition to be coming down next year, but we do feel like there is an opportunity to put some money to work with a bit of a longer payback.
On the brands side in particular sort of top of funnel brand advertising dropping 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.
Understood. Thanks for taking my question.
Well take our next question from Bob Napoli with William Blair.
Thank you and.
Good evening I guess.
Kind of follow up on just on the the revenue growth the loan growth in revenue growth is there.
The potential through some of the deposit products today, the consumer banking products the growth of a riva pay b to B that you could get revenue growth.
Higher than loan growth.
Overtime is that a goal or.
And is there potential to do that and it seems your made a lot of investments in.
The network and.
And b to B payments over the last several years.
Yeah.
You know fee to be payments.
Benefit is probably so far more in terms of volume than profitability. The margins can be very fan, 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 math.
That that can be a multiyear initiatives. So I wouldnt necessarily expect something transformational in 2020, but we have a unique collection of payments assets. If you look at.
Paulson Diners club and serve the fact that we built the third largest global network in terms of acceptance.
So the team is very focused on monetizing map, but again, you're talking about a b to b sales cycle and so that will take some time.
Okay no.
Maybe a follow up on a competitive environment and.
With the some maybe with the entrance of of the Apple.
Card.
Which I mean, maybe as going.
After the Youre your demographic the growth of Neo bank, probably going after the deposit space.
In your target segments several of them.
Some of those companies getting Super high valuations as private companies.
What are your thoughts on on the Applecart on the Neo banks and in some of your investment in brand in response to the competitive environment.
So our 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 Friday 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 that Apple card as you know you can't underestimate anything that Apple does it's a new competitor and one that I'm sure we'll be formidable, but I don't think its transforming the overall competitive environment in the card space.
On the deposit side.
You know, 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 posted.
We feel like we have the product set and ability to compete we really just need to build awareness and a lot of the focus is on you know moving deposits from some of the traditional branch based players as opposed necessarily going head to head with some of these emerging online players.
Okay. Thank you.
We'll take our next question from John Hecht with Jefferies.
Yes, hi, thanks, very much for taking my questions actually most of my questions have been asked that a couple throughout their number one is.
You mentioned some unfavorable funding you 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 so actually what that was.
If you go back.
Got a year to half ago, we had.
We had some really cheap Cds on the books and then.
There was fed rate actions more expensive.
Deposits came on the books and over time, if theres no fed action yield see favorability come through into the into the piano on that so.
And if you look at what duration with should we expect that in where you'll get that favorable outcome on the deposit costs, yes. So its throughout this year and into next year.
Okay, and then follow up question would be you've taken deposit as a percentage of funding up a couple hundred basis points in 2019 period, how should we think about funding mix over the course of 2020.
Yes so.
Are you know we enjoyed great great growth, there and I think it's a testament to.
Both the team and the products and and.
Discover in general.
We have a longer term target of.
Of 70.
70% direct to consumer deposits thereabouts.
And I would say next three to five years on that so.
One way to do it would be to draw a line.
Yes.
Plus plus it accordingly.
Great Thats very helpful. Thank you guys very much.
Well take our next question from David Scarf with JMP.
Hi, good afternoon and.
Once again pretty much all my questions have been answered except I did want to just follow up on what I hope Snyder repetitive topic.
On the investment spend it seemed like a.
Collections was highlighted.
A couple 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.
Just curious I mean should should we be thinking about sort of under capacity within 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 so just to be clear in terms of collections, which we define as sort of prior to charge off due to 100% of that in house.
And so thats with our own us 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 there end, but like seeing the offers and as they have online and so I think collections is an era, 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 and recovery fees, but that usually means there is a net benefit right.
And.
Just adding on to that so the recoveries.
Our up year over year about 28%.
So.
What youre seeing is that that's the.
Hi, Thank a factor of.
Portfolio, but probably more more.
Reflective of where we are in the economic cycle and the fact that.
The consumer strength.
It is probably.
Frankly, increasing.
And as as wealth distribution is also.
Improving mildly so.
Not to not a bad story there on on the professional fees whatsoever.
Got it anything else.
I went out on the recovery side, we do not sell any of our charge off paper and so and haven for well over 10 years show you know you do enjoy a stream from those recoveries as opposed to people, who just shell and take the NPV.
Right and as far as just a quick follow up <unk> I assume embedded in your.
Net charge off a range you provided for 2020 is a consistent recovery rate because as a percentage of.
Gross charge off rate or is there any modification conservatism built out 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.
Great. Thank you.
Well take our next question from Ming Zhao with Deutsche Bank.
Good good afternoon, guys. Most my questions have been answered already I just had to one quick question I guess ended deposits. It looks like I guess the broker deposits were pretty down. This year is is that the I guess the run rate going forward as we see more I guess run rate run off in the broker deposits range as well as continued expansion of the director.
Consumer.
Yes that in general that's the plan, we're going to keep that opened as the channel.
But in terms of our funding stack.
That.
That should continue to decrease as an overall percent percentage of the funding stack as the DTC increases.
Gotcha, Okay, and then I guess the second question is yes.
In terms of M&A I know, you're you guys are focused on b to b partnerships and noting that you got less interest in a bank deal.
Has that changed materially from from in prior quarters or is that still the same message going forward.
Yeah, I think we feel good about the businesses, we're in and our ability to grow the organically and I think if you look on the banking side I don't see any any gaps in our model that we would need to Phil.
Great. Thank you.
Well take our next question from Bill Ryan with Compass point.
Thanks for taking my question.
A question I'll student lending if you could maybe give us some idea whats your origination volume was in 2019 versus 2018.
Dollars handle 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. Thanks.
So in terms of.
Growth.
We said organically we had.
Nine 9% organic growth in student loans on not on originations, but.
The loan balance and we 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 thats probably the most helpful.
Information.
Okay.
Any color on pricing or where do you think your market share as and things like that.
Yes, I 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.
Thank you.
Well take our next question from Dominic Kimbrough with Oppenheimer.
Hi, Thanks, so much for taking my question.
When you talk about the investment spend how much of the investment spend or are there plans to use. This this period of time to significantly invest in the global network in particular.
And how much is the focus there given given what you've talked about on investment spend thanks.
Yes, I think we highlighted the two areas, where we want to call out a significant increase one was around the branded advertising. The one other one was are 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 submit those very cost effective liebelt through these networks and network agreements and that will remain a core part of the strategy.
Okay, great. Thanks, so much.
And there no further questions at this time machine you're closing remarks. Please.
Thanks, AGA, thank 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.
And can anybody off but if you have any follow up please come back to me and we will take care, but thank you. Thank you.
Ladies and gentlemen. This is this does conclude today's conference call. Thank you for participating you may now disconnect.