Q2 2022 Discover Financial Services Earnings Call
Speaker 1: payments model and our focus on managing the business while investing for growth amidst an increasingly fluid
Speaker 1: Let's turn to the summary on slide three.
Speaker 1: For the second quarter, we reported net income of $1.1 billion after tax, or $3.96 per share. Our operating metrics in the second quarter remained very strong. Loan growth increased by 13 percent from the prior year, driven by a combination of higher sales and strong new account growth. And our asset quality remained solid across all products, reflecting our focus on prime lending.
Speaker 1: in our approach to underwriting and credit management.
Speaker 1: We also advanced several strategic priorities in the quarter. In our payment services segment, we continue to expand our global acceptance through new partnerships. In June , we announced a network alliance in Italy with Banco Mat, one of Europe's largest payment networks. This should provide our customers with access to merchants in Italy through Banco Mat's extensive acquirer relationships. This partnership represents a significant advancement in our acceptance across Western Europe .
Speaker 1: and we remain committed to expanding our international merchant coverage.
Speaker 1: In our digital banking segment, our combination of industry leading customer service and compelling products continues to differentiate us in the marketplace. The company's digital banking segment continues to alongside their customers. the marketplace.
Speaker 1: We were recently awarded the highest ranking in customer satisfaction by J.D. Power among mobile credit card apps and websites. We also achieved J.D. Power's top customer satisfaction in checking accounts for direct retail banks.
Speaker 1: This recognition underscores our customer service model, which combined with our compelling cashback rewards and no fee products, create a value proposition that we believe others will struggle to match. For this reason, we're confident that we are well positioned to generate substantial growth and shareholder value over the long term. And shareholder value over the long term.
Speaker 1: Notwithstanding our strong performance, we continue to closely monitor today's evolving economic environment.
Speaker 1: Slide 4 provides some views on the current macro conditions.
Speaker 1: Measures of inflation remain persistently high, and the Federal Reserve has signaled its intent to address this through restrictive monetary policy. Our business model has somewhat of a natural hedge against inflation, as higher expenses are largely offset by the contribution inflation makes to our sales volumes. And because our balance sheet is moderately asset-sensitive, rate hikes improve our outlook for spread income.
Speaker 1: despite driving higher funding costs.
Speaker 1: Perhaps more significantly, tighter monetary policy may have raised the risk of an economic recession, but behavior and trends from our consumer loan portfolio currently do not suggest that a downturn is imminent. Our credit metrics remain strong, and sales are robust even as our customers maintain high payment rates.
Speaker 1: Similarly, most labor market measures indicate employment conditions remain broadly supportive of consumer financial health and credit performance.
Speaker 1: Nonetheless, should there be changes in macroeconomic conditions, we will make the appropriate adjustments. Our through the cycle underwriting considers all stages of a credit cycle, including downturns. And our history of conservative credit management positions as well for any future periods of economic stress. Our actions during the recent pandemic are a good example of how nimble we can respond to changing circumstances.
Speaker 1: We also maintain a strong balance sheet and capital position. Our current level of common equity tier one is 14.2%, well above our internal target and regulatory minimums.
Speaker 1: And as John will detail, our reserves capture our estimate of losses over the expected life of our loan portfolio.
Speaker 1: This brings me to one topic about which one to make you aware. As we addressed in our press release, we are temporarily suspending our share repurchase program in light of an internal investigation being conducted by a board appointed independent special committee. This investigation concerns our student loan servicing practices and related compliance matters. And while we cannot comment further at this time, I can say this matter was contemplated.
Speaker 1: As John , we affirm our expense guidance for the year.
Speaker 1: In summary, while macroeconomic conditions remain somewhat uncertain, we continue to advance our strategic goals and are benefiting from the combination of strong sales and receobles growth, expanding margin and slowly normalizing credit.
Speaker 1: These trends give us confidence in our outlook over the forecast horizon, while our reserves and high level of capital position us to withstand a range of macroeconomic environments. The forecast is expected to be expected to be expected in a range of macroeconomic environments.
Speaker 1: I'll now turn the call over to John to review key aspects of our financial results in more detail. Thank you.
Speaker 2: Thank you Roger and good morning everyone. I'll start with our financial summary results on slide 5.
Speaker 2: As Roger indicated, we reported net income of $1.1 billion.
Speaker 2: which was 35% lower year over year. However, I'd like to call out two items. The first is that in the second quarter of last year, we had a $729 million unrealized gain and a equity investment. The second is that in the second quarter of last year, we had a $729 million real estate investment. The second is that in the second quarter of last year, we had a $729 million real estate investment.
Speaker 2: Compared to a $42 million loss this quarter.
Speaker 2: Adjusting for these, our earnings would have been $4.07 per share in the current quarter.
Speaker 2: Second, the provision for credit losses increased from the prior year due to a $110 million reserve bill in the current quarter compared to a $321 million reserve released in the prior year.
Speaker 2: The current quarter reserve field was primarily driven by higher long receivables.
Speaker 2: Excluding the impacts these two items, our profit before tax and reserves would have been up 38% year-over-year.
Speaker 2: Moving to slide six.
Speaker 2: Net interest income was up $311 million or 14% driven by higher average receivables and improved net interest margin.
Speaker 2: NIM was 10.94%, up 26 basis points from the prior year and 9 basis points sequentially.
Speaker 2: On both a year over year and sequential basis, the increase in net interest margin reflects the higher primary and favorable funding mix. The primary and favorable funding mix. The primary and favorable funding mix.
Speaker 2: Partially offset by increased promotional balances and higher funding costs.
Speaker 2: Receivable growth was driven by card, which increased 15% year-over-year from strong sales and robust new account growth last year and into this year.
Speaker 2: In the quarter, the payment rate increased 40 basis points and remains more than 500 basis points above the pre-pandemic level. We continue to expect that the normalization payment rate will be modest this year and will continue through the back half of 2023.
Speaker 2: Organic student loans increase 4% reflecting solid growth and originations. Organic student loans increase 4% reflecting solid growth and originations.
Speaker 2: Personal loans were up 4% reflecting a return to growth. We view this as a validation of our approach to marketing, underwriting, and pricing of this product over the past several quarters. And we believe we are competitively positioned to grow, particularly relative to some non-bank originators.
Speaker 2: In terms of funding mix, our customer deposit balances were flat year over year and up 1% sequentially. And up 1% sequentially. And up 1% sequentially.
Speaker 2: Increases in our savings balances offset the runoff in higher cost CDs.
Speaker 2: Our strong acic growth may cause deposits to vary as a proportion of our funding mix.
Speaker 2: But we continue to target 70 to 80% of positive funding over the medium term. The positive funding over the medium term.
Speaker 2: Looking at other revenue on slide 7.
Speaker 2: Excluding the impacts of equity investments detailed earlier, non-interest income increased $105 million or 19%. Non-interest income increased $105 million or 19%.
Speaker 2: This was driven by higher net discount interchange revenue, which was up $51 million or 15% reflecting strong sales. The price was up $51 million or 15% reflecting strong sales.
Speaker 2: and favorable sales mix partially offset by higher rewards.
Speaker 2: Sales were up 18% year over year with growth across most categories.
Speaker 2: For the first half of the year, our sales growth was 20%. We estimate that inflation contributed between 200 and 300 basis points to this figure.
Speaker 2: Strong sales also drove higher rewards expense compared to the prior year. Our rewards rate increased six basis points year over year reflecting two factors.
Speaker 2: Our standard 5% category, Aligning with customer needs included gas this. Aligning with customer needs included gas this.
Speaker 2: order. Second, the substantial growth in new accounts over the past year increased the cost of our cash back match.
Speaker 2: However, on a sequential basis, the reward rate was up one basis point and up three basis points through the first half of the year. This is consistent with our expectations of two to four basis points of annual rewards cost increases.
Speaker 2: Lone fee income was up $37 million to 35%.
Speaker 2: primarily driven by an increase in latency instances.
Speaker 2: Moving to expenses on slide eight.
Speaker 2: Total operating expenses were flat year over year and up 8% from the prior quarter.
Speaker 2: Compensation costs were up slightly year over year, primarily due to increased head count and higher average salaries.
Speaker 2: like many organizations.
Speaker 2: we are seeing salary and wage pressure, which will likely continue through the balance of this year and into next year.
Speaker 2: Marketing expenses increase $79 million or 45%. As we continue to invest for growth in our card and consumer banking products.
Speaker 2: We grew new card accounts by 39% from last year's second quarter. This speaks to the strength of our brand, the relevance of our value proposition, and the benefits of our investments in targeting analytics. And the benefits of our investments in targeting analytics.
Speaker 2: As Roger discussed, we closely track economic and competitive conditions and we remain disciplined about our through the cycle approach to underwriting. This approach contributes to our confidence about investing in brand and acquisition.
Speaker 2: Moving to credit performance on slide nine.
Speaker 2: Net charges remain low and we're in line with expectations for continued credit normalization.
Speaker 2: Total net charge costs were 1.8%. 32 basis points lower than the prior year, and up 19 basis points from the prior quarter.
Speaker 2: Total net charge-off dollars were down $27 million from the prior year and up $61 million sequentially.
Speaker 2: In the Cardport folio, the net charge offer rate increased 17 bases points sequentially worth $50 million.
Speaker 2: Looking at our receivables, we are not seeing evidence of emerging credit stress at this point.
Speaker 2: Our delinquencies are virtually unchanged from the first quarter, and while we expect some increases in delinquencies over the back half,
Speaker 2: This is consistent with our outlook for steady credit normalization into 2020-2008.
Speaker 2: Turning to the discussion over allowance on slide 10.
Speaker 2: This past quarter we increased our allowance by $110 million, largely due to higher receivable balances.
Speaker 2: Our reserve rate continued to decline, however, dropping 31 basis points to 6.8%.
Speaker 2: As a reminder, our reserves are based on our expectation of life of loan losses.
Speaker 2: On the macroeconomic view, we believe the balance of risk has shifted to include the potential for an economic slowdown resulting from bad policy actions.
Speaker 2: For us.
Speaker 2: The most significant driver of loss is changes to employment conditions. As Roger mentioned, current labor, the current labor market conditions remain healthy.
Speaker 2: As examples, the number of job openings still exceeds the number of unemployed people.
Speaker 2: and the unemployment rate remains low. But an unemployment claims have started to creep up. But an unemployment claims have started to creep up.
Speaker 2: As part of our reserving process, we consider the prospect of higher unemployment and a range of macroeconomic scenarios.
Speaker 2: Looking at slide 11.
Speaker 2: Our common equity tier one for the period was 14.2%, well above our 10.5% target. The strength of our capital position is underscored by the recent CCARS regulatory stress test.
Speaker 2: Based on the C-Cars results, our preliminary stress capital buffer should decrease by 110 basis points.
Speaker 2: which effectively lowers our minimum requires the E.T.1 ratio to 7 percent, the lowest possible ratio.
Speaker 2: We repurchase 600 and 601 million dollars of common stock during the quarter and declared a quarterly common dividend of 60 cents per share. Currently, the office is in the leads to only 30 possible existence in to Debbie points. Providing to conc Republicans declared a courtally delayed Gods Nvidia? pls Mitte P alternate significantly too the approval of a htt delic distance curTech f Only Rev? Lowway Let's- Let me rise up name antennae zost- mac best Motors Pub-4 Go to see Hot ? on Would N pie b H H las The Collin? L?? Billboard ????? s report you
Speaker 2: including on slide 12.
Speaker 2: As we look into the back half of this year, our perspectives for 2022 remains favorable. We are improving some elements of our expectations.
Speaker 2: We are revising our view on loan growth to low teens.
Speaker 2: Continued strong sales and new account acquisitions through the second quarter support are confidence in this outlook. Our confidence in this outlook.
Speaker 2: There's no change to our view on them.
Speaker 2: We continue to seek five to 15 basis points of upside for the full year relative to the first quarter level of 10.85%.
Speaker 2: Our expectations for expenses remain at mid-single-digit growth versus last year. We still expect marketing costs to come in above 2019 levels, with non-marketing expenses to increase by low single digits.
Speaker 2: We are improving our credit outlook.
Speaker 2: We now expect net charge us to be between 1.9 and 2.1% for the full year.
Speaker 2: And we intend to return to share repurchases at an appropriate time in the future. We are now at an appropriate time in the future.
Speaker 2: In summary.
Speaker 2: Loan growth accelerated as we benefited from robust sales from strong account acquisition.
Speaker 2: Credit performance remains solid, reflecting our disciplined approach to underwriting and credit management. Credit performance remains solid, reflecting our disciplined approach to underwriting and
Speaker 2: We manage operating expenses while investing in new account acquisition, brand, and digital capabilities.
Speaker 2: and our balance sheet and capital position are strong.
Speaker 2: The results demonstrate the resiliency of our integrated digital banking and payments model. And I'm confident that we are well positioned for continued profitable growth to a range of economic conditions.
Speaker 2: With that, I'll turn the call back to our operator, Katie, to open the line for Q&A.
Speaker 3: Thank you. At this time, if you would like to ask a question, please press star 1 on your telephone keypad. If you wish to remove yourself from the queue, you may do so by pressing the pound key. We remind you to please pick up your handset for optimal sound quality. We will pause for just a moment to allow questions to queue.
Speaker 3: Thank you, our first question will come from Emotion or in Buck with Credit Swiss. Your line is out open.
Speaker 1: Great, thanks, and really strong results in terms of accounts and loan growth. And maybe, Roger, could you just talk a little more detail about kind of as you see the competitive environment, you're adding a lot of accounts. I know you've talked about how you kind of originate them with a through the cycle approach, but just talk a little bit about both how you see the competitive environment and how you see any kind of tweaks you are making because of the current environment.
Speaker 1: and talk about that in terms of the outlook. Thanks so much. Sure, Moishe, thanks for the question. You know, I would say the competitive environment remains intense. You know, with the consumers staying strong, we are seeing strong levels of marketing for most of our prime competitors, but I think our differentiated value proposition is succeeding well in the marketplace across all of our products. You know, from a credit standpoint, I would say we're roughly back to where we were pre-pandemic.
Speaker 1: the student loan side, given that this is the key quarter coming up in terms of originations. In the last quarter, you talked a little bit about how you expected to have some advantages versus market funded players. Obviously, you've got the issue that you've got from a compliance standpoint. You talk about how that could impact you from a, you know, from a richenation standpoint. If that does, you know, how long that could last.
Speaker 1: Yeah, we are moving forward with our plans for peak season. Again, what has been a wild card over the last couple of years has been sort of overall, you know, number of kids going back to school and their demands for funding. So I think that the market size is always a bit uncertain. But we feel good about how prepared we are as we move into the peak origination months.
Speaker 4: Thanks very much.
Speaker 3: Thank you. Our next question will come from Bill Carcacci with Wolf Research. Your line is now open.
Speaker 5: Thank you. Good morning, Roger and John . You guys. Certainly have a historically remained profitable through the cycle with risk adjusted yields remaining quite strong, even in a deeper session, like we sign only and it makes sense that you're continuing to invest here against the backdrop that we're in. But could you maybe frame for us?
Speaker 5: What it would take to curb your appetite for investing for growth?
Speaker 5: and maybe just what it would take for you to have a pullback.
Speaker 1: Yeah, thanks for the question. So there are a whole series of things we carefully monitor in terms of the health of our customers in portfolio. And that goes into our appetite for growth. I would say part of the things we watch most carefully externally are the job market and rising unemployment. And so we have a finely tuned playbook in terms of how we'll adjust originations.
Speaker 1: But you know we continue to originate throughout the cycle and so even during the financial crisis that you referred to we kept up a certain level of account production even as we became more conservative in credit. And our underwriting always uses a through the cycle approach as we think about the profitability of accounts we're booking. So those are some of the things we look to.
Speaker 5: Thank you, and if I may follow up on that, maybe could you also frame how you're thinking about the risk that the strength that we're seeing in the consumer and labor markets is in and of itself inflationary and could lead the Fed to have to do more? And since we know that monetary policy operates with long and variable lags, the increases in unemployment that follow those Fed hikes tend to be quite lagged, and so those effects could take some time to show up.
Speaker 5: Maybe, you know, could you just speak to that dynamic, how that feeds, if that feeds in any way into your reserving models? You know, we haven't had a significant inflation cycle in a long time, and so there are some concerns that, you know, current underwriting models may not be picking that up. We'd love to hear your thoughts on that. Thank you. Yeah. Hey, Bill, I'll take that one. Good question. We spent plenty of time thinking about it. So if you'll join me and I'll do my think- crock- contact us and we'll see how that goes.
Speaker 2: Inflation unto itself is not correlated to loan losses based on all the historical data we've looked at. Now certainly, you know, we've seen some changes in consumer behavior, so we'll keep an eye on it. But typically, it would be unemployment or changes in employment levels overall. I have a particular view that as we try or the Fed tries to deal with
Speaker 2: the inflation situation. Certainly it's going to be quite a period of time before the job market is directly impacted in a significant way. So unemployment remains super low, so 3.5%.
Speaker 2: There's still about 11.3 million job openings right now versus six million people looking for jobs.
Speaker 2: spending remains a robust and you know credits performing very, very well. So as we look at those factors, we're going to. We're going to keep an eye and see if there's any material changes on that, but in terms of reserving at this point, you know that that life of loan approach that we take looking at broad macros as well as portfolio performance. Gave us confidence in the reserving levels we chose and the corresponding.
Speaker 2: reduction in the reserve rate. So we'll keep an eye on it and update it quarterly. So we'll keep an eye on it and update it quarterly.
Speaker 5: That's very helpful. Thank you Roger and John , I appreciate it.
Speaker 3: Thank you. Our next question will come from Sanjay Sakhrani with KBW. Your line is that open.
Speaker 6: Thanks, good morning. I guess my first question is on the share or purchase suspension. Obviously that decision was probably not something that was taken lightly. Could you just talk about the thought process in making that decision given all the positive news on your excess capital and stress capital buffers and such? I mean, should we infer that the size and scope of damages could be pretty significant?
Speaker 1: Thanks for the question Sanjay. I think I tried to address that when I said our expense guidance that John reaffirmed includes our views on this matter. So there are many factors that go into a share repurchase program. It's not just potential financial exposure. So, and I would say, you know, returning our shareholders capital in the form of the repurchase has been a big focus for management and the board and will continue to do. And that's why John .
Speaker 2: Yeah, thanks, Sanjay. So the NIM guidance gave a range benchmarking off the 1085, and we said 5 to 15 basis points range of upside from that. Based on the bed actions to date, we're tracking towards the upper end of that guidance range at this point. So that's a positive. We are seeing.
Speaker 2: deposit cost increase, and that's the function of two things. The competitive environment, and then also the fact that we had a record loan growth in the quarter, that 13%. So the funding mix, as I said in my prepared remarks, you know, that will likely change in the back half of the year. And we're going to continue to focus on that 70, 80%. So. So. So. So. So. So.
Speaker 2: year we had a very very low beta. I would expect that to normalize as the funding environment migrates.
Speaker 4: Okay, great. Thank you.
Speaker 3: Thank you. Our next question will come from Rick Shane with JP Morgan. Your line is now open.
Speaker 5: Good morning guys, thanks for taking my question. When we look back at some of the changes over the years like the pommelgation of the card act, there were impacts that people thought would be cyclical that became secular in terms of loss rates and in terms of yield. I'm wondering when we look at payment rates today, if there's something that you guys might see that suggests that this is more of a secular change than a cyclical change.
Speaker 2: Yeah, thanks Rick.
Speaker 2: Yeah, it's hard to call right now, but we do have some preliminary data that shows that the decrease in the use of cash and the touchless transactions you may do at Starbucks or other institutions where folks previously would use cash, a lot of that's gone away. So it's creating a higher level of transactions through our cards, good thing for us from an interchange.
Speaker 2: I would say maybe 100 to 200 basis points of that could be a permanent change. And then the rest has to do with the strength of the portfolio and the strength of the consumers. The portfolio and the strength of the consumers.
Speaker 5: Got it. Yeah, it's helpful and I agree with that conclusion. It just feels like on a day-to-day basis, we're all using less cash. And I'm wondering if that's just driving more and more and creating more and more trans actors for you guys. I'm trying to create more and more trans actors for you guys.
Speaker 7: Yeah.
Speaker 4: Yes. Thanks for the question.
Speaker 2: Anything else?
Speaker 5: That's it. Thank you guys.
Speaker 4: You got it.
Speaker 3: Thank you. Our next question will come from Ryan Nash with Goldman Sachs. Your line is now open.
Speaker 1: Hey, good morning, John . Good morning, Roger. Good morning. So, John , maybe a question on the allowance. So, if I look...
Speaker 5: You know, I recognize that, you know, obviously, this is a life of loan count, but, you know, when I look at the level of reserve today, you're only modestly below where you were at March of 2020, called low sevens versus high sixs. So you maybe just give us a little bit more color in terms of what's assumed in the reserve in terms of scenarios. And, you know, if we see a modest downturn, just given how healthy your consumers are, like, you know, what could that do to both losses in the allowance over time. Thanks.
Speaker 2: Sure. So.
Speaker 2: As I mentioned in my previous comments, we looked at a number of different scenarios, but I can give you a couple data points here. In terms of unemployment, it ranged from a low of 3.3 at the end of 2022 to peak of 5.8. And then as we look for a 23, we're going to have to just about 5.5.
Speaker 2: You know, we're seeing a level of GDP growth slowing. You know, we haven't baked in a full recession, but certainly, GDP does reduce and is near zero in one of the scenarios we ran.
Speaker 2: You know, you know, the employment situation is still as robust.
Speaker 2: And we certainly considered that as well. So as we look out into 23, we're gonna evaluate what the macro conditions are and the impact on life of loan losses. But, you know,
Speaker 2: For me, the portfolio performance really, really strong. Job market really, really strong. Uncertainty on the broad macros and we can serve it a little bit model dose. So overall, I feel like we're 100% consistent with how we've reserved in the past. We're 100% consistent with how we've reserved in the past.
Speaker 2: We've taken that through the cycle underwriting approach. That has benefits through into the portfolio and we've been conservative in our process to ensure that our reserves are fairly stated under GAAP.
Speaker 1: Got it. And maybe Roger, maybe a follow up to Sanjay's question. I guess, given that it doesn't sound like you're expecting much in terms of a cost from this investigation, I guess maybe just talk about.
Speaker 8: to spend the buyback and I know you're limiting what you could say but any sense for the timing of how long an investigation like this could take thanks.
Speaker 1: Yeah, no, I am to your point, limited what I can say. You know, we can't really give you anything to expect in timing other than, you know, you know our views on capital. And so as soon as we can, we hope to restart the buyback. And so as soon as we can, we hope to restart the buyback.
Speaker 4: I figured I'd try. Thanks.
Speaker 3: Thank you. Our next question will come from Mark Degrees with Barclays. Your line is now open.
Speaker 2: Yeah, thanks. Just one more question on the by-back. When you are able to resume, should we expect the cadence to kind of mirror what you did in the first half this year or could you accelerate repurchases? You know, we'll look at that mark. You know, certainly, you know, we have that broad authorization for the board for over five quarters. It's 4.2 to 4.3 billion of repurchases.
Speaker 2: Well, we'll do what we can do.
Speaker 1: Okay, great. And then maybe a question for Roger. I mean, just given kind of the pullback we've seen in FinTech valuations, is there anything that looks interesting here, you know, to deploy that capital inorganically? Good question. You know, I think while valuations have pulled back, I'm not sure there are any bargains yet, but, you know, for us, we've tended not to focus on partnerships and potential investments as opposed to...
Speaker 1: acquisitions and you know a lot of capabilities you know given our our great technology team we feel like we can build ourselves.
Speaker 1: So we have a good business development effort that's what was out there, but I wouldn't necessarily expect something.
Speaker 9: Okay, got it. Thank you.
Speaker 3: Thank you. Our next question will come from John Pankari with Evercore ISI. Your line is now open.
Speaker 4: Morning.
Speaker 10: Morning, Bruno. John . I'm just sorry back to the back to the student loan issue. Just I know you've given all that you can comment on, but there's also in the public, we know that there's also a consent order related to this with the CFPB. It looks like 2020 and I believe it's even tied to consent order from 2015. Did that impact, did that influence the suspension and was there something new that develops back?
Speaker 1: cause the internal investigation? I guess the only thing I can say is, both the consent order and the investigation are in the area of student loan servicing, but beyond that, there really isn't anything else I can add at this time.
Speaker 10: Okay, all right, thank you. Thanks for helping there. And then separately, just on the, this is sort of related to it, but more around the expenses. I indicated that the
Speaker 10: The investigation is already contemplated into the expense guide, and I appreciate that color. Does that mean that there were potential expense offsets that would help keep the expense guide unchanged or that getting back to your earlier comment that there is unlikely to be an expense impact? Yeah, so John .
Speaker 2: The way I would take about it is we're continuing to kind of run and manage our business and try to be disciplined in the way we...
Speaker 2: distribute expense dollars and spend expense dollars. Certainly, there's puts and takes in every single expense line. And we've continued to have our foot on the gas in terms of new account acquisition. And now you have earned the funds that are based in this office.
Speaker 2: media which contributed to the marketing increases. The rest of it is we considered as part of the cost of our operation and we're trying to make it as efficient as we can.
Speaker 10: Okay, thanks for that. If I could just ask one more on the credit side, I know the delinquencies edged up a little bit for 2Q. Did you see any pressure in the lower FICO bands or any color around the modest increase in delinquencies that you saw?
Speaker 2: Yeah, so what we're seeing is the lower fico bands normalizing. And you would expect those to normalize more quickly than the higher fico bands. And frankly, we consider that when we do our underwriting.
Speaker 2: You know, what we're interestingly, what we've seen is...
Speaker 2: early stage delinquencies across the board have corrected in later stage buckets more quickly than we see it in the past. And some of that could be some of the work we've done in terms of analytics and optimized time to contact and collection strategies, and some of it could be just customer performance. So there's really no takeaways from the portfolio.
Speaker 2: other than, you know, it continues to perform very, very well and gave us a degree of comfort as we reduce the overall reserve rate.
Speaker 10: Okay, thanks for taking my questions.
Speaker 3: Thank you. Our next question will come from Betsy Grasick with Morgan Stanley . Your line is now open. Your line is now open.
Speaker 11: Hi, good morning.
Speaker 12: Morning, Betsy.
Speaker 11: Just on the investigation one for me here, you did mention that it is embedded in your full your God on expenses. And I'm wondering if we should take that to mean that you expect the review will be finalized by the end of this year. Is that a fair conclusion?
Speaker 1: I wouldn't necessarily link those 2. I mean, I think what we can say is that we did not. You know, see anything that would change our view that non marketing expenses. This year would grow in the low single digits. And we did indicate that we would hope to have it concluded, but it's done by an independent committee that reports to the to the board.
Speaker 11: Right, and the buyback restarting is a function of the investigation concluding. Is that fair?
Speaker 1: Rather than like a particular CT1 level? Yeah, the termination of the buyback has nothing to do with our capital levels. It does not necessarily require the investigation to be fully complete. For us to resume there are many complex factors that go into it.
Speaker 11: Okay, so it's a bit open-ended on RN thinking about, you know, when to put it back in the model.
Speaker 11: I realize you understand that, so I suppose there'll be a wide range of opinions after this call on that.
Speaker 11: Just on the business, can we talk a little bit about the interchange rate? The gross interchange rate has been really strong in recent quarters and wondering if there's anything in particular driving that. You know, are there increases in competitors that you're matching or is there something else going on? But is there a reason to consider an interchange rate in particular driving theou're some
Speaker 2: Yeah, you know, the overall interchange has largely been a function of a robust sales volume. So we're up, our sales are up 20% through the first half of the year, 18% through the end of the second quarter. So that's driving overall interchange. Now mixed does.
Speaker 2: does come into play in terms of the interchange rate. Obviously, you know, we don't spend a lot of time discussing.
Speaker 2: that. But overall, the solid business performance is driving interchange. And then maybe your follow-on might be rewards. We did see a spike in rewards, which to me wasn't a bad thing whatsoever. What happened was gas was one of the 5% categories in the quarter. Everybody knows about the inflation at the pump.
Speaker 2: So we had a larger percentage of customers maxing out on that 5% category, which drove the rate up. But overall the rate...
Speaker 2: The rate is, we expect two to four basis points of inflation there. Interchange in the aggregate, super strong interchange rate, very, very solid rewards coming in at expectations.
Speaker 11: Got it. Yeah, and that was the follow up. So appreciate it. Thank you.
Speaker 3: Thank you. Our next question will come from Ming Zhao with Dolce Bank. Your line is now open.
Speaker 13: Hey, good morning guys and thanks for taking my question. John , you mentioned I think sales goes up 18 percent through the end of the second quarter. I wanted to see if that was sort of holding through the first three weeks of the third quarter and then are there any specific verticals you called out in terms of sales volume?
Speaker 2: Yeah, so it is holding. So through Monday, we stopped 17%. So again, incredibly robust. Those figures actually have surprised me a little bit to the upside, which is nice. You know, we're seeing, you know, travel increase. Obviously we're seeing petroleum increase and everyday categories.
Speaker 2: have increased. The one thing that we did see through the first half is home improvements band actually.
Speaker 2: decreased versus everyday spend. So it's still positive year over year, but not increasing at the same rate as everyday spend and other recap. and other recap.
Speaker 13: Okay, got it, that makes sense. And then I guess secondly, are you guys sort of seeing any change in consumer behavior in regards to the inflationary environment in terms of sort of any substitution effects or anything that any call there would be helpful?
Speaker 2: Yeah, we're seeing a little bit of it. We believe that in terms of gas, that there's certainly, it's significantly up year over year, but call it the volume of transactions, indicate at a certain level of substitution or decrease in consumption levels.
Speaker 2: And then across the other categories, nothing discernible at this point, but we do expect in the second half of this year with the high rate of inflation that consumers are going to make some choices and substitutions or decrease in consumptions will likely happen.
Speaker 3: Okay, great. Thank you guys. Thank you. Our next question will come from Kevin Barker with Piper Sandler. Your line is now open.
Speaker 14: Great, thanks for taking my questions. Just a little, when I follow up on the student loans side, you have, the charge offs take up, although they're fairly low still, in on student loans.
Speaker 14: but it's just a higher than what we've seen from a quarterly-reminant basis for the last few years. Is there anything related there to the investigation on why the charge also may have ticked higher just in this particular quarter, giving credit metrics to them, which are really good within that portfolio? is there anything more?
Speaker 1: Yeah, no, those aren't linked. And actually I would view it as sort of a one time move and we feel very good about the credit in our student portfolio. In our student portfolio.
Speaker 14: Okay. And then in regards to the Iowa for NIM, appreciate everything for this year. But as you look out, further out, just given the yield curve today, I mean, would you expect some reversing back to your longer term, NIM down to a low 10%, just given the positive cost or likely to remain fairly elevated as we go into next year, or maybe even continue to move higher?
Speaker 2: peak this year and there are a number of factors impacting it, certainly.
Speaker 2: You mentioned deposit costs. That's it. Thank you. Thank you. Thank you. Thank you.
Speaker 2: you mentioned deposit costs, that's going to.
Speaker 2: kind of create some impact. We're going to have impacts on credit, which will impact it. But fundamentally our funding mix has... but fundamentally our funding mix has...
Speaker 2: Has changed which will I believe will drive?
Speaker 2: improved net interest margin versus historical levels.
Speaker 14: Thank you, Chair.
Speaker 3: Thank you. Our next question will come from Meher Batia with Think of America. Your line is now open.
Speaker 13: So good morning and thank you for taking my question. Maybe I'll start with just on the counter competitive intensity a little bit. You're saying quite disciplined on rewards and operating costs, even as you drive growth. Could you talk a little bit about where your account field is coming from? And then you can ask, you know, we've seen a few aggressive offers around cash-backed, introduced in recent months.
Speaker 13: That's historically been your bailiwick. I was curious if you are seeing any kind of impact from some of those offers out in the market.
Speaker 1: Yeah, you know, there are different competitors who do different offers. We tend to try and be more consistent and sustainable. So we like the double cashback for the first year as worked very well for us. So, you know, someone will be $300, $500, you'll see different issuers doing very long-term balanced transfers. You know, we just don't think that's really driving sustainable growth and a lot of that promotion actively.
Speaker 1: productivity can drive sort of new accounts, but not necessarily long-term relationships. So we, you know, like our long-term focus and approach and it has served us well in a variety of competitive environments.
Speaker 13: Thank you. I'm sorry, and I don't mean to be the dead horse here, but one lot of from me just one question on the buyback suspension. Is that something that regulators require or encourage you to do while you get your arms around the servicing issue, or was the decision to spend buybacks just solely driven by you, and don't we have the FS on the board?
Speaker 1: Yeah, the decision was made by discovery.
Speaker 1: The decision was made by the Scudder. Thank you.
Speaker 3: Thank you. Our next question will come from Dominique Gabrieli with Oppenheimer. Your line is now open.
Speaker 14: Hey, great. Thanks so much for taking my questions. I was wondering, how do you monitor want versus needs-based long growth as the consumer might feel some pressure both on an individual and a portfolio level? How do you monitor that? Is there some internal data that perhaps we don't have access to that help you understand good borrowing behavior versus bad borrowing behavior? You know, outside of the length-wency trends.
Speaker 1: having a better value proposition than they're seeing with their other cards.
Speaker 14: Okay, great. Thanks for that. And then, you know, I was just curious, how long out does your through the cycle loss expectation look out for changes in economic overlays? So does it include today, let's say, through the fourth quarter of 2023? You know, given our analysis, we see that that's the rough timing where some of these macro dominoes might fall into place with possibly higher unemployment related net charge offs.
Speaker 14: So how does the waiting work and the, from a timing perspective of when you think an event may actually begin to occur and affect either your growth algorithm or your loss algorithm, anything you can write on that would be really great. Thank you.
Speaker 1: Yeah, I would say we tend to look out roughly four to five years, but it is not as sensitive in terms of whether it's in 18 months or two years or two and a half years. If you think about this is a long-term product and the cash flows associated with a credit card. And if you're not careful, you know, you can find yourself whipping around your new account criteria every week based on sort of the latest change in economic forecast.
Speaker 3: Thank you. Our next question will come from Bob Napoli with William Blair. Your line is now open.
Speaker 1: Thank you and good morning everybody. You know, really solid fundamental results. Great to see. Just the network, leveraging the network, you know, partnerships, you know, the Ariba SESL, but just having this global payments network and just any update you can on that, your efforts to leverage that network. I know Ariba B2B payments, is there anything else on the table there? I don't know.
Speaker 1: order volume for us. You know, we remain in a wide range of discussions with different FinTech players truly around the world, but we tend not to comment on deals.
Speaker 1: I would point out too though, we see a lot of value from the network, not just in the payment services segment, but for the differentiation and capabilities it gives our card issuing business, and in particular the support it provides for rewards on debit, which is a real differentiator in the marketplace.
Speaker 1: Thank you. My follow-up was I guess rewards on debit. It seems like a pretty good opportunity for discover any updated information you can give us on. Cashbacked it and the importance to your business over the next five years or potential benefits from that. Thank you. Thank you. Thank you.
Speaker 1: Yeah, I think it long-term it will be really exciting and a great benefit for the business and provide another entry point into the franchise versus most of our customers now coming from the credit court.
Speaker 1: You know, we continue to be deliberate in terms of how we grow that. We want to make sure that we're really solid operationally, that we have the right fraud prevention in place. But it's a business we were going to scale for the long term. And again, we're excited about some of the early signs we're seeing in terms of cost per account and the usage from some of the customers we're putting on.
Speaker 3: Thank you. Thank you. Our next question will come from Don Faddetti with Wells Fargo. Your line is now open.
Speaker 2: John , I was wondering on the funding side if you could talk a little bit about the ABS market. I know you've been a bit more active and so other card issuers. Are you pleased with sort of the post pandemic from a depth in pricing and leverage perspective and also the same question in terms of brokerage CDs? And also the same question in terms of brokerage CDs.
Speaker 2: Yeah, great question. So I'm going to break it into two categories. So very pleased with the team's execution when we go into the ABS market.
Speaker 2: You know, I feel like the offerings are solid and the execution has been very, very good. The, um, the, um, the, um,
Speaker 2: The other side of the coin is when we were in that low rate environment, the all in rates on some of those transactions were unbelievable. We were down at 71 basis points.
Speaker 2: So it took me personally a little bit to come to terms with, you know, something in the twos or threes right now. But, you know, that's a function of where we are relative to...
Speaker 2: what we're driving in terms of top-line yield, it's still super efficient, secured, and an important funding source. The rest of the funding stack continues to be stable. The broker CDs that you mentioned, you know, they're pricing higher than our online deposits.
Speaker 2: And we're trying to get the right balance in terms of ensuring we're competitive that we're not a market leader in terms of pricing, deposit pricing decisions, but also not having to kind of lean into more expensive funding sources. But we'll continue to evolve there and make sure we're making good, efficient choices for the franchise.
Speaker 3: Thanks, Joe. Thank you. Our next question will come from Erin Saginawitch. Your line is out open.
Speaker 14: Thanks. The stronger loan growth that you've seen recently and increasing your guidance for the full year, how much of normalizing of payment rates is included in that versus just the continued momentum that you're having acquiring new accounts?
Speaker 2: Yeah, Aaron, thanks for the question. Very little. So we modeled out a.
Speaker 2: sustained high payment rate normalization back in through 2023. And frankly, if the payment rate should reduce, you know, that, that provides some more energy for growth. You know, we haven't anticipated that, you know, the drivers at growth have been at the Strong Sales Performance, the new accounts that we put on the books and later part of 20 and into 21 and into this year.
Speaker 2: and customers' footing are guard-top of wallet. So we've been really pleased and feel like the balance of kind of risk versus opportunity in terms of additional growth is probably more on the opportunity side at this point. So we've been really pleased with the opportunity side of the opportunity side.
Speaker 14: Okay, thanks. And then secondly, the internal investigation, obviously that's internal, have you discussed this with the regulators already? Are they involved? I just want to know if there's, you know, another leg, so to speak, to drop with respect to this. Yeah, that's something I can't comment on. I would say though, in terms of internal, just to reinforce it is independent from the board.
Speaker 3: But I can't comment on our discussions with regular members. Okay. Thank you. Thank you. This concludes today's Q&A. I would now like to turn the program back over to Mr. Wassers from from any additional or closing remarks.
Speaker 10: All right, well thank you all for joining us. The IR team is available all day, so please reach us with any additional questions and have a great day.
Speaker 3: Thank you ladies and gentlemen. This concludes today's event. You may now disconnect.
Speaker 3: This concludes today's event. You may now disconnect.