Eric Wasserstrom:

Thank you, and welcome to this morning's call. I'll begin by referencing Slides 2 and 3 of our earnings presentation, which you can find in the financial section of our Investor Relations website, investorrelations.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 the second quarter 2024 earnings press release and presentation as well as the risk factors detailed in our annual report and other filings with the SEC. Our call today will include remarks from our Interim CEO, Michael Shepherd; and John Greene, our Chief Financial Officer. There will be no question-and-answer session following today's remarks. However, the Investor Relations team will be available for any inquiries. It is now my pleasure to turn the call over to Michael.

John Greene:

Thank you, Michael, and good morning, everyone. I'll start with our summary financial results on Slide 5. In the quarter, we reported net income of $1.5 billion, which was up 70% from the prior year quarter. Our fundamental performance in the period was driven by revenue expansion from loan growth, higher net interest margin and non-interest revenue growth. Credit continues to perform in line with expectations, supporting our view that losses are near peak and will plateau during the second half of 2024. There are several unusual items which impacted the quarter. These included a $869 million student loan reserve release, a gain of $26 million from the sale of our Lake Park facility. And largely offsetting one another were the favorable litigation settlement and a charge for expected regulatory penalties related to the card misclassification matter. Excluding unusual items, we would have reported net income of approximately $915 million and EPS of about $3.63 per share. Let's review the details beginning on Slide 6. Our net interest margin ended the quarter at 11.17%, up 11 basis points from the prior year and up 14 basis points sequentially. On a quarter-over-quarter basis, margin expansion was primarily driven by a lower card promotional balance mix. As anticipated, receivable growth continues to normalize from its early 2023 peak. Card receivables increased 7% year-over-year due to a lower payment rate and a smaller contribution from new accounts. The payment rate declined about 130 basis points compared to last year and is now about 90 basis points above 2019 levels. Discover card sales were down 3% compared to the prior year, spending at restaurants, which is a large category for sales volume declined sequentially as a result of being included in the 5% promotion during the first quarter. Accounting for the influence of promotional categories, sales trends are relatively stable. We continue to see a cautious consumer, evidenced by less card member spend with lower income households being most affected. Personal loans were up 13% from the prior year period. In response to market conditions, we prudently tightened underwriting over the past year, which has served to modestly reduced originations. Student loans were down 1% year-over-year. As Michael mentioned, we have entered into an agreement to sell our student loan portfolio. We expect the transaction to be completed in four tranches by the end of 2024. The purchase price has added a premium to the principal balance and is based on a formula that varies depending on the closing timing, interest rates and other factors. In association with this development, student loans are now accounted for as held for sale. The two most notable impacts to the financial statements are that we will no longer maintain a credit reserve for student loans and future student loan net charge-offs will be recognized through operating expense rather than credit losses. Average consumer deposits were up 15% year-over-year and 1% sequentially. Deposit balances are being managed in relation to our liquidity needs, which will benefit from the student loan sale. Our disciplined approach to deposit pricing has led to a modest reduction in average deposit rates in the second quarter, consistent with our practice of leading the industry on pricing in down parts of the cycle. Looking at other revenue on Slide 7. Non-interest income increased $313 million or 45%. Discount and interchange revenue was up $67 million as a result of lower rewards cost. Our rewards rate was 132 basis points in the period, a decrease of 10 basis points versus the prior year quarter. The decline reflects lower cash back match. Other income increased due to unusual items, including the litigation settlement and the facility sale. On an adjusted basis, non-interest revenue grew 14%. Moving to expenses on Slide 8. Total operating expenses were up $325 million or 23% year-over-year. The most significant driver of this increase was a charge for expected regulatory penalties related to the card misclassification issue. It is important to note that actual penalties imposed are subject to further discussions and may be more or less than this amount. Adjusting for this charge, our expenses would have increased by 9% year-over-year. Looking at our major expense categories. Compensation costs increased $70 million or 12%, primarily due to an increase in business technology resources. Professional fees were up $80 million or 37%, driven by higher recovery fees and investments in compliance and risk management. Our expectation for compliance and risk management expenses for the full year remains in the $500 million range with an upside bias. This figure excludes cards misclassification related costs. Moving to credit performance on Slide 9. Total net charge-offs were 4.83%, 161 basis points higher than the prior year and down 9 basis points from the prior quarter. In card, delinquency formation improvement continued. The 30-plus day delinquency rate was down 14 basis points versus the prior quarter. From a vintage perspective, our 2023 card vintage continues to perform in line with our 2022 vintage. As we look into the second half of the year, we expect there could be some variability in monthly card losses from both seasonality and various credit management actions we've taken. This has not changed our broader outlook for losses to generally peak and plateau this year. Turning to the allowance for credit losses on Slide 10. Our credit reserve balances declined $777 million from the prior quarter, reflecting the student loan reserve release, partially offset by a $92 million reserve build primarily to support loan growth. Our reserve rate was just over 7.2%, largely unchanged after adjusting for student loans. Looking at Slide 11. Our common equity Tier 1 for the period was 11.9%, up 100 basis points, bolstered by core earnings generation and the reserve release. We declared a quarterly cash dividend of $0.70 per share of common stock. Concluding on Slide 12. We have revised our 2024 outlook and having included the impacts of the pending student loan sale. We are updating our loan growth expectations to be down low single digits, reflecting the roughly $10 billion asset sale. Absent this, year-over-year loan growth would be consistent with our prior view. We are increasing our net interest margin range to 11.1% to 11.4%. This change was driven by two factors. We now anticipate higher card yields reflecting a lower promotional balance mix and the student loan sale, which increases NIM by about 10 basis points. Our operating expense guidance is unchanged, notwithstanding the inclusion of the student loan net charge-offs in this line item. Our base case for net charge-offs remains at the low end of the 4.9% to 5.2% range. This includes the 10-basis points impact from student loans. And finally, our capital management expectations have not changed. To summarize, we continue to generate solid financial results, remain steadfast in our efforts to resolve compliance matters and look forward to consummating our planned merger. This concludes our remarks. I'll turn the call back over to the operator.

Eric Wasserstrom:

Thank you, and welcome to this morning's call. I'll begin by referencing Slides 2 and 3 of our earnings presentation, which you can find in the Financial section of our Investor Relations website investorrelations.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 first quarter 2024 earnings press release and presentation as well as the risk factors detailed in our annual report and other filings with the SEC. Our call today will include remarks from our Interim CEO, Michael Shepherd; and John Greene, our Chief Financial Officer. There will be no question-and-answer session following today's remarks. However, the Investor Relations team will be available for any inquiries. It's now my pleasure to turn the call over to Michael.

John Greene:

Thank you, Michael, and good morning, everyone. I'll start with our summary financial results on Slide 5. In the quarter, we reported net income of $308 million, which was down 68% from the prior year quarter. Impacting our operating results was a $799 million increase to our reserve for remediation related to the card misclassification issue. The decision to increase the reserve was based upon, among other factors, the company's experience to date with remediation efforts, regulatory dialogue and our pending merger with Capital One. As Michael indicated, we believe this action is aligned with our compliance and risk management objectives and will significantly help advance the resolution of this issue. Our core financial performance remains strong. Key highlights for the quarter include double-digit revenue expansion from loan growth, a resilient net interest margin strong consumer deposit growth and credit performance consistent with our view that losses will peak and plateau in mid to late 2024. Excluding the card misclassification remediation reserve increase, we would have reported net income of approximately $915 million, EPS of about $3.50 per share and an efficiency ratio under 36%. These figures indicate a strong start to 2024. Let us review the details beginning on Slide 6. Our net interest margin ended the quarter at 11.03%, down 31 basis points from the prior year and up 5 basis points sequentially. On a quarter-over-quarter basis, expanding loan yields from a lower card promotional balance mix and payment rate moderation were partially offset by higher net funding costs. Receivable growth is slowing from its peak in the first quarter of 2023, but continues to be strong. Card receivables increased 11% year-over-year due to a lower payment rate and contribution from prior year new account growth. The payment rate declined about 20 basis points from the sequential quarter and is now about 70 basis points above 2019 levels. Discover card sales were down 1% compared to the prior year quarter. Sales slowed across categories with the largest decline occurring in the everyday category, which includes supermarkets, gas and wholesale clubs. While we continue to add new accounts, in general, we are seeing card members spend less, particularly among lower-income households which are most impacted by the cumulative effects of inflation. Based on trends in the period, we expect sales to be flat to slightly negative this year. Personal loans were up 21%, driven by continued strength in originations and lower payment rates versus the prior year. We are seeing strong uptake on our offering as higher interest rates in card can make debt consolidation more appealing for Summit consumers. Approximately 50% of our first quarter originations and personal loans were utilized for debt consolidation with disbursements primarily made directly to creditors. Student loans were flat year-over-year. As previously announced, we stopped accepting applications for new student loans on February 1. We formally launched the sales process in mid-March and several thousand potential buyers have provided an initial indication of interest. We continue to anticipate strong demand and still target a closing date late in the third quarter or fourth quarter. Average deposits were up 18% year-over-year and 4% sequentially. Our direct-to-consumer balances grew $3 billion in the period. We have started to decrease pricing on our deposit products ahead of any potential moves in reference rates. This is consistent with our practice of leading the industry on pricing in the down part of the cycle and this action contributed to our strong NIM performance in the quarter. Looking at other revenue on Slide 7. Noninterest income increased $113 million or 19%. This was primarily driven by higher net discount and interchange revenue, an increase in loan fee income and higher transaction processing revenue from our PULSE business. PULSE continued to grow at a healthy clip as debit volume increased by $13.8 billion or 21% year-over-year. Our rewards rate was 139 basis points in the period, a decrease of 2 basis points versus the prior year quarter. The decline reflects lower cash back match from slowing new account growth and the active management of our 5% categories. Prior to reviewing expenses, I would like to briefly comment on the CFPB late fee proposal. We continue to closely monitor the legal process around the proposal. If the rule were to be implemented, on an annualized basis, we estimate a pretax reduction of around $600 million or approximately 4% of revenues. Moving to expenses on Slide 8. Total operating expenses were up $926 million or 67% year-over-year. As mentioned, the predominant driver of this growth was the increase to our remediation reserve. Absent this, our expenses would have increased 9% year-over-year. Looking at our major expense categories. Compensation costs increased $46 million or 7% due to an increase in business technology resources and severance related to organizational changes including the wind down of our student loan business. Professional fees were up $60 million or 26%, driven by continued investments in compliance and risk management initiatives higher recovery fees and merger-related expenses. Information processing increased due to technology investments. Our expectation for compliance and risk management expenses for the year excluding remediation-related costs, remains in the $500 million range with an upside bias. Moving to credit performance on Slide 9. Total net charge-offs were 4.92%, 220 basis points higher than the prior year and up 81 basis points from the prior quarter. In Card, as we anticipated, delinquency formation is improving as more recent vintages season. The 30-plus day delinquency rate was down 4 basis points versus the prior quarter. From a vintage perspective, our 2023 card vintage is performing relatively in line with our 2022 vintage. Both vintages remain profitable and above our return thresholds. This performance has been contemplated in our full year net charge-off guidance. We executed some incremental tightening during the first quarter, which will influence our new account growth for the year. Personal loan net charge-offs were 4.02%, 208 basis points higher than the prior year and up 63 basis points from the prior quarter. We expect losses in this product to trend higher in the near term before plateauing beginning late this year or into 2025. Turning to the allowance for credit losses on Slide 10. Our credit reserve balances declined $25 million from the prior quarter, and our reserve rate increased by 9 basis points to 7.32%. The reserve rate increase was primarily driven by the reduction of seasonal transactor balances in the quarter. Given our expectation for total company losses to peak and plateau in mid- to late 2024 and we believe the credit reserve rate is likely at or near peak levels, assuming a stable macroeconomic environment and no significant unexpected changes in portfolio performance. Looking at Slide 11. Our common equity Tier 1 for the period was 10.9%, down 40 basis points sequentially. The impacts from the increase in expenses in the CECL phase-in were offset by lower receivables and core earnings generation. We declared a quarterly cash dividend of $0.70 per share of common stock. Concluding on Slide 12. We have made the following updates to our 2024 outlook. We are increasing our loan growth expectations to up low single digits. This primarily reflects our expectation of further decline in the payment rates, offsetting our view of flat to slightly negative sales growth this year and a modest contribution from new accounts. We are increasing our net interest margin range to 10.7% to 11%. This change was driven by 2 factors

Eric Wasserstrom:

Thank you, and welcome to this morning's call. I'll begin on Slide 2 of our earnings presentation, which you can find in the Financial section of our Investor Relations website, investorrelations.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 fourth quarter 2023 earnings press release and presentation. 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, we request that you ask one question, followed by one follow-up question. After your follow-up question, please return to the queue. Now it's my pleasure to turn the call over to John.

John Greene:

Thank you, John, and good morning, everyone. I'll start with our summary financial results on Slide 4. In the quarter, we reported net income of $388 million, down from just over $1 billion in the prior year quarter. There are three broad trends to call out. First, we grew revenue 13%, reflecting 15% loan growth, partially offset by modest NIM compression. Second, provision expense grew by $1 billion. Charge-offs increased, but landed at the low-end of our expected range. Strong loan growth and higher delinquency drove the increase to our reserve balance. Finally, expenses increased 19% year-over-year, reflecting investments in compliance and risk management, a reserve for customer remediation and higher marketing expense to support our national Cashback Debit campaign. We'll get into the details of these topics on the following pages. Turning to Slide 5. Our net interest margin ended the quarter at 10.98%, down 29 basis points from the prior year and up 3 basis points sequentially. The decline from the prior year quarter was driven by higher funding costs and higher interest charge-offs, which were partially offset by higher prime rates and increases in revolving balances. For the full year, net interest margin was 11.07%, up 3 basis points from the prior year. This margin performance reflects the improvement in our funding mix over the past several years and a reduced level of balance transfer and promotional balances as we tightened underwriting. Receivable growth remained robust. Card increased 13% year-over-year due to contributions from the prior year new account growth and a lower payment rate. The payment rate declined about 110 basis points from the sequential quarter and is now 100 basis points above 2019 levels. Overall, new account growth declined 9% as a result of credit actions. Sales were up 3% compared to the prior year quarter. Personal loans were up 23%, driven by continued strength in originations and lower payment rate versus the prior year. Student loans were flat year-over-year as we prepare for a potential sale of this portfolio we will cease accepting applications for new loans on February 1. Our Deposit business delivered outstanding performance in a challenging year. Average deposits were up 21% year-over-year and 4% sequentially. Our direct-to-consumer balances grew $3 billion in the period and $14 billion in the year. Looking at other revenue on Slide 6. Non-interest income increased $74 million or 11%. This was primarily driven by an increase in loan fee income, higher transaction processing revenue from our PULSE business and higher net discount and interchange revenue. Our rewards rate was 137 basis points in the period and 140 basis points for the full year 2023, a decrease of 1 basis point on a full year basis. The decline reflects lower cashback match from slowing new account growth and our active management of our 5% categories. Moving to expenses on Slide 7. Total operating expenses were up $280 million, or 19% year-over-year, and up 22% from the prior quarter. Looking at our major expense categories, compensation cost increased $73 million or 13% from higher headcount. Marketing expenses increased $59 million or 19%. Professional fees were up driven by continued investment in compliance and risk management capabilities, while other expense reflects a reserve for customer remediation. Moving to credit performance on Slide 8. Total net charge-offs were 4.11%, 198 basis points higher than the prior year and up 59 basis points from the prior quarter. In card, as anticipated, delinquency formation is slowing as more recent vintages season. We added a slide detailing some of the drivers of our credit performance in the appendix to the earnings presentation. Turning to the allowance for credit losses on Slide 9. This quarter, we increased our reserves by $618 million, and our reserve rate increased by 17 basis points to just over 7.2%. The increase in reserves was driven by receivable growth and higher near-term loss content from higher delinquencies. Under CECL, reserve levels increase as you approach peak losses. We expect our losses to rise through the midyear and then plateau through the back half with some seasonal variation. In terms of our macroeconomic outlook, our view of unemployment was relatively unchanged, while household net worth projections increased slightly. These changes provided a small benefit to reserves. Looking at Slide 10. Our common equity Tier 1 for the period was 11.3%. The sequential decline of 30 basis points was driven largely by asset growth. We declared a quarterly cash dividend of $0.70 per share of common stock. Concluding on Slide 11 with our perspective on 2024. These exclude the impact of a potential student loan portfolio sale. We expect end-of-period loan growth to be relatively flat, while average loan growth will be up modestly year-over-year. We expect full year net interest margin to be 10.5% to 10.8%. We're currently anticipating core rate cuts of 25 basis points in 2024. This is two more rate cuts than in our forecast in December. Each cut reduces NIM by approximately 5 basis points subject to a deposit beta. We expect total operating expenses to increase by a mid-single-digit percent. This contemplates our expectation for compliance-related costs to be approximately $500 million this year. Total expenses may increase as incremental resources or remediation is required. We expect net charge-offs in the range of 4.9% to 5.3%. Finally, regarding capital return. We will participate in this year CCAR's process, and believe the results should help inform our view of capital management for 2024. Importantly, our capital management priorities have not changed and remain centered on supporting organic growth and returning capital to shareholders. To summarize, we continue to generate solid financial results. For 2024, we will continue to advance our compliance and risk management capabilities and invest in actions that drive sustainable, long-term value creation. With that, I'll turn the call back to our operator to open the line for Q&A.

Rick Shane:

Good morning everybody and thanks for taking my questions. I'm not a little under the weather today, so I apologize. The loan growth expectations, is that organic loan growth or is that net of the portfolio sale of the student loans?

Rick Shane:

Okay. That’s it for me. Thank you guys.

Moshe Orenbuch:

Great. Thanks. John, maybe just a follow-up on Rick's question. I mean given the strong growth that you're currently seeing in the Personal Loan business, and the fact that you're still adding accounts, albeit at a lower level in the Credit Card business, you did mention kind of lower balance transfers, but is there something else going on? Can you talk about kind of deconstruct that loan growth expectation for us a little bit?

Moshe Orenbuch:

Great. Thanks. And maybe just as a follow-up on the credit side. I mean, you did talk a month ago and then mentioned again today that you expect kind of losses to peak around the middle of the year. How do we think about the performance after that peak? I mean you said kind of flattish. What's driving that? Why isn't that something that improves? And how do we think about reserving in that context?

Moshe Orenbuch:

Great. Thanks.

Ryan Nash:

Hi, good morning, everyone. John, maybe to dig a little bit deeper on some of the commentary you gave regarding loan growth. Maybe just focusing on the account growth. The market clearly thinks there's a better chance of a soft landing right now. We're seeing peers who are talking about mid- to high single-digit growth. And I'm just curious on the account growth. Is this more just conservative underwriting? Are you trying to make sure that you make more progress on risk governance and compliance before you increase growth? Maybe just a little bit more color on why you're seeing such a slowdown in terms of the account growth relative to the last few years?

Ryan Nash:

Got it. And maybe as my follow-up, can you maybe help us understand where you stand with the student loan sale? And how would you foresee that impacting the outlook as well as capital return over the next four to six quarters? Thank you.

Ryan Nash:

Thank you for all the color.

Mihir Bhatia:

Hi. Thank you for taking my question. We're going to start with loan growth also. And I just want to go back to the building blocks a little bit. I think you essentially said in terms of the building blocks, you're expecting payments rates to be elevated ex – like flat to stay at the elevated level and sales to be flat. You're also adding accounts. So I'm just like trying to understand I guess, what's the bank account? Like how does loan growth stay flat given the sale, you had 15%. I'm just trying to understand like - that's something we're missing, I feel like, and I'm just trying to understand that.

Mihir Bhatia:

Got it. And then I wanted to go back to expenses and the reserve for customer remediation that you mentioned that you took this quarter. Can you just provide some color on that? Like is that related to the merchant mispricing issue? How much was the reserve this quarter? Where does that leave the reserve overall I think you had $365 million in 2Q. Just trying to understand how the estimate for the costs related to that issue changed? I think you also mentioned it could be higher -- expenses would be higher in 2024. If you need to take more reserves there, like -- where are we with that investigation? Just give us an update on that merchant mispricing issue too?

Mihir Bhatia:

Thank you. Thanks for taking my questions. I’ll get back in queue.

Sanjay Sakhrani:

Thanks. Good morning. Sorry, multi-part question on the same topic and then a follow-up. Can you update us, John, on the progress made with the regulatory agencies; I think that was sort of alluded to in the previous question. But maybe just the firmness around capital return post CCAR? What exactly happens to the CFPB consent order when the loan servicing is transferred? And then just curious, the loan growth expectations, was that any part driven by any regulatory related matters? Thanks.

John Greene:

Okay. Sanjay, I feel like your question is a five-part question, but what we'll do our best to answer it. So the loan growth aspect that you asked, it is completely unrelated to any regulatory issues, so nothing to connect on that point. In terms of capital return, our commitment to capital return and capital allocation have not changed. So, first to invest in profitable organic growth; and second, to return excess capital to shareholders. So as we kind of progressed through the fourth quarter, we remained on pause with our buybacks. And given we've got a new CEO coming in, we are contending with a number of different compliance and risk management matters. We got the merchant tiering reserve. We don't have any feedback from our regulators on that point. We decided that it would be most appropriate to remain conservative in terms of our guidance related to buybacks. We will go through CCAR, as I said in my prepared remarks, that will form a view of capital under significant stress as it always does. And then we're going to have the exit or hopefully, the exit from the Student Loan business, which will provide free up at least $2 billion worth of capital. So what you're hearing here hopefully is some indications that one, we're committed to returning excess capital to shareholders; two, that there will be excess capital generated and available; and three, we're going to go through a diligent process internally, share it with our Board and then take the Board's direction in terms of buybacks.

John Greene:

And...

John Greene:

Yes, that was part 5A, I think. Yes. So that remains in effect and our chosen provider, Nelnet is fully aware of the consent order requirements in terms of kind of servicing excellence. And they were chosen because they've got a track record in terms of being able to kind of service a portfolio such as this, and they've dedicated both technology and resources to ensure a seamless transition.

John Greene:

Yes, yes. Thanks for that. We are hoping that, that question would come out. So the -- let me talk about the reserves for the quarter, and then I'll give you perspective on 2024 and what could potentially happen there. So we grew receivables in the quarter, $5.7 billion. Now some of that was transactor balances that are reserved light. But one thing that we've been consistent on in terms of our communication is that as we approach peak losses, reserve levels increase. And what we've said previously is, typically, we hit the highest reserve rate level one to two quarters before peak losses. So that's the path we're on. Let me provide some details on some assumptions that were used to set the reserve levels this year at year end. And then I'll give a perspective on what we -- what could happen in 2024. So macro is relatively benign. So unemployment levels, we ended the year at 3.7 what we've assumed is an unemployment level of 4.2. So a mild increase, household worth, mild decrease, savings rate, mild increase and GDP to be in 2024 to be about 1.3%. So relatively conservative, but not overly optimistic of assumptions. Now what will come into play in 2024 is obviously the macros, which will continue to be important. The portfolio performance and -- by the way, it is tracking to our expectations with month-over-month delinquency formation declining. The credit quality of the book remains relatively consistent with what we've done historically. So our expectation is that assuming the macros remain consistent and the portfolio performance remains to our expectation that there will be some level of opportunity to reduce the reserve rate in 2024. Now that's subject to a significant amount of governance, and we're going to make sure that we comply with our internal processes and generally accepted accounting principles. So they're my caveats. But there's a lot of things that are different today than day one. So the step down will be aligned with those points I just mentioned.

Operator:

Thank you. Our next question will come from Bill Carcache with Wolfe Research. Please go ahead.

John Greene:

Yes. And thanks for the question, Bill. So, I just to give you kind of the benefit of some data here. From September through December this year, so the 30-plus delinquencies have declined month-over-month. So in September, we peaked at an increase month-over-month of 26 bps. What we said in the fourth quarter is we expected that to decline. Our October formation increased 20 bps, so relative to decline to the prior month. November, 15 bps, December, 11 bps, and our expectation is that will continue to decline. Where it becomes negative, we're not going to get into that because it will be subject to a number of different things, including kind of our origination path and broad macro. So to get to the essence of your question, we do have a level of confidence regarding kind of what’s happening in the portfolio and the trend. And as we progress in 2024 that will be reflected in hopefully, tightening guidance and then also -- tightening guidance to the lower end and then also, hopefully, reserve rate changes.

John Greene:

Okay. Yes. Thanks, Bill. So our expectation is that the long-term efficiency ratio will be sub-40%. So there's still a view that, that will happen. The reason we put the -- what I'll call is the caveat in the 2024 expense guidance was a number of different institutions when they've been on this compliance and risk management journey have not been able to call what the actual compliance and risk management spend would be. We had that remediation reserve in the fourth quarter. There were some indications that we might have to put something up for that. But we didn't know. There's still some level of unknowns, unknowns. And I wanted to make sure we're clear to the people listening to this call that, there is some level of risk to the expense guidance. Now that said, 5% on our expense base is a significant amount of dollars. We feel like we have nearly a full complement of resources around risk and compliance today, which is good news. Our issues management capabilities significantly improved. Our path to improving overall governance is certainly on the right trajectory. So those factors give me confidence that we're not going to have a huge surprise. But there could be just don't have enough certainty given where we are on our compliance journey. Now, the rest of the cost base, there's a couple of things to keep in mind here. So right -- today, we have nearly 3,000 resources dedicated to risk and compliance management. A significant amount of those resources are dedicated to issues related to student loan servicing, which with a successful exit and transfer, it will give us an opportunity to scrutinize the cost base in a different way. So that's certainly on the list of planned activities for the second quarter, third quarter, and then hopefully, we begin some execution in the fourth quarter. So overall, I feel comfortable with the expense guidance that we've provided. And we're going to do our best to make sure that every dollar we spend is wise and that the shareholders get the benefit from that.

John Greene:

You're welcome, Bill Thanks.

John Pancari:

Good morning. Regarding the new $80 million remediation charge, did all of that remediation relate to the student loan business, specifically, and was that in part tied also to the July 2022 disclosure around the student loan issues that surfaced then? And did any of that $80 million relate to the other business that you point that you mentioned that could have had a tangential impact and what was that business? Thanks.

John Pancari:

Okay. And just related to that, so this is a newer issue versus what was discussed in July? And is it also newer versus what is in your existing consent order tied to student loans?

John Pancari:

No, that's fine. Thank you for that. And my last thing is very quick one on the loan growth guidance. You guided to average balances for 2024 were up modestly. Can you help maybe quantify the up modestly. It could give me -- help frame it. Thanks

John Pancari:

Okay. Great. Thanks, John.

Don Fandetti:

John, you know, it's good to see the delinquency formation showing some progress. Can you talk about later stage delinquency rates? I mean, they seem like they're still going up on a year-over-year basis or like our cure rates. I'm still trying to get my arms around this like potentially 5% NCO rate. it just seems high for Discover.

Don Fandetti:

Okay. And the 2023 vintage, can you talk a little bit about what your early read is on that?

Don Fandetti:

Does that mean it's not really trending that well relative to your expectations? Or is it kind of in line?

Don Fandetti:

Okay. Thanks.

Jeff Adelson:

Hi. Thanks for taking my questions. John, I just wanted to kind of follow up on the charge-off guide. I know you've mentioned that you're hopeful this -- your comment at the low end. But could you maybe just dive into what would take us to the low versus the high end here? And if this delinquency formation slowing continues throughout the year, is that kind of what's embedded in your expectation at getting at the low end here?

Jeff Adelson:

Got it. And just as my follow-up, as we think about the NIM guide this year, I know you mentioned you're embedded in an expectation of four rate cuts. If I think about where NIM exited the year though, it feels like the range of rate cuts using your 5 basis points for every 25, it seems like there's more rate cut that embedded in there. Can you maybe just help us understand the drivers is, there may be a little bit more interest accrual reversal going on? And maybe help us understand what you're assuming in positive betas on the way down? Is it going to be a little bit slower than what we've seen in the last four rate cuts on the way up?

Jeff Adelson:

Okay. Thank you for taking my questions.

Terry Ma:

Hi, thanks. Good morning. Maybe I just want to touch on the loan growth guide for 2024 a little bit. Aside from the balance transfers and promos, how much control do you actually have on growth because going from 15% loan growth to 0% just seems like a hard pivot to me. So maybe can you just talk a little bit more about that? And then my second question is just what needs to happen before you can actually grow again, and is there a way to think about what that growth rate looks like as we look out towards 2025 and beyond? Thank you.

Terry Ma:

Thanks. And is there a way to think about what growth would look like before when you reaccelerate?

Eric Wasserstrom:

So, Todd, I think we have time for one more, please.

John Hecht:

Morning guys. Thanks for taking my question. I know you've answered a lot on credit, so I apologize for one more. But your 2018 and 2019 charge-off levels were in the low 3% range. And I think we -- we've all kind of said that was a good environment, but a relatively normal environment. You're guiding toward a high -- relatively higher, closer to 5% charge-off rate this year despite low unemployment. I know you kind of called out the 2022 vintage is something to think about there. But maybe can you talk about the attribution of the difference in charge-off rates between that period and now? I think the kind of -- the reason for the question is just to give us a sort of level of understanding of where we are in the credit cycle and give us comfort that things will stabilize, if not improve from here?

John Hecht:

That's super helpful. And maybe could you give us a sense of the charge-offs by product or maybe like the -- is the mix going to be consistent with historical mixes just to give us a sense from a modeling perspective?

John Hecht:

Thank you.

Operator:

And this does conclude today's Discover Financial Services earnings conference call. You may disconnect your line at this time, and have a wonderful day.

Eric Wasserstrom:

Thank you, Chelsea, and welcome to this morning's call. I'll begin on Slide 2 of our earnings presentation, which you can find in the Financials section of our Investor Relations website, investorrelations.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. 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 will be permitted to ask one question, followed by one follow-up question. After your follow-up question, please return to the queue. Now, it's my pleasure to turn the call over to John.

John Greene:

Thank you, John, and good morning, everyone. I'll start with our financial summary results on Slide 4. In this 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 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 6% year-over-year. Further details are reflected on Slide 5. 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 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-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 $4 billion. Looking at other revenue on Slide 6. Non-interest income 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 7. Total operating expenses were up $86 million or 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, or 4%, primarily from increased headcount. 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 8. Total net charge-offs 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 delinquency rates than older vintages. Losses remained consistent with targeted ranges. These newer vintages support strong long-term profitability. Turning to the allowance for credit losses on Slide 9. This quarter, we increased our reserves by $601 million and our reserve rate increased by 22 basis points to just over 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 burdens. Looking at Slide 10. Our common equity Tier 1 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 $0.70 per share of common stock. Concluding on Slide 11 with our outlook. 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. And there is no change to our expected range for net charge-offs to be between 3.4% and 3.6% for the year. 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. With that, I'll turn the call back to our operator to open the line for Q&A.

Sanjay Sakhrani:

Thanks. Good morning. I just wanted to get a little bit more on the reserve build. As we look ahead, John Greene, can you just talk about like how we should think about that reserve rate increasing from here? Because, obviously, you made some adjustments, but you've said the credit numbers are performing pretty consistent with your expectations. 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 basis, assuming the unemployment assumptions don't change much.

Sanjay Sakhrani:

Yeah. Thank you. That's clear. And just 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 fees not any change to that. So, could you just give us a sense of sort of how to think about that unpausing of the share repurchase? I know John Owen mentioned it might take several quarters to resolve the merchant issue. So, just trying to reconcile these -- those comments. Thanks.

John Owen:

Let me just add a little bit to John's answer on kind of where we are from a regulatory standpoint. The FDIC consent order that was made public this month related really to findings from end of 2021 looking back. As we 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. But I would tell you, as 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 with where 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 complete 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, we're awaiting feedback from regulators.

Operator:

Thank you. Our next question will come from Bill Carcache with Wolfe Research. Your line is open.

John Greene:

Yeah. Thanks, Bill. So, let me go back a little bit and be real clear about what happened in 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 early part of '22, we continued with that traditional Discover credit box. We did do a test in marginal prime and near prime which we turned on. We saw the results and we turned off in the second quarter or early third quarter of '22. So, about six months of originations, not dramatic volume by any means, but certainly a test, it's a good opportunity to learn to see if we could capture some unprofitable share. What we found was, those accounts weren't meeting our return of volatility threshold. 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. 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 that vintage is significantly larger than other vintages. So, the natural loss content of new originations is somewhere between 12 and 24 months, and we expect that to play out, and as I've said, the delinquencies and charge-offs to 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 vintages.

John Owen:

Yeah. Happy to 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 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 through that process as we speak. But again, that's something we do as part of our annual planning process.

Operator:

Thank you. Our next question will come from Ryan Nash with Goldman Sachs. Your line is open.

John Greene:

Good morning, Ryan.

John Greene:

Sure. I'm not going to be real specific on '24. We're 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 a general kind of direction of what we're seeing. So, the first point I think is important to point out there is that, we continue to target our efficiency ratio to be below 40%. Now, that's over the medium-term. Obviously, our execution this year with the revenue growth and even with substantial investments in compliance and in other areas of the business shows an efficiency ratio significantly below 40%. But over the mid-term, that's something I think investors can expect. The second piece that's important is that despite a significant amount of investment in risk and compliance resources, we will continue to be disciplined in our allocation of expense dollars. 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 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 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'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 will translate into what we hope is a reasonably good set of expense and efficiency numbers into the future.

John Greene:

Yeah. A lot to parse there, Ryan. Let me start by kind of walking you through what we're seeing in the portfolio. So, we are seeing kind of differences in performance on customers that historically have been transactor 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 their 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 vintages, early indications are that it's performing very, very well. 2022 is performing well, but not as well as 2023. So, my expectation is that delinquencies 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.

Operator:

Thank you. Our next question will come from John Hecht with Jefferies. Your line is open.

John Greene:

Great. Yeah. I'll take that. So, the environment continues to be competitive from a card origination standpoint. We are seeing less competition in kind of the lower FICO band. So, remember, we're a prime revolver, so we're focused on prime customers, and the lower tier of 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. The upper prime remains very, very competitive. The rewards competition, you can see it by the television ads, has certainly subsided significantly. So, the market is always competitive. The competition varies among various FICO bands. And we're going to continue to compete and generate positive new accounts, but we're also mindful of the credit situation.

Operator:

Thank you. Our next question will come from Jeff Adelson with Morgan Stanley. Your line is open.

John Greene:

Yeah. I think it will peak, and then, upon its peak, I think it will 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.

John Greene:

Yeah. So, let me start with sales. So, what we're seeing is a downward trend in sales. So, if you go back to the fourth quarter of '23, we're at about 10% year-over-year growth. First quarter was 8%, 2.5% in the second quarter, and about 1% here in the third quarter and through mid-October, about 1%. Interestingly enough, the dynamics are changing in terms of categories. 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 of 20%, which is hard for me to understand at this point. But we're trying to dig into the details. In terms of implications for next year, we're going to assume a relatively modest sales growth, maybe slow in the lower single digits. The transactor revolver components of that, I mentioned that already. So, more pullback on the revolver base. The other piece of your question is 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 volumes. So, our PULSE team is executing well and appears to be capturing some share.

John Greene:

You're welcome.

Rick Shane:

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 seizing them vintage. You've talked about some exposure to lower FICO scores within the cohorts. At the same time, you guys are starting to apply a lot more machine learning to your portfolio and your process. 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. And then the follow-up to that is, with that information, can you then apply different servicing strategies to enhance that performance?

Rick Shane:

Got it. Hey, John, it's very interesting, and very helpful. Thank you.

Mihir Bhatia:

Good morning, and thank you for taking my questions. To start, I wanted to actually ask about personal loans. You're continuing to see some very healthy growth there. Can you talk a little bit more about some of the drivers? I think I know you mentioned a little bit of payment rate pullback, but what about from a competition standpoint? What's driving that? And then, just related to that -- the comments you've been making about on the credit card side, I wanted to understand if you're seeing any meaningful deterioration in credit there? Anything on the -- do the vintage comments apply here? Anything like we should be thinking about there? Are you tightening underwriting currently in that personal loan space too? Yeah, thanks.

Mihir Bhatia:

Okay. That's helpful. Thank you. Maybe if I could just turn back a little for a second to the compliance issue question and the timing, et cetera. It sounds like from what you're saying related to the merchant mispricing 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 buybacks to resume. I understand it's difficult to put a specific date out there. But is the overall message, it's going to take several quarters for those to review? Maybe just help us understand what needs to happen here for you to get comfortable. And, again, like, I understand you don't want to put a specific timeframe, but is the right message, like, it's going to be several quarters more? Thanks.

Mihir Bhatia:

Okay. Thank you.

Bob Napoli:

Thank you. Follow-up on return on equity. One of the questions we get, I mean, obviously, Discover has reported very strong ROE for a 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?

Bob Napoli:

Thank you. I appreciate that. And then, just on -- the overall -- the long-term growth of your business, your core customer, the TAM of your business and the ability for Discover to grow, I mean, I think historically, high-single digit kind of loan growth and spending growth. What are your thoughts? Is the ability to grow at those types of rates what we should continue to expect? And how does the Cashback Debit product maybe affect that growth?

Bob Napoli:

Thank you.

Kevin Barker:

I just wanted to follow up on some of the spending on tech in particular in the info processing line. Could 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 the franchise? Thank you.

John Owen:

Two other areas I would call out. Around our fraud detection, we continue to invest heavily in our fraud detection. That's an ongoing battle every quarter, but we've made significant investments in fraud and continue to push on that area. The 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 their Cashback Debit. And so, we spend a lot of time and effort in customer flows and customer engagement and how we onboard customers in a more seamless manner.

John Greene:

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. And that's back in this -- I think it was the month of July, we saw a chunk of charge-offs come through as a result of settlements from these institutions. 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. So that's actually part of our -- how we take a look at overall credit and reserving.

John Greene:

You're welcome.

Nick Holowko:

Hi, good morning. This is Nick Holowko 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. So, obviously, card growth remains really robust and you raised your guidance to mid-teens for the year. And I'm just wondering, given the comments on the stress in the lower and mid FICO scores, and then the delinquency trends, and then your comments that the revolve rate has really normalized, I'm wondering if you can help us with which parts of the FICO band in your portfolio are driving the loan growth, and whether you're seeing any outsized contribution from those on the lower end?

Nick Holowko:

Got it. Thank you for taking my question.

Dominick Gabriele:

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 new accounts? And also, what was the -- and just added to that, what is the benefit that Discover saw to spending in the quarter related to gas on the growth? And then, I just have a follow-up. Thanks.

Dominick Gabriele:

Okay, great. And then, 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 might be affecting either payment rates or demand for private loans or refinancings? Anything you can provide as far as how this affects the consumer that you're seeing in your data, only in 19 days or whatever, but anything you can provide would be really helpful. Thank you.

Dominick Gabriele:

Got it. Thank you.

Operator:

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.

Operator:

Thank you, ladies and gentlemen. This concludes today's program, and we appreciate your participation. You may disconnect at any time.

Eric Wasserstrom:

Thanks, Todd. And good morning, everyone. Welcome to this morning's call. I'll begin on Slide 2 of our earnings presentation, which you can find in financial section of our Investor Relations website investorrelations.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 second quarter earnings release and presentation. On our call today, we'll include remarks from our CEO, Roger Hochschild and, John Green, our Chief Financial Officer. After we conclude our formal comments, there will be time for a Q&A session. During the Q&A session, we ask that you pose one question followed by one follow-up question. After your follow-up question, please return to the queue. Now, it's my pleasure to turn the call over to Roger.

John Greene:

Thank you, Roger, and good morning, everyone. I'm going to open by addressing the financial implications of the card misclassification. We have established a liability on our balance sheet of $365 million to accrue for estimated compensation owed to merchant and acquirers. In establishing the liability, we adjusted retained earnings by $255 million net of tax. $11 million was taken this quarter and is reflected in discount and interchange revenue. The first half 2023 impact was $22 million. With that, I'll transition to our financial summary results on Slide 4. From this, you can see that the financial performance of the business remains solid. In the quarter, we reported net income of $901 million, which was 18% lower year-over-year. Our results reflect strong revenue growth partially offset by a provision increase driven by receivable growth and higher expenses. The trends for the quarter were robust loan growth, a low efficiency ratio even as we invested in compliance management and technology, and strong capital and liquidity positions. Further details are reflected on Slide 5. Net interest income was up $567 million year-over-year or 22%. Our net interest margin ended the quarter at 11.06%, up 12 basis points from the prior year and down 28 basis points sequentially. The benefits from higher prime rates were offset by higher funding costs and increased promotional balances. Receivable growth was robust. Card increased 19% year-over-year, reflecting a lower payment rate versus the prior year and modest sales growth. The card payment rate remains stable quarter-over-quarter and about 200 basis points over 2019 levels. Sales volume grew 3% in the quarter. Through mid-July, growth continued to slow and was up about 1%. Turning to our non-card products. Personal loans were up 27% driven by strength in originations over the past year. We continue to experience strong consumer demand while staying disciplined in our underwriting. Deposit growth in the quarter was solid, with average consumer deposits up 20% year-over-year and 4% sequentially. Our direct-to-consumer balances grew $2 billion and consumer deposits made up 66% of our total funding mix. We continue to target 70-plus-percent of funding from deposits. Looking at other revenue on Slide 6. Non-interest income increased $98 million or 16%. This was partially due to a $42 million loss on our equity investments in the prior year quarter compared to a $1 million gain this quarter. Adjusting for these, our non-interest income was up 9%, primarily driven by loan fee income. Moving to expenses on Slide 7. Total operating expenses were up $181 million or 15% year-over-year and up 2% from the prior quarter, primarily driven by our investments in our compliance management systems. These investments impacted several of our expense line items. Looking at our major expense categories, compensation costs were up $73 million or 14%, primarily due to increased headcount. Marketing expense increased $14 million or 6% as we prudently invested for growth, particularly in our deposits and personal loan products. Our commitment to disciplined cost management has not changed and we continue to target an efficiency ratio in the high 30s. Moving to credit performance on Slide 8. Total net charge-offs were 3.22%, 142 basis points higher than the prior year and up 50 basis points from the prior quarter. Consistent with our expectation, we are seeing credit normalization across all of our lending products. Looking ahead in card, we continue to expect the seasoning of new accounts vintages and normalization of older vintages to result in higher losses through the back half of this year and into 2024. Turning to the allowance for credit losses on Slide 9. This quarter, we increased our reserve by $373 million, driven by our double-digit loan growth. Our reserve rate remained flat at 6.8%. Our outlook on the macro economy has improved modestly. We continue to monitor economic conditions and will make adjustments to our expectations as needed. Looking at slide 10, our capital position remains robust. Our common equity Tier 1 for the period was 11.7%, well ahead of regulatory requirements. The cumulative impact of the correction to the financial statements related to the card misclassification reduced our CET1 ratio by approximately 20 basis points. In the quarter, we repurchased 6.8 million shares of common stock and declared a quarterly common dividend of $0.70 per share. As Roger indicated, we are reviewing our compliance, risk management and corporate governance and are in discussions with our regulators on these topics. While this is ongoing, we have decided to pause share repurchases. Concluding on Slide 11 with our outlook. There has been no change to our loan growth expectations to be in the low to mid-teens. We are updating our NIM expectations to be around 11% for the full year, reflecting a combination of slightly lower asset yields driven by promotional mix and higher funding costs. We are raising our guidance for operating expenses to be up low double digits. As previously indicated, we are seeing upward pressure on expenses from the build-out of our compliance management systems. And we are lowering our expected range of net charge-offs to 3.4% to 3.6% based on our current delinquencies and roll rates. To wrap up, our business model continues to generate solid financial results and our capital, funding and liquidity positions remain strong. We continue to invest in actions that drive sustainable long-term performance, enable us to achieve excellence in all parts of our business. With that, I'll turn the call back to our operator, Todd, to open the line for Q&A.

Rick Shane:

Thanks guys for taking my questions this morning. Look, I'd love to understand a little bit the link between what you identified in terms of the miscalculation and then how that precipitated the sort of inquiry into governance and consumer tracking?

Rick Shane:

Got it. And is the expectation, when we've seen these in the past that they result in things like memorandum of understanding and can do things like either constrain growth limit, repurchases and capital actions, how do you see this playing out? And most importantly, I think what everybody really wants to know is what is a reasonable timeframe to get some further clarity here?

Rick Shane:

Got it. Okay. I realized there's -- you have to be pretty circumspect about what you say here. So, thank you.

Operator:

Thank you. We'll take our next question from Betsy Graseck with Morgan Stanley.

Roger Hochschild:

Yeah. I'll cover that piece and then maybe John can talk a bit about the buyback. So I would say the consent order in student loan servicing was a compliance matter. And so I think there's a link between that and the broader focus on our compliance management system. With that, maybe I'll let John talk a bit about the buyback.

Jeff Adelson:

Okay. Thank you. And just maybe shifting gears a bit here. Just wanted to see if we could get an update on what you're seeing in the consumer in your book today. Could you maybe also give us an update on the spend trajectory you've been seeing so far in July? I know you've talked about the growth rate slowing down to 3% in recent months. Wondering if we're seeing something similar from here?

Jeff Adelson:

Got it. Thanks for taking my questions.

Ryan Nash:

Hey, good morning guys.

Ryan Nash:

Roger, again, I know that we're probably limiting what we could say here on the compliance side, but I guess just a broader question. Can you maybe just help us understand, what are the areas that you feel that the company has underinvested in? And maybe just give us a framework for what you guys are doing in internally to fix these. I understand that John had talked about raising costs, but you -- can you give us a little bit more color in terms of what the investments you're making and what you think the timeline is to get these done?

John Greene:

And then, Ryan, on the trajectory, and so I made this comment publicly about 1.5 months ago. 2019 to 2023, we increased our spend in compliance and I'll say some gentle items to ensure compliance works as we wish it to work. I indicated it was about an increase of $250 million as we relooked at it. We were going to accelerate that spend to probably $300 million increase from 2019 and a $200 million increase ‘22 to ’23. Now the implications for that on ’24, where we sit today, we expect once we achieve that level in ‘23 to be relatively consistent into ’24. And then as we kind of shape this piece of our business into something that we desire, our regulators desire and our shareholders deserve, we expect that expense burn to reduce.

John Greene:

Yeah, great. So yeah, the tightening in the range was reflective of a couple of things. So first, as time moves on, we get more and more comfort with our forecasting on it. And to date, our forecasting has been right on top of actuals, our actuals have been right on top of the forecasting. So that gave us comfort. Second is, as time goes on, we can move from the analytical model to a more kind of traditional roll rate model that gives us a greater level of comfort around the charge-off and delinquency rates 30 day -- 30 days out to 180 days out. So that gave us comfort to tighten that range. And then on top of that, certainly the jobs -- jobs data and the forecast around employment gave us additional comfort. In terms of what we're seeing with the portfolio, exactly what I said in the prepared comments. So the newer vintages seasoning to expectation and older vintages basically normalizing to kind of 2019 levels. In terms of the shape of the curve, what we expect charge-offs to do in the back half of this year is the acceleration in terms of the rates of charge-off to begin to slow. And currently, we're expecting, kind of, charge-offs to peak in the second half of ‘24. It may push a little bit into ’25, but right now we're seeing it in the second half of ‘24 and then reach the level, which likely will stabilize that for two to three quarters after.

Operator:

Thank you. We'll take our next question from John Hecht with Jefferies.

John Greene:

Yeah. So certainly real robust loan growth in the first half of this year and the last quarter of 2022. We expect the rate of increase to slow certainly in the third and fourth quarter and also against really, really strong comps from 2022. And traditionally what this business has delivered is loan growth somewhere between 2 times and 4 times GDP growth. Now, we don't know what GDP is going to look like right now into ‘24, but I would say this. We did cut the edges on the lower credit quality, which is -- will impact new account growth in card for the balance of this year. We're seeing, as Roger indicated, and I mentioned in my comments, sales growth to slow and probably stabilize in the single digits. So that will also impact loan growth for the balance of this year and into next year. So the stabilized number is a multiple of GDP typically unless there's some change to the macros that indicates it's a good investment to either open up credit or appropriate to tighten credit.

Roger Hochschild:

I think we continue to see good results from the way we put to work on the marketing front in terms of our cost per account. Obviously, we've talked about the relaunch of cash back debit. We'll put some money against that, including the mass market campaign in the fall, but have been excited with what we're seeing in terms of the cost per funded account there. So while -- yeah the competitive environment is always intense across all of our businesses, we feel good about how our value proposition is competing out there across all of our consumer products.

Operator:

Thank you. Our next question comes from Don Fandetti with Wells Fargo.

John Greene:

It was found internally.

John Greene:

Yeah. The -- it's a little bit of both actually. So we ended ‘22 at 11.04%. We said that we would be -- initial guidance up modestly. And then in the first quarter call, we said NIM has likely peaked and then it would begin to move downward and what I'll say normalize, likely to a higher level than it has been historically. So in the quarter, the reason that we tweak that guidance was we are -- we are investing in promotional balances. So attracting new customers or building balances with existing customers. Now, the returns on those offers are fantastic. The impact on NIM in the short term and the promotional period, it's minor. But given our activity there, it took a few points of net interest margin out. And we thought that was an important impact to communicate. Second, in terms of deposit competition, we had said that we thought that the beta would come in somewhere around 60% to 70%. What we've seen in late in the first quarter and into this quarter was our competitive set being more aggressive in terms of price increases. And as I've communicated in the past, we don't seek to be a price leader here. We try to compete on our brand, our customer offering, our digital assets that are first class in order to attract deposit customers. And we've been very successful as you can tell by the numbers there. But part of the proposition is also price. So what we're seeing now is betas likely to be north of 70% which is impacting net interest margin to the extent I just talked about in the guidance point. So those two factors are playing most substantially on the revised outlook.

Operator:

Thank you. We'll take our next question from Sanjay Sakhrani with KBW.

John Greene:

Yeah. Thanks, Sanjay. So the decision on the share repurchase was out of prudence. We have done a number of tests internally, stressing a number of factors, so that for example, the CCAR process we go through includes extreme stress. We dusted that off and ran some simulations. And the output of that was that both capital and liquidity, even in an extreme situation, remain well above regulatory requirements. So we feel comfortable about our capital and liquidity. The issue on the share repurchase was again out of prudence given what we have going on in the organization and we wanted to make sure that our actions are consistent with the right message in terms of being conservative and dealing with the first level of priority. In terms of…

John Greene:

In terms of expense leverage, we continue to look at all of the lines and all of the investments we make in our expense base and the incident management situation we're dealing with in terms of resources to get that under control. That's a significant investment. Some resources supplement technology, people and consultants, certainly an investment. On the indirect side, we continue to leverage our procurement organization and ensure that, first, we concentrate on demand management and then, second, on making sure there's a fair value exchange. So that's the plan right now and will be the plan through the balance of this year.

Roger Hochschild:

Yeah. Good question, Sanjay. You have seen that growth start to slow a bit. And I think it isn't necessarily that far out of line with what you're seen from our other, I'd say sophisticated prime focused competitors. It is really strong demand for the product. And as we've been clear, we have been tightening, not loosening credit, and are watching the accounts we book very carefully. And so we're always ready to make adjustments whether it's in the card product, the personal loan or elsewhere. But again, we feel good and are closely monitoring the performance. Within the credit, we're making adjustments continuously both on the portfolio side and the new account side. But these are very strong new accounts we're bringing in. And I think part of it is the differentiated value proposition that Discover offers continues to resonate well with our target customer.

Operator:

Thank you. We'll take our next question from Kevin Barker with Piper Sandler.

John Greene:

Sure. So as we sit here today, we feel comfortable with what we shared in terms of low double digit expense growth this year. We've taken a preliminary look at next year. We'll share -- we'll share that at appropriate time after -- after we kind of review and get our plan approved by our Board. But I'm feeling like it's very, very achievable. And that's why we -- we enunciated that target or that goal. But I would say this. As we see opportunities to grow profitably and not -- no contradiction to Roger's point earlier about the demand for our products, but we'll continue to take a look and invest for the medium term and longer term. And we're going to do that on the growth side. We're focused right now on the compliance side and we'll dial each of the expense levers in order to ensure we achieve results that our shareholders want, that our Board expects and that the management team expects.

John Greene:

Yeah. So we're investing in advanced analytics that we're driving efficiencies in our rewards cost. We continue to look at third-party spend and have achieved great results in terms of year-over-year reduction in unit cost. The situation this year is that we've invested heavily in resources, people. So we're up -- we're about up about 3,000 people this year. So when you bring on additional people, both in collections and customer service as well as salary personnel, there's other costs that go along with it. So as we manage through this situation, I continue to believe there will be opportunities to drive efficiencies by combining like activities, taking a look at how resources are deployed to organizational structures and over time optimizing that. But right now, with the situation we're in, we've decided that the first priority is get the right resources in to focus on the issues we've talked about. And then we're going to be able to drive efficiencies in the future.

Operator:

Thank you. We'll take our next question from Mihir Bhatia with Bank of America.

Roger Hochschild:

Yeah. Good question. So the tightening was not in the second quarter and was not in response to something we're seeing. And actually in terms of applicant quality, whether it's for home equity, personal loans, student loan or in card, where we're seeing very stable characteristics in terms of average FICO, in terms of the custom scores we use. So it was a series of changes we made, I would say, in prior quarters. But a lot of stability in terms of the quality of applicant over the course of this quarter.

Roger Hochschild:

Yeah, great question. So, our aspiration is to be the leading digital bank. And so when you think about a digital bank, you think about the core DDA or debit product. And because we have a proprietary network, we can offer rewards in debit in a way no other large bank can. And it builds on our heritage around cashback and as the inventor of credit card rewards. So it's not just to cross-sell to our card customers. We think that this can pretty quickly become a significant entry point into the franchise for new customers. And then over time, much as we've done on the card side, if you can provide a superior value proposition and customer experience, they will want to buy other products from you whether that's a savings account and savings accounts where you also have the checking account and to have a lower beta or the card product. So again, a very important initiative for us, I think over time, will help continue transforming Discover. And we're excited for the potential and you'll see significant marketing against it this fall.

Roger Hochschild:

Yeah. And to frame the compliance issue, I would not over-focus on the regulatory portion. This is something where we as a team know we are not where we want to be and it is our top priority. So it is aligned with the views of the regulators, but our focus is taking many forms, from simplifying our architecture, automating manual processes, streamlining and standardizing business processes, bring on some great new talent as John talked about into the firm. And we know that the result will not just be better compliance but a better customer experience and more efficient organization. So the regulatory piece is important, but I would say what most -- is most important is the commitment from me, the team, the Board on achieving excellence in this area. That will be a multi-year initiative. But again, I think critically important to the future of the company and one that we as a team are very excited about. I would also separate that from the buyback. But again, it will be a journey on the compliance side, but one that we are 100% committed to.

Operator:

Thank you. We'll take our next question from Erika Najarian with UBS.

Roger Hochschild:

Yeah. I'll talk maybe more broadly about operational complexity and then John can talk about the businesses. I think there's a great opportunity to simplify, whether it's -- we may have a similar process that is done differently. And again, we have a much more, I would say, homogeneous set of business is than just about any other bank or size. So we think there are significant opportunities to simplify, and again, those won't just help from a compliance standpoint over time once the investments are made, it will also help on the efficiency side.

Nick Holowko:

Got it. Thank you for taking my question.

Bob Napoli:

Thank you, and good morning. And I -- just from a big picture perspective with the competitive environment, the compliance environment, Roger, as you look at your business, what is your confidence that Discover can deliver the types of returns that it has that investors have come used to over the last 10 to 20 years? Is there -- are you confident in delivering those returns with the higher compliance bar or the competitive set?

Bob Napoli:

Thank you. And a follow-up, just on compliance, having followed Discover for a very long time, coming out of the great financial crisis, there was a lot big investment in compliance across the industry including -- at Discover. Has it become more difficult? I mean, I know there's been a number -- quite a few consent orders put out by regulators, but has it become -- maybe give us some color on what you're investing in compliance today. I don't know, if it's people or percentage of expenses versus historically, and how has it become a lot more difficult?

Bob Napoli:

Thank you.

Arren Cyganovich:

Thanks. On the net charge-off peak that you highlighted for -- into second half of ‘24 and possibly into ’25, is that an expectation that it would go north of kind of your normal underwriting charge-off rate?

Arren Cyganovich:

Okay. Thanks. And then just to clarify on the expense commentary, it sounds like you're not planning to pull back on marketing opportunities as your compliance costs are rising. And then if you could just clarify the numbers that you gave earlier, are those annual numbers? I think you said like $50 million up to $250 million and then $350 million and then down to $200 million. I'm just a little confused on the -- on the trajectories there.

Arren Cyganovich:

Yeah.

Arren Cyganovich:

Yes. Yes, I got it. I got it now. Thank you.

Operator:

Thank you. We'll take our next question from Dominick Gabriele with Oppenheimer.

John Greene:

Yeah. I learned a long time ago not to give quarterly guidance because I found that I was not as accurate as I would have liked and other people would have liked. So the range of, kind of, the double digit growth that we talked about, you can take a look at the portfolio. We made some comments on what was driving it. So new accounts and certainly new account growth ‘22 to ‘23 has slowed. Sales, while still very robust at an absolute level, have slowed into July. We're doing targeted promotional activities to drive high generating, high returning accounts. And the comp in the fourth quarter of ‘22 versus prior quarters is certainly a tougher comp. So your math is certainly your math and I don't want to get into any more specifics than what I just did.

John Greene:

Yeah. So --

John Greene:

Yeah. Arren, the answer to both questions is yes. So the loan fee income, typically late fees and NSF fees. And in terms of employment levels, if unemployment was to increase, that would certainly impact net charge offs. But I would say this. In the cohort of folks that we typically target, there -- what we've seen is if they are impacted by a job situation, their time of recovery is pretty quick. So by recovery, I mean, finding a new role. So the fact that this cohort of prime revolvers isn't in the upper tier of income levels allows them to have a greater opportunity to find jobs of equal pay -- equal or more pay in the current environment. So the employment -- early indications of employment or some challenges in some states, we don't see any sign of that translating into a credit situation for us.

John Greene:

Yeah. So we'll look at -- we'll look at kind of opportunities to drive loan growth. And part of that is the sales data or the spending data from consumers and reflect that in our next set of guidance that we provide. But specifically in correlation, in this form, I'm not going to get into.

Operator:

Thank you. We'll take our next question from Bill Ryan with Seaport Research Partners.

Roger Hochschild:

Yeah. So in terms of overall competition, I'd say there's been a little bit of a pullback on the supply side from, I would say, markets and others as they pulled out. But there are a good number of competitors. A lot of them are much more broader spectrum than us in terms of how far down they go. I think what you're seeing is really strong consumer demand as rates have gone up and our product is primarily used for debt consolidation, people are looking to consolidate and pay down their credit cards. And so we're seeing very strong demand that is giving us ability to tighten credit and even at the margin, raise our prices and still see strong demand. So it's a product where underwriting and credit is everything. The mix is largely new, but a good amount are cross-sold to our existing cardholder base. So its customers where we also have experience with them.

Eric Wasserstrom:

So I think we are going to conclude our call there. Thanks very much for joining us. If you have any follow-ups, please reach out to the IR team and we wish you a very good day. Thanks very much.

Eric Wasserstrom:

Thank you, Chelsea, and good morning, everyone. Welcome to this morning's call. I'll begin on slide two of our earnings presentation, which you can find in the financial section of our Investor Relations website, investorrelations.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 first quarter earnings press release and presentation. Our call today will include remarks from our CEO, Roger Hochschild; 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 followed by one follow-up question. After your follow-up questions, please return to the queue. Now, it's my pleasure to turn the call over to Roger.

John Greene:

Thank you, Roger, and good morning, everyone. I'll start with our financial summary results on slide four. Our performance this quarter was characterized by strong revenue growth, continued credit normalization, a slight change to our outlook on the macroeconomic environment, resulting in a reserve increase, and a year-over-year increase in expenses. Let's review the details starting on slide five. Net interest income was up $653 million year-over-year or 26%. Our net interest margin continued to expand, benefiting from higher prime rates, partially offset by higher funding costs and increased promotional balances. NIM ended the quarter at 11.34%, up 49 basis points from the prior year and seven basis points sequentially. Receivable growth was driven by card, which increased 22% year-over-year, reflecting stable sales growth, modest new account growth, and payment rate moderation. Sales increased 9% in the period, slightly higher than the 8% growth we experienced in the prior quarter and down from the 16% growth we experienced in 2022. Sales growth so far in April is a modest 2.5% but this is coming off a very high comp of 22% in April of last year. New card account growth decelerated, reflecting the tightening of underwriting standards over the past several months, but grew by 3% from the prior year. The impact of slowing sales growth on receivable expansion was offset by decreases in payment rates. The card payment rate decreased 80 basis points in the quarter and is currently slightly over 200 basis points above the pre-pandemic level. Turning to our non-card products. Personal loans were up 21%, driven by higher originations over the past year and lower payment rates. We continue to experience strong consumer demand, while staying disciplined in our underwriting of this product. Organic student loan receivables grew by 3%, largely driven by a reduction in the payment rate. In terms of funding mix, consumer deposit balances were up 17% year-over-year and 7% sequentially. As Roger highlighted, we achieved record quarterly deposit growth. Deposits now make up 66% of our total funding mix with over 90% insured and we continue to target 70% to 80% deposit funding over the medium term. Outside of deposits, our funding channels remain open and at attractive costs. As an example, in early April, we issued $1.25 billion of card ABS fixed rate notes. This offering was upsized and our spread was nine basis points tighter than our November securitization. Additionally, we recently received a ratings upgrade by Moody's for our bank subsidiary and our banking holding company. Moody's cited a number of reasons to support this upgrade, including our prudent underwriting, conservative risk management, and resiliency in an economic downturn. Looking at other revenue on slide six. Non-interest income increased $198 million or 47%. This was partially due to a $162 million loss on our equity investments in the prior year quarter compared to an $18 million loss this quarter. Adjusting for these, our non-interest income was up 9%, primarily driven by the loan fee income and higher net discount and interchange revenue. Moving to expenses on slide seven. 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, or 26% as we continue to prudently invest for growth in our card and consumer banking products. Professional fees increased $55 million, or 31%, driven by investments in technology and increases and consulting activities that support our consumer compliance initiatives. Even with these increases, our efficiency ratio was 37%, and we generated about 700 basis points of operating leverage in the period. Moving to credit performance on Slide 8. Total net charge-offs were 2.72%, 111 basis points higher than the prior year and up 59 basis points from the prior quarter. 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. Consistent with our commentary back in January, we expect the seasoning of new account vintages from the past two years and normalization of older vintages to a more typical loss rate. These trends remain consistent with our expectations. Turning to the discussion of our allowance on Slide 9. This quarter, we increased our allowance by $385 million, and our reserve rate increased by 25 basis points to 6.8%. This increase in reserve rate was driven by two factors. About 10 basis points reflects the runoff of seasonal transactor balances that we typically experienced in the fourth quarter. 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. This change reflects the potential for a reduction in lending impacting economic growth. We will continue to monitor the macroeconomic conditions and make adjustments to our expectations. Looking at Slide 10. Our common equity Tier 1 for the period was 12.3%, and we repurchased $1.2 billion of common stock during the quarter. The net unrealized loss on our AFS 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. 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. 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 $0.70 per share. Including on Slide 11 with our outlook. Following the strong first quarter performance, we are raising our expectations for loan growth this year to be low to mid-teens. There is no change to our NIM forecast. We are maintaining our guidance for operating expenses to be less than 10%. 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 and professional service support and continued investment in technology. We are targeting our expected range of net charge-offs to 3.5% to 3.8% based on our current delinquencies and roll rates. This represents a reduction to the top end of the range by 10 basis points. Finally, as mentioned, our Board of Directors approved a new share repurchase authorization. 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. To conclude, 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.

Sanjay Sakhrani:

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 4.5% to 4.75%. When we average that out, between all the scenarios, does that take you above the 5% unemployment rate assumption, or how should we think about that? And also just in terms of the narrowing of the range of the charge-offs this quarter, was that more because the unemployment rate hasn't necessarily panned out the way you expected it to, meaning it's coming in better?

Sanjay Sakhrani:

Okay. Thank you.

Moshe Orenbuch:

Great. Thanks. I guess, first, you talked about kind of slowing of new account growth. Could you kind of, Roger, perhaps drill down a little more into that the drivers, I guess, in terms of what you're seeing either in the competitive environment or in the consumer kind of credit environment?

Moshe Orenbuch:

Got it. And maybe can you talk, John, maybe talk a little bit more about the expense comment that you made, how much of that would be tied to revenue growth if expenses were higher.

Operator:

Thank you. Our next question will come from Bob Napoli with William Blair. Your line is open.

Roger Hochschild:

Yeah. So I would say that, the slowdown is pretty broad-based. And 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, 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% year-over-year. For us, the most important thing for the consumers, the strength of the job market, and that remains pretty robust. So while we are tightening credit and continuing along that, overall, the consumer is still holding up pretty well.

Roger Hochschild:

Yeah. No, that -- it's a product we're really excited about. Offering 1% cash back 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 one of the outcomes from the pandemic is consumers even for their primary checking or debit account are a lot more comfortable dealing with the direct bank. So this is going to be a critical initiative, not just for this year, but for many years to come. And part of our transition to being way more than credit cards, first loans, student loans, home equity, but being the true leading digital bank.

Operator:

Thank you. Our next question will come from Rick Shane with JPMorgan. Your line is open.

Roger Hochschild:

Yeah. It varies for new accounts versus what we look for in our portfolio. For the portfolio side, yeah, it's hard to pick an individual factor given the complexity of the models we use. But certainly, overall 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 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.

Roger Hochschild:

Yeah. So you may find it 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 a composite behavioral score that I see on a lot of our internal risk reporting. But again, there are literally countless variables in some of our most complex machine learning models that are evaluating portfolio credit.

Operator:

Thank you. Our next question will come from Betsy Graseck with Morgan Stanley. Your line is open.

John Greene:

Yes, 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 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 consumers. 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 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 health care sector, manufacturing sector, defense, oil and gas, and onshoring of supply chain continues. So my sense is that we're not going to have any seismic changes to unemployment despite the fed tightening action. So that means that we'll look at -- 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 service and collection folks can reach out to ensure that collections and cash flows remain strong.

John Greene:

Hello. Jeff or operator? Is the line open?

John Greene:

Okay.

John Greene:

Yes. So why don't I -- I'll take that briefly. And Jeff or Betsy, we can follow up separately in the afternoon, if you like. So in terms of investing in technology. So there's three -- there's, 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. And third, around the network, making sure that our network continues to have leading edge or at a minimum market global capabilities. So, those are the tiers and we continue to invest in those aspects as well as technology to support our overall compliance management system as we talked about in the prepared remarks. So, overall, it's an area of investment. We're a digital institution. We need to continue to invest in technology to ensure that we keep capabilities, advancing.

Operator:

Thank you. Our next question will come from Dominick Gabriele with Oppenheimer. Your line is open.

Roger Hochschild:

Yes. Great question. So, AML BSA, KYC is one element of compliance. There are many others that we focus on. 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 theft. And while there are sort of nuanced differences by product, very, very similar in terms of what we do when someone is opening a new credit card account versus opening a checking or a debit account.

John Greene:

Yes, thanks Dominick. So, yes, 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, call it, a three-quarter or four-quarter period and the CECL reserves, which is life of loan losses, which would include charge-offs through the life of the relationship. And the modeling systems that we use are essentially the same. Same tools, same people 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 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're talking about a three-quarter period of forecasting on the charge-offs. And we gave a fairly wide range, which we intend to tighten as each quarter passes. On the reserves, we take a number of different factors, 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.

John Greene:

Thank you.

Unidentified Analyst:

Hi. This is Nate Rich [ph] on for Mihir Bhatia. 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?

Unidentified Analyst:

Okay. And then as a quick follow-up, can you just talk about the performance? Like how are card loan business from like 2020 or 2022 performing versus the loans pre-pandemic?

Unidentified Analyst:

Okay. Thank you.

Mark DeVries:

[indiscernible]

Operator:

Okay. Yes, sir. And as at 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.

Operator:

Thank you, ladies and gentlemen. This does conclude today's conference, and we appreciate your participation. You may disconnect at any time.

Eric Wasserstrom:

Thanks, Todd, and good morning, everyone, and welcome to today's call. I'll begin on Slide 2 of the earnings presentation, which you can find in the financial section of our Investor Relations website, investorrelations.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 the fourth quarter earnings press release and presentation. On our call today will include remarks from our CEO, Roger Hochschild; 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 followed by one follow-up question. After your follow-up questions, please return to the queue. And with that, it's my pleasure to turn the call over to Roger.

John Greene:

Thank you, Roger, and good morning, everyone. I'll start with our financial summary results on Slide 4. The takeaway of the quarter is largely about strong asset growth and net interest margin expansion, partially offset by growth-based provisioning. Asset growth combined with a NIM rate improvement, increased revenue 7% sequentially and 27% year-over-year. Similar to last quarter, asset growth also drove an increase in our reserves of $313 million. This increase kept our reserve coverage ratio relatively flat at 6.6%. In the prior year, we released $39 million of reserves. So while our reported net income was down 3% year-over-year, adjusting for the reserve change, our net income would have been 23% higher on a year-over-year basis. Let's review the details starting on Slide 5. Net interest income was up $584 million year-over-year or 24%. Our net interest margin expanded, benefiting from the higher prime rate partially offset by higher funding costs and increased promotional balances. NIM ended the quarter at 11.27%, up 46 basis points from the prior year and 22 basis points sequentially. For the full year, NIM was 11.04%, up 28 basis points from the prior year. Receivable growth was driven by card which increased 21% year-over-year, reflecting continued strong sales, new account growth and payment rate moderation. Sales increased 8% in the period, a deceleration from the 15% growth we experienced in the prior quarter and the 20% in the first half of the year. New card accounts grew by 17% from last year's fourth quarter. Similar to the prior quarter, the sales growth decline was mitigated by a decrease in the payment rate, which fell 150 basis points in the quarter. We expect payment rates to continue to decline through 2023, but at a more moderate pace. Turning to our non-card products. Organic student loans increased 4% as a result of peak season originations. Personal loans were up 15%. We continue to stay disciplined in our approach to marketing, underwriting and pricing of this product. Our attractive value proposition has positioned us well in the market that is experiencing strong consumer demand and some improvement in competitive conditions. In terms of funding mix, our customer deposit balances were up 10% year-over-year and 5% sequentially. Deposit pricing continues to be in line with what we expected in a rising rate environment. Recently, we have seen some moderation in the pace of pricing changes. Looking at other revenue on Slide 6. Non-interest income increased $212 million or 47%. This was partially due to a $138 million loss on our equity investments in the prior year quarter, compared to a $6 million loss this quarter. Adjusting for these, our non-interest income was up 14%. This increase was primarily driven by two items. First, loan fee income was up $51 million or 39%, driven by volume. And second, we had higher net discount and interchange revenue, which was up $23 million or 7% reflecting strong sales and a favorable sales mix, partially offset by higher rewards costs. Moving to expenses on Slide 7. Total operating expenses were up $183 million or 14% year-over-year and up 8% from the prior quarter. Compensation costs were up primarily due to increased headcount and wage inflation. Marketing expenses increased $42 million or 15% as we continue to prudently invest for growth in our card in consumer banking products. Premise and equipment expense was elevated this quarter due to a onetime write-off related to the exit of our Phoenix servicing location. Adjusting for this, premise and equipment would have been flat to the prior year quarter. With this recent action, we have resized or exited three of our four major call center locations, and we'll continue to evaluate our footprint going forward. Moving to credit performance on Slide 8. Total net charge-offs were 2.13%, 76 basis points higher than the prior year and up 42 basis points from the prior quarter. In the card portfolio, the net charge-off rate of 2.37% was 87 basis points higher than the prior year and 45 basis points higher sequentially. As expected, portfolio loss rates are normalizing, reflecting seasoning of new account vintages from the past two years, normalization of older vintages and mild deterioration and low credit bands, largely inflation-driven. These trends are within our expected risk tolerances and are consistent with our historical approach to underwriting and credit management. Among our core prime revolver segment, we don't see evidence of broader stress given the robust labor market. I'll cover our 2023 view in a moment. Turning to the discussions of our allowance on Slide 9. This quarter, we increased our allowance by $313 million driven by the increase in receivable balances. Our reserve rate declined slightly to 6.6%. Adjusting for the elevated level of transactor balances in the fourth quarter, our reserve rate would have been near sequentially flat. Under the CECL accounting standard, we are required to contemplate life of loan losses and adjust our reserve levels accordingly. For us, the changes to employment conditions pose the most significant risk to our forecast. For the year-end 2022 reserve, our baseline assumption was unemployment in 2023 between 4.5% and 6.5% and with alternative scenarios above 6%. Looking at Slide 10. Our common equity Tier 1 for the period was 13.3%. Our longer-term target remains at 10.5%. We expect to make progress against this target over the next four to six quarters. Yesterday, we announced a quarterly common dividend of $0.60 per share. And in the fourth quarter of 2022, we repurchased $602 million of common stock. Concluding on Slide 11 with our outlook. Momentum is strong, which should help to generate double-digit revenue growth and positive operating leverage. We expect end-of-period loan growth to be in the low double digits with average loan growth somewhat higher. This is driven by three factors

Moshe Orenbuch:

Great. And John, thanks for kind of outlining the parameters of the range of expected credit loss. But could you talk a little bit about the past kind of from here to getting to the 3.5%? Like what either has to happen that's bad or not happen, that's good. And at what points along that way, would you know whether that 3.5% base case is too high or too low?

Moshe Orenbuch:

Perfect. And just as a follow-up, the reserve rate was down. You mentioned that was largely a result of transactor balances. But I guess even with that, it wasn't up. And so when you think about that, kind of how do you -- I mean, how should we think -- it doesn't feel like you're anticipating a deteriorating environment if you're keeping your reserve certainly no worse than flat. And how do we think about that going through '23 as well?

Operator:

Thank you. Our next question will come from Sanjay Sakhrani with KBW.

John Greene:

Yes. So in terms of the impact of the vintages, I explicitly called out the card vintage in 2022, so the $15.7 billion to give the folks that are listening here, a place to anchor on in terms of thinking about the vintage and then you can run out peak losses for our portfolio in terms of what typically happens after a significant vintage and in a stable macro. So that should help you at least in terms of the thinking in terms of the vintage. As we think about this year, we gave that range of 3.5% to 3.9% on the loan base -- on the average loan base. So you should think about the ultimate kind of range here. It will depend first on the macro. Second, we'll continue to give updates in each of the quarters in terms of what we're seeing. But ultimately, we expect this vintage will mature in 2024. And then, we should see in a stable macro, the curve not only slope pending, but actually inverting slightly.

Roger Hochschild:

Yes. Good question, Sanjay. I think you've seen us operate this business through multiple cycles and the disciplined approach we take both in good times as well as in bad. And frequently, the accounts that you put on during a challenging economic time, perform extraordinarily well, and you can see very good cost per account as competitors pull back. So, we have been pretty clear at that starting in the back half of last year, we started tightening credit standards, and you can expect us to continue to look at that and adjust according to economic conditions, both for new accounts as well as the portfolio. Nevertheless, we're seeing great returns on the marketing investments we're putting out there. And so, that's what gives us the confidence to keep investing in growth.

John Hecht:

And not to beat the dead horse, but maybe just one more question on the kind of the provisioning and the credit. John, I think you kind of detailed the unemployment assumptions. I think they were kind of in the 4.5% to 6% range with maybe somewhere making the 5% range, kind of the middle of the fairway. Just maybe can you tell us what's the sensitivity for the -- either the charge-offs or the ALL at say unemployment moves to level like 100 basis points higher than that.

John Hecht:

Okay. That's helpful. And then you gave annual guidance with NIM, and it sounds like maybe an elevated NIM in the first part of the year coming down second, what are the drivers of that with respect to the yield and the cost of capital?

Operator:

Thank you. Our next question comes from Mark DeVries with Barclays.

John Greene:

Yes. So you were right on your call here. We gave a range for 2023 of 3.5% to 3.9%. I talked about the curve and what we think will happen to the curve and the slope of that. So, Mark, as a matter of prudence, I think that's probably as far as I'm going to go here.

Operator:

Thank you. Our next question comes from Betsy Graseck with Morgan Stanley.

John Greene:

Yes. So typically, we'll see it around 18 months. And it varies based on credit quality. So, the highest credit quality. So, I think FICO would typically peak a little later. And then the weaker, I'll say, the weaker credits typically peak a little bit earlier. But on average, I think, about 18 months or so.

John Greene:

Yes. So -- the first part of that answer would be it would depend on the vintage. So if you go back to our 2020 vintage and remember, there's COVID, right, we were locked down. We ceased underwriting kind of the near prime and lower prime and concentrated on upper prime that vintage will season at a peak loss level below what Discover historically has done. If you look at '21, '22, we were essentially back to an underwriting standard consistent with history. And you can use that information to get some level of comfort around what can be expected in '24 on this vintage.

John Greene:

It is. Yes. Yes. The one difference that I think is important for folks to codify in their minds is that we're coming off an abnormally low base, right? So the entire portfolio is normalizing. We've talked about that consistently actually, since the beginning of last year that we thought the portfolio was normalizing. And what you're seeing here in the 2023 guidance is essentially the portfolio normalizing.

John Greene:

Yes. Otherwise, my controller would have taken an exception to our reserve process.

John Greene:

Yes. Although what we're seeing in personal loans is, again, loss rates below historical norms. Payment rate is beginning to normalize. And we had talked about the fact that we perhaps overcorrected on that product in terms of underwriting, in terms of the pullback. We pulled back significantly. So I expect some seasoning and normalization there. But again, we're very, very confident about the loss performance of that product. We understand where it is on the payment priorities for folks. So we're going to be mindful of the economy on that. And student loans, yes, that's normalizing. We did have and likely we'll have a little bit of impact when we see the full impact of the student debtors on the government programs having to pay back loans, but it's underwritten to a high standard. 80-plus percent have cosigners. So, we feel very comfortable about that product as well.

Rick Shane:

Look, this is an interesting milestone where the reserve rate is 658 basis points. It basically is apples-to-apples seasonality versus CECL day one and up 50 basis points. I'm curious when we think about your economic outlook and how you build a CECL reserve where you compare to CECL day one on a like-for-like basis, would you build the same allowance? Or have you made adjustments and then compare your economic outlooks in each of those points in time, please?

Rick Shane:

John understood. I'm more curious that if you like were you've described that the models have evolved. And I think that, that's fair, and I think everybody appreciates that. What I'm asking is, on a like-for-like basis, would -- do you think that reserve rates are lower today using the same assumptions as you refine them versus CECL day one?

Operator:

Thank you. Our next question comes from Bob Napoli with William Blair.

Roger Hochschild:

Yes. Thanks Bob. It remains, I would say, intensely competitive. But as you've seen from the growth and especially the performance in new accounts, our value proposition is competing well. And again, I want to give credit to some of the advancements on the analytics that let us sort of personalize the marketing messages across different channels. I guess where competition has lightened a bit is in the personal loan space. I think there are a lot of non-bank funded folks there who may have some challenges on the other side of the balance sheet. And obviously, one big player who had been active is pulling out. On the deposit side, I would see there, I think you're starting to see the gap between the direct banks, the branch banks really get wide enough that you're seeing flows to the direct system, right? It's now at 3.3% for a savings rate. It's now a lot more worth your money. So again, really excited about how our products are competing across every segment. And so that's part of why we're optimistic going into 2023.

Roger Hochschild:

You're highlighting probably the big launch for next year, which will be the re-launch of cash-back debit and we hope to be doing some mass-market advertising of that. Beyond that, I really believe we have the right product set. We're seeing great demand, for example, on the home equity side, given how rates have moved and the lack of cash-out refi. So I think part of how we keep our costs as low as they are, is a very simple, lean operating model. So I wouldn't expect anything other than the re-launch of the cash-back debit and we'll put a lot of weight behind that.

John Pancari:

Back to the credit topic, anything about the charge-off guidance that baked into your guidance, that is a surprise at all in terms of what you're observing. I know you talked about the seasoning and the vintages and it sounds like there's nothing there that really surprised you. But I'm wondering, anything about the credit migration within the vintages, within the portfolio in the past dues and/or customer behavior that surprised you that led to the increase in the charge-off guidance that seems to be well above where The Street was expecting?

John Pancari:

Okay. That's helpful. And then, again, just -- I know this gets to CECL and the whole spirit of it. But given your commentary and that you just indicated reserve flat, so if the macro outlook progresses within your scenarios and the loss migration progresses as you described here into 2024 of this 2022 vintage, and no other surprises elsewhere, then would you expect accordingly that the reserve at 660 would generally remain around that level in that case? Or could there be incremental upside to the reserve, assuming that macro backdrop remains as they're within the scenario bands.

Operator:

Thank you. Our next question comes from Bill Carcache with Wolfe Research.

John Greene:

Yes. I mean we don't typically forecast the delinquency rates. You would -- what I suggest you do is take a look at the trust data and the relative difference between the trust data historically and where the total company is coming out, that will give some insights. And then also, the trends in delinquencies typically are pretty consistent, right? You can go point to point to point. And then I've given some views in terms of where we see the slope starting to flatten and then perhaps spend. So, I'd use that information in order to -- if you're interested in calculating overall delinquency rates for firm.

John Greene:

Yes, there obviously, a relationship there, certainly. Although remember, you should have -- you should take into account the kind of the vintage impact and what I'll say normal seasoning, right? So, there's $18 billion of incremental loans. Some of those are just going to perform extremely well and a small percentage will season, out as we typically see. So, I would consider that in the analysis, but nothing at it. There should be no substantial break.

John Greene:

Yes. Yes. Well, there's a couple of different components, right? There is -- there's a bankruptcy bucket. There's a non-bankruptcy bucket that just flows through the buckets. And then there's also the recovery element. So if you put those three together, sometimes the bankruptcy bucket is it will pop in a particular quarter, depending on flow of work in the court system and the non-bankruptcy just flows quarter-over-quarter. So, I would certainly look at this quarter, prior quarter and what comes out in the first quarter, and that will be the insights you're looking for.

Mihir Bhatia:

I wanted to just talk a little bit more about credit. So specifically, I think you mentioned a little bit of mild deterioration in credit among the lower bands. Does your guidance contemplate that stress spreading to your prime core revolver portfolio at all as unemployment increases, I guess said differently, what I'm trying to understand is, do you think we go from credit formalization to deterioration for DFS overall? Or is it just normalization with just the vintage seasoning impacts that we've been talking about?

Roger Hochschild:

Yes. And maybe just to clarify, the lowest income segments which are a pretty small portion of our base are the ones that get additional pressure from inflation, right? By and large, a prime book can adjust. They trade down, they readjust their pattern. So I think John was referring to incremental stress there. But there's no reason to believe that the vast majority of our portfolio will be driven by the traditional drivers of losses, which is charge-offs -- I'm sorry, which is unemployment.

John Greene:

Yes. Thanks, Mihir. So -- we've been asked that question over the years many, many times. And what I typically refer people back to is, if you take a look at the details of the kind of the charge-off history, you can go back through 2008. And see kind of quarter-over-quarter what's happening on the charge-off front, you can discern kind of normalized charge-off rate from that and then make adjustments for economic periods or kind of vintage-based seasoning.

Kevin Barker:

And in regards to your employment forecast and your base assumptions, you're pretty clear that the low end, the 3.5% assumes the 4.5% to 5% unemployment rate. But can you help us understand or just confirm that the -- is it the 3.9% higher end of the range, implying a 6% unemployment rate or some other scenario out there within your expectations?

Kevin Barker:

Okay. And then with your baseline assumption of 4.5% to 5%, is that something that we make our way to throughout the year and then maintain that level or something where you expected to peak there and then startly drift lower?

Operator:

Thank you. Our next question comes from Don Fandetti with Wells Fargo.

Roger Hochschild:

Yes. I'll start. January is off to a very strong start. So, we're seeing about a 13% year-over-year growth in sales, and again, reflects the new accounts we put on last year, but also, again, for those who aren't employed a robust environment. We have been seeing increases in the day-to-day category commensurate with inflation and so more spending shifting there. And a lot of what you heard from retailers in terms of softness around home improvement, and hard goods, but a lot of that was just, I think, some of the challenging comparisons to really robust levels from before. So, overall, I'd say, stable, but we're certainly encouraged by what we're seeing so far in January.

Arren Cyganovich:

On the marketing outlook, you had indicated that you expect to spend more than 2022 levels, which obviously was a very strong acquisition year for you. What's the thought process there in terms of expecting to increase spend after such a strong year?

Arren Cyganovich:

And then on the personal loan side, you had indicated that it's -- it's clear that it's performing better than historically. With respect to the guidance, does the personal loan net charge-off rate, is that expected to go as high as credit cards in 2023? Or are you still expecting it to be somewhat better?

Eric Wasserstrom:

So, I think we're going to conclude our call there. Any additional questions, please reach out to the IR team, and thanks very much for joining us this morning.

Eric Wasserstrom:

Thank you, Katie and good morning everyone. Welcome to today’s call. I’ll begin on Slide 2 of our earnings presentation, which you can find in the financial section of our Investor Relations website, investorrelations.discover.com. Our discussion today contains certain forward-looking statements that are subject to risks and uncertainties and that may cause actual results to differ materially. Please refer to our notices regarding forward-looking statements that appear in our third quarter’s earnings release, press release and presentation. Our call today will include remarks from our CEO, Roger Hochschild; 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 will be permitted to ask one question followed by one follow-up question. After your follow-up question, please return to the queue. Now, it’s my pleasure to turn the call over to Roger.

John Greene:

Thank you, Roger, and good morning, everyone. I’ll start with our financial summary results on Slide 4. There were three important trends in the quarter

Ryan Nash:

Hey, good morning guys.

Ryan Nash:

So maybe to start on the net interest margin John, you commented that it implies another uptick given the rate hikes that we saw at the end of the quarter. Can you maybe just talk about where we go from here on the margin? I think last quarter; you talked about it potentially peaking out. I’m just curious; do you think you can continue to hold their line around these levels? And maybe what is incorporated within that in terms of deposit betas and the like?

Ryan Nash:

Got it. Thanks for the color. Roger, maybe one for you. You mentioned you guys are marginally tightening on account acquisition. Can you maybe just give additional color regarding some of the changes you’re making to underwriting? And what do you think this might mean for growth over the intermediate term? Thanks.

Ryan Nash:

Got it. Appreciate the color.

Moshe Orenbuch:

Great. Thanks. I was hoping maybe you could talk for a little bit of a different tack. Maybe talk a little bit about the competitive environment and what you’re seeing from a credit standpoint and from a competitive marketing standpoint, kind of, in your two installment loan businesses, both in the personal loan business and the student loan business and maybe talk about that and the outlook there for a moment?

Moshe Orenbuch:

Got it. Thanks. It is interesting. I mean, I think we’ve seen that for others that are at the higher end of the credit spectrum where the stress you’re talking about we do see at the lower end. Follow-up question that I had is, you talked about hoping to restart the buyback by year-end or so, a little bit growth kind of causing a 30 basis point downtick in your capital, but you’re still well above. Just talk about, I guess, the appetite for that given – and does the kind of macro environment figure into that? Just talk about the appetite for the buyback once that restarts? Thanks.

Moshe Orenbuch:

Thank you.

Sanjay Sakhrani:

Thanks. Good morning. John, I wanted to just walk through the expense guide increase. You mentioned it’s a blend of marketing and comp costs. Could you just parse apart what part is – how much of each sort of contributed to the increase? And I’m just trying to put the marketing comments to slightly pulling back the credit box. And then as far as like the headcount increases, was that related to the growth? I’m just trying to figure out what changed in terms of the comp cost?

Sanjay Sakhrani:

Okay. That’s very helpful. And then I know we’re trying to read between the lines in terms of the student loan servicing inquiry or investigation that’s going on. But just to be clear, there is no change to how you guys are thinking about it relative to last quarter. And as far as the expenses are concerned, it seems like things are progressing as you expected it to and it’s just a matter of timing. Is that a correct statement?

Sanjay Sakhrani:

Okay. Great. Thank you.

John Hecht:

Good morning guys. Actually, most of my questions have been asked, and I was going to ask one about marketing. But maybe since you addressed the spend patterns, maybe can you talk about – just because it’s a topic that we haven’t really talked about in detail recently your perspective on rewards and the competitive environment around rewards and what that means for the intermediate term?

John Hecht:

Okay. And then second question is maybe thinking about like a 2021 cohort, and I know it’s probably early for the 2022 cohort, but what can you tell us in terms of how they’re seasoning utilization rates and kind of delinquency seasoning? Is there – is it back to what it looked like in 2019? Or is there something different that’s worth pointing out with respect to more recent vintages?

John Hecht:

Okay. Thank you guys.

John Pancari:

Good morning.

John Pancari:

On the efficiency ratio came in around 40% for the third quarter. And just given the commentary that you gave around the investments that you’re making and your expense expectations, can you maybe help us think about how that could shape up for the fourth quarter, and more importantly into 2023, how we could think about the trajectory there? Thanks.

John Pancari:

Okay. Thank you. That’s helpful. And then on the reserve front, just wanted to get your take on how you see that trajecting here? I know you allowed the reserve to bleed a bit in terms of the ratio this quarter. But now as you’re seeing some of the normalization that you indicated and some of the pressure on delinquencies, how should we think about the reserve as you look here, particularly as you factor in the economic conditions and how you’re looking at the economy, the impact on the economy plays out? Thanks.

John Pancari:

Got it. Okay, thanks for taking my questions.

Betsy Graseck:

Hi, good morning.

Betsy Graseck:

I just wanted to see if I could get you to unpack your statement on no seismic changes in 2023. Maybe we could speak a little bit about how you’re thinking – and I know you just detailed a little bit, but how you’re thinking about how the loan yield should traject. I know in the slide deck, you called out that the loan yield was driven by prime obviously, but with a partial offset from higher promotional mix and the timing of pricing changes. Could you help us understand how that works? How much the promo mix and the timing impacted loan yields and how you’re thinking about that trajecting as we continue to go through a Fed rate hike period here?

Betsy Graseck:

Okay. Got it. And I appreciate that. Thanks. My follow-up has to do with the buyback discussion that we had earlier. And I know you mentioned that you’re hopeful it can resume in 4Q. Would you expect to put out an 8-K, that indicates that you can now resume buybacks? Or would we hear about buybacks only after you started, there’s no obligation to put a notification into the market that you can resume. Thanks.

Betsy Graseck:

Okay. No obligation, but you would likely do it. Okay. Thanks.

Operator:

Thank you. Our next question will come from Robert Napoli with William Blair. Your line is now open.

John Greene:

Yes. Hey Bob, thanks for the question. I just want to be very specific about something you said. And our comments have consistently been here on this call that we hope to resume the buyback in the fourth quarter. So, we say that because we’re hopeful, but there’s ultimately, it will be a decision that the Board helps with. So in terms of the 10.5% target, so we’ve been well north of that for quite some time, there’s – we have said that we want to step towards that, we intend to step towards that. So certainly, the earnings power that the firm has generated and the buybacks as well as dividends, have impacted our ability to get there. So we’re going to step towards that when throughout 2023 and 2024. What we said previously is, we hope to be around the 10.5% target, sometime in 2024 or 2025.

John Greene:

Yes. Yes. So, I would put two points out there. First, I would take a look at the historical trends and use that and make certain judgments. The other item here, I’m going to say is a matter of judgment. But certainly, I have a belief that credit cards have increased in the payment priority because folks can access the digital economy without a credit card – some folks with a debit card, but most specifically around a credit card. So that, I believe, helps prioritize the primary credit card among many other debt obligations that a consumer has. So could that impact the relative charge-off rates versus the historical trend? My belief is yes, but your judgment is, what I’d say you should apply when you’re working through your forward-looking outlooks.

Operator:

Thank you. Our next question will come from Don Fandetti with Wells Fargo. Your line is now open.

John Greene:

Yes. Yes, thanks for the question, Don. So certainly, nice growth there. On the personal loan front, you go back in a few quarters, and it was flat. And we said it was flat to down. Actually, if you go back three or four quarters as a result of some underwriting decisions we took. We’ve been – we set strength in the underwriting for that product, and it’s given us greater confidence to be able to market that product, and there’s been a high level of appeal to it. So, we’ll continue to be mindful of the product in the face of a tougher economic condition. But certainly, we feel like it’s a good product and its meeting customer needs, and that’s helped drive the growth. In terms of kind of forward-looking guidance, I’m not going to start to do that at a product level, all it would do is ensure that I was wrong more often. But if I go to the kind of the home equity loan, that’s portfolio is relatively small. So it’s actually not moving the dial at this point from an earnings standpoint. But what we’ve seen is a great level of interest in the second lien product, and we’re also originating a first lien product as well. So both products are performing well and nice appeal.

Operator:

Thank you. Our next question will come from Mihir Bhatia with Bank of America. Your line is now open.

John Greene:

Yes. So Mihir, thanks for the question. And I’m certainly appreciate the specificity. What I’ve said about NIM is probably as far as I’m going to go here on this call. We do expect sequential improvement, as I said. Beyond that, it will be tough to give specific details.

John Greene:

Yes. So normalization through 2023 and the macro environment will help us determine whether it pushes 2023 into 2024. But where we’re sitting today, we’re very pleased with the portfolio performance and the only surprise is frankly, the pace of normalization on the upper end is a little slower than we expected, which helped drive the improved guidance that we gave on the charge-off rate.

Operator:

Thank you. Our next question will come from Rick Shane with JPMorgan. Your line is now open.

Roger Hochschild:

Yes. Great question. So our base probably does skew a little upwards, so more in the prime, but we’re seeing continued strength in sales in October. So, I’d say, year-over-year in the low teens. Some of the trends you’ve heard about were picking up. So consumer durables softening in terms of year-over-year. But again, our households, by and large, they have the liquidity to absorb inflation. It causes some pain, and we’ll switch categories, we’ll downgrade within a category. But I would say travel is coming off some of the very, very strong growth we saw over the summer. So a little less strength in travel and consumer durables are probably the key trend.

Operator:

Thank you. Our next question will come from Bill Carcache with Wolfe Research. Your line is now open.

John Greene:

Good morning.

Roger Hochschild:

Yes. So great question. So, I mean, in terms of late cycle, I think back pre-pandemic, we talked about it being late cycle for a couple of years, and then it ended in a way that I think no one expected. And so that’s part of why we tend to use a through-the-cycle loss rate and look to be disciplined in our credit management. So while I would be, it’s not a time probably to be widening credit. We’re seeing a lot of benefits from the investments in advanced analytics, in particular, around the personal loan product and on the card side, where the growth we’re achieving the growth while swapping in and swapping out different populations. And again, with a policy that I think is appropriate for late cycle. And it builds on some of the really strong new account production we had in 2021 and as those accounts mature. So again, we’ll continue to look at it, both in terms of our portfolio actions as well as new account originations across all of our products, but we feel good about the credit approach and just the traction our products are getting in the marketplace. And I’ll pass it to John for part two.

Bill Carcache:

Thank you.

Kevin Barker:

Thank you concerning the comments regarding unemployment rate, maybe some slight tightening on underwriting. That being said, are you seeing any minor shifts in consumer spending or payment patterns that may indicate certain pockets of stress, whether it’s the lower end of prime or other parts or maybe even certain vintages of customers that are on your books?

Kevin Barker:

Okay. And then I know it’s a fluid situation, but the student debt repayment is supposed to restart here maybe early next year or who knows, given what’s happening with the fighting in the courts, but do you expect any incremental impact to credit with a lot of student debt payments. Obviously, there’s the forgiveness is obviously a credit positive, but is there something that you could see as a potential headwind as student debt repayments restart here potentially in January?

Kevin Barker:

Okay, thank you for taking my questions.

Mark DeVries:

Yes. Thanks. How should we think about how you manage expense discipline, if we start to see some revenue and credit weakness if the economy softens here?

Mark DeVries:

Okay. Got it. And then just given where the rewards cost has trended so far this year in the guidance I think you said it was 2 basis points but guidance is 2% to 4%. Is it right to assume that 4Q is a relatively big quarter for expenses? Maybe you’ve got more of the 5% categories this quarter.

Mark DeVries:

Okay, got it. Thank you.

Bill Ryan:

Thanks. Good morning and a couple of quick questions. Just following up on the personal loans business. Historically, it’s been heavily focused on your credit card base. And I was just wondering if that’s still the case. And you also had, I’d say, very, very strong credit checks in that business, paying off creditors directly. Has anything changed there as well?

Bill Ryan:

Okay. And just one follow-up on the promotional balances, that’s kind of been brought up on the card book for the last several quarters. Is it still increasing as a percentage of the overall card portfolio? Or is it kind of stabilized and maybe give us some historical perspective of where it stands to recent history? Thanks.

Bill Ryan:

Okay, thanks for taking my questions.

Operator:

Thank you. Our next question will come from Dominick Gabriele with Oppenheimer. Your line is now open.

Roger Hochschild:

Yes. I’d start by saying we don’t necessarily optimize on protecting profitability on a quarter-by-quarter basis. We focus on sort of delivering long-term value to the shareholders. And I think as I’ve been in this business a while, people who just totally got marketing in a downturn, miss out on what usually turn out to be some of the most profitable vintages. And so yes, you cut marketing mainly because as you tighten the credit box, there are fewer people to market, too. But I think we try and operate our company almost like we’re always in a recession, always be conserved on credit or was be tied on expenses, there’s more you can do, especially around discretionary items. But that ability to keep momentum through a downturn has really distinguished us in previous cycles, and we would try and do that again.

Roger Hochschild:

Yes. I mean we haven’t put out product-by-product guidance. But I would say that given how we underwrite the personal loans, I’m not sure why our portfolio would jump much faster than the card book. In general, we have a higher FICO for the personal loans business. They do tend to be a little more volatile than card in a recession. But I wouldn’t – that isn’t necessarily behavior I would expect.

Eric Wasserstrom:

All right. Well, thank you everyone for joining us. And thank you, Katie. And if there’s any additional follow-ups, please reach out to the IR team. We’ll be here and looking forward to speaking with you. Thanks, and have a great day.

Operator:

Thank you. Ladies and gentlemen, this concludes today’s event. You may now disconnect.

Operator:

Good morning. My name is Katie and I will be your conference operator today. At this time, I would like to welcome everyone to the second quarter 2022 Discover Financial Services Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you. I would now turn the call over to Mr. Eric Wasserstrom, Head of Investor Relations. Please go ahead.

Roger Hochschild:

Thanks Eric and thanks to our listeners for joining today's call. I'm very pleased with our results this quarter. We generated robust revenue growth and strong earnings, while advancing several strategic initiatives. This solid performance reflects the strength of our integrated digital banking and payments model and our focus on managing the business, while investing for growth amidst an increasingly fluid macroeconomic backdrop. Let's turn to the summary on slide three. For the second quarter, we reported net income of $1.1 billion after-tax or $3.96 per share. Our operating metrics in the second quarter remained very strong. Loan growth increased by 13% from the prior year, driven by a combination of higher sales and strong new account growth and our asset quality remains solid across all products, reflecting our focus on prime lending and our approach to underwriting and credit management. We also advanced several strategic priorities in the quarter. In our Payment Services segment, we continue to expand our global acceptance through new partnerships. In June, we announced a network alliance in Italy with BANCOMAT, one of Europe's largest payment networks. This should provide our customers with access to merchants in Italy through BANCOMAT's extensive acquirer relationships. This partnership represents a significant advancement in our acceptance across Western Europe and we remain committed to expanding our international merchant coverage. In our Digital Banking segment, our combination of industry-leading customer service and compelling products continues to differentiate us in the marketplace. We were recently awarded the highest ranking in customer satisfaction by J.D. Power among mobile, credit card apps, and websites. We also achieved J.D. Power's top customer satisfaction and checking accounts for direct retail banks. This recognition underscores our customer service model, which combined with our compelling Cashback rewards and no fee products, create a value proposition that we believe others will struggle to match. For this reason, we're confident that we are well-positioned to generate substantial growth and shareholder value over the long-term. Notwithstanding our strong performance, we continue to closely monitor today's evolving economic environment. Slide four provides some views on the current macro conditions. Measures of inflation remain persistently high and the Federal Reserve has signaled its intent to address this through restrictive monetary policy. Our business model has somewhat of a natural hedge against inflation as higher expenses are largely offset by the contribution inflation makes to our sales volumes and because our balance sheet is moderately asset sensitive, rate hikes improve our outlook for spread income, despite driving higher funding costs. Perhaps more significantly, tighter monetary policy may have raised the risk of an economic recession, but behavior and trends from our consumer loan portfolio currently do not suggest that a downturn is imminent. Our credit metrics remain strong and sales are robust even as our customers maintain high payment rates. Similarly, most labor market measures indicate employment conditions remain broadly supportive of consumer financial health and credit performance. Nonetheless, should there be changes in macroeconomic conditions, we will make the appropriate adjustments. Our through-the-cycle underwriting considers all stages of a credit cycle including downturns. And our history of conservative credit management positions us well for any future periods of economic stress. Our actions during the recent pandemic are a good example of how nimbly we can respond to changing circumstances. We also maintain a strong balance sheet and capital position. Our current level of common equity Tier 1 is 14.2%, well above our internal target and regulatory minimums. And as John will detail, our reserves capture our estimate of losses over the expected life of our loan portfolio. This brings me to one topic about which we want to make you aware, as we addressed in our press release, we are temporarily suspending our share repurchase program in light of an internal investigation being conducted by a Board appointed independent special committee. This investigation concerns our student loan servicing practices and related compliance matters. And while we cannot comment further at this time, I can say, this matter was contemplated as John reaffirms our expense guidance for the year. In summary, while macroeconomic conditions remain somewhat uncertain, we continue to advance our strategic goals and are benefiting from the combination of strong sales and receivables growth, expanding margin and slowly normalizing credit. These trends give us confidence in our outlook over the forecast horizon, while our reserves and high level of capital position us to withstand a range of macroeconomic environments. I'll now turn the call over to John to review key aspects of our financial results in more detail.

Operator:

Thank you. Thank you. Our first question will come from Moshe Orenbuch with Credit Suisse. Your line is now open.

Roger Hochschild:

Sure, Moshe. Thanks for the question. I would say the competitive environment remains intense with the consumers staying strong. We are seeing strong levels of marketing from most of our prime competitors, but I think our differentiated value proposition is succeeding well in the marketplace across all of our products. From a credit standpoint, I would say we're roughly back to where we were pre-pandemic. But keep in mind, that's sort of a late cycle approach that we had towards the end of 2019. So we think we remain conservative on credit, but the differentiation for the brand and the product are really working well to drive growth even in this competitive environment.

Roger Hochschild:

Yes. We are moving forward with our plans for peak season. Again, what has been a wild card over the last couple of years has been sort of overall number of kids going back to school and their demands for funding. So, I think that the market size is always a bit uncertain. But we feel good about how prepared we are as we move into the peak origination months.

Operator:

Thank you. Our next question will come from Bill Carcache with Wolfe Research. Your line is now open.

Roger Hochschild:

Yes. Thanks for the question. So, there are a whole series of things we carefully monitor in terms of the health of our customers and portfolio, and that goes into our appetite for growth. I would say part of the things we watch most carefully externally are the job market and rising unemployment. And so, we have a finely tuned playbook in terms of how we'll adjust originations? But we continue to originate throughout the cycle. And so even during the financial crisis that you referred to, we kept up a certain level of account production even as we became more conserve in credit. In our underwriting always uses a through-the-cycle approach as we think about the profitability of accounts, we're booking. So those are some of the things we'd look at.

John Greene:

Yes. Hey Bill, I'll take that one. Good question. We spent plenty of time thinking about it. So, inflation unto itself is not correlated to loan losses based on all the historical data we've looked at. Now certainly, we've seen some changes in consumer behavior. So, we'll keep an eye on it. But typically, it would be unemployment or changes in employment levels overall. I have a particular view that as we try or the Fed tries to deal with the inflation situation, certainly it's going to be quite a period of time before the job market is directly impacted in a significant way. So, unemployment remains super low, so 3.5%, there's still about 11.3 million job openings right now versus 6 million people looking for jobs. Spending remains robust. And credit is performing very, very well. So, as we look at those factors, we're going to keep an eye and see if there's any material changes on that. But in terms of reserving at this point, that that life of loan approach that we take, looking at broad macros as well as portfolio performance gave us confidence in the reserving levels we chose and the corresponding reduction in the reserve rate. So, we'll keep an eye on it and update it quarterly.

Operator:

Thank you. Our next question will come from Sanjay Sakhrani with KBW. Your line is now open.

Roger Hochschild:

Thanks for the question, Sanjay. I think I tried to address that when I said our expense guidance that John reaffirmed includes our views on this matter. So, there are many factors that go into a share repurchase program. It's not just potential financial exposure. So -- and I would say, returning our shareholders' capital in the form of the repurchase has been a big focus for management and the Board and will continue to do. And that's why John said we hope to get back to the repurchase program as soon as we are able.

John Greene:

Yes. Thanks Sanjay. So, the NIM guidance gave a range of benchmarking off the 10.85%, and we said five to 15 basis points range of upside from that. Based on the Fed actions to-date, we're tracking towards the upper end of that guidance range at this point. So, that's a positive. We are seeing deposit costs increase and that's a function of two things. The competitive environment and then also the fact that we had record loan growth in the quarter at 13%. So, the funding mix, as I said in my prepared remarks, that will likely change in the back half of the year. And we're going to continue to focus on that 70%, 80%. So, competitively, we're not going to lead certainly in terms of deposit pricing, but we're going to respond to ensure we remain very competitive and have a proposition -- a strong value proposition for our customers. So, how that translates into betas, it's hard to call right now. But I would say the first part of the year, we had a very, very low beta. I would expect that to normalize as the funding environment migrates.

Operator:

Thank you. Our next question will come from Rick Shane with JPMorgan. Your line is now open.

John Greene:

Yes. Thanks, Rick. So -- yes. It's hard to call it right now. But we do have some preliminary data that shows that the decrease in the use of cash and the touchless transactions you may do at Starbucks or other institutions where folks previously would use cash. A lot of that's gone away. So it's creating a higher level of transactions through our card. Good thing for us from an interchange perspective, but also that cash that folks used to expend, I believe there's some portion of it that is now going to pay down balances which is increasing the payment rate. Now -- how much is that? It's hard to call right now. We're about 500 basis points higher than the pre-pandemic level. If I were to ask to give a range, I would say maybe 100 to 200 basis points of that could be a permanent change. And then the rest has to do with the strength of the portfolio and the strength of the consumers.

John Greene:

Yes. Thanks for the question. Anything else? .

John Greene:

Yes.

Ryan Nash:

Hey, good morning, John. Good morning, Roger. So John, maybe a question on the allowance. If I look I recognize that, obviously, this is a life of loan count. But when I look at the level of reserve today, you're only modestly below where you were at March of 2020, call it low 7s versus high 6s. So can you maybe just give us a little bit more color in terms of what's assumed in the reserve in terms of scenarios. And if we see a modest downturn just given how healthy your consumers are, like what could that do to both losses in the allowance over time? Thanks.

Ryan Nash:

Got it. And maybe, Roger, maybe a follow-up to Sanjay's question. I guess, given that it doesn't sound like you're expecting much in terms of cost from this investigation, I guess, maybe just talk about -- to spend the buyback? And I know that you're limited in what you could say, but any sense for the timing of how long an investigation like this could take? Thanks.

Ryan Nash:

I’ll figure that. Thanks.

Mark DeVries:

Yes, thanks. Just one more question on the buyback. When you are able to resume, should we expect the cadence to kind of mirror what you did in the first half of this year, or could you accelerate repurchases?

Mark DeVries:

Okay. Great. And then maybe a question for Roger. I mean, just given kind of fintech valuations, is there anything that looks interesting here to deploy that capital inorganically?

Mark DeVries:

Okay. Got it. Thank you.

John Pancari:

Good morning.

Roger Hochschild:

Good morning, John.

Roger Hochschild:

I guess the only thing I can say is both the consent order and the investigation are in the area of student loan servicing. But beyond that, there really isn't anything else I can add at this time.

John Greene:

Yes. So John, the way I would think about it is we're continuing to kind of run and manage our business and try to be disciplined in the way we distribute expense dollars and spend expense dollars. Certainly, there's puts and takes in every single expense line. And we've continued to have our foot on the gas in terms of new account acquisition and media, which contributed to the marketing increases. The rest of it is we consider as part of the cost of our operation and we're trying to make it as efficient as we can.

John Greene:

Yes. So what we're seeing is the lower FICO bands normalizing. So -- and you would expect those to normalize more quickly than the higher FICO bands and frankly, we consider that when we do our underwriting. What -- interestingly, what we've seen is early stage delinquencies across the board have corrected in later-stage buckets more quickly than we see it in the past. And some of that could be our -- some of the work we've done in terms of analytics an optimized time to contact and collection strategies and some of it could be just customer performance. So there's really no takeaways from the portfolio other than it continues to perform very, very well and gave us a degree of comfort as we reduce the overall reserve rate.

Operator:

Thank you. Our next question will come from Betsy Graseck with Morgan Stanley. Your line is now open.

Roger Hochschild:

Good morning, Betsy.

Roger Hochschild:

I wouldn't necessarily link those too. I mean, I think what we can say is that, we do not see anything that would change our view that nonmarketing expenses this year would grow in the low single digits. And we did indicate that we would hope to have it concluded, but it's done by an independent committee that reports to the Board.

Roger Hochschild:

Yes. The termination of the buyback has nothing to do with our capital levels. It does not necessarily require the investigation to be fully complete for us to resume there are many complex factors that go into it.

John Greene:

Yes. The overall interchange has largely been a function of the robust sales volume. So, we're up – our sales were up 20% through the first half of the year, 18% through the – into the second quarter. So that's driving overall interchange. Now mix does come into play in terms of the interchange rate. And obviously, we don't spend a lot of time discussing that. But overall, the solid business performance is driving interchange. And then maybe your follow-on might be, rewards. We did see a spike in rewards which to me, wasn't a bad thing whatsoever. What happened was gas was one of the 5% categories in the quarter, everybody knows about the inflation at the pump. So, we had a larger percentage of customers maxing out on that 5% category, which drove the rate up. But overall, the rate – the rate is – we expect 2 to 4 basis points of inflation there. So, interchange in the aggregate, super strong interchange rate very, very solid rewards coming in at expectations.

Operator:

Thank you. Our next question will come from Meng Jiao with Deutsche Bank. Your line is now open.

John Greene:

Yes. So it is holding. So through Monday, it was up 17%. So again, incredibly robust. Those figures actually have surprised me a little bit to the upside, which is nice. We're seeing travel increase. Obviously, we're seeing petroleum increase. And the everyday categories have increased. The one thing that we did see through the first half is home improvement spend actually decrease versus everyday spend. So it's still positive year-over-year, but not increasing at the same rate as everyday spend in other retail.

John Greene:

Yes. We're seeing a little bit of it. We believe that in terms of gas that there's -- certainly, it's significantly up year-over-year, but call it the volume of transactions indicate a certain level of substitution or decrease in consumption levels. And then across the other categories, nothing discernible at this point, but we do expect in the second half of this year with the high rate of inflation that consumers are going to make some choices and substitutions or decrease in consumptions will likely happen.

Operator:

Thank you. Our next question will come from Kevin Barker with Piper Sandler. Your line is now open.

Roger Hochschild:

Yes. No, those aren't linked. And actually, I would view it as sort of a one-time move, and we feel very good about the credit in our student loan portfolio.

John Greene:

Yes, good question. So I would say that. So my expectation is that NIM will peak this year. And there are a number of factors impacting it. Certainly, you mentioned deposit costs. That's going to kind of create some impact. We're going to have impacts on credit, which will impact it. But fundamentally, our funding mix has changed, which will, I believe, will drive improved net interest margin versus historical levels.

Operator:

Thank you. Our next question will come from Mihir Bhatia with Bank of America. Your line is now open.

Roger Hochschild:

Yes. There are different competitors who will do different offers. We tend to try and be more consistent and sustainable. So, we like the double cash back for the first year has worked very well for us. So yes, someone will be $300, $500, you'll see different issuers doing very long-term balanced transfers. We just don't think that's really driving sustainable growth. And a lot of that promotional activity can drive sort of new accounts, but not necessarily long-term relationships. So, we like our long-term focus and approach, and it has served us well in a variety of competitive environments.

Roger Hochschild:

Yes. The decision was made by Discover.

Operator:

Our next question will come from Dominick Gabriele with Oppenheimer. Your line is now open.

Roger Hochschild:

Yes. I mean it's a bit of a different answer for the portfolio, but for new accounts. But I would say for our new accounts, virtually all of it is want based, right. We're not accepting anyone who doesn't have significant availability on other credit cards outside of potentially our secured card where some of those people, we represent their first card. So, it really is about want and having a better value proposition than they're seeing with their other cards.

Roger Hochschild:

Yes. I would say we tend to look out roughly four to five years, but it is not as sensitive in terms of whether it's in 18 months or two years or 2.5 years. If you think about this is a long-term product and the cash flows associated with a credit card. And if you're not careful, you can find yourself whipping around your new account criteria every week based on sort of the latest change in economic forecasts. So while we can react quickly if it's far enough out, you're not going to see sort of continuous adjustment for that. And then for the portfolio, it's much more driven by account level dynamics, we're really looking at the risk of individual accounts.

Operator:

Thank you. Our next question will come from Bob Napoli with William Blair. Your line is now open.

Roger Hochschild:

Yes. Great question. So I did talk about one of our latest network-to-network deals. So we continue to invest and expand acceptance. And some of those deals to also generate volume and more cross-border volume for us. We remain in a wide range of discussions with different fintech players, truly around the world, but we tend not to comment on deals. I would point out too, though, we see a lot of value from the network, not just in the Payment Services segment, but for the differentiation and capabilities it gives our card issuing business, and in particular, the support it provides for rewards on debit, which is a real differentiator in the marketplace.

Roger Hochschild:

Yes. I think long term, it will be really exciting and a great benefit for the business and provide another entry point into the franchise versus most of our customers now coming from the credit card. We continue to be deliberate in terms of how we grow that. We want to make sure that we're really solid operationally that we have the right fraud prevention in place. But it's a business we're going to scale for the long term. And again, really excited about some of the early signs we're seeing in terms of cost per account and the usage from some of the customers we're putting on.

Operator:

Thank you. Our next question will come from Don Fandetti with Wells Fargo. Your line is now open.

John Greene:

Yes. Yes. Great question. So, I'm going to kind of break it into kind of two categories. So very pleased with the team's execution when we go into the ABS market. I feel like the offerings are solid and the execution has been very, very good. The other side of the coin is, when we were in that low-rate environment, the all-in rates on some of those transactions were unbelievable. We were down at 71 basis points. So, it took me personally a little bit to come to terms with something in the 2s or 3s right now. But that's a function of where we are and relative to what we're driving in terms of top line yield, it's still super-efficient, secured and an important funding source. The rest of the funding stack continues to be stable. The broker CDs that you mentioned, they're pricing higher than our online deposits and we're trying to get the right balance in terms of, ensure we're competitive, that we're not a market leader in terms of pricing – deposit pricing decisions, but also not having to kind of lean into more expensive funding sources. But we'll continue to evolve there and make sure we're making good, efficient choices for the franchise.

Operator:

Our next question will come from Arren Cyganovich. Your line is now open.

John Greene:

Yes, Arren, thanks for the question. Very little. So, we modeled out a sustained high payment rate normalization back in through 2023 and frankly it’s a payment rate should reduce, that provides some more energy for growth. We haven't anticipated that the drivers of growth have been kind of the strong sales performance, the new accounts that we put on the books in the later part of '20 and into '21 and into this year. And customers putting our card top of wallet. So we've been really pleased and feel like the balance of kind of risk versus opportunity in terms of additional growth is probably more on the opportunity side at this point.

Roger Hochschild:

Yes. That's something I can't comment on. I would say though, in terms of internal, just to reinforce it is independent from the Board. But I can't comment on our discussions with regulators.

Operator:

Thank you. This concludes today's Q&A. I would now like to turn the program back over to Mr. Wasserstrom for any additional or closing remarks.

Operator:

Thank you. Ladies and gentlemen, this concludes today's event. You may now disconnect.

Eric Wasserstrom:

Thank you, Ashley. And good morning, everyone. Welcome to today’s call. I'll begin on Slide 2 of our earnings presentation, which you can find in the Financials section of our Investor Relations website, investorrelations.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 fourth quarter earnings press release and presentation. Our call today will include remarks from our CEO, Roger Hochschild; and John Green, 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 will be permitted to ask one question, followed by one follow-up question. After your follow-up question, please return to the queue. Now, it's my pleasure to turn the call over to Roger.

John Greene :

Thank you, Roger. And good morning, everyone. Once again, our results this quarter reflect strong execution on our business priorities with accelerating loan growth and solid credit performance. I'll begin with our financial summary results on Slide 5. There are a few things I'd like to call out here. The first is that our net income is lower year-over-year because of our reserving actions. In the first quarter of last year, we had an $879 million reserve release, while this quarter included $175 million release. Adjusting for reserve changes, our profit before tax and reserves would have been up 19% year-over-year. Second, our reported total revenue net of interest expense increased $107 million, or 4% from the prior year. However, this included $162 million net loss and equity investments. Excluding this loss, total revenue increased 10%. These points underscore the strength of our core earnings power even in a fluid economic environment. Let's turn to the details of the quarter. Looking at Slide 6, net interest income was up $149 million or 6% driven by improved net interest margin and higher average receivable. NIM was 10.85%, up 10 basis points from the prior year and four 4 points from the prior quarter. The year-over-year increase in net interest margin reflects lower funding costs and a favorable shift in funding mix partially offset by a higher mix of promotional rate balances. We made further progress on our funding mix with consumer deposits now making up 71% of total funding. On a sequential basis, the modest increase in NIM was driven by light link improved revolve rate on credit card loans partially offset by increased funding costs. The better revolve rate reflected a 70-basis point decline in the payment rate quarter-over-quarter. This helped boost sequential loan yields by 5 basis points. However, the payment rate remains nearly 500 basis points of pre-pandemic levels. We continue to expect that the normalization in the payment rate will continue through the back half of 2023. Receivables were higher driven by card, which increased 10% year-over-year from the continued strong sales and robust new account growth last year and into this year. Organic student loans increased 4% reflecting solid originations through the 2021 peak season. Personal loans were down 1% due to a sustained high payment rate. Looking at other revenue on Slide 7. Excluding the $162 million loss in equity investments, non-interest income increased $120 million, or 26%. This was driven by net discount and interchange revenue, which was up $79 million, or 33%, reflecting strong sales. Sales were up 23% year-over-year with growth across all categories. Inflation drove a modest portion of the growth in the quarter, and we expect that inflation will remain a benefit to sales growth over the short term. Strong sales also drove higher rewards expense compared to the prior year. However, the rewards rate was down two basis points year-over-year. We still anticipate the full year rewards rate to increase two to four basis points. Loan fee income was up $33 million, or 31%, primarily driven by an increase in late fee instances. Moving to expenses on Slide 8. Total operating expenses were up $49 million, or 5% year-over-year. Excluding marketing investments, expenses increased just 1%. Compensation expense was slightly down year-over-year on lower bonus accruals and headcount, which was partially offset by higher average salaries. We expect some degree of salary and wage pressure in 2022, and possibly into 2023 as we take steps to remain competitive. Marketing expense increased $38 million, or 25%. We continue to invest for growth in our card and consumer banking products, including support of our relaunch cashback debit products. Information processing increased $16 million, or 15% year-over-year versus a low level in the period a year ago. This expense was flat sequentially. Going forward, we will continue to prioritize investments in analytics to support growth, innovation, and generate operating efficiencies. Moving to Slide 9. Net charge-offs remain low and we’re in-line with our expectation for modest credit normalization. Total net charge offs were 1.61%, 87 basis points lower than the prior year and up 24 basis points from last quarter’s record low. Total net charge-off dollars were down $160 million -- $169 million from the prior year and up $55 million sequentially. Moving to the allowance for credit losses on Slide 10. This quarter, we released $175 million from reserves and our reserve rate continued to decline dropping 17 basis points to 7.1%. The reserve release primarily reflects the sustained strong credit performance in our portfolio, partially offset by loan growth. Looking at the macroeconomic environment, the pandemic now has a lesser impact on her outlook. The primary sources of risk have shifted to the impacts of inflation and a potential slowdown from Fed actions. While the risk has shifted, the economic view of the U.S. consumer remains healthy. Looking at slide 11. Our common equity tier 1 for the period was 14.7%, slightly lower than the prior period and still well above our 10.5% target. We repurchased $944 million of common stock during the quarter executing on our remaining authorization. Our board of directors also approved a new $4.2 billion share repurchase program that expires on June 30, 2023 and increased our common stock dividend by 20% to $0.60 per share. This repurchase authorization represents our largest ever over a five quarter horizon. It is evidence of our commitment to returning excess capital to shareholders while sustaining our investments in strong organic growth. Concluding on Slide 12. Our outlook for 2022 remains favorable, and we are improving some elements of our expectations. Starting with loans, spending trends through the first quarter and a modest decline in the payment rates improved our conviction for high-single digit growth. We are revising our view on NIM. We now see 5 to 15 basis points of upside for the full year relative to the first quarter. This view includes five Fed rate hikes at 25 basis points each. Our prior view reflected two rate hikes of the same magnitude. If the Fed increases rates beyond this, it would provide modest upside to net interest margin. Despite inflationary pressures, there's no change to our guidance for operating expense. Marketing is expected to be above 2019 levels with non-marketing expenses up low-single digits. We are improving our credit outlook. We expect losses to be between 2.2% and 2.4% for the full year. While there's still some uncertainty about the back half of this year, our current credit performance and delinquency trends give us confidence in a tighter range. And as previously mentioned, our board recently approved a new share repurchase program and increased our dividend. In summary, loan growth accelerated as we benefited from robust sales and strong account acquisitions last year and into 2022. Credit performance reflected our disciplined approach to underwriting and credit management with moderate normalization as expected. We manage operating expenses while investing in new product, features and functionalities. And our highly capital generative model enable us to increase our dividend and share repurchase authorization while supporting strong organic asset growth. These results demonstrate the resiliency and flexibility of our integrated digital banking and payments model. And I'm confident that we are well positioned for continued profitable growth through a range of economic conditions. With that, I'll turn the call back to our operator to open the line for Q&A.

Bill Carcache :

Thank you. Good morning, Roger and John.