Discover Financial Services
Q2 2011 Earnings Call Transcript

Published: 23 Jun 2011

[Operator:]

Welcome to the Second Quarter Earnings Conference Call. My name is John, and I'll be your operator for today's call. [Operator Instructions] Please note that the conference is being recorded. I will now turn the call over to Mr. Craig Streem. Mr. Streem, you may begin.

[Craig Streem:]

Thank you very much, John. Good morning, everybody, and welcome to today's call. As normal, let me begin by reminding all of you that the discussion today contains certain forward-looking statements about the company's future financial performance and business prospects, which are subject to risks and uncertainties and speak only as of today. Factors that could cause actual results to differ materially from these forward-looking statements are set forth within today's earnings press release, which was furnished to the SEC in an 8-K report, in our Form 10-K for the year ended November 30, 2010, and in our Form 10-Q for the first quarter of 2011, both of which are on file with the SEC. In the second quarter 2011 earnings release and supplement, which are now posted on our website at discoverfinancial.com and have been furnished to the SEC, we've provided information that compares and reconciles the company's non-GAAP financial measures with the GAAP financial information, and we explained why these presentations are useful to management and to investors. And we urge you to review that information in conjunction with today's discussion. Our call this morning will include formal remarks from David Nelms, our Chairman and Chief Executive Officer; and Mark Graf, our Chief Financial Officer and, of course, the Q&A session at the end. And now it's my pleasure to turn the call over to David.

[David Nelms:]

Good morning, everyone, and thanks for joining us. Before the market opened this morning, we reported all-time record quarterly earnings of $600 million or $1.09 per share, driven by continued improvements in credit as well as outstanding fundamental performance in both of our business segments. Our results this quarter reflect the Discover business model, delivering exceptional results despite a slow and uneven economic recovery. There are 2 items in our result this quarter that really stand out for me

[R. Mark Graf:]

Thanks, David. Before I add my comments on our second quarter performance, I'd like to take a minute to say that I'm really very excited to be part of the Discover team. My first few months have validated my initial perspective that I was joining a great organization, so I'm looking forward to the future and also very much to working with all of you. Now onto business at hand. Turning to the segments, Direct Banking, which includes cards, student loans and personal loans, earned $883 million pretax this quarter versus $386 million last year. In terms of yield on the card portfolio, we reported an 8 basis point decrease from the first quarter. This compression wasn't unexpected as we've grown the level of lower yielding promotional balances and have continued to experience impacts from the CARD Act. These combined impacts were partially offset by lower levels of interest charge-offs and, as a result, the overall trend in card yield continues to track above the level reflected in our card profitability model. Our total portfolio yield declined 17 basis points due to the card yield impacts I just mentioned plus the effect of our strategic shift toward lower yielding, but also lower charge-off student and personal loans. Looking forward, we expect some additional yield compression throughout 2011 due to these same factors, but expect this to be partially offset by ongoing improvement in credit. Second quarter net interest income was up $46 million year-over-year and $23 million from the first quarter. Net interest margin for the segment was down 7 basis points sequentially, driven primarily by card and student loans. This was partially offset by lower funding and related costs as interest expense as a percent of loans decreased 10 basis points. All in, we expect net interest margin to be relatively stable throughout the rest of the year. Other income was $22 million higher than the prior year. The primary driver of the increase was the second -- was that in the second quarter of 2010, there was included a degree of overlimit fee charge-offs that bled into quarter after we ceased assessing overlimit fees in February of that year. The current quarter also included transition services revenue related to The Student Loan Corporation and a small increase in the value of the federal student loans held for sale. Other income includes discount and interchange revenue, and as you can see in the financial supplement, we are now giving you gross discount and interchange revenue as well as rewards cost. So you don't have to wait for the Q to be issued to see this data. This quarter, discount and interchange revenue increased a bit ahead of our sales growth but this was offset by an increase in rewards. This increase resulted from some enhancements to the program as well as increased customer engagement. Continuing with expenses, we've spent a bit more aggressively on the back of credit improvements as operating expenses increased $119 million over the prior year. The primary components of the increase were as follows

[Operator:]

[Operator Instructions] And our first question comes from Sanjay Surigi (sic) [Sakhrani] from KBW.

[Sanjay Sakhrani:]

Two questions. One was, I thought the credit card receivables growth was particularly encouraging this quarter. I guess, should we assume that we're kind of past the inflection point now and growth should persist through the second half? And maybe you could just talk about, David, the distribution of that growth, how much of it came from existing customers versus new accounts? And then second question is, is it fair to assume that most of the look-back on the repricing related to the CARD Act is now behind us?

[David Nelms:]

Sure. Well, yes we were pleased with the sequential receivables growth and yes, we believe that suggests that we are still on track for getting to year-over-year growth in the second half. And we have certainly increased our new account acquisition, marketing spend, put in place programs and we have some of the things that have been working for a while now, like increased acceptance, that are continuing to help grow not only sales but now receivables. In terms of the CARD Act and in terms of the look-back specifically, Sanjay, I would say that we had just a very modest impact in the current quarter, and going forward, that impact would be de minimis.

[Operator:]

Our next question comes from Ryan Nash from Goldman Sachs.

[Ryan Nash:]

Just a couple of quick questions. So you saw 9% year-over-year spending growth, I think that was a little bit higher than I had expected. Can you talk about what some of the key drivers of that were? I know you, David, mentioned a little bit in the prepared remarks. Was it really new customer acquisition, existing customer spending more? Was it anything outside that, like that higher gas prices?

[David Nelms:]

Well, I think that the higher gas prices probably drive 2% to 3% of that, if you assume no substitution, and it probably is some. We don't know how much. But that really was in the place last quarter when we were up 6% year-over-year. If you look at the sequential acceleration, I would say the accelerated new account growth is probably the biggest single factor, but the underlying trends are the acceptance, the marketing, the branding is all continuing to work very nicely for us.

[Ryan Nash:]

Okay, just one other question on credit. Losses came in roughly 5% and I'm assuming we saw sequential improvement in each of the months. So from what you're seeing in the portfolio, can we move much lower? Are we starting to bottom out? How sustainable are we at these levels in terms of risk-adjusted returns at this point in the cycle?

[David Nelms:]

Well, I'd say that we have not bottomed out yet. If you look at the reduction in delinquency rates, as I mentioned in my prepared remarks, it will go lower from here. How much lower, we don't know. We don't know exactly when or at what level it will bottom out, but we certainly didn't see too many trends of it bottoming out if you look at the last quarter -- this last quarter's improvement.

[Operator:]

And our next question comes from Craig Maurer from CLSA. Craig Maurer - Credit Agricole Securities (USA) Inc. Two questions. First, could you discuss spending growth on, if you can, on a same-store sales basis? So trying to figure out, excluding the addition of new merchants, what you saw in terms of spend volume growth. Secondly, how do you see Capital One's acquisition or proposed acquisition of ING Direct and the asset generation capability or skills they might bring to that bank as threatening your own direct bank?

[David Nelms:]

Well, I don't think I can give you much on same-store sales. I would just say that we are -- we believe we're growing market share and it is coming from a combination of new merchants, growth of existing merchants and it's also a combination of new customers and growth on existing customers. So all of 4 of those factors are improving. In terms of ING Direct, we love Direct Banking. I think I just see this as a validation that we're not the only ones who see value in Direct Banking. To me, Direct Banking is the future of banking. And I think we are particularly well positioned because we are much more of a pure direct bank without the legacy branches and all that comes with it.

[Operator:]

Our next question comes from Mike Taiano from Sandler O'Neill.

[Michael Taiano:]

Just had a couple questions. I guess the first on capital. And obviously, you guys announced the $1 billion share buyback. But I guess if you just roll forward the model towards the end of 2012 and unless your loan growth is going to be a lot faster I think than you've suggested or if you're going to do a big acquisition, it seems like your TCE could end up sort of north of 12% even with the share buyback. And just was curious maybe, Mark, kind of helping us understand at what point would you also maybe reconsider about potentially upping that? And how do you think about it from the standpoint of SIFI [systemically important financial institutions] buffers and having dry powder for acquisitions?

[R. Mark Graf:]

Sure, Mike. I'd be happy to. I guess, regarding the SIFI, I'd start there. We obviously don't have any clear guidance on the SIFI topic at this point in time. We've got a lot of speculation and hearsay out there. We're hopeful that the regulators will take into account the relative size and complexity differences between ourselves and the majority of the other institutions in the over $50 billion bucket. What I can say definitively is that the current capital plan that we've got was developed with full transparency with our regulators and those same regulators provided us with a notice of non-objection to that plan. So we were very, very comfortable moving forward on that basis. Regarding the size and timing of the program itself, we took into account a couple of different factors, I guess, as we were looking at it. I'd list our current capital position, our ability to continue to generate excess capital and the current understanding of the likely direction of that evolving regulatory landscape we just talked about. We sized the program at about 8% of our current market cap. If you compare that to peer bank programs, it's within the range but it's at the high-end of the range. I don't have the numbers in front of me but I think the range is 2.5% to 8.5% roughly market cap as what we've seen folks do. So we felt comfortable that from a signaling perspective to the market that, that was the right place to be. I would tell you we will continuously monitor the market conditions as well as all those factors I noted we evaluated when we established the program. And if needed, we can have discussions with our board and our regulators about adjusting the program upward if we see that as necessary.

[Michael Taiano:]

Great. And then just a follow-up on sort of what the competitive environment looks like. And I think particularly Chase has gotten very aggressive in terms of cashback rewards programs of late. I'm just curious, given the widening out of risk-adjusted margins in the business with credit improving so rapidly, how do you think about sort of where pricing is likely to head over the next 6 to 12 months? Do you think you could get back to some irrational pricing? Or do you think given the consolidation of the industry that the guys that are there likely to stay fairly rational at this point?

[David Nelms:]

Well, I do expect rational competition. As you say, it's consolidated and I think the people who are left are fairly rational and profit-driven just as we are. We certainly have seen competition be restored and marketing be restored in the industry. But interestingly, our attrition rates remain low, in fact near historic lows, so really have not seen an uptick in our attrition. In new accounts, we've picked up our marketing but we're seeing good response rates anyway. And so -- and then you're seeing in our results, sales and receivables showing good solid gains despite the higher level of competition. So overall, my read on a macro basis is that both supply and demand have recovered at about the same rate with consumers being more receptive and with more being available from competition.

[Operator:]

Our next question comes from Betsy Graseck from Morgan Stanley.

[Betsy Graseck:]

Two questions, one on the account growth. Can you give us a sense of the composition, how much of that was BTs? And are you seeing the same type of response rate as you were pre-crisis or has there been an improvement beyond what you were experiencing before?

[David Nelms:]

Well, without giving specifics, I would say we've been pleased both with our response rates holding up and maybe even improving a little bit even as we ramp up mailings and Internet marketing and so on, which is a great sign. I've also been pleased with the activation usage and the particular sales usage of these new accounts. And so we've been very focused on -- sometimes you get an account that only does the balance transfer but we've been very focused on using that as a tool with ultimately getting customers who spend and earn their Cashback Bonus and contribute to the sales gain, and those metrics all look very good.

[Betsy Graseck:]

Okay, so I would think that, given Internet usage as well that maybe your cost to acquire is flat to potentially down. Are you reinvesting in the customer service end to get the usage rate up? Is that the right way of thinking about how the business is being run right now relative to maybe what it was pre-crisis?

[David Nelms:]

I would think more of about the improvement in credit giving the ability, and credit returning to more normal levels quickly is giving us some flexibility to increase more in both activation of current customers as well as more acquisition of new customers. And we've taken steps, you saw for instance the Cashback Bonus line was up quite a bit this quarter. I mean that's partly because we marketed it more. We're seeing more customers engage in it more, we're having less breakage, we're having more spending at the higher tier because the spend per account is higher. So I think we are looking across the portfolio of marketing and investments and getting some nice gains both from current and new customers.

[Betsy Graseck:]

Okay. And then second question is on Durbin impact. David, you mentioned a little bit about what the opportunity is to the degree we go with non-exclusives. Could you give us a sense as to how much extra capacity you think you have in your PULSE network? Can you talk about how quickly you think you could start new relationships up in the event that the legislation went that way? And then lastly, could you talk a little about more holistically about what you think the Durbin impact is as we head into third quarter for the various components of your income statement?

[David Nelms:]

Well, I think there's a lot we don't know right now. Hopefully, we'll learn a bit more next Wednesday when the Fed comes out with their guidance and one of the important factors is not just what is the guidance but what is the timing. And I would say we have -- our PULSE network is highly scalable. We have taken actions to build capacity in advance of potential demand because we were afraid we might not have time to ramp it up as quickly. And if we need to add even more capacity, we'll add even more. But we are positioned so that even if it was substantial that we would be able to, we think, accommodate a lot of that substantial volume increase should it be needed.

[Betsy Graseck:]

Are you talking about multiples of what you're doing today or...

[David Nelms:]

I wouldn't want to speculate on exact amounts, but it could be substantial for us, but we don't know how quickly and we don't know if it will really occur or not. We need to see the final rules and there's going to be a lot of competitive dynamics that play out probably over the next year or 2.

[Betsy Graseck:]

Sure. And then is there anything that would lead you add to the debit offerings that you have to date including more in the way of signature based on how Durbin comes out?

[David Nelms:]

Well, today, we are the -- only the third -- there are only 3 signature debit products out there in the world, we have the third, but it's tiny in terms of percentage. So we would certainly be poised if that should be needed as well. Certainly, most of industry observers are thinking more of that it's going to be one signature, one PIN sufficient. But should that not be the case, we would certainly -- we've got some maybe unique options that we would need to look at to help fulfill our customer needs.

[Betsy Graseck:]

Okay. So you've got flexibility either way it goes?

[David Nelms:]

Yes.

[Operator:]

[Operator Instructions] Our next question comes from Brian Foran from Nomura.

[Brian Foran:]

I guess do you think delinquencies can keep diverging from unemployment? And if delinquencies are at a 25-year low, should we expect losses to be at a 25-year low by the end of this year?

[David Nelms:]

Well, I would say that certainly, losses should continue to fall. Delinquencies are not as good of a predictor of bankruptcies, and I don't think bankruptcy filings are not anywhere near a 25-year low in the economy. So that is maybe a factor that could hold things up a bit. As we’ve talked about on earlier calls, we do think that the new job loss right now is probably having more of an impact because we have increasingly already recognized the losses from the longtime unemployed and from the people that are significantly underwater on their houses, and so we think that is why it's diverging. If you look at our current delinquencies relative to new job losses, it's not as far off the curve as if you look at the overall unemployment rate, which reflects a lot of people that have been unemployed for quite a long time.

[Brian Foran:]

I apologize if I missed this, but could you give us a core expense number for the quarter? I know you – I guess you didn't want to break out some of the individual items, but what kind of run rate should we think about going forward?

[R. Mark Graf:]

Well, I think if you look at the run rates going forward, I'd guide you to our financial summary and I'd point out a couple of different points. The employee comp and benefits line, that $230 million we're showing there for the quarter is probably a reasonable range proximity for what you should be looking at going forward. The additions in the primary quarter were really due to growth initiatives and the impact of SLC where we had only 2 of 3 months in the prior quarter. Marketing and business development at $124 million for the quarter. I would guide you back to the previous 2 quarters and say going forward, I'd be looking at something slightly higher, more in the range of those prior 2 quarters. Everything else, I would say, is pretty accurate for modeling purposes in terms of what you should be looking at.

[Operator:]

Our next question comes from Bill Carcache from Macquarie.

[Bill Carcache:]

I have, first, a big picture question for David. David, can you share your thoughts on the prepaid opportunity in the industry and whether you see that in any way serving as a growth driver for Discover in the future? And then a second question on student loan balances, are you still targeting $1 billion net receivables growth in 2011? And can you clarify what the growth outlook is both with and without PCI loans and also is the rate at which the PCI loans decreased this quarter a reasonable proxy for how quickly they'll run off going forward?

[David Nelms:]

Okay. I'm not sure I could remember all those questions. But in terms of the first one -- and, Mark, maybe you could. The prepaid is already a nice network opportunity, particularly in PULSE but also a growing amount of Discover network third-party volume is actually prepaid and we work with a number of the market leaders in the prepaid space. So that's contributing, for instance, to our 25% year-over-year PULSE growth in particular. And then we also issue some prepaid cards, some of our rewards are delivered through them. And in the future, we're going to continue to define profitable parts of the prepaid space. We don't think everything will necessarily be profitable in that space, but we do think that it is clearly a growing market opportunity and one that we will participate in, in a growing way over time. Mark?

[R. Mark Graf:]

With respect to Student Loan growth, I think we're still comfortable with that plus or minus $1 billion number for the year, and I think the other question was related to PCI loans this quarter and what's going on there.

[Bill Carcache:]

Is that $1 billion with and without – the $1 billion, does that include PCI loans when we look at the growth in 2011 or is that without?

[David Nelms:]

Bill, maybe it's best if we clarify that...

[Bill Carcache:]

Okay, no. Yes, that's fine. And then the last part of that was whether the rate at which the PCI loans decreased this quarter, if you kind of view that as a reasonable proxy, for how quickly they'll run off going forward?

[R. Mark Graf:]

Yes, I would say the overall expected cash flows from the PCI loans increased very modestly, so they're performing pretty much right in line with our expectation, so the impact on yield and amortization is immaterial. So it's probably a pretty good assessment.

[Operator:]

Our next question comes from John Stilmar from SunTrust.

[Jason Freuchtel:]

This is Jason Freuchtel stepping in for John Stilmar. We've seen in the monthly trust data elevated dollar recoveries recently, how should we think about longevity of recoveries helping loss improvement? Do you think there's going to be a near-term inflection point? Or is this is a longer-term phenomenon?

[David Nelms:]

I would say that right now we have an awful lot of inventory because of the last 3 years' elevated charge-offs. And also as some people have gotten back to work and have an ability to repay some of their loans, that's been helpful. I wouldn't expect any major movement necessarily one way or another. Over time, I would expect it to eventually start to diminish as we work through some of that inventory. And obviously, we're producing fewer charge-offs today at 5% to recover against in future periods.

[Operator:]

Our next question comes from Mark DeVries from Barclays.

[Mark DeVries:]

With your reserves currently over -- a little over 5% and 2Q charge-offs at 4.42% and as you indicated, still trending lower and basically, reserves at above kind of what would be the implied run rate for the next 12 months charge-offs. With that as backdrop, can you help us think about how you understand what the appropriate level of reserves are at this point?

[R. Mark Graf:]

Yes, I would say we're very comfortable with the current level of our reserve profile. Obviously, we've entered uncharted territory here in terms of credit performance, as I think we've indicated a few times on the call, and we continue to watch those developments intently. But I would say from our perspective, the reserving methodology is pretty heavily prescribed by the SEC and we're making sure we follow that to the letter of the law. So we feel comfortable with the reserves given where we sit right now.

[Mark DeVries:]

Is it reasonable to assume, though, if charge-offs continue to trend lower, we'll see more reserve releases?

[R. Mark Graf:]

Absolutely yes, no question about it.

[Operator:]

And our next question comes from Jason Arnold from RBC Capital Markets.

[Jason Arnold:]

It was also great to hear about adding to wallet share and new card members. Just curious if you could talk about marketing and rewards expenses going forward in a little bit more detail just given that there seem to be more opportunities to gain traction with consumers and potentially gain market share. Do you expect this to lead to somewhat higher expenses here than what you've talked about in the past?

[David Nelms:]

Well, certainly, our Cashback bonus and Rewards line is significantly higher now than it was a year ago and some of that is because of the higher sales itself, but even the rate relative to sales is elevated. And I do expect that to continue. The higher level of engagement marketing, some of the factors I went through earlier, we do expect to continue. I don't expect it to keep rising at the rate that you've seen it, an acceleration like you've seen in the last year. But I think we've sort of had a little bit of a step function up to a new higher run rate as we've enhanced our program and are getting great customer response.

[R. Mark Graf:]

And with respect to the marketing expense overall, I would say that, again, this quarter's number's probably a little bit light for what I would be expecting going forward. I'd point you back to the last 2 quarters previous to this one and something in that range is really what you should be looking for from us going forward.

[Jason Arnold:]

Okay, so it sounds pretty consistent with what you've talked about in the past, just spend a little bit more to make a little bit more. Is that a fair assessment?

[David Nelms:]

That's right. And our marketing expense will vary quarter-to-quarter. So for instance, our first quarter, we had some of our larger sponsorships with college football, Orange Bowl, hockey this past quarter. So it can be a bit up and down and this was a little bit down, even though the sales results are high that partly reflects what we said last quarter.

[Operator:]

Our next question comes from Don Fandetti from Citigroup.

[Donald Fandetti:]

David, obviously some of the economic data we've seen over the last month or 2 has signaled some moderation. Was curious if you've seen that in your spend trends if you strip out your market share gain going into June?

[David Nelms:]

Well, I really can't strip out the market share gains because competitors report after us, and we do feel we're making market share gains if I look at retailer sales. But what I'd say is I've looked very closely at the last couple weeks to see if we've seen any moderation as we started to see some of those lower confidence numbers in others. And the good news is that I'm not seeing it in my numbers at this point. Our sales gains a year-over-year are continuing to hold.

[Donald Fandetti:]

And do you attribute that to anything? Or is it more sort of a lag issue or…

[David Nelms:]

I mean our -- when customers use their card, it posts within days, so I don't think we would expect any lag issue unless there's a -- customers haven't reacted yet. I would certainly like to think we continue that momentum and I'm just really pleased with our marketing efforts and how our customers are responding.

[Operator:]

Our next question comes from Rick Shane from JPMorgan.

[Richard Shane:]

I just wanted to delve a little bit more into promotional balances. At Investor Day, you talked about migrating from a Q1 level about 12% ultimately to a normalized level of about 15%. Mark mentioned balances were up or promotional balances were up. I was just curious how far along you are from that 12% to 15% migration, how quickly you think you'll hit that target. And then finally, given what's going on competitively, is there any reason to think that, that target rate may move up or down that 15% long-term target?

[David Nelms:]

I'd say it could move up or down, but right now I think that's still a good, a pretty good number. We're not at 15% yet, but we do expect it to modestly move higher as we -- when we put on new accounts, for instance, you tend to have a higher percentage of promotional balances. And so as that mix of new accounts grows, you would expect it to normalize more to that order magnitude 15% range.

[Richard Shane:]

And again, is that a pretty quick migration given what's going on competitively? I mean, is that something you think you'll see that target rate in the next couple quarters?

[David Nelms:]

I would say just looking at the numbers more specifically right now that number is sitting at about 12%, give or take 11% or 12% in that range. So we've got some room to grow to get to that 15% level. We kind of look at BTs as a very cost-effective way to generate new receivables and increase our engagement and our relationship with our customers, so we're pretty comfortable with them in that range and I would say that the ultimate level you're looking at probably isn’t a bad place to be settling in.

[Operator:]

Our next question comes from David Hochstim from Buckingham Research.

[David Hochstim:]

Just following up on those questions. The spending of your existing customers or older customers, are you seeing any mix change within the quarter or since the quarter in terms of gasoline or discretionary purchases? It sounds like…

[David Nelms:]

No, I think the gasoline impact was about the same this quarter as it was last quarter, and we continue to see larger gains with the more creditworthy individuals and we're continuing to see transactors increase sales faster than revolvers. But as you can see from our growing revolving balances that we're now seeing those gains be really kind of across the board and that's why you're seeing us return to receivables growth.

[David Hochstim:]

Okay. And there was a question earlier about the look-back with the CARD Act, but when you're issuing 18-month 0% teasers, how do you avoid having some of effect on existing accounts from that?

[David Nelms:]

I'm not sure I understand the question. The CARD Act look-back doesn't have anything to do with new promotional balances being put on. Rather, it had to do with looking back on repricings that took back -- that took place in past periods to see if we are able to cure people to lower rates.

[David Hochstim:]

But aren't you obligated to compare rates on new accounts to existing accounts prospectively?

[David Nelms:]

No.

[David Hochstim:]

So it's really just the repricing after the rule change and that’s it.

[David Nelms:]

If I understand you correctly, yes, that's correct. We continue to be allowed to price the way we feel is appropriate. We just have significant restrictions on being able to change those rates for new accounts after the accounts are booked.

[Operator:]

Our next question comes from Brad Ball from Evercore.

[Bradley Ball:]

Another follow-up on the promo balances. Did you say what portion of the growth in the quarter were promotional balance-driven?

[David Nelms:]

We didn't. But I think if you look at our yield, you'd have to conclude that it wasn't -- that we saw growth in -- we didn't just see growth in promo balances, we saw growth in full-rate balances as well.

[Bradley Ball:]

Right. It'd be, what was it, 8 basis point decline in the yield, you're saying, was not entirely driven by new promo balances?

[R. Mark Graf:]

Yes, not at all. If you kind of decompress that a little bit, I guess it’s a couple different things. On the CARD Act side, you have the, obviously, the run-off of the default in the cash balances and then you also have the increased use of the promotional balances. And I would say the CARD Act piece of that was disproportionately larger.

[Operator:]

Our next question comes from Chris Brendler from Stifel Nicolaus.

[Christopher Brendler:]

I also want to talk about promo for a second. I recall -- if I recall correctly, you made a change a couple years ago where you amortized balance transfer fees into interest income now. Is that helping support the yield given your pickup in balance transfer activity? Or are those amortized over such a long period it wouldn't have an effect on a quarter-to-quarter basis?

[R. Mark Graf:]

I would say that, that is the accounting methodology we follow and the impact is relatively immaterial.

[Christopher Brendler:]

Okay. And then just more broadly on the same topic of the yield, the other part of that slide that I thought was interesting at Investor Day was the default rate balances and how high they continue to be despite how strong the credit trends have been. Have those started to tick down at all yet? Are we still looking at some potential card yield compression over the next year or so as that falls to a more normal level?

[R. Mark Graf:]

I would say we've seen some modest reduction there, but not dramatic reduction there. In the near term, I'd expect some relative stability in the margin because the CARD Act impact, the increased user promos are being heavily offset by the lower levels of charge-offs as well as improvements in our cost of funds. Over a longer-term horizon, clearly, there will be impacts from those and I'd point you back to our Investor Day discussion for March in terms of longer-term expectations for margin.

[Operator:]

[Operator Instructions] And our next question comes from Bob Napoli from Piper Jaffray.

[Robert Napoli:]

David, just wanted -- hoping you could give some update on your thoughts on your movements on the mobile -- on your mobile strategy with Isis being more open. And are you still -- how closely are you still working with Isis and where do you think -- there's obviously announcements every day with Visa and American Express coming out with -- as well as MasterCard. Where do you stand? And what direction do you think this all goes from here?

[David Nelms:]

Well, I remain bullish on the potential for mobile payments and we continue to be very active not only with Isis but also with many other efforts throughout the industry. I think importantly, we continue to expand mobile-enabled terminal deployment throughout the country and our Zip has very broad representation in terms of acceptance on terminals. We also have passed the 500,000 account mark in terms of cards that have Zip, and we have really focused our efforts on some of the early adopters and people who have requested cards. So we continue to make progress on a lot of fronts with it. But I think sitting here today, it's going to be tough to pick necessarily the winners and losers but I am convinced that it will gradually gain traction and be important for us and our customers.

[Operator:]

We have no further questions at this time. I will now turn it back to you, Mr. Streem, for closing remarks.

[Craig Streem:]

Thanks, John. Thanks to all of you for your interest and for your questions this morning and, of course, please feel free to get back to us with any follow-ups. Have a good day. Thank you.

[Operator:]

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