Q3 2023 Discover Financial Services Earnings Call
Good morning, My name is Chelsea and I won't be your conference operator today.
At this time I would like to welcome everyone to the third quarter 2023 discover financial services earnings Conference call.
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I'll now turn the call over to Mr. Eric Walsh head of Investor Relations. Please go ahead.
Thank you Chelsea and welcome to this morning's call I'll begin on slide two of our earnings presentation, which you can find in the financials section of our Investor Relations website Investor Relations got discovery Dot Com. Our discussion today contains certain forward looking statements that are subject to risks and uncertainties that may cause actual results to differ materially. Please refer to our notices regarding forward looking statement.
That appear in our third quarter earnings press release and presentation of our call. Today will include remarks from our interim CEO , Jonathan and John Greene, Our Chief Financial Officer.
After we conclude our formal comments there'll be time for a question and answer session. During the Q&A session. You will need for me to ask one question followed by one follow up question.
After your follow up question fees return to the queue now it's my pleasure to turn the call over to John Thank you, Eric and thanks to our listeners for joining today's call as I shared a few months ago I had three priorities in my role as interim CEO .
Just to continue delivering a great customer experience at every touch point, which we do by providing our customers award winning service and products at.
At the heart of this is a team of more than 20000 employees connected by common values and a shared mission to help people achieve a brighter financial future. Our second priority is to advance our culture of compliance we've made significant strides in this area.
Now you've all had the opportunity to review the consent order issued by the FDIC in September .
Consistent with the terms of this consent order.
Meaningful investments in improving our corporate governance, and enterprise risk management capabilities and expect to drive further enhancements across the organization in the coming quarters.
<unk> started the process of engaging with our merchant partners on the card Misclassification issue remain in active dialogue with our regulators on this topic. The resolution of this issue is likely to be complex and we anticipate it will take several quarters fully resolved our third priority is to sustain our strong financial performance in the third.
<unk> revenue was up 17% year over year, driven by strong asset growth or credit losses continued to perform in line with expected ranges. In addition, we're off to a strong start with the launch of our cashback debit product. We continue to believe that this product will be an important channel welcome many new customers into our cup.
To highlight the discover experience and support our brand and banking products.
They have just introduced a new national advertising campaign, featuring celebrity spokesperson Jennifer Coolidge as we continue to advance our priorities. We are focused on preserving and enhancing the elements may discover a great place to work last month.
We're ranked among the 2023 fortune best workplaces in financial services and insurance. This accolade builds upon our recognition as one of Fortune's 100, best companies to work for before handing the call off to John Greene, Our briefly comment on the CEO search the board is considering several excellent candidates both internal <unk>.
External remain confident that we will identify the next outstanding leader for this organization in the coming months in summary, we continue to target excellence in all parts of our business driving sustainable long term financial performance I will now hand, the call off to John to review our results in more detail. Thank you John and good morning.
Unknown Executive: Good morning, my name is Chelsea and I will be your conference operator today.
Unknown Executive: At this time, I would like to welcome everyone to be third quarter 2020-3 Discover Financial Services earnings conference call. All lines have been placed on you to prevent any background noise.
Everyone I'll start with our financial summary results on slide four in next quarter, we reported net income of $683 million down from just over $1 billion in the prior year quarter provision expense grew by $929 million, reflecting an increase in reserves and charge offs strong.
Unknown Executive: After the speaker's remarks, there will be a question and answer session. If you would like to ask a question at that time, please press star one on your telephone keypad. If you should need operator assistance, please press star zero. Thank you.
Eric Wasserstrom: I will now turn the call over to Mr. Eric Wasserstrom, head of investor relations. Please go ahead. Thank you Chelsea and welcome to this morning's call. I'll be going on slide two of our earnings presentation which you can find in the financial section of our investor relations website investor relations.discover.com. Our discussion today contains certain forward-looking statements that are subject to risks and uncertainties that may cause actual results to differ materially. Please refer to our notices regarding forward-looking statements that appear in our third quarter earnings press release and presentation.
Loan growth, along with changing macroeconomic and household liquidity conditions drove the increase to our reserve balance charge offs increased due to portfolio seasoning and remain in line with expectations revenue grew 17% deposits grew 23% and expenses increased six <unk>.
Year over year further details are reflected on slide five net interest income was up $479 million year over year or 17%. Our net interest margin ended the quarter at 10, 95% down 10 basis points from the prior year and down 11 basis points sequentially. This decrease.
Eric Wasserstrom: Our call today will include remarks from our interim CEO John Owen and John Greene, our chief financial officer. After we conclude our formal comments, there will be time for a question and answer session. During the Q&A session, you'll be permitted to ask one question by one follow-up question. After your follow-up question, please return to the Q&A.
<unk> was driven by higher funding costs, which were partially offset by the benefits from higher prime rates receivable growth was robust card increased 16% year over year, reflecting new account growth and a lower payment rate versus the prior year the payment rate declined about 30 basis points quarter.
John Owen: Now it's my pleasure to turn the call over to John. Thank you, Eric. Thanks to our listeners for joining today's call.
John Owen: As I shared a few months ago, I had three priorities in my role as in from CEO versus continued delivering a great customer experience at every touch point which we do by providing our customers in the award-winning service and products. At the heart of this is a team of more than 20,000 employees connected by common values in a shared mission to help people achieve a brighter financial future. A second priority is to advance our culture of compliance. We made significant strides in this area.
Over quarter, but remains just under 200 basis points above 2019 levels sales volume was relatively flat for the quarter personal loans were up 25% driven by strength in originations over the past year and lower payment rates, we continue to experience strong consumer demand.
While staying disciplined in our underwriting student loans were up 1% deposit growth in the quarter was solid with average consumer deposits up 23% year over year, and 4% sequentially. Our direct to consumer balances grew four 1 billion looking at other revenue on slide six non interest income.
John Owen: By now, you've all had the opportunity to review the consent order issued by the FDSC in September. Consistent with the term to this consent order, we have made meaningful investments in improving our corporate governance and enterprise risk management capabilities and expected to drive further enhancements across the organization in the coming quarters. We've also started the process of engaging with our merchant partners on the cardless classification issues remain in active dialogue with our regulators on this topic. The resolution of this issue is likely to be complex and anticipate it will take several quarters fully resolved.
Increased $97 million or 16%. This was primarily driven by higher transaction processing revenue from our pulse business an increase in loan fee income and strong net discount and interchange revenue moving to expenses on slide seven total operating expenses were up $86 million or.
John Owen: My third priority is to sustain our strong financial performance. The third quarter revenue is up 17 percent year over year driven by strong asset growth. Our credit loss is continued to perform in line with expected ranges. In addition, we are off to a strong start with a launch of our cash-back debt-of-product. We continue to believe that this product will be an important channel to welcome many new customers into our company.
6% year over year and up 4% from the prior quarter. This increase is driven primarily by investments in our compliance and risk management programs and is reflected across several of our expense line items looking at our major expense categories compensation costs were up $24 million a four person.
<unk>, primarily from increased head count the increase in information processing expense was driven by software licensing renewals professional fees reflect an increase in third party support as we focus on accelerating our compliance and risk management efforts moving to credit performance on slide eight <unk>.
John Owen: To highlight this cover experience and support our brand and banking products, we're proud to have just introduced a new national advertising campaign featuring celebrity spokesperson Jennifer Coolidge. As we continue to advance our priorities, we're focused on preserving and enhancing the elements to make discover a great place to work. Last month, we're ranked among the 2023 Fortune Best Workplaces in financial services and insurance. This accolade builds upon our recognition as one of Fortune's 100 best companies to work for.
Net charge offs were $3, five 2% 181 basis points higher than the prior year and up 30 basis points from the prior quarter in card. We continue to see the effects of seasoning of newer accounts, which have higher delinquency rates than older vintages.
John Owen: Before handing the call off to John Green, our briefly comment on the CEO's search. The board is considering several excellent candidates, both internal and external, remain confident that we will identify the next outstanding leader for this organization in the coming months.
<unk> remained consistent with targeted ranges. These newer vintages support strong long term profitability turning to the allowance for credit losses on slide nine this quarter, we increased our reserves by $601 million and our reserve rate increased by 22 basis points to just over <unk>.
John Owen: In summary, we continue to target excellence in all parts of our business, providing sustainable long-term financial performance.
John Owen: I will now hand the call off to John to review our results to more detail. Thank you, John.
7% the reserve increase reflects a modest deteriorating macroeconomic outlook, increasing delinquencies and higher loan balances our macro assumptions reflect a relatively strong labor market, but also consumer headwinds from declining savings rates and increasing debt birds looking.
John Greene: Good morning, everyone. I'll start with our financial summary results on slide four. In this quarter, we reported net income $683 million down from just over $1 billion in the prior year quarter. Prevision expense grew by $929 million for selecting an increase in reserves and charge loss. Strong along growth, along with changing macroeconomic and household liquidity conditions drove the increase to our reserve balance. Charge loss increased due to portfolio seasoning and remain in line with expectations.
At Slide 10.
Our common equity tier one for the period was 11, 6% the sequential decline of 10 basis points was driven largely by our strong organic asset growth, we declared a quarterly cash dividend of <unk> 70 per share of common stock concluding on slide 11, with our outlook, we now expect our loan.
John Greene: Revenue grew 17%, deposits grew 23%, and expenses increased 6% year over year. Further details are reflected on slide five. Net interest income was up $479 million, year over year, or 17%. Our net interest margin ended the quarter at 10.95% down 10 basis points from the prior year, and down 11 basis points sequentially. This decrease was driven by higher funding costs, which would partially offset by the benefits from higher crime rates. Receivable growth was robust.
Growth to be in the mid teens as declining payment rates are offsetting the impact of slowing sales. There is no change to our NIM expectations to be approximately 11% for the full year, we're maintaining our expectations for operating expenses to be up low double digits and there is no change to our expected range for net.
Charge offs to be between three four and three 6% for the year in conclusion, our business fundamentals remained strong we continued to generate solid financial results, while building out our compliance and risk management capabilities and prudently investing in actions that drive sustainable.
John Greene: Card increased 16% year over year reflecting new account growth in a lower payment rate versus the prior year. The payment rate declined about 30 basis points quarter over quarter, but remains just under 200 basis points above 2019 levels. Sales volume was relatively flat for the quarter. Personal loans were up 25% driven by strengthened originations over the past year and lower payment rates. We continue to experience strong consumer demand while staying disciplined and are underwriting.
Long term performance.
That I will turn the call back to our operator to open the line for Q&A.
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John Greene: Student loans were up 1% deposit growth in the quarter was solid. With average consumer deposits up 23% year over year and 4% sequentially, our direct to consumer balances grew $4 billion. Looking at other revenue on slide six, non-interesting income increased $97 million or 16%. This was primarily driven by higher transaction processing revenue from our pulse business and increase in loan fee income in strong net discount and interchange revenue. Moving to expenses on slide seven total operating expenses were up $86 million or 6% year over year and up 4% from the prior quarter.
And we'll take our first question from Sanjay <unk> with <unk> your.
Your line is open.
Thanks, Good morning.
I wanted to get a little bit more on the reserve build as we look ahead John Greene.
Could you just talk about like how we should think about that reserve rate increasing from here because obviously you've made some adjustments, but you've said the credit numbers are performing pretty consistent with your expectation. So is it a reflection on how you see things unfolding next year, maybe you can just talk about the relation and how we should think about that reserve coverage on a go forward.
Third basis, assuming the <unk>.
Unemployment assumptions don't change much.
John Greene: This increase is driven primarily by investments in our compliance and risk management programs and is reflected across several of our expense line items. Looking at our major expense categories, compensation costs were up 24 million dollars or 4% primarily from increased head counts. The increase in information processing expense was driven by software licensing renewals. Professional fees reflect an increase in third party support as we focus on accelerating our compliance and risk management efforts.
Yes.
Thanks, Sanjay I appreciate the question.
So.
Let me back up and just given a little bit of overview in terms of what happened in the quarter.
Why why we increased the reserve rate so.
As we took a look at the portfolio performance on our loan growth, obviously, we had to make.
<unk> build for loan growth and that represented about 50% of the $600 million.
John Greene: Moving to credit performance on slide eight total net charge loss were 3.52% 181 basis points higher than the prior year and up 30 basis points from the prior quarter. In card, we continue to see the effects of seasoning of newer accounts which have higher assistance with targeted range. These newer ventures support strong, long-term profitability. Turning to the allowance for credit losses on slide 9, this quarter we increased our reserves by $601 million in our reserve rate increased by 22 basis points to just over 7%.
The other.
The other 50% or approximately $300 million.
Reflected our view on the macros now.
The unemployment numbers remain relatively in line and strong by historical standards.
We are we are seeing some indications of stress and if we go back to.
The pandemic and the learnings there.
John Greene: The reserve increase reflects a modest deteriorating macroeconomic outlook, increasing delinquencies and higher loan balances. Our macro assumptions reflect a relative relatively strong labor market, but also consumer headwinds from declining savings rates and increasing debt burdens. Looking at slide 10, our common equity tier one for the period was 11.6%. The sequential decline of 10 basis points was driven largely by our strong organic asset growth. We declared a quarterly cash dividend of 70 cents per share of common stock, concluding on slide 11 with our outlook.
Found that certainly unemployment remains an important factor in terms of reserve.
But there's other factors and what we've done over the past year is try to build into those other factors in into our loss models and reserve models and we've done that so as we took a look at.
<unk>.
Household net worth and.
In savings rate, both have deteriorated and we are seeing deterioration more specifically in lower FICO bands.
No.
We use those macro factors in order to.
Capture loss content that we felt was appropriate from from a reserving standpoint.
As we look as we look at reserve levels today and into the future there's a cut.
John Greene: We now expect our loan growth to be in the mid-teens as declining payment rates are offsetting the impact of slowing sales. There is no change to our NIM expectations to be approximately 11% for the full year. We're maintaining our expectations for operating expenses to be up low, double digits. There is no change to our expected range for net charge to be between 3.4 and 3.6% for the year.
Couple of things that I'll say or just.
Kind of a general process items first it will be dependent on on on the macro views and whether they remained stable or deteriorating.
Certainly in the.
Portfolio performance will.
We will be a very very important factor and then third will be the timing and trajectory of.
John Greene: In conclusion, our business fundamentals remain strong. We continue to generate solid financial results while building out our compliance and risk management capabilities and prudently investing in actions that drive sustainable long-term performance.
Loss content so as.
As losses become <unk>.
Closer in terms of our projection period their probability adjusted.
And therefore could increase reserve rate.
Unknown Executive: With that, I'll turn the call back to our operator to open the line for Q&A. 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. We remind you to please pick up your handsets for optimal sound quality.
Now.
There's a lot of detail that I just provided so let me give a view.
Our expectation so first the portfolio is performing generally well, although we are seeing mild mild.
Increased stress at.
At the lower FICO bands to mid FICO bands. We're also seeing that 2022 vintage perform slightly worse in 'twenty, one 'twenty three although highly profitable.
Sanjay Sakhrani: And we'll take our first question from Sanjay Sakharani with KBW. Your line is open. Thanks.
John Greene: Good morning. I just wanted to get a little bit more on the reserve build as we look ahead, John Green. You know, please just talk about how we should think about that reserve rate increasing from here because obviously you made some adjustments, but you said the credit numbers are performing pretty consistent with your expectation. So is it a reflection on how you see things unfolding next year? Maybe he just talked about the relation and how we should think about that reserve coverage on a go forward basis, assuming, you know, the unemployment assumptions don't change much. Yeah. Thanks, Sanjay. Appreciate the question.
So as we look forward to 'twenty four.
We'll run our process.
And.
And adjust the reserve as as we.
As we deem most appropriate.
An important piece will also be the charge off trajectory. So what we've said previously is we expect charge offs to.
Peak some time.
The midpoint of the year to the second half of the year.
Yes.
Half of 2024, so if we don't.
John Greene: So let me back up and just give a little bit of overview in terms of what what happened in the quarter and why why we increased the reserve rate. So as we took a look at the portfolio performance and the loan growth, obviously, we had to make a reserve build for loan growth, and that represents about 50% of the 600 million, and the other 50% or approximately $300 million reflected our view on the macros.
If we don't see a slowing in delinquency rates between now and.
First quarter, certainly that that could be an indication that.
We will have to take incremental provisions. So a lot there hopefully enough for you to be able to digest and.
And move forward with.
Yes. Thank you that's great.
Under the banner of sort of regulatory stuff.
Question number one it doesn't seem like there is a whole lot to update in terms of other actions. We obviously got the consent order and then I saw in the perspective for 2023, you still have a pause for the capital management piece not any change to that so could you just give us a sense of sort of how to think about that and pausing of the share repurchase I know.
John Greene: Now, while the unemployment numbers remain relatively in line and strong by historical standards, we are seeing some indications of stress. And if we go back to the pandemic and the learnings there, we found that certainly unemployment remains an important factor in terms of reserve, but there's other factors. And what we've done over the past years, try to build into those other factors into our loss models and reserve models, and we've done that.
John Owen mentioned it might take several quarters to resolve the merchant issue. So just trying to reconcile those.
Those comments thanks.
Sure Yes.
Take that one too Sanjay so.
Let me first start.
Chart out by saying our capital allocation priorities are unchanged. So.
So invest in the business and return excess.
John Greene: So as we took a look at household network and savings rate, both have deteriorated and we're seeing deterioration more specifically in lower phyco bands. So we use those macro factors in order to capture lost content that we felt was appropriate from a reserving standpoint.
Excess capital to shareholders.
That's very clear.
Our business model, our management team and our board.
The second piece to the answer.
It relates to our continued work on the card tearing issue and other governance issues. So.
We're making reasonably good progress on both of those.
And what we'll do as part of our 2020 for planning process, we will make a recommendation to the board regarding our capital actions and specifically.
John Greene: So as we look at reserve levels today and into the future, there's a couple things that I'll say are just kind of general process items. First, it'll be dependent on the macro views and whether they remain stable or deteriorating. Second, certainly the portfolio performance will be a very, very important factor. And then third, we'll be the timing and trajectory of lost content. So as losses become closer in terms of our projection period, their probability adjusted and therefore could increase reserve rate. Now there's a lot of detail that I just provided.
The buyback and then we'll provide an update on our January call associated with our fourth quarter earnings.
Let me just add a little bit to the correct. Let me just add a little bit to John's answer on kind of where we are for a regulatory standpoint.
The FDIC consent order that was made public this month related really to findings from end of 2021 looking back.
I said before we've made significant investments in our risk management compliance capabilities over the last 18 months from a spending standpoint, we've increased our spending from $225 million in 2022 to about $460 million in 2023, what I would tell you is we've made good progress resolving many of our issues, but we.
John Greene: So let me give a view of our expectations. So first, the portfolio is performing generally well, although we are seeing mildly increased stress at the lower phyco bands to mid-phyco bands. We're also seeing that 2022 vintage perform slightly worse than 21-23, although highly profitable. So as we look forward to 24, we'll run our process and adjust the reserve as we deem most appropriate. An important piece will also be the charge off to generations.
You'll have a significant amount of work to do before classified before we are on the card Misclassification issue, it's not part of that FDIC consent order, that's a separate matter.
And where we are on that as we've mentioned before we did have an outside law firm completed an investigation on the card Misclassification issue.
That work is substantially complete at this point in time.
We've shared that result of that with our board of directors and also with our regulators at this point in time, our waiting feedback from our regulators.
Thank you.
Yes.
Thank you.
Our next question will come from Bill.
<unk> with Wolfe Research your line is open.
Thank you good morning, I wanted to follow up on the reserve rate comments, John Greene, you referenced several macro variables impacting the reserve and you also cited higher delinquencies, which.
John Greene: So what we've said previously is we expect charge off to peak some time around the mid-point of the year to the second half of the year, if the second half of 2024. So if we don't see a slowing in the linkancy rates between now and first quarter, certainly that could be an indication that we'll have to take incremental provisions.
You are more idiosyncratic some investors are concerned that rising dq's may be.
Sanjay Sakhrani: So a lot there, hopefully enough for you to be able to digest and move forward. Yes, thank you. That's great.
A function of more than just seasoning.
Maybe could you just.
To help us with.
Your response would be to the concern that some investors have expressed that the outsized reserve build as a sign that discover may have reached for growth to aggressively during the pandemic and is now facing the consequences, perhaps what could ultimately end up being greater credit degradation in 2024, and possibly beyond particularly.
Particularly since we're still in an environment, where the unemployment rate is three 5%.
John Greene: And just under the banner of sort of regulatory stuff, you know, question number one, it doesn't seem like there's a whole lot to update in terms of other actions. We obviously got the consent order. And then I saw in the perspective for 2023, he still have a pause for the capital management. He's not any change to that. So could you just give us the sense of sort of how to think about that unpausing of the share repurchase?
Yeah. Thanks Bill.
Let me go back.
A little bit and.
And be real clear about what happened in the second half of 'twenty one into 'twenty two in terms of origination so.
Second half of 'twenty, one we resumed and we went back to our traditional credit box.
John Greene: I know John Owen mentioned it might take several quarters to resolve the merchant issues. So just trying to reconcile these those comments. Thanks. Sure. Yeah, I'll take that one to Sanjay. So let me first start out by saying our capital allocation priorities aren't changed. So so invest in the business and return access access capital shareholders. You know, that's very clear from our business model, our management team and our board. The second piece to the answer relates to our continued work on the card tearing issue and other governance issues. So we're making reasonably good progress on both of those. And what we'll do as part of our 2024 planning process is we'll make a recommendation to the board regarding our capital actions and specifically the buyback.
In the early part of.
'twenty two.
We.
Continued with that traditional discover credit box, we did do test and marginal prime and near Prime.
We turned on we saw the results and we turned off.
And.
Second quarter or early third quarter of 2002, so so about six months of origination not not dramatic volume by any means but certainly a test is a good opportunity to to learn to see if we could.
Capture some profitable share.
What we found was that those those accounts.
Aren't meeting our return of volatility thresholds. So they were shut down the rest of the 22 vintage.
Within the traditional credit box that discover ads and 23 remains there although we're <unk>.
John Owen: And then we'll provide an update on our January call associated with our fourth quarter earnings. Let me just add a little bit to let me just add a little bit to John's answer on kind of where we are for regulatory standpoint. You know, the FDIC consent order that was made public this month related really to findings from end of 2021 looking back. So we said before we made significant investments in our risk management compliance capabilities over the last 18 months.
Selling back I will say this the <unk>.
Two vintage was certainly outsized as a result of demand and great execution from our marketing team.
The.
The profitability of that still remains very very strong in the short term medium term and long term so.
If we're going to do it all over again at this point, we'd certainly.
Definitively, yes, we would continue to originate.
John Owen: From a spending standpoint, we've increased our spending from 225 million in 2022 to about 460 million in 2023. What I would tell you is we've made good progress resolving many of our issues, but we still have a significant amount of work to do before we're satisfied before we are on the card misclassification issue. It's not part of that FDIC consent order. It's a separate matter. And where we are on that, as we've mentioned before, we did have an outside law for completed investigation on the card misclassification issue. That work is substantially complete at this point in time. You know, we've shared that results of that with our board of directors and also with our regulators at this point in time.
The loans that we put on the books, but the vintage is.
Significantly larger than other vintages.
So the natural the natural loss content of.
New originations is somewhere between 12, and 24 months and we expect that to play out.
And as I said, the delinquencies and charge offs to peak sometime in 2024 so.
I hope that is helpful in terms of giving.
Little bit of.
Of color in terms of.
The process, we went through.
Our risk tolerance and what.
What what we expect to see from those vintages.
John Owen: So we're waiting feedback for regulators. Thank you.
Yes. That's helpful. Thanks, Thanks, John I appreciate that if I could ask a follow up of John Owen.
Bill Carcache: Our next question will come from Bill Carcacci with Wolf Research. Your line is open. Thank you.
Could you speak to.
The possibility of potentially.
I guess your overall interest level and potentially pursuing strategic alternatives for any of the other businesses, whether that be a student lending or or anything else.
Bill Carcache: Good morning. I wanted to follow up on the Reservary comments, John Green. I mean, you referenced several macro variables impacting the reserve, and you also cited higher delinquencies, which are more idiosyncratic. Some investors are concerned that writing DQs may be a function of more than just seasoning.
Or is that more likely to wait.
Are you more likely to hold off until the new CEO comes onboard which you mentioned is probably in the next several months.
Yes, I can talk about that as you know, we really can't speculate or talk about rumors or selling parts of the business. What I can tell you as part of our strategic planning process that we do every year is to evaluate all of our businesses for returns and fit from a strategic standpoint, we do that is an annual process.
John Greene: Maybe could you just help us with what your response would be to the concern that some investors have expressed that the outside reserve build is a sign that discover may have reached for growth to aggressively during the pandemic and is now facing consequences perhaps what could ultimately end up being greater credit degradation in 2024 and possibly beyond. Particularly since we're still in an environment where the unemployment rate is three and a half percent. Yeah, thanks, Bill.
And with that process as we speak.
But again, that's something we do as part of our annual planning process.
Thank you for taking my questions I appreciate it.
John Greene: So, let me go back a little bit and be real clear about what happened if the second half of 21 and 22 in terms of originations. So, second half of 21, we resumed and we went back to our traditional credit box. In the other part of 22, we continued with that traditional Discover Credit Box. We did do a test in marginal crime and near crime, which we turned on, we saw the results and we turned off in the second quarter or early third quarter of 22.
Thank you.
Our next question will come from Ryan Nash with Goldman Sachs. Your line is open.
Hey, good morning, guys.
Good morning, Ryan.
So.
John you reiterated the expense guidance for 'twenty, three which is obviously a positive.
Im sure Youre going through the budgeting process right now, but I guess based on what you know today regarding the consent order the work that John that one that you referenced.
That you're doing you have made substantial progress plus overall inflation any sense for what expense growth is going to look like into 2024, and maybe just talk about some of the moving pieces that you expect to drive the expense base next year.
Sure.
Yes, im not going to be real specific on 24, we're still in the process of.
John Greene: So, about six months of origination, not dramatic volume by any means, but certainly a test was a good opportunity to learn to see if we could capture some profitable share. What we found was those accounts weren't meeting our return of volatility thresholds, so they were shut down. The rest of the 22 vintage was within the traditional credit box that Discover had. And 23 remains there, although we're peeling back. I will say this, the 22 vintage was certainly outsized as a result of demand and great execution from our marketing team.
Building out the budget and we're yet to share our recommendation with the board, but I can give you.
General kind of direction of what we're seeing so.
The first the first point I think is important to put out there is that.
We continue to target our efficiency ratio to be below 40%.
Now thats over over the medium term.
Obviously, our execution this year with the revenue growth.
And even with substantial investments in compliance and other areas of the business.
Shows an efficiency ratio significantly below 40%, but over the mid term.
John Greene: The profitability of that still remains very, very strong in the short term, medium term, and long term. So, if we're going to do it all over again, at this point, we'd certainly answer definitively. Yes, we would continue to originate the loans that we put on the books. But the vintage is significantly larger than other ventages. So, the natural loss content of new originations is somewhere between 12 and 24 months. And we expect that to play out.
That's something I think.
Investors can expect.
Second the second piece that's important is that.
Despite a significant amount of investment in risk and compliance.
Resources.
We.
We will continue to be disciplined in our allocation of expense dollars and.
Sure.
We're focused on making sure that the expense dollars that we do spend.
Either help us with our compliance and risk management programs overall or generate positive.
John Greene: And as I said, the delinquencies and charge off the peak sometime in 2024. So, I hope that is helpful in terms of giving it a little bit of color in terms of the process we went through our risk tolerance and what we expect to see from those ventages. Yes, that's helpful. Thanks, John. I appreciate that.
Positive earnings potential further firm. So they are the focal point in terms of some of the things where we continue to look at.
We're looking at our facilities footprint.
We expect to be able to continue to make some progress on that our third party spend.
We're scrutinizing significantly with the help of our procurement and vendor management teams and we're going to continue to look at resource levels to make sure. They are appropriate for the environment and what we're trying to execute on so I hope that provides.
John Owen: If I could ask a follow-up of John Owen, could you speak to the possibility of potentially, you know, I guess that your overall interest level and potentially pursuing strategic alternatives for any of the other businesses, whether that be student lending or anything else?
Some context, Ryan on how we're thinking about the expense base in the aggregate and that will translate into.
John Owen: Or is that more likely to hold off until the new CEO kind of comes on board, which you mentioned is probably in the next several months? Yeah, having to talk about that.
What we hope is a.
Reasonably good set of <unk>.
Expense inefficiency numbers into the future.
Got it thanks for the color on maybe the follow up on some of Sanjay and Bill's question. So if I'm thinking about the comments that you and John made regarding the trajectory of the 2002 vintage 23 likely hasnt begun season, yet and inflations weighing on consumers.
John Owen: As you know, we really can't speculate or talk about rumors or selling parts of the business. What I can tell you is part of our strategic planning process that we do every year is to evaluate all of our businesses for returns and fit from a strategic standpoint. We do that as an annual process. We are going to that process as we speak. But again, that's something we do as part of our annual planning process.
Unknown Executive: Thank you for taking my questions, appreciate it. Thank you.
Maybe just help us understand more broadly just thinking about.
How we should see the trajectory of delinquencies, meaning could we actually see the underperformance that we've experienced get worse as we sort of go through this next period of time given that you do have this really big vintage that's coming through and any commentary on framing how much of this is seasonal and how much.
Ryan Nash: Our next question will come from Ryan Nash with Goldman Sachs. Your line is open. Hey, good morning, guys. Good morning, Ryan. So, you know, John, you reiterated the expense guidance for 23, which is obviously a positive and I'm sure you're going through the budgeting process right now, but I guess based on what you know today regarding, you know, the consent order, the work that, you know, John Owen, that you referenced, you know, that you're doing, you've made substantial progress plus overall inflation. Any sense for, you know, what expense growth is going to look like into 2024 maybe just talk about some of the movement pieces that you expect to drive the expense base next year? Sure.
Each of the delinquency performance is seasoning of the book versus actual underlying deterioration that you are seeing in the core customer base.
Yes.
Lots of lots of parts there Ryan.
Let me, let me start by.
Kind of walk you through what we're seeing in the portfolio. So we are seeing kind of differences in performance.
Customers that historically have been transacted versus revolver. So.
Our revolver base.
We are seeing.
More significant decrease in sales activity, which makes.
John Greene: I'm not going to be real specific on 24. We were still in the process of building out the budget and we're yet to share our recommendation with the board, but I can give you general kind of direction of what we're saying. So the first point I think is important to put out there is that, you know, we continue to target our efficiency ratio to be below 40%. Now, that's over over the medium term.
Makes sense right as they try to manage their household budget.
Seeing.
Accounts.
<unk> is in 'twenty, one 2020 two beginning to revolve more so.
John Greene: Obviously, our execution this year with the revenue growth and, and even with substantial investments in compliance and in other areas of the business shows an efficiency ratio significantly below 40%. But over the midterm, that's, that's something I think investors can expect. The second, the second piece that's important is that despite a significant amount of investment and risk and compliance resources, we, we will continue to be disciplined in our allocation of expense dollars.
Revolve rate is back to where we were historically.
And the <unk>.
<unk> three vintages early indications.
Or that it's performing very very well.
'twenty, two is performing well, but not as well as 'twenty three.
So.
My expectation is that delinquencies will slow.
And in the first half of 'twenty.
2024.
It doesn't happen that's an indication that the.
John Greene: And we're focused on making sure that the expense dollars that we do spend either help us with our compliance and risk management programs overall or generate positive, positive earnings potential for the firm. So they're the focal point in terms of some of the things where we continue to look at. We're looking at our facilities, but Prince, we expect to be able to continue to make some progress on that. Our third party and we're scrutinizing significantly with the help of our procurement and vendor management teams.
The stress that the consumers are seeing is more significant than what we're observing today.
Okay.
Thanks for all the color John .
Thank you.
Our next question will come from John Hecht with Jefferies. Your line is open.
Hey, guys. Thanks, very much actually most of my questions and again if that just even in the last question was exactly overlapping so maybe I'll just quickly ask it.
Number one is maybe a quick update on kind of the competitive environment.
Zero balance transfer activity, you're engaging in and other kind of factors that you would tie to competition.
As kind of the credit environment, maybe migrate to a little bit and then what are you guys on that front. What are you doing with respect to underwriting to.
To account for some of these changes that you're seeing as well.
John Greene: And we're going to continue to look at resource levels to make sure they're appropriate for the environment and what we're trying to execute on. So I hope that provides some context Ryan on how we're thinking about the expense base in the aggregate and that'll translate into what we hope is a reasonably good set of expense and efficiency numbers into the future. Got it.
Great.
I'll take that so.
The environment continues to be competitive.
Card origination standpoint, we are we are seeing less competition in kind of the lower FICO bands. So so remember we're a prime revolver. So we're focused on.
On prime customers.
The lower tier of origination.
Nope.
<unk>.
Frankly less competitive so.
We're careful.
John Greene: No, thanks for the color and maybe the follow up on some of Sanjay and Bill's question. So if I think about the comments that you and John made regarding, you know, the trajectory of the 22 vintage, you know, 23 likely hasn't begun to season yet, inflation's weighing on consumers, you may be just help us understand, you know, more broadly, just thinking about, you know, how we should see the trajectory of delinquencies, meaning could we actually see.
As we're looking at that to make sure that.
Those folks seeking credit or are worthy of credit and not going to turn into a a.
Subsequent charge off.
The upper the upper Prime remains.
Remains very very competitive rewards competition, you can see it by the TV ads.
John Greene: You know, the underperformance that we've experienced get worse as we sort of go through, you know, this next period of time given that, you know, you do have this really big vintage that's coming through and any commentary on, you know, framing, you know, how much of this is season and how much of the delinquency performance is seasoning of the book versus actual underlying deterioration that you're seeing in the core customer base. Yeah, a lot of parts there, Ryan, let me start by kind of walking through what we're seeing in the portfolio.
<unk> has certainly subsided significantly so.
The market is always competitive.
The.
Competition varies among various FICO bands and.
And we're going to we're going to continue to compete and generate positive new accounts, but we're also mindful of the credit situation.
Great. Thank you guys very much.
Thank you.
Our next question will come from Jeff Adelson with Morgan Stanley . Your line is open.
John Greene: So we are seeing kind of differences in performance on customers that historically have been transactors versus revolver. So our revolver base, we're seeing a more significant decrease in sales activity which makes sense right as they try to manage our household budget. We're seeing accounts that transacted in 21, 20 and 22 beginning to revolve more. So the revolve rate is back to where we were historically. And the 23 vintage early indications are that it's performing very, very well.
Hey, good morning, Thanks for taking my questions.
John just wanted to follow up on the commentary of peak losses, I think you mentioned, sometimes in sometime in mid to late 2024.
Last quarter, you talked about maybe just getting pushed into 2025 is there a risk that maybe the peak kind of plateaus at or around those higher levels or do you think azure 2020 vintage kind of peaks out and starts moderating in size the losses and delinquencies should just naturally drift lower.
Yes, I think.
It will it will peak.
And then.
Upon its peak I think it'll stabilize out there or.
A few quarters, maybe maybe two to three quarters and then we expect it to.
John Greene: 22 is performing well, but not as well as 23. So my expectation is that the linkancies will slow in the first half of 2024. If that doesn't happen, that's an indication that the stress that the consumers are seeing is more significant than what we're observing today.
Come down that's all subject to kind of the macro environment, obviously, but in terms of what we're seeing today that's the expectation.
And then just on the sales volumes I know there were a pretty flattish this quarter just wondering under the hood, what's going on there is this representative of maybe more of a slower growth in new accounts.
Ryan Nash: Thanks all the colleagues. Thank you.
As maybe your same store customer are still growing at a faster pace year over year and then just maybe.
John Hecht: Our next question will come from John Hecht with Jeffries. Your line is open. Hi, guys. Thanks very much. Actually, most of my questions and the fact is even the last question was exactly overlapping.
Picking through the dynamic of faster network volumes faster debit volumes anything going on there thats driving your debit network volumes to Reaccelerate versus your proprietary card volumes as well.
John Owen: So maybe I'll just quickly ask it, you know, number one is, you know, maybe quick update on kind of the competitive environment, you know, kind of zero balance, kind of transfer activity you're engaging in and other kind of factors that you would tie to competition. As kind of the credit environment, maybe migrates a little bit. And then what are you guys on that front, what are you doing with respect to underwriting to account for some of these changes that you're seeing as well. Great.
Yes.
So let me start with wood sales so.
What we're seeing is.
The downward trend in.
And sales so if you go back to the <unk>.
Fourth quarter 'twenty, three we're at about 10% year over year growth.
First quarter was 8%.
Two and a half in the second quarter.
John Owen: Yeah, I'll take that. So, you know, the environment continues to be competitive from a card originations standpoint. We are, we are seeing less competition in kind of the lower phyco ban. So, so remember, we're prime revolvers, so we're focused on on prime customers and and the lower tier of our origination envelope is frankly less competitive. So we're careful as we're looking at that to make sure that those folks seeking credit are worthy of credit and not going to turn into a subsequent charge off.
And about 1% here in the third quarter and through mid October about about 1%.
Interestingly enough the dynamics R. R.
Changing in terms of categories.
Online spend.
It's up.
Around 4% to 5%.
Everyday spend.
Is up about 3%, that's largely inflation driven we believe.
Discretionary is flat to down.
With the exception of.
Entertainment expense.
Entertainment.
Category, which is up.
North of 20%, which is hard for me to understand at this point, but we are.
John Owen: The, the upper, the upper prime remains, remains very, very competitive. The rewards competition, you can see it by the television ads has certainly subsided significantly. So the market's always competitive. The competition varies among various phyco bands and and we're going to continue to compete and generate positive new accounts. But we're also mindful of the credit situation. Great. Thank you guys very much. Thank you.
We're trying to dig into the details in terms of <unk>.
Implications for next year, we're going to we're going to.
Assume.
Relatively modest sales growth maybe.
Slow and.
And the lower lower single digits.
<unk>.
The transaction revolver.
Components of that.
I mentioned I mentioned that already so more pullback on.
The revolver base.
The.
The other piece of your question is.
John Greene: Our next question will come from Jess Adelson with Morgan Stanley. Your line is open. Hey, good morning. Thanks for taking my questions. John Green just wanted to follow up on the commentary of peak losses. I think you mentioned sometimes in sometime in mid to late 2024. I think last quarter, you talked about maybe this getting pushed into 2025. Is there a risk that maybe the peak kind of flat toes at or around those higher levels, or do you think as your 2020 vintage kind of peaks out and starts moderating in size, the losses and delinquency should just naturally drift lower?
Okay.
Debit transactions.
We've had great execution from our pulse business. So we've expanded a number of contractual arrangements and also.
Debit choice routing has actually made a.
Difference in the volume so.
Our pulse team is executing well and.
<unk> appears to be capturing.
Sure.
Okay, great. Thanks for taking my questions Youre welcome.
Thank you.
Our next question will come from Rick Shane with J P. Morgan Your line is open.
John Greene: Yeah, I think it will peak and then upon its peak, I think it'll stabilize up there for a few quarters, maybe two to three quarters, and then we expect it to come down. That's all subject to kind of the macro environment obviously, but in terms of what we're seeing today, that's the expectation.
Thanks, guys for taking my questions. This morning look.
We decided a couple of things that are driving.
The increase in delinquencies, you've talked about seizing them vantage you've talked about some exposure to lower FICO scores within the cohort.
At the same time, you guys are starting to apply a lot more.
Sheen learning to your portfolio and your process I'm curious if you're identifying other factors that are contributing to the increase in delinquencies whether it's.
Jess Adelson: And then just on the sales volumes, I know they were pretty flatish this quarter, just wondering under the hood, what's going on there is this representative of maybe more of a slower growth and new accounts is maybe your same store customer still growing out of faster pace. And then just maybe picking through the dynamic of faster network volumes, faster debit volumes, anything going on there less driving your debit and network volumes to re accelerate versus your proprietary car volumes as well.
Age demographic.
Geography.
What what might be other factors that are contributing to this in the context of strong labor markets.
And then the follow up to that is.
With that information can you then apply different servicing strategies to enhance that performance.
Yes.
Jess Adelson: Yeah, so let me start with sales. So, you know, what we're seeing is, you know, a downward trend in sales. So if you go back to the fourth quarter, 23, we're at about 10% year over year growth. First quarter was eight percent, two and a half in the second quarter, and about 1% here in the third quarter and through mid October, about about 1%. Interestingly enough, the dynamics are changing in terms of categories.
Yes, you are into that.
Secret sauce of underwriting Rick but.
Ill give you a little bit of overview so.
We spent a lot of time trying to revive.
Yes.
To update our models.
And.
We looked at.
No no exaggeration, probably 300 different.
Risk identifiers or risk letters and what we did what we did find is savings rates important.
Household net worth is important.
The amount of.
Jess Adelson: So online spend is up around 4 to 5%. Every day spend is up about 3%, that's largely inflation driven, we believe. And discretionary is flat to down with the exception of entertainment expense or entertainment related categories, which is up north to 20%, which is hard for me to understand at this point, but we're trying to dig in the details. In terms of implications for next year, we're going to we're going to assume relatively modest sales growth, maybe, you know, slow in the in the lower, lower single digits.
Credit on us so on the credit report and and discovered.
Balance sheet as well as the amount of credit off.
Are continue to be really really important and then also.
There is some work being done on on cash flow underwriting because of some of the some of the off Bureau.
Credit debt.
We experienced or the whole market experience.
In 'twenty, one and 'twenty two so.
We're going to continue to look to refine our models and.
See what we can do to.
Identify accounts that are going to be highly profitable and originate those.
In terms of the second.
Part of your question around servicing strategies.
Ben there's been a lot of work done on.
Jess Adelson: The Transactor Revolver Components of that, I mentioned that already, so more pullback on the revolver base. The other piece of your question is of debit, yeah, debit transactions. We've had great execution from our pulse business, so we've expanded a number of contractual arrangements, and also debit choice routing has actually made a difference in the volume, so our pulse team is executing well and appears to be capturing some share. Thanks for taking my questions. You're welcome. Thank you.
Best Best time to contact and we've got some machine learning models that are focused on that as well as best Chantal to contact. So is it is it via phone E mail text or other means.
All of that work is ongoing and.
Frankly.
It will never stop it will be a continued refinement of the models so that.
We can.
Collect effectively and originate profitably.
Got it hey, Jon its very interesting and very helpful. Thank you.
Thank you.
Our next question will come from Mihir Bhatia with Bank of America Merrill Lynch. Your line is open.
Okay.
Good morning, and thank you for taking my questions.
Scott I wanted to ask about Boston.
So loans.
You're going to see some very healthy growth there.
Rick Shane: Our next question will come from Rick Shane with JP Morgan. Your line is open. Thanks guys for taking my questions this morning. Hey look, you've cited a couple of things that are driving the increase in delinquencies. You've talked about season and vintage. You've talked about some exposure to lower phycoscores within the cohort. At the same time, you guys are starting to apply a lot more machine learning to your portfolio and your process.
Can you talk a little bit more about some of the drivers I think I know you mentioned a little bit of a payment grade pullback, but what about from a competition standpoint, what's driving that and then just related to that.
John Greene: I'm curious if you are identifying other factors that are contributing to the increase in delinquencies, whether it's age demographic, geography, what might be other factors that are contributing to this in the context of strong labor markets. Then the follow-up to that is with that information, can you then apply different servicing strategies to enhance that performance?
Comments, you've been making about on the credit card side wanted to understand if you're seeing any meaningful deterioration in credit there anything on the when they do open pits comment apply.
Anything like we should be thinking about that you're tightening underwriting currently in that both in the loan space too.
Yep Yep.
Thanks Peter.
So.
Our average ticket on a personal loan is significantly larger than.
Many of our competitors.
And.
Yes.
The predominant share of the volume now is for debt consolidation efforts and.
Important to recognize that as.
As part of our underwriting process.
When there is a debt consolidation.
Customer.
We're between 70%, 80% of the disbursement goes to the creditors to insure that.
John Greene: Yeah, you're into the secret sauce of underwriting, Rick, but I'll give you a little bit of overview. So, you know, we spent a lot of time trying to revive or to update our models. And, you know, we looked at no exaggeration, probably 300 different risk identifiers or risk litters. And what we did, what we did find is savings rates are important. Household net worth is important. The amount of credit on us, so on the credit report and discovers balance sheet as well as the amount of credit off are continued to be really, really important.
The overall cost of.
Of that for that customer is lowered and therefore their ability to pay is high.
That's an important distinction.
In terms of growth what we've seen is.
High level of demand, but also a reduction in the payment rate.
And that reduction in payment repayment rate is also.
Then responsible for.
A very significant chunk of the growth that we've seen in the quarter.
In terms of.
The performance there.
It is it is.
What I'll say.
Returning to more historical performance metrics, but again highly profitable and.
John Greene: And then also there's some work being done on cash law underwriting because of some of the off bureau credit that we experienced or the whole market experience in 21 and 22. So, you know, we're going to continue to look to refine our models and see what we can do to identify accounts that are going to be highly profitable and originated those. In terms of the second part of your question around servicing strategies, there's been a lot of work done on best time to contact and we've got some machine learning models that are focused on that as well as best channel to contacts. So, is it the phone, email, text, or other means? All that work is ongoing and frankly, it'll never stop. It will be a continued refinement of the models so that we can collectively and originate properly.
You can see.
From the report from.
The details in terms of delinquency rates.
They remain.
Very very low relative to historical standards.
Okay.
That's helpful.
Thank you.
Maybe if I could just go back for a second to the compliance.
Issue question, and the timing et cetera.
It sounds like from what Youre, saying related to the motion.
Pricing issue outside law firm has completed the investigation discuss results with regulators already.
So I think a lot of what a lot of people are just trying to understand is what needs to happen for the buyback to review I understand its difficult to put it.
Date out there, but is the overall message its going to take several quarters for those to review, maybe just help us understand what needs to happen for you to get comfortable and again like I have to tell you to want to put a specific timeframe, but is the right message its going to be several quarters mall.
Unknown Executive: Ashley, John A. Jones, very interesting, very helpful. Thank you.
Yeah, So no specific timing on the resumption. So what we wanted to do is have.
Further dialogue with our merchants to ensure we're progressing the <unk>.
Mihir Bhatia: Our next question will come from Mihir Bhatia with Bank of America, Merrill Lynch. Your line is open. Good morning and thank you for taking my questions.
The mediation in negotiations.
We also continue to have discussions with our regulators regulatory agencies.
Mihir Bhatia: I wanted to ask you about personal loans. You're a little bit more about some of the drivers. I know you mentioned a little bit of payment grateful back, but what about from a competition standpoint? What's driving that? And then just related to that, to the comments you've been making about on the credit cards. I wanted to understand if you're seeing any meaningful deterioration and credit there, anything on the wind, do the vintage comments apply here?
<unk>.
We're looking to progress those.
And we're also reviewing our capital positions right. There is a number of pulls on on.
Capital this year, certainly the phenomenal loan growth that we've seen.
Got it.
Basil and game that's on the Horizon, we have the.
Seasonal phase in.
Mihir Bhatia: Anything like we should be thinking about about you tightening underwriting currently in that personal loan space, too? Thanks. Thanks, Mihir. So, you know, our average ticket on a personal loan is significantly larger than many of our competitors. And the predominant share of the volume now is for debt consolidation efforts and important to recognize that as part of our underwriting process, when there's a debt consolidation customer somewhere between 70% and 80% of the disbursement goes to the creditors to ensure that the overall cost of debt for that customer is lowered and therefore the ability to pay is high.
Also impacting capital level so.
We're going to we're going to take a look at the profitability for 2024.
<unk>.
Take a look at the <unk>.
Progress, we're making on the car sharing issue and overall risk and governance items and make a recommendation to the board. So my.
Bye.
Say my key summary here is that our capital priorities haven't changed.
Sure.
We're focused on generating.
Positive earnings to be able to invest in the business and return excess capital to shareholders.
Our margin rates remain robust our return on equity this.
This quarter and for the year remains really really strong. So it's a matter of just making sure we've got the right balance between.
Investing and return of capital.
Mihir Bhatia: So, that's an important distinction. In terms of growth, what we've seen is high level of demand, but also a reduction in the payment rate, and that reduction in the payment rate has also been responsible for a very significant benchmark of the growth that we've seen in the quarter. In terms of kind of the performance there, it is what I'll say returning to more historical performance metrics, but again, highly profitable and you can see from the report or from the details in terms of the linkancy rates, they remain, you know, very, very low relative to historical standards. Okay, that's possible. Thank you.
Okay. Thank.
Thank you.
Thank you.
Our next question will come from Bob Napoli with William Blair. Your line is open.
Alright, Thank you follow up on <unk>.
Return on equity of one of the questions we get asked.
Obviously discoveries reported very strong ROE for very long time with the changes in regulations and potential capital changes.
What are your thoughts on discover being able to generate the types of return on equity that we've seen over the last 15 years or so.
Yes.
Certainly.
Yeah.
Relative to kind of history, and then going forward a couple of important points, though we have we have operated with capital well above our operating target.
Better part of.
At least as long as I've been here.
For years, now and we are approaching the 10, 5% target.
John Greene: Maybe if I could just turn back a little for a second to the compliance issue question and the timing, etc. It sounds like from what you're saying related to the motion or misspricing issue, the outside law firm has completed the investigation. You've discussed results with regulators already. So, I think a lot of what a lot of people are just trying to understand is what needs to happen for the buyback to resume and it's difficult to put a specific date out there, but if the overall message is going to take several quarters for those to resume, maybe just help us understand what needs to happen here for you to get comfortable.
Sure.
I will I will say that our <unk>.
Overall capital position does remain very very strong right. So.
Regulatory minimums four 5% the SCB two five so the required capital, 7% and we're at.
The 11 11, 6% here on CET, one for the quarter. So.
My expectation is we're going to manage the business to continue to generate high returns.
<unk> deliver a high level of.
John Greene: And again, like I understand you don't want to put a specific time frame, but is the right message that's going to be several quarters more? Thanks. Yeah, so no specific timing on the resumption. So what we want to do is have further dialogue with our merchants to ensure we're progressing the remediation and the negotiations. We also continue to have discussions with our regulatory agencies and we're looking to progress those. And we're also reviewing our capital positions right there's there's a number of polls on on on capital this year, certainly the phenomenal loan growth that we've seen.
Return on equity overall, and being able to invest in the business and return excess capital to shareholders.
As we go out three to five years, it's been challenging to predict the regulatory regime and.
The expectations for institution, such as ours in terms of overall capital levels, but.
We're well positioned to generate positive capital and returned capital.
Yes. Thank you I appreciate that and then just.
On the overall long term growth of your business or your core customer the Tam of your business.
The ability for discover to grow.
Historically high single digit kind of loan growth.
John Greene: We've got the basil and gain that's on the horizon. We have the Cecil phase in also impacting capital levels. So, you know, we're going to we're going to take a look at the profitability for 2024. Take a look at the progress we're making on the card tearing issue and overall risking governance items and make a recommendation to the board. So my, my, I'll say my key summary here is that our capital priorities haven't changed were, you know, we're focused on generating positive earnings to be able to invest in the business and return.
And spending growth what are your thoughts.
Is the <unk>.
The ability to grow.
Those types of rates.
What we should continue to expect and how does the cashback debit product maybe.
Brent.
Yes, I mean, certainly our expectation is to.
Continue to grow.
At least in line with.
The historical norms.
The.
The cashback debit product.
Actually I think has a lot of.
A lot of power behind it so.
<unk> features the features of the product itself or Super right. So one 1% cash back on.
John Greene: We're going to return access capital shareholders. You know, our, our margin rates remain robust, our return on equity, you know, this quarter and for the year remains really, really strong. So it's a matter of just making sure we've got the right balance between investing and return of capital. Okay. Thank you.
Debit transactions.
We have a.
Positive kind of business impact from our ability to capture interchange.
On those transactions, so thats positive and then it's a whole new customer outlet for us.
<unk> executed well it'll bring in.
A new cohort of customers that we can then.
Bob Napoli: Our next question will come from Bob Napoli with William Blair. Your line is open. So, thank you. Follow up on return on equity. One of the questions we get. I mean, obviously, discover is reported very strong are we for very long time. I was the changes in regulations and potential capital changes. What are your thoughts on discover being able to generate the types of return on equity that we've seen over the last 15 years or so.
Alright, and cross sell to and.
Further further help the customer experience in terms of meeting additional banking needs and.
Turn that.
That.
Checking product into a into a credit card relationship or perhaps a personal loan down the road. So we're super excited about it.
Thank you.
Thank you.
Our next question will come from Kevin Barker with Piper Sandler Your line is open.
Bob Napoli: Yeah, you know, certainly, you know, relative to kind of history and then going forward a couple of important points. So we have, we have operated with capital well above our operating target for the better part of, I don't know, at least as long as I've been here for years now. And, you know, we are approaching the 10 and a half percent target. I will, I will say that our overall capital position does, does remain very, very strong, right?
I just wanted to follow up on some of the spending on tech in particular in the info processing line to provide a little more detail on some of the projects that you have in place and whether you expect those to be ongoing or are there additional projects that you anticipate particularly around tech investment.
And other investments that youre, making within it within the franchise. Thank you.
Yes so.
We're a digital institution so so.
The first piece is yes, we're going to continue to invest in tech and advanced analytics.
Bob Napoli: So regulatory minimums for and a half percent, the SCB, two and a half. So the required capital, seven percent. And we're at 11 11.6 percent here on CET one for the quarter. So, you know, my expectation is we're going to manage the business to continue to generate high returns and deliver a high level of return on equity overall. And be able to invest in the business and return excess capital to shareholders.
To kind of help to help their customer experience and then also help us to generate positive.
<unk> returns.
Some of the specific projects that.
That we're working on so we've got a number of advanced analytics programs around.
Collections and around originations in order to be able to.
Servicing customers, well and then target the right sort of customers. We also did a bunch of work last year and into this year in terms of.
John Greene: So, you know, as we go out three to five years, it's, you know, good challenging to predict the regulatory regime and, you know, the expectations for institutions such as ours in terms of overall capital levels. But, you know, we're well positioned to generate positive capital and return cap. Thank you. I appreciate that.
Improving the closure rate of leads.
From a lead into.
Our funded customer whether it was.
A.
Save it savings or.
Credit customer.
This year we're in.
Investing heavily in our risk and compliance systems.
John Owen: And then just on the overall the long-term growth of your business, your core customer, the tan of your business and the ability for a discover to grow. I mean, I think historically, you know, high single digit kind of loan growth is, you know, in spending growth. What are your thoughts? Is the ability to grow? And those types of rates, what we should continue to expect? And how does the cashback debit product maybe, you know, expect that growth?
Certainly there is tech spend going on there we also have.
Tech spend.
Related to our on Prem servers and.
Moving to <unk>.
Hybrid and cloud environment.
That's certainly a significant spend and then also.
Given given the risk and compliance issues that we've seen historically.
We're spending a lot of time, taking a look at how how our core systems work the data that goes in and the data the data that comes out and what we do with the data.
John Owen: Yeah, I mean, certainly our expectation is to continue to grow at least in line with kind of historical norms. The cashback debit product, we actually think has a lot of a lot of power behind it. So the features, the features of the product itself are super, right? So 1% cashback on debit transactions. You know, we have a positive kind of business impact from our ability to capture interchange on those transactions. So that's positive.
And looking to kind of.
Reduce the amount of manual touches to that data so all of that is.
Part of the reason.
Or the reasons why we're seeing kind of information processing and tech spend overall increase this year to other areas that would call out around our fraud detection, we continue to invest heavily in our fraud detection.
Ongoing battle every quarter, but we've made significant investments abroad and continue to push on that area of the second thing around our digital capabilities as a digital bank.
John Owen: And then it's a whole new customer outlet for us. So, you know, executed well. It'll bring in a new cohort of customers that, you know, we can then underwrite and cross sell to and further, further help the customer experience in terms of meeting additional banking needs. And turn that, that checking product into a, into a credit card relationship or perhaps a personal loan down the road. So we're super excited about it. Thank you.
We've got a very easy to use system easy application process.
Easy for customers to open up and our cashback debit.
We spent a lot of time and effort in customer flows and customer engagement and how we onboard customers in a more seamless manner.
Thank you for all that detail and just a follow up on your investment on.
Enhancing recovery rates have you seen any particular shift in the recovery rates, you have today or where they're trending relative to past cycles.
No no specific.
Specific changes to recovery rates, we are.
John Greene: Our next question will come from Kevin Barker with Piper Sandmore. Your line is open. I just want to follow up on, you know, some of the spending on tech in particular in the info processing line. You provide a little more detail on some of the projects that you have in place. And whether you expect those to be ongoing or are there additional projects that you anticipate, particularly around tech investment and other investments that you're making within it within the franchise. Thank you. Yeah.
We are seeing.
More customers.
Peak.
Credit assistance and negotiate settlements there seems to be cut.
Cottage industry developing around that.
And that's.
Back in this.
I think it was a month of.
July we saw a chunk of charge offs come through as a result of settlements from from these institutions.
John Greene: So, you know, we're a digital institution. So, so the first piece is, yeah, we're going to continue to invest in tech and advanced analytics to help help the customer experience and then also help us to generate positive positive returns. Some of the specific projects that that we're working on. So we've got a number of advanced analytics programs around collections and around originations in order to be able to service customers well and then target the right sort of customers.
But overall recovery rates remained strong the pool of charge offs to be able to capture recoveries from obviously is increasing as the charge offs increase so.
That's that's actually part of our.
Sure.
How do we take a look at overall credit and.
And reserving.
Thank you John .
Welcome.
Thank you.
Our next question will come from Erika Najarian with UBS. Your line is open.
Hi, Good morning. This is Nick <unk> on for Eric Thanks for taking our questions.
John Greene: We also did a bunch of work last year and end of this year in terms of improving the closure rate of leads from a lead into a funded customer, whether it was a savings or credit customer. You know, this year, you know, we're investing heavily in our risk and compliance systems. So certainly there's tech spend going on there. We also have tech spend related to our on-prem servers and moving to a hybrid and cloud environment.
Most of them have been answered, but just wanted to follow up with one question on loan growth.
So obviously card growth remains really robust in Europe , you raised your guidance to mid teens for the year.
I'm just wondering given the comments on the stress in the lower and mid FICO scores than the.
The delinquency trends and then in your comments that the revolve rate has really normalized I'm wondering if you can help us with which parts of the FICO band and your portfolio are driving the loan growth.
And whether youre seeing any outsized contribution from those on the lower end.
Yes.
<unk>.
John Greene: That's that's certainly a significant spend. And then also given given the risk and compliance issues that we've seen historically. We're spending a lot of time taking a look at how our core systems work, the data that goes in and the data, the data that comes out and what we do with the data and looking to kind of reduce the amount of manual touches to that data. So all of that is, you know, part of the reason or the reasons why we're seeing can information processing and tech spend overall increased this year.
No.
We are seeing is.
Kind of a loan build.
Driven by two factors so it's.
Somewhere.
Between 30% and 40% of the <unk>.
The build is.
Loan growth is from new accounts and then.
The remainder is coming from payment rate normalization, so we're seeing kind of portfolio of customers increasing their balances. So.
And that that normalization of payment rate is pretty consistent.
On the upper.
Or bands to call into the <unk>.
Mid mid point to the.
John Greene: There are two other areas that would call out around our fraud detection. We continued to invest heavily at our fraud detection. That's a ongoing battle every quarter, but we've made significant investment to fraud and continue to push on that area. This second thing around our digital capabilities as a digital bank. We've got a very easy to use system, easy application process, very easy for customers to open up our cash back debit. And so we spent a lot of time and effort in customer flows and customer engagement and how we onboard customers in a more seamless manner.
Top two thirds of the portfolio.
The bottom third that the payment rate normalized.
Last year.
And.
We're seeing that.
Pretty close to historical levels, maybe maybe mild deterioration from that.
Got it thank you for taking my question.
Okay.
Thank you.
Our next question will come from Dominick Gabriele with Oppenheimer. Your line is open.
John Greene: Thank you for all that detail and just follow up on your investment on enhancing recovery rates. Have you seen any particular shift in the recovery rates you have today or where they're trending relative to past cycles? No specific changes to recovery rates. We are seeing more customers seek credit assistance and negotiate settlements. There seems to be a cottage industry developing around that. That's back in the month of July. We saw a chunk of charge-offs come through as a result of settlements from these institutions.
Hey, thanks, so much.
Sort of related to that so we just think about the year over year spending growth.
Roughly 1% I guess.
What was the year over year growth in the.
The number of cards or new accounts.
And also what was the and just added to that what is the.
Benefit that discover soar to spending in the quarter related to gas on the growth and then I just have one follow up.
Yes so.
We grew.
We have made public comments on this in 2022.
We grew.
We grew accounts.
About about 20%.
Overall this year as we've.
Taken a taken a look at kind of the credit performance.
We're on pace to kind of originate about the same number overall.
John Greene: But overall recovery rates remain strong. The pool of charge-offs to be able to capture recoveries from obviously is increasing as the charge-offs increase. That's actually part of how we take a look at overall credit and reserving.
John Greene: Thank you, John.
Overall accounts so the growth in terms of new accounts will be relatively flat, but the new account generation will be pretty consistent year over year.
That could change if we pair back.
Credit here.
In the fourth quarter and into next year.
In terms of gas.
That was interesting so gas was up.
One 1% in the quarter. It was also 5% category. So when when you adjust for.
Erika Najarian: Thank you. Our next question will come from Erika Najarian with UBS. Your line is open.
Erika Najarian: Hi, good morning. This is Nikoloko on for Erika. Thanks for taking our questions. Most of them have been answered, but just wanted to follow up with one question on loan growth. Obviously, card growth remains really robust and you raised your guidance to mid-teens for the year. I'm just wondering, given the comments on the stress and the lower and mid-FICO scores, then the delinquency trends and your comments that the revolver rate has really normalized, I'm wondering if you can help us with which parts of the FICO band in your portfolio are driving into loan growth. And whether you're seeing any outsized contribution from those on the lower end.
Kind of the deflationary impact usage there was.
Or at least through our card was up over 10%.
Okay great.
And then.
Obviously, you have a lot of student loans or one of the major players we have the moratorium ending.
I know that that doesn't affect you directly perhaps in your own loans because they are private loans, but what are you seeing in the data that youre watching of how this might be affecting either payment rates or demand for private loans.
Refinancings anything you can provide.
As far as how this effects the consumer that youre seeing in your data.
John Greene: Yeah, so no, what we're seeing is kind of loan build driven by two factors. So it's somewhere between 30 and 40% of the build is or the loan growth is from new accounts. And then the remainder is coming from payment rate normalization. So we're seeing kind of portfolio customers increasing their balances. And that normalization of payment rate is pretty consistent on the upper bands to call it to the midpoint to the top two thirds of the portfolio. The bottom third of the payment rate normalized, last year. And, you know, we're saying that at pretty close to historical levels, maybe a mild deterioration from that. Got it.
Only 19 days or wherever but anything you can provide would be really helpful. Thank you.
Erika Najarian: Thank you for taking my question. Thank you.
Yes.
So we're not seeing anything in our data yet whatsoever.
We did actually a couple of quarters ago.
Quantify what we thought the impact could be to our portfolio in terms of charge offs and as it turns out based on.
The executive order direction in terms of kind of the repayment.
Structure.
Biden administration is putting in place and making payments levels.
Associated or tied to income levels, we expect the impact on our portfolio to be.
De Minimis now, we'll see how it all.
Plays out legislatively.
But we're not expecting a significant impact.
Certainly this year and will evaluate to see.
What happens and take a look at our data to make a determination. If it is going to have an adverse impact on.
Our.
Dominick Gabriele: Our next question will come from Dominick Gabriele with Oppenheimer. Your line is open. Hey, thanks so much. Something sort of related to that. So we just think about the year over year spending growth, roughly 1%. I guess, what was the year over year growth in the number of cards or a new accounts. And also, what was the, and just added to that, what is the benefit that the discover saw, to spending in the quarter related to gas on the growth. And then I just have a call of things.
Charge offs, but today.
Nothing.
Got it thank you.
Youre welcome Dominic.
This concludes the Q&A portion of the call.
I would like to turn the floor back over to Eric <unk> for any additional or closing remarks.
Thank you very much for joining us. This morning, if you have any additional questions. Please reach out to the IR team and we look forward here, thanks very much take care.
Thank you ladies and gentlemen, this concludes today's program and we appreciate your participation.
May disconnect at any time.
John Owen: Yeah, so, you know, we, we grew, and I, we made public comments on this in 2022, we grew, we grew accounts about about 20% overall this year as we've taken a, taken a look at the credit performance. We're on pace to kind of originate about the same number of overall accounts. So the growth in terms of new accounts will be relatively flat, but the new account generation will be pretty consistent year over year. You know, that could change if we pair back credit here in the fourth quarter of the next year.
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Okay.
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Okay.
John Owen: In terms of gas, that, that was interesting. So gas was up 1% in the quarter. It was also 5% categories. So when, when you adjust for kind of the deflationary impact, the usage there was. Or at least through our card was up over 10%.
Dominick Gabriele: Okay, great.
Dominick Gabriele: And then, you know, obviously you have a lot of student loans. You're one of the major players. We have the moratorium ending. I know that that doesn't affect you directly perhaps in your own loans because they're private loans. But what are you seeing in the data that you're watching of how this is might be affecting either payment rates or demand for private loans or, you know, the financing anything you can provide.
Dominick Gabriele: As far as how this affects the consumer that you're seeing your data, you know, only in 19 days or ever, but anything you can provide would be really helpful. Thank you. Yeah, so we're not seeing anything in our data yet whatsoever. We did actually a couple quarters ago. Quantify what we thought the impact could be to our portfolio in terms of charge us. And as it turns out, based on the executive order direction in terms of kind of the repayment structure that the Biden administration is putting in place and making.
Dominick Gabriele: Kind of payments levels associated or tied to income levels. We expect the impact on our portfolio to be the minimum. Now, we'll see how it all plays out legislatively. But we're not expecting a significant impact certainly this year. And, you know, we'll evaluate to see what happens and take a look at our data to make a determination if it is going to have an adverse impact on. Thank you. You're welcome, Dominick.
Eric Wasserstrom: This concludes the Q&A portion of the call, and I'd now like to turn the floor back over to Eric Wasserstrom for any additional or closing remarks.
Eric Wasserstrom: Well, thank you very much for joining us this morning. If you have any additional questions, please reach out to the IR team. Thank you very much.
Unknown Executive: Take care. Thank you ladies and gentlemen.
Unknown Executive: This concludes today's program, and we appreciate your participation. You may disconnect at any time.