Q4 2020 Discover Financial Services Earnings Call
Okay.
Yes.
Good morning, My name is Maria and I'll be your conference operator today.
At this time I would like to welcome everyone to the fourth quarter and fiscal year 2020 Discovery Financial services earnings Conference call.
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After the Speakers' remarks, there will be a question and answer session.
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Thank you I'll now turn the call over to Mr. Eric wants a strong head of Investor Relations. Please go ahead.
Thank you Maria and good morning, everyone and welcome to this morning's call I'll begin on slide two of our earnings presentation, which you can find in your financial section of our Investor Relations website Investor Relations Dr discover dot com.
Our discussion today contains certain forward looking statements that are subject to risks and uncertainties that may cause the actual results to differ materially.
These refer to our notices regarding forward looking statements that appear in today's press release and the presentation.
Our call today will include remarks from our CEO, Roger Hochschild, and John Greene, Our Chief Financial Officer.
How should we conclude our formal comments there'll be time for question and answer session. During the Q&A session. Please limit yourself to one question and if you have a follow up question. Please get back into queue. So we can accommodate as many participants as possible.
Finally, I'd like to extend a tremendous thank you to Craig stream for all of his help and support over the past few weeks and for his friendship and guidance over the past many years. So thank you Craig and with that I'd like to turn the call over to Roger.
Thanks, Eric and thanks to our listeners for joining today's call I want to add a farewell to Craig and thank him for many years of service to discover dating all the way back to great support in our original spinoff for Morgan Stanley.
Our strong fourth quarter results, where the capstone to good performance in a very challenging year proving the value and resilience of our digital banking business model.
While the economic impacts of the coronavirus pandemic, where expansive our business stood up to these challenges and we earned $799 million after tax for the fourth quarter and over $1 1 billion for the full year.
Our fourth quarter results underscore the capital generation of our model.
While our revenues were down 4% year over year, our outstanding credit performance combined with the actions we took to reduce our funding costs and control our expenses enabled us to exit the year with a 30% Roe.
In the fourth quarter.
Looking back on the full year, our operating results highlight the strength of our business and the execution of our team.
We proactively adapted to the many ways in which the pandemic has altered our operating environment, including changes in consumer spending patterns, we payment trends and borrowing habits.
Discover has always provided best in class customer service and this did not change with the pandemic, while other issuers face significant challenges with long hold times. There was no disruption to our outstanding services, we leveraged our digital capabilities and our 100% U S based customer service.
We kept average hold times under five minutes through the trough of the downturn and they quickly return to normal levels of under one minute. Additionally.
Additionally, our operational flexibility allows us to keep our employees safe with nearly all employees continuing to work from home since mid March.
Similarly, our history of Conservative credit management, and the resilience of our prime customer base position us well as we entered this period of economic stress. We also took quick action at the onset of the pandemic to mitigate credit risk by tightening new account underwriting criteria, reducing promotional rate offers.
Pulling back on credit line increases and we added $2 4 billion to reserves as the macroeconomic outlook deteriorate.
As expected the tightening of our underwriting criteria combined with elevated payment rates impacted our loan growth and our total loans decreased 6% year over year. However, we took substantial market share in private student lending and gained share and car Atlantic.
Our digital bank operating model combined with disciplined expense management has historically generated industry, leading efficiency, but in 2020, we took additional action to control costs and delivered on our commitment to cut $400 million from planned expenses, despite absorbing several onetime items.
<unk> that occurred during the year.
Excluding the one time items expenses were down nearly 2% year over year.
We achieved this while still investing in analytics automation and core technology capabilities to support long term growth and efficiency improvement. For example, we have invested in new analytics to optimize acquisition marketing to our core customers and we enhanced customer engagement through more.
Targeted offers and interactions our payments business was also well positioned heading into last year's sudden economic decline on.
Post debit business had a strong year with volume up 10% from 2019, reflecting the impact of stimulus funds and higher transaction sizes as debit became a critical way of procuring goods during the pandemic.
Our discover proprietary network was down 2% for the year, but exited the fourth quarter at plus 5% in line with card sales volume, while diners club volume declined reflecting the impact of the pandemic on global <unk> spending we signed five new International network partners as we continue.
To expand global acceptance.
As we look into 2021, we believe there is a significant amount of uncertainty around the timing and shape of the economic recovery.
Some of the impacts from last year's downturn have yet to be fully realized for this reason, we anticipate deterioration in our credit performance in the back half of this year Nonetheless.
Nonetheless, we see reasons for optimism after bottoming in April our card sales steadily rebounded throughout the year and return to growth in the fourth quarter.
We saw improvement across all categories, especially in grocery and retail, which now represent more than half of our sales mix.
This favorable sales trend has also continued into the first half of January.
In this environment, we will remain disciplined on expense management, but also committed to making investments for growth and efficiency and anticipate higher marketing expenses relative to 2020 levels. We also anticipate resuming a more normal pattern of capital return earlier this week our board of.
<unk> approved a new $1 $1 billion share repurchase plan and we may begin buybacks as soon as the first quarter subject to the federal reserve's limitations.
In conclusion two.
2020 presented us with unparalleled challenges, but our business model has us well positioned and I couldnt be more pleased with how the team here at discover respond.
I'm confident that the actions, we took strengthened our business and will drive long term value for our shareholders and customers. While there is still uncertainty around the pace of the recovery I am optimistic that 2021 will be a better year on.
I'll now ask John to discuss key aspects of our financial results in more detail.
Thank you Roger and good morning, everyone.
I'll walk through our fourth quarter results starting on slide four.
We earned $799 million on net income or $2 59 per share <unk> results included several one time expenses totaling $137 million. Excluding these EPS would have been $2 94.
There were a number of factors both positive and negative that influenced our performance during the year.
<unk> our results for 2020 reflects proactive management of our funding and operating cost and our conservative approach to credit management.
These factors helped to offset the revenue impact of elevated payment trends and lower sales volumes.
However, we're seeing some positive signs with a return to sales growth in the quarter and continued expansion of our net interest margin.
In the fourth quarter net interest income was down 2%, reflecting a 5% decline in average receivables and lower loan yields.
This was mostly offset by decreased funding costs, driven by lower market rates and management of our deposit cost.
Non interest income was 14% lower driven by higher rewards costs from strong engagement in the 5% category. This quarter, a onetime write off of certain real estate facilities and lower loan fee income also contributed to the year over year decrease.
The provision for credit losses was $305 million lower than the prior year due to meaningful improvement in credit performance. There was no change to reserve levels in the current quarter, whereas the prior year included an $85 million reserve build.
Operating expenses increased 8% year over year, driven by one time items related to software write off charges for penalties and restitution and costs.
The voluntary early retirement program.
<unk> expense also contributed to the increase.
These were partially offset by lower marketing costs and decreased professional fees.
Excluding onetime items expenses were down 4% from the prior year.
Turning to loan growth on slide five.
Total loans were down 6% from the prior year driven by a 7% decrease in card receivables.
Lower card receivables were the result of three factors.
First pain.
Payment rates continue to be elevated.
While this has reduced loan balances it has had a favorable impact of credit performance.
Second promotional balances have continued to decline due to actions. We took early independencia two tightened credit and third an increase in transaction activity.
Looking at our other lending products in student loans, we had a strong peak origination season, increasing market share and leading to 7% loan growth.
Personal loans were down 7% as a result of actions we took early independently commitment minimized potential credit losses.
Moving to slide six.
Net interest margin continued to improve up 34 basis points from the prior year and 44 basis points from the prior quarter to 10, 63%.
Impaired to the third quarter lower deposit pricing was the primary driver of the improvement in net interest margin, we cut our online savings rates. Another 10 basis points from the third quarter as we continue to actively manage funding costs lower.
Online savings rates.
12 month, and 24 month Cds are all down to 50 basis points.
Lower interest charge offs and a favorable mix of promotional rate balances also contributed to the margin expansion from the prior quarter. These factors offset the impact of the high level of balance sheet liquidity that we are currently carrying.
While this is depressing our net interest margin today, which should benefit margin as we deploy this liquidity.
Future loan growth.
Average consumer deposits increased 18% from the prior year, we continue to see steady demand for our consumer deposit products, which were up $1 billion from the prior quarter all of the growth from the third quarter was from indeterminate maturity accounts, which allows us to immediately capture the benefit of deposits.
Decreases.
Turning to slide seven we.
We continue to optimize our mix on our funding mix and our goal remains to have 70% to 80% of our funding from deposits. We also have an opportunity to benefit from higher rates funding maturities over the next couple of years.
Both of these items are expected to benefit net interest margin in future quarters.
Looking at slide eight.
As Roger noted we delivered on our commitment to reduce planned expenses by at least $400 million during the year and I'm pleased to say that we accomplished this goal. Despite several onetime expense items that occurred in 2020.
Total operating expenses in the fourth quarter increased $94 million or 8% from the prior year driven completely by $137 million in onetime expense items.
Excluding these operating expenses would have been down $43 million on a 4% year over year yet.
Yet even as we remain disciplined on costs, we continue to invest in analytical capabilities that we expect will drive future growth and efficiency improvements.
Looking at some of the individual line items.
Floyd compensation was up $57 million or 13% driven by a one time item related to a voluntary early retirement program as well as staffing increases in technology and higher average salaries and benefits.
Marketing and business development expense was down $75 million or 32% most of the reduction was in brand marketing and card acquisition as we aligned marketing spend and tightened credit criteria in response to the changing economic environment.
Professional fees decreased $22 million or 10%, mainly driven by lower third party recovery fees related to courts operating at limited capacity.
On slide nine you can see our credit metrics for the quarter.
Once again credit performance was very strong and total charge offs below two 4% in credit card net charge offs.
Two 6% the card net charge off rate was 78 basis points lower than the prior year, while the net charge off dollars were down $180 million.
Or 28%.
Compared to the third quarter net card charge off rate declined 82 basis points to 30, plus delinquency rate was 55 basis points lower than last year and increased 16 basis points from the prior quarter.
Credit also remained strong in our private student loan portfolio with net charge offs down 31 basis points year over year.
Excluding purchase loans.
That 30, plus delinquency rate improved 40 basis points from the prior year and nine basis points compared to the prior quarter.
And our personal loan portfolio net charge offs were down 147 basis points and the 30, plus delinquency rate was down 29 basis points year over year.
To wrap up credit.
This was another quarter of strong performance across all of our lending products driven by the actions we've taken in underwriting line management and collections.
The resiliency of our prime customer base and the impact of government stimulus.
We believe that losses will increase in the second half of 2021 and into 2022, however, the timing and magnitude of losses could be impacted by any additional government assistance or material shifts in the economic environment.
Moving to the allowance for credit losses on slide 10.
We help allowance flat to the prior quarter.
While the macro environment has improved the outlook remains uncertain.
<unk> to our past approach, we modeled several different economic scenarios.
The primary assumptions on our economic model.
Year end 2021, unemployment rate of about 8% and GDP growth of about two 7%.
Did not include any additional stimulus beyond what has already been provided to consumers.
Our economic scenarios also considered the increasing number of Covid cases, the timing of the vaccine rollout and the recent increase in unemployment claims.
Turning to slide 11.
Our common equity tier one ratio increased 90 basis points sequentially to 13, 1%.
Remaining above our 10, 5% internal target and well above regulatory minimums.
We have continued to fund our quarterly dividend at <unk> 44 per share.
Regarding share repurchases as Roger indicated earlier. This week, we received authorization from our board directors to repurchase up to one 1 billion of common stock.
And we intend to begin share buybacks in the first quarter subject to the federal reserve's regulatory limitations.
Moving to slide 12, and some perspective on how we how to think about 2021.
We anticipate modest positive loan growth for the year, we see opportunities for customer acquisition, but the level of growth will be dependent on payment rate trends and the timing and pace of the broad economic recovery.
With respect to our net interest margin as I previously mentioned, we expect we will continue to see benefits to margin from lower deposit rates and maturity of higher rate funding.
We also remain committed to disciplined expense management, and we will continue to invest to drive profitable long term growth and efficiency improvements.
This includes increased marketing investments for new customer acquisition as well as investments in advanced analytics and technology capabilities.
In terms of credit performance as I've already noted, we expect losses to increase in the second half of 2021 and remain elevated into 2022.
Finally, our capital allocation strategy has not changed and we remain committed to returning capital to shareholders through dividends and buybacks.
In summary, we.
We had a solid fourth quarter with strong credit performance across the portfolio.
Net interest margin expansion driven by lower funding costs.
Flat reserves and excluding onetime items operating expenses were down year over year.
I am very pleased with our execution throughout 2020 and discovery efforts to protect employees and provide uninterrupted best in class service to our customers.
The quick actions, we took at the onset of the pandemic and our investment in core capabilities protected and strengthen the discover franchise in 2020.
The challenges we face demonstrate the resiliency of discovers digital banking business model and while uncertainty remains we are well positioned for growth as our economy continues to recover.
With that I'll turn the call back to our operator Maria to open the line for Q&A.
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We will take our first question from Moshe Orenbuch from credit Suisse.
Great Thanks, and welcome Eric.
Craig is listening.
It's been a pleasure working with you too.
I guess.
Both Roger and John you talked about.
Okay.
Increasing marketing expenses into.
2021 could you just kind of flesh that out a little bit talk a little talk some about.
<unk>.
How much you'd like to grow accounts.
What you are looking for what signals would drive you to step on the gas a little harder or pull your foot off and.
Because you've seen some of your competitors already start to spend the marketing.
We don't know yet what that's generated but maybe you could talk about that a little bit.
Yes, thanks, Thanks Moshe so.
Here's how we're thinking about the expense base for 2021, and then and then I'll talk more specifically around marketing and new customer acquisition and growth. So.
In terms of.
Expenses.
On the business is committed to driving positive operating leverage over over the midterm.
Now opportunities in 2021.
We will dictate how much marketing dollars, we ultimately end up spending for new customer acquisition, but in terms of the overall expense base.
There'll be incremental dollars for marketing new customer acquisition and third party recovery fees of course, reopen we expect that bill.
Those seasonal increase.
Consistent with the level of <unk>.
Recoveries that we.
We hope to achieve on bankrupt accounts.
No.
Outside of those areas, we're targeting to keep expenses flat across the business now certain accounts may go higher certain lower but.
The way you can think about it as growth initiatives incremental spend the balance of the income statement in terms of the expenses will be flat to down.
In terms of new account growth what we're targeting.
<unk>.
Mid single digits maybe.
Maybe if we're fortunate we see some opportunities upper upper.
Upper single digit.
<unk> growth and we hope that will translate into.
Increased loan balances.
We didn't give any specific guidance on loan balances because of.
The broad broad economy uncertainty there and.
And frankly repayment trends have been pretty remarkable with it potential new round of stimulus.
That could further increase prepayment trends so so.
That's how we're thinking about growth and expenses so.
If there's a if there's follow up we can take a quick follow up if not.
Next question.
Great. Thanks very much.
Our next question comes from the line of Santos on chronic kidney W.
Thanks, Good morning, and my congratulations to Eric and Craig as well.
I wanted to drill down on the credit quality and reserve assumptions.
Understand sort of the reversion to the mean assumption given the underlying unemployment rate. However, I think Luis has been improving there are laws there unemployment assumptions.
That rate is declining sort of in the second half of this year into 2022 on.
Just curious sort of how Tim.
But sort of euro assumption that loss rates will get to the reserve levels.
<unk> added in the reserve assumptions and at what point do you reassess that is there something you're seeing inside your portfolio, that's leading you to be more conservative.
Okay. Thanks.
Thanks, Sanjay so so I'll take this one as well so.
Let me start off by saying, we're very pleased with the portfolio's performance. So the resiliency of our customer base.
It's Ben.
Remarkably strong.
So in terms of the modeled assumptions so in my script I talked about.
8% unemployment at the end of 2021, I realize that's higher than where where we are today from a reported number and we also assume GDP growth of 2.7% now there are some some folks forecasting.
<unk>.
And an increase in GDP as well so as we thought about the reserves and the positioning of the balance sheet Theres. A couple a couple of things that we took into account so first.
As the.
The overall unemployment numbers.
There is about $10 7 million people out of work Theres. Another seven 3 million people that are included in the implant and the on.
Unemployment number due to the fact that.
They have and actively look for for work in the past four weeks or so.
So to me.
Where we are from a life of loan loss reserving standpoint made perfect sense is conservative we didn't feel like we had enough data points.
At this point given the level of uncertainty may to make a material change to the absolute level of reserves in the fourth quarter, given a life of loan reserving assumptions.
But but I can say this.
Going to continue to look at our portfolio.
And the macro environment, we're going to look specifically at the trajectory of unemployment and the type of unemployment. So are we seeing unemployment levels transition from service workers to white collar workers, who would more likely be representative of our customer base.
The impact of stimulus so.
Today, we are well positioned and we're going to continue to reassess its first quarter second quarter and ended the second half of <unk>.
Next year and makeup.
And make appropriate adjustments.
Thank you.
Our next question comes from the line of Rick Shane of Jpmorgan.
Good morning, and congratulations Erik and Craig.
Solve the I'm, hoping you're listening on I saw the voluntary early retirement I hope you're right.
Usable chunk of that number.
Yes.
<unk>.
Right.
Sorry.
When we think about what you've said in terms of marketing and adding new accounts.
That makes sense.
Will presumably be a lag in loan growth as you add accounts.
Historically, when you started to grow the portfolio again, it's been led by wallet share gains.
And line limit increases.
I'm curious when you think you might take that sort of.
<unk>.
Brown out on line limit increases are and how we should think also about the awards right as you think about wallet share going forward.
Yes, so ill started on.
On the.
<unk> right.
We tend to keep our rewards program very stable. It provides a lot of value and so while you've seen competitors make dramatic changes.
We feel like our leadership position in cash rewards serves as well. So we have in the past talked about a low single digit increase in rewards rate due to the structural changes that will likely continue but beyond that we feel very good about where we're positioned and the competitiveness of our program in terms of growth.
<unk>, it's always been a mix of new accounts and stimulating the existing portfolio.
So it will remain that going forward.
In terms of what would get us to loosen credit I think many of the indicators that John talked about Ryan So getting better line of sight in the direction of White collar employment is probably the most critical one.
Got it okay. Thank you guys.
Okay.
Our next question comes from the line of Mark disease of Barclays.
Yes. Thank you.
On a follow up to <unk> question.
Clearly the credit performance, we have experienced so far is much better than you would've expected just given all of the different macro assumptions and so my question is what do you. What do you think you need to see.
In the data before you feel comfortable.
Releasing reserves.
Okay. Thanks, Mark So first first of all day.
The performance of the portfolio itself, so what's happening on specific where all right.
Our.
Are they holding or are they deteriorating consistent with what our modeled expectations are.
Broad macro is going to be important.
We also do know that if there is another round of stimulus.
That will.
Which isn't baked into our reserve assumptions, we do know that that will have an impact on couple of factors certainly delinquency.
Repayment rate and ultimately charge offs and required provision. So we'll keep an eye on that Roger talked that Roger and I both talked about.
White collar.
Employment levels and.
We will also be.
New jobless claims so.
Those factors together with a strong overview on how the portfolio itself is performing will be the key factors in determining.
What we do with reserves.
In 2021.
Got it thank you.
Our next question comes from the line of Great Day of Morgan Stanley.
Hi, good morning.
Good morning.
I had a couple of questions on the buybacks that you announced I just wanted to understand.
Yes.
Buyback announced.
What kind of CET. One you are thinking about when you are.
Putting forth that buyback estimate and then the second question that's related to that has to deal with whether or not even bedded reserve releases in your estimates for.
For that I mean, because on a four quarter trailing federal right now it is kind of circular reference there. So wanted to understand how youre thinking about reserve releases and what your target CET one it.
Okay.
So so.
We continue to target 10, 5%.
In terms of how we thought about buybacks this year.
The first piece I would say is we wanted to ensure we are prudent with our capital given given the level of uncertainty.
We do we do have the the fed constraints in terms of the four quarter average of net income and so so the.
First quarter and.
The second quarter and first quarter of 2020 are impacting net calculation.
Or.
For the first quarter of 'twenty, one and then.
We're also thinking about the.
The seasonal transition impact, which will be somewhere between.
202 hundred 50 basis points as we think about CET one.
So.
Ultimately, we didn't want to be out at the far edge of the buyback envelope, we felt that $1 1 billion.
Was.
And appropriate return of capital given the level of uncertainty and.
And.
That will take a dent on out of the what I'll say is the excess capital that we have.
Right now but.
Our earnings power, we really important in and that will give us an opportunity to reassess that.
In 2022 as well.
Okay. Thanks, and then just separately.
And a follow up question here on how youre thinking about the.
Interchange rate I mean, theres been a couple of.
There has been some pressure on it recently after years of improving and I just wanted to understand if the recent.
Behavior more of a short term phenomenon less <unk> or is there something else going on that we should be thinking about when we're modeling out that line.
Yes.
Yes, so the fourth quarter.
It did come down a little bit and.
We can largely point to mix.
As.
Yes.
There was a strong pull away from the traditional online.
Excuse me, the brick and mortar retailers to the online retailers, which certainly impacted it.
But from our perspective, very well aligned with our 5% categories in the fourth quarter, which also.
Sure.
Which also.
Drove incremental sales through our card and ultimately we think it'll translate into other forms of revenue.
Specifically on.
Interest income as balances revolve.
Okay. So this quarter was primarily the 5% cash back on the.
Dot coms that.
Obviously utilized very very fully.
Okay. Thanks, Jeff.
Our next question comes from Ryan railcar catchy of Wolfe research.
Thanks, Good morning.
My congratulations to drinking Craig I wanted to ask about the net interest margin and I believe the 10 six 3%.
On the highest we've ever seen can you talk about whether the trough is behind us how sustainable this level on the extent to which you see room.
<unk> cash to expand from here given.
Yes.
The room for deposit repricing and the remixing towards more cost deposits.
<unk> see.
Yes sure Bill.
<unk>.
Yeah.
From the trough.
Our our second half NIM.
<unk> bye.
Nearly 80 basis points incredible so so obviously.
We can't run that trajectory in perpetuity so.
No.
<unk> way to think about that is.
We ended the fourth quarter at 10, 63% that you just mentioned.
<unk>.
My view is that we still have some opportunity on deposit pricing, especially if there is another round of stimulus because that will put a lot on liquidity in the market and.
The.
Competition for deposits will further abate.
Now how much ultimately we have room, we have there on certain is that 10 to 20.
Or more beds to be determined but it might be.
Lease tend to very conservative view.
Maturity profile, we've included that in that information in the deck to allow folks to be able to model through some improvements that we'll see there.
And then.
Some frankly, some things that are pushing against net interest margin, especially in the second half of the year.
If the credit losses.
To accelerate as.
As we've indicated that that will put some dampening pressure on net.
Net interest margin so.
Broadly speaking, we do see further room for expansion there but.
We jumped from the fourth quarter number.
And.
Do those steps I, just mentioned to get to it reasons.
Reasonable way of thinking about the <unk>.
On a year.
Got it alright, thanks very helpful.
Our next question comes from loan growth.
<unk> of Wells Fargo.
Hi, good morning.
I'm curious if you could comment on what do you think about the sort of long term growth rate on the card business if its been impacted by Covid.
A lot of new areas like personal loans, you have buy now pay later.
This is just on the edges or do you think.
Some impact on the growth.
The card industry.
Could you be wrong on that I guess on.
Some of these new initiatives in fintech be more impactful.
I certainly could be wrong, so I'll say that upfront, but we have not seen either of those have an impact on card loan growth and <unk> seen that in the past, whether it's been a home equity loan boom, where a lot of people are doing cash out refis and using that to pay down debt.
A lot of consumers seem to carry a level of credit card debt that they are comfortable with certainly our base and they tend to revert back to that amount and so buyout pay later is the most recent trend that's out there. We're looking at that very carefully and have yet to be able to see.
Net impact on our revolving loan balance it so.
Decades in this business there is always something thats going to kill off credit cards, but if so far.
The growth trajectory of the industry business.
But we also as we think about our growth. It's a combination of where the industry goes but also our ability to take share from our competitors and capture a disproportionate of students and young adults who are coming into the day.
The industry and so we feel good about that.
Okay. Thank you.
Our next question comes from the line of Kevin Barker of Piper Sandler.
Good morning.
I just wanted to follow up on your expert your guidance for losses to increase in the second half of 'twenty, one and then likely remain elevated in the 'twenty. Two I mean are you envisioning just given the current economic environment.
That these are likely.
Have a plateau in 2022 or is it going to be like a slow decline.
After we peak in the second half of 'twenty one.
Just given.
What your view is on the economy and how things are playing out so far.
Yes, okay.
So.
At this point there is a bit of both art and science in terms of modeling.
On a peak charge offs and.
And what we've seen as we've gone through this pandemic is that peak has continued to push.
Enter into future period and essentially.
That's what we're seeing today.
It's hard to believe given the level of absolute unemployment and.
And those facts and those folks that are outside of the employment ranks that arent in the unemployment number that there isn't going to be some material impact to <unk>.
Credit and charge offs at.
At some point Bill.
Roll rates, we're seeing right now in terms of from aging buckets, one to the next are incredibly strong.
Which deposits so that so that means.
By itself.
There can't be an acceleration of charge offs.
At least in the first four months of the year Bill.
On net.
You would expect given the unemployment numbers.
The roll rates have deteriorated charge offs will increase.
<unk> continued to increase until there is absolute stability. So we're seeing a peak in late 'twenty one.
And that could carry through into into 'twenty, two and then <unk>.
Moderate as.
As the.
Counts go bad and.
The economic the broad macros improve so.
That's that's how we're thinking about it.
I'm not sure if we've got it 100% right.
We don't we're going to adjust accordingly.
Okay and then the follow up on your comments about targeting to keep expenses flat across the business is that relative to account growth or is that saying were year over year absolute expenses will remain flat in 2021.
Yes so.
I want to be careful here, but wasn't absolute expenses. So what I tried to do is distinguished between those expenses that will help us accelerate growth and we expect those to increase.
Those that arent.
Targeted to accelerate growth, we expect will remain flat to down we expect if you go through kind of the line items on the expense base salaries and wages, we've done some things this year too.
Sure.
To level that off.
Moving the voluntary early retirement program we.
We have activated our procurement organization around third party spend and we've driven a lot of productivity.
Through that we have looked at every single line item on the expense base, and we're making determinations on whether or not those those expenses will help us drive long term growth.
If the answer is yes, maybe maybe it will increase the answer is no we're going to be flat to down.
So just to be clear.
<unk> expenses that are driving growth.
Should they be.
In line with account growth or.
The above or below just dependent upon.
What youre seeing underlying the business.
So maybe one way of looking at that for required new accounts. As an example, we expect our cost per account to be below what we saw in 2019 and thats with a tighter credit box and reflects that.
Assets, we're seeing from it.
Sales of our investments in advanced analytics as well as just the differentiation and appeal of our product.
Thank you very much.
Our next question comes from the line of Bob Napoli of William Blair.
Thank you.
Thank you good morning.
I would say goodbye to Craig like at least eight times over the last two decades.
I don't think its over the last one performing.
Good luck.
Roger.
So the world has.
Tom Distinguished direction, if you would I think the digital banking Hall Branchless banking.
The structure that you have and then you have the unique assets.
The network, obviously, but what are you working on Theres a lot of changes while the market's telling your direction. There is a lot of new businesses.
Thanks digital banks.
And developmental companies like venmo or private companies shine.
Are there things that Youre doing as you look at this to be on offense.
Expand the ecosystem of your products and services to try to get direct deposits to get more of that.
Transaction banking accounts as well what are you doing on the banking side.
With all of the innovation in the market, whereas discover investing.
Yeah, So great question.
The World is coming your way you've got to keep moving to stay ahead and so that is our focus we've always stood for innovation back to our founding and inventing credit card rewards, but more recently with everything from the FICO score on statements ability to freeze your account and so you can rest assure that that focus is still there.
Sure.
On a pipeline of customer driven innovation across all of our products.
Specifically in the deposit side, we think there's a lot of opportunity to get into transaction accounts it'll be a while before they become a material part of our funding base, but with our low cost.
Direct to consumer digital model as well as the advantage we have from being exempt from the Durbin interchange caps, because we own our proprietary network. We are uniquely positioned for bank over $10 billion and so it isn't maybe the primary focus right now just given the access level.
Fundings, but is a critical initiative and we feel good about our ability to compete both against traditional branch based banks, but also against any of the new Fintech players.
Okay.
Thank you and I'd love some color on what.
<unk> also looked at you're thinking about there, but as you look at the day.
Your customers the customers that you're adding.
Is there any change in the demographic mix all day, new customers Youre, adding in a lot of time can you again on getting palm and carry on.
Questions around well the millennials are not going to borrow on their credit cards the way all.
All those David and the other new forms of.
Credit is discover getting the same share of those younger customers and are you keeping them do you feel there is fall.
Anything to the thought that millennials will be less likely to use credit cards.
And if so are you looking at other products like buy now pay later on.
So in terms of millennials based on the data, we see we're either the leading or one of the leading underwriters for college students.
The brand is incredibly strong with college students and young adults that I appreciate sort of the leading digital functionality as well as some of the innovations I talked about and we're seeing very similar usage patterns as.
As we saw in prior generations of customers. So yes.
We're very excited about the growth there and I think being in the student loan business and the second largest originator helped to get our brand out there in front of the next generation of consumers.
Okay.
Thank you appreciate it.
Our next question comes from the line of John Hecht of Jefferies.
Good morning, congratulations too.
<unk>.
Eric and Craig as everybody else does that.
And thank you guys for taking the questions.
Maybe follow on to Bob's question, but it is a different way I mean, you guys have tightened.
Over the past several quarters <unk> had substantial net paydowns I'm wondering has your kind of back book composition changed.
And in a good or bad way.
A positive or negative way based on those patterns.
I would say nothing dramatic and part of the advantage. We had we've been tightening for a number of years coming into this we felt like we were late cycle had talked about that with you guys on the call clearly we didn't expect it to and the way. It did in early 2020, but that helped us from having to take some of the <unk>.
Magnitude of changes that I think some of our competitors. So we try and be consistent in how we run the business and so a targeted the same prime consumer.
And I think as Roger has not seen any dramatic shifts in terms of our composition either with the new accounts, we're booking or our existing portfolio.
Okay, great. Thanks, and the second question is private student lending I think you guys referred to some market share gains.
On the recent periods, there's been some shifts in terms of other big bank centered exiting that segment and then there's a new administration and maybe some changing policy or some thoughts about potential changing policy, maybe maybe just some commentary given your momentum there and your outlook there given those factors.
Yes, so I would say, there's always a lot of discussion about what much might happen and Washington about student loans.
I'd say keep in mind that over 90% of student loans are the federal student loan program and so that's where a lot of the attention is focused very different animal in terms of bill.
Quite frankly lack of underwriting of that product and the losses, they experienced compared to how we go to market. So we feel really good about the business.
Clearly benefited from one other larger players stepping back, but we believe we would have gained share even if they hadn't and show and it reflects the fact that the brand is well positioned.
It resonates with consumers and we take the same approach in terms of customer experience and differentiation with the student loan product as we do on the card side.
Okay. Thank you guys very much.
Our next question comes from the line of Mihir Bhatia of Bank of America.
Hey, maybe just staying with some of you on non card products. I was wondering if you could talk a little bit about just the outlook in competitive intensity EUR theme for some of the.
But on student loans, both standalone, but even just on the network side of your business I know that Athena focus to growth.
Okay.
So maybe just talk a little bit about what you're expecting from those businesses as we head into 2021. Thank you.
Sure so ill.
Start on the on the payment side, we're always very intense competition in the payment side, we compete largely against two very large players.
So, especially.
Especially in debit its really head to head competition for merchant routing day in day out we don't expect that to change.
I feel good about the products, we have and we have a great team on it.
In terms of other products, we talked about student loans for personal loans, we have modestly widened credit on that that was the product we tightened the most just given the volatility in the downturn, we've loosened up I would say marginally and feel good about what we're originating.
Positioned a little differently than most we've always had a relatively narrow credit box for that and those loans are sort of bigger ticket debt consolidation primarily bill.
I would say across all of our products given the the returns we get these are all highly competitive very challenging markets and that sort of occurs day in day out.
Thank you and then just if I could quickly follow up on some of your NIM comments I know you mentioned the funding side of the balance sheet optimizing also on.
Opportunity opportunity a little bit to optimize on the asset side of the balance sheet, maybe you were running with a little bit of excess cash in 2020.
Given the downturn or does that.
Fairly well optimized already thank you yes.
Yes. Thanks.
I'll jump in on that one yes, we do have some excess liquidity right now and there is there is an opportunity to continue to.
Move that move that forward now.
We're going to we're going to.
I will say gauge that based on the level of asset growth because asset growth, we'll consume that liquidity.
And where we built the plan that assumes a level of growth.
So thats one positive the other piece.
Is.
Around deposit pricing and how we price how we price the deposits coming in turning into cash and then in terms of balance sheet positioning.
Our mildly asset sensitive right now so in a rising rate environment that will us so.
The beneficial to net interest margin so so.
Quite honestly.
The liquidity I think will take care of itself over time and that positioning of the balance sheet in terms of asset sensitivity.
Very very positive too.
Be accretive to net interest margin.
The rising rate environment.
Thank you.
Our next question comes from the line of mangrove.
Bank.
Hello. Good morning, Thanks for taking my question I, just wanted to get a sense on how you guys are thinking about deposit growth specifically.
Both the direct to consumer in the broker deposits I guess for DTC now 62% of total funding I believe previously you mentioned on longer term target of 70% on fundings back does that still hold or do you expect DTC deposits to be even higher than percentage of funding stack going forward.
Yes, so we're targeting.
Targeting 70%, 80%, 80%, so 62 Youre correct on the number.
Direct to consumer.
Our proposition has been very very positive we don't compete on the basis of price.
Which.
It has been a good thing in terms of.
On helping us to modulate some other liquidity that we have but also the fact that deposits continue to grow shows that there is a level of loyalty and trust with the discover brand in terms of.
On the broker Cds, we actually use that almost as a as a valve of sorts right. So.
As our funding needs and increase will go more heavily into into brokered Cds as they decrease we shrink it so.
That's the way.
We've managed that traditionally it's going to continue to be a liquidity channel for us but a.
What I'd say is on less important channel over time in terms of total quantity.
Of deposits.
Great and then a second question.
Broad based share I guess anything structurally different.
In regards to releasing reserves under Cecil.
And.
And the prior method of looking at allowance reserves.
Not so much structurally.
We've got a.
Thorough process that considers all the elements of CFL under under GAAP.
The one thing I would say is the life of loan.
Reserving.
Does require more modeling and.
Frankly at a greater level of judgment, given how far out into the horizon youre projecting losses. So.
There is certainly.
A very strong governance element there is a science to it and then there is a level of.
Professional judgment on our two it.
As well so.
Yes.
Same could be safe said for incurred but the.
The horizons much.
Much more.
Difficult given.
Given timing of.
What we're trying to project.
Great. Thanks for taking my questions.
And ladies and gentlemen, we have time for one more question. Our final question will come from the line of dominant came out of Oppenheimer.
Thanks, so much for taking my questions.
We just think about.
On a potential windfall of excess capital from reserve releases.
Excuse me.
If that was to happen in the economic situation for assisted the way. It is today and you felt comfortable releasing reserves can you talk about the breakdown.
How you would use that.
Excess capital on me when tax reform came in there was a flow of capital company and started talking about.
Jill will do have for our third for growth serves our capital return on a third for investment in technology is something like that can you talk about how you think about those those pieces should flow of capital come your way.
Yes.
I'll, let John talk about capital return, but I would say our business does not lend itself to rapid deployment of capital Ryan, Yes, we market on a consistent basis sort of flooding the market in a given quarter based on the amount of capital we have.
I don't think makes sense from a long term standpoint. The same holds true for technology right. A lot of it is about spending smart not just putting huge amounts of money. So cyber wheel hard David if we do have a quarter with a big reserve release.
There may be some things at the margin in terms of investments in the business, but by and large it will fall to the bottom line and I'll, let John pick it up there.
And.
So dominic.
I appreciate your optimism regarding a.
Slug of capital as a result of reserve releases.
The powerful economy.
Our priority actually remained the same so in terms of how we think about capital and allocating the dollars first to growth then.
Dividend and share repurchases and then.
The last priority would be small M&A bolt on capabilities or certain niche.
Niche products that we think will drive long term shareholder value. So.
No change there we go through an annual capital planning process here.
Financial services institutions do.
And.
We share.
Look with our board and our priorities.
And obviously there is some regulatory constraints.
We manage to as well.
And then we will.
Make good long term decisions to generate profitable growth.
And shareholder return.
Great. Thank you that makes a lot of sense and then if we just think about the if you look at the NIM in particular in the risk.
This quarter.
<unk>.
Right.
Interest charge offs reductions in the quarter that had a big impact on on the yields.
And so could you just talk about the balance between.
Let's say that.
Interest and fee charge offs, even just reverting to normalized levels not including the spike of velocity Bill today, but is that sort of just normalized with 'twenty one.
Versus some of the benefit you have on the.
The interest expense savings that youre doing given all of the.
Sure.
Bill.
What youre doing there maybe gives you a balance of those two against each other could you still see.
On the NIM expansion our levels in 'twenty, one versus staybolt on improving versus 2020. Thanks.
Yes.
<unk>.
We do see opportunities.
For NIM expansion, even in the face of.
Increased.
Interest interest charge offs as net.
On the portfolio matures.
Content with some of the economic stress.
But.
The numbers in terms of quantum are probably not going to get into that level of detail on the call here, but.
We will go back to what I said earlier in one of my questions in terms of how to think about it.
So we do see an opportunity for <unk>.
NIM expansion.
<unk>.
That.
Some of that will be tapered by.
And on credit and the impact of delinquencies, but even contemplating that.
There will be a level of expansion.
Excellent. Thanks, so much.
Okay.
Very good.
Alright, well. Thank you all very much for joining us anyone who has additional questions. Please give us a ring Emily and I will be here to answer questions and have a great day.
Thanks, everybody.
And thank you ladies and gentlemen, this does conclude today's conference call you may now disconnect.
Okay.
Net income.
[music].
Yes.
Sure.
[music].
Thank you David.
David.
Tim.
Sure.
[music].
Okay.
Yes.
[music] net.
Yes.
Thank you.
On.