Q1 2023 Discover Financial Services Earnings Call
Moving to expenses on slide seven.
Speaker 1: Moving to expenses on slide seven.
Speaker 1: Total operating expenses were up $253 million, or 22% year over year, and down 7% from the prior quarter. Compensation costs were up primarily due to increased headcount and wage inflation. Marketing expenses increased $49 million at 26% as we continue to prudently invest for growth in our card.
Speaker 1: consumer banking products.
Speaker 1: Professional fees increase $55 million, or 31 percent, driven by investments in technology and increases in consulting activities that support our consumer compliance initiatives.
Speaker 1: Even with these increases, our efficiency ratio was 37 percent and we generated about 700 basis points of operating leverage in the period.
Speaker 1: We will wait for credit performance on slide 8.
Speaker 1: charge-offs were 2.72%, 111 basis points higher than the prior year, and up 59 basis points from the prior quarter.
Speaker 1: In the card portfolio, the net charge-off rate of 3.1% was 126 basis points higher than the prior year and 73 basis points higher sequentially.
Speaker 1: consistent with our commentary back in January .
Speaker 1: We expect the seasoning of new account vintages from the past two years and normalization of older vintages to a more typical loss rate.
Speaker 1: These trends remain consistent with our expectations.
Speaker 1: Turning to the discussion over our allowance on slide nine.
Speaker 1: This quarter, we increased our allowance by $385 million and our reserve rate increased by 25 basis points to 6.8%.
Speaker 1: This increase in reserve rate was driven by two factors.
Speaker 1: About 10 basis points reflects the runoff of seasonal transactor balances that we typically experience in the fourth quarter.
Speaker 1: The remaining portion was largely driven by deterioration in our expectations of the macroeconomic environment. We increased our expectations for the 2023 year-end employment rate to the midpoint of our 4.5 to 5% range.
Speaker 1: This change reflects the potential for a reduction in lending impacting economic growth.
Speaker 1: We will continue to monitor the macroeconomic conditions and make adjustments to our expectations.
Speaker 1: Looking at slide 10.
Speaker 1: Our common equity tier one for the period was 12.3% and we repurchase $1.2 billion of common stock during the quarter.
Speaker 1: The net unrealized loss on our AFF securities portfolio at the end of the quarter was $45 million. The impact on our regulatory capital if our OCI opt-out were not allowed would have been about 20 basis points.
Speaker 1: Our capital position remains robust and well ahead of regulatory requirements. We continue to prioritize investment in strong organic growth and returning excess capital to shareholders.
Speaker 1: Included in our press release was the announcement that our Board of Directors approved a new $2.7 billion share repurchase program for the five quarters ending June 2024, and increased our common stock dividend by 17% to 70 cents per share.
Speaker 1: including on slide 11, weather outlook.
Speaker 1: Following the strong first quarter performance, we are raising our expectations for loan growth this year to be low to mid teens.
Speaker 1: There is no change to our NIM forecast.
Speaker 1: We are maintaining our guidance for operating expenses to be less than 10%.
Speaker 1: However, we do see risk of upward pressure on this from collection and customer service expense related to growth in our lending and deposit accounts.
Speaker 1: and professional service support and continued investment in technology.
Speaker 1: We are targeting our expected range of net charges to 3.5 to 3.8 percent.
Speaker 1: based on our current delinquencies and roll rates.
Speaker 1: This represents a reduction to the top end of their range by 10 basis points.
Speaker 1: Finally, as mentioned, our Board of Directors approved a new share repurchase authorization.
Speaker 1: We have returned substantial excess capital over the past two years, and we anticipate moving towards a more standard cadence of share buybacks over the second half of this year.
Speaker 2: To conclude.
Speaker 1: Our first quarter results have given us significant momentum into this year and we're well positioned to deliver on our financial objectives. With that, I'll turn the call back to our operator to open the line for Q&A.
Speaker 3: Thank you.
Speaker 4: 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 star 2.
Speaker 4: We remind you to please pick up your handset for optimal sound quality.
Speaker 4: And we'll take our first question from Sanjay Sakrini with KBW. Your line is open.
Speaker 5: Thank you. Good morning. John , quick question on the reserve commentary you had. Just to be clear, I know you guys had a weighting of scenarios and it sounds like the low end went from four and a half to 4.75. When we average that out between all the scenarios, does that take you above the 5% unemployment rate assumption?
Speaker 5: Or how should we think about that? And also just in terms of the narrowing of the range of the charge offs this quarter, is that more because the unemployment rate hasn't necessarily panned out the way you expected it to, meaning it's coming in better.
Speaker 1: Thanks, Sanjay. I'll start with the reserve portion of the question and then swing over to the charge-off aspect. As we mentioned, we run a number of different scenarios.
Speaker 1: We looked at unemployment ranges from 3.5 to north of 6%. We centered around a range between 4.5 and 5% for 2023, and then a slight improvement in 2024.
Speaker 1: And that was essentially the driver of the increase in the reserve rate outside of the 10 basis points I talked about in my prepared remarks related to kind of transactors running off as they typically do in the first quarter. So hopefully that
Speaker 1: clarifies your question or clarifies any questions you have on reserves. Related to charge-offs.
Speaker 1: So there's a couple factors there. The first, and what I would say is the most important, is that the portfolio is performing almost exactly as we expected it to in terms of charge-off, roll rates, and delinquency. So we're. We can handle the benefits of the firstly, if the company helping me with product
Speaker 1: We're generally pleased with that. As each month and quarter goes by, we have better line of sight to what we expect the total year to be. Our internal roll rate model basically can take a...
Speaker 1: Very, very good look at six months forward and then we move to more advanced models for anything beyond that. So as the first quarter passed, a great line of sight through September and then beyond September we've relied on our analytical models. To begin with give us your questions in the comments section below.
Speaker 1: That's essentially the reason why we're able to tighten the charge-off guidance from the upper end. And each quarter we'll give an update on that, certainly.
Speaker 2: Okay, thank you.
Speaker 3: Thank you.
Speaker 4: Our next question will come from Moshe Orenbuck with Credit Suisse. Your line is open.
Speaker 6: Great, thanks. I guess first, you talked about a kind of slowing of new account growth. Could you kind of, Roger, perhaps drill down a little more into the drivers, I guess, in terms of what you're seeing either in the competitive environment.
Speaker 1: capitalized a lot of deposits. So, you know, cards tends to always be competitive. I think what you're seeing are the results of some of the changes we've made in credit policy. We've talked about tightening at the margin. And then also some very tough comps over the growth.
Speaker 6: We saw last year, so we feel really good about the new accounts we're booking But also believe our credit policy is appropriate for the current environment Got it And maybe you know can you talk a little? John maybe talk a little bit more about the expense comment that you made you know it
Speaker 1: although we're seeing a little bit of pressure on those lines I mentioned. So in terms of marketing, what we said in January was that we expected marketing to be up double digits. We still expect that to be the case, despite the reduction in...
Speaker 1: reduction in the rate of growth of new accounts, we are still seeing good opportunities to generate positive account growth with an appropriate risk tolerance.
Speaker 1: The other portion of that marketing spend will be to roll out the.
Speaker 1: the cash back debit program, which we anticipate to
Speaker 1: be rolled out late in the second quarter, maybe early in the third quarter. So we're going to put some substantial dollars behind that to generate some activity, both new account generation as well as awareness of the product and the product features that we think are going to be important for us.
Speaker 1: will help build, continue to build our strong deposit franchise.
Speaker 3: Thank you.
Speaker 4: Our next question will come from Bob Napoli with William Blair. Your line is open.
Speaker 7: Thank you and good morning. The slowdown in spend growth you called out in the month of April . I was wondering if you could give a note to top comps versus a year ago, but just any color on what you're seeing on that front and then any change in your view of the health of the consumer.
Speaker 6: Yeah, so I would say that the slowdown is
Speaker 6: And it is really a continuation of the trend. If you look at the quarter itself, overall sales growth was a little over 9%, but March it had dropped to 4%. So broad-based across all categories, you know, I think some of it is just a reduction in the pressures from inflation.
But also you've got some tough comps in terms of last April , sales were up 22 percent year over year. For us, the most important thing for the consumer is the strength of the job market, and that remains pretty robust. While we are tightening credit and continuing along that.
overall the consumer is still holding up pretty well.
Thank you. Thank you.
what you believe that will, I guess, do for you strategically. Just any thoughts on, I know you guys have been doing a lot of work on it over the years, and it seems like you're ready to really roll with it.
Yeah, no, that is it's a product we're really excited about, you know, offering 1% cashback on debit transactions is virtually unique. It's something that no big bank can match. We take advantage of having a proprietary payments network. And you know, one of the outcomes from the pandemic is consumers even for their primary story.
cards, personal loans, student loans, home equity, but being the true leading digital bank.
Thank you.
Thank you. Thank you.
Our next question will come from Rick Shane with JP Morgan. Your line is open.
Thanks everybody for taking my question this morning. Roger, when you look at the credit outlook and you updated the MCO guidance, I'm curious about some of the puts and takes you see in terms of sort of the internals of numbers, whether it's roll rates, utilization, payment rates.
What do you see out there that is the most constructive, and what's the factor that gives you the most pause?
Yeah, you know, it varies for new accounts versus what we look for on our portfolio. For the portfolio side, it's hard to pick an individual factor given the complexity of the models we use. But certainly overall, it's hard to pick an individual factor.
levels of indebtedness, their behavior in terms of payments, the amount of payment. We even look at when a payment comes in during the month. So, you know, given that we're still focused on growth, I would say in general, the consumers are doing well. But we have continued to tighten.
And it's something we look at every account every day across all of our different products. Got it. And is there one metric you might point to that kind of
When you get your daily reports, you scan to right away because it's a concern for you.
Yeah, so you may find this hard to believe, but there are very few numbers I look at on a daily basis. I'm lucky to have an amazing team. And so I can look at it a little less frequently. But you can't point to a single number. We have kind of a composite behavioral score that I see on a lot of our internal risk reporting.
come from Betsy Grasick with Morgan Stanley . Your line is open.
Yeah, hi, this is Jeff Adelson on for Betsy. Good morning. Hi, this is Jeff Adelson on for Betsy.
John , I just wanted to follow up on the comment about the potential for a reduction in lending impacting economic growth. I know that was more of a macro overlay comment, but just wanted to understand maybe where you think Discover is going to fit into that potential tightening regime. I know you're already doing some tightening, slowing account growth on your side, but just wondering if you could talk a little bit more about that.
Do you see yourself at some point this year taking a more meaningful cut? But maybe what would cause you to revisit the loan growth that you're seeing today?
Thanks for the question, Jeff. So as we look at loan growth for 2023, we feel very, very positive. And that's why we moved the loan growth range up a bit. So in terms of the
the overall lending environment and what would trigger additional cuts. It would be meaningful changes to the unemployment outlook, meaningful changes in the number of job openings, and then further signs of stress within the consumer. So that would...
within the portfolio itself, it would be payment rates, timing of payments, we take a look at flow rates from one bucket to another. So those would all be certainly signs as well as kind of the broader indications of delinquency and
and the rate of charge off on a vintage basis. But as we look at things right now, employment, I believe, will continue to be strong, right? So we have strong growth in the healthcare sector, manufacturing sector, defense, oil and gas.
means that we'll continue to look at things around the margins and make good calls to ensure that the accounts we're putting on are profitable and the accounts that are in the portfolio that we have early warning triggers so that our customer servicing collections folks.
can reach out to ensure that collections and cash flows remain strong.
Thank you. And one follow up I just want to have on expenses and technology investment. You know, there's been a lot of focus out there on AI, some advances in that technology, and I know Discover has been pretty nimble and investing on its own in that space. Just wondering, is there anything.
Oops. Hello, Jeff or operator? The line opened. Yes, his line is still open.
Hello, Jeff or operator? The line open. Yes, his line is still open.
Okay, Jeff, I think we missed the last a little bit of your question, but I think it was essentially about the use of AI. So, yeah.
So why don't I take that briefly and Jeff or Betsy we can follow up separately in the afternoon if you'd like. So in terms of investing in technology, so there's three, I'll call it three or four different strengths. The first is to ensure we have leading-edge capabilities.
which would include machine learning, AI. Second is ensure that our core systems are robust and resilient. Third, around the network, making sure that our network continues to have leading edge or at a minimum market equivalent. We're going to use the same technology to make sure that our network is robust and resilient. Third, ensure that our core systems are robust and resilient. Third, ensure that our network continues to have leading edge or at a minimum market equivalent. Third, ensure that our network continues to have leading edge or at a minimum market equivalent.
We're a digital institution. We need to continue to invest in technology to ensure that we keep capabilities advancing.
Okay, thank you.
Thank you. Our next question will come from Dominic Gabrieli with Oppenheimer. Your line is open.
Hey, thanks so much and good morning. I would imagine that discover given the prudence of the way you run your franchise franchise has really.
strong KYC.
And I think some of the FinTech players are actually having some difficulty there. And so I'd love to hear you talk about your checklist for opening an account.
And is there a difference for KYC?
when you issue a debit card versus extending credit with a credit card. I just have a follow up. Thanks so much guys.
Yeah, great question. So, you know, a M. L. BSA is one element of compliance. There are many others that we focus on. You know, first thing I'd say is our task might be a little easier just given that we don't handle much cash, not having branches.
We don't have huge private net worth operations much outside the US, but it is a key area of focus. There's a pretty big overlap between what we're required to do from a KYC standpoint, and actually what we do ourselves to tackle fraud. A huge amount of the new fraud attacks do come via identity.
You know, I guess kind of a double question here, but is, you know, how closely aligned is your CECL unemployment rate and thus reserve outlook.
correlated with your net charge-off guidance.
Is there a possibility that, I mean, you had mentioned before that you don't expect, you know, unemployment rate to rise very much. Is there a chance that there could be actually a disconnect between the CISO reserve and the federal reserve?
and company NCO outlooks. Thank you so much. Yeah, thanks, Dominic.
We have a process that we take great pains to make sure there's no disconnects between our outlook on kind of charge offs over all of the three quarter or four quarter period and the CECL reserves which is life of loan.
losses which would include charge offs through through the life of the relationship and and the modeling systems that we use are essentially the same same tools same people of kind of managing those and a bunch of
work to ensure that the organization, so each of the functions, credit and risk management systems and finance and accounting are on the same page in terms of what we're trying to to accomplish here. So there's no chance to disconnect here at Discover.
I will say that the difference in terms of the tightening of our charge off outlook in terms of updated guidance and what happened in the reserve has a couple of factors that are at play there. The first is we are talking about a three quarter period of...
including the macro environment portfolio. And then there's certainly a level of management judgment that we use to ensure that we have an appropriate reserve under financial accounting standards. So that's essentially...
A quick sketch of the process that we use. Excellent, thanks so much for taking my questions. Have a good day.
of the process that we use. Excellent, thanks so much for taking my questions. Have a good day. Thank you.
Thank you. Our next question will come from Meher Bhatia with Bank of America. Your line is open.
Hi, this is Nate Richman from EagerBot. Quick question for me. Are you seeing any changes to the credit quality for new applicants? I understand that you're tightening credit and underwriting, but just curious to see how those consumers are asking for loans now versus a year or two ago.
Yeah, I mean, it's a tricky question to answer because it varies by channel. Obviously, we do quite a lot of pre-approved marketing, so we kind of set the criteria who applies and even within our non-pre-approved channels, we tend to be targeted. So I haven't seen, I would guess, a huge difference in terms of applicant profile.
But our new account profile has tended to improve as we've tightened credit. Okay, here and then as a quick follow up, can you talk about the vintage performance? Like, how are card loan vintages from 2020 through 2022 performing versus the loans? Yeah, I think, you know, in general, you know, John mentioned all of the vintage
Thank you.
Thank you. Our next question will come from Mark De Vries with Barclays. Your line is open.
Hey Mark, I think your line is open.
We'll come back to Mark offline.
Okay, yes sir, and as of this moment, there are no further questions in the queue, so I would like to turn it back over to management for any additional or closing remarks.
Great. Well, if there are any additional questions, please reach out to us here at the IR team, and thanks very much. Have a great day.
Thank you ladies and gentlemen. This does conclude today's conference and we appreciate your participation. You may disconnect at any time.