Discover Financial Services
Q3 2022 Earnings Call Transcript

Published: 25 Oct 2022

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 Third Quarter 2022 Discover Financial Services Earnings Conference Call. All lines have been placed on mute to prevent any background noise. I will now turn the call over to Mr. Eric Wasserstrom, Head of Investor Relations. Please go ahead.
Eric Wasserstrom:

Thank you, Katie and good morning everyone. Welcome to todayâs call. Iâll 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 quarterâs 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, itâs my pleasure to turn the call over to Roger.
Roger Hochschild:

Thanks, Eric and thanks to our listeners for joining todayâs call. Iâm very pleased with our results this quarter. Against a fluid macroeconomic backdrop, we generate strong financial performance while continuing to advance our strategic priorities. Letâs start with a summary on Slide 3. For the third quarter, we reported net income of $1 billion after tax or $3.54 per share. Over the past three months, as Fed policy has become more restrictive, it has made fears of a recession more acute. Against this backdrop, the key narratives of the third quarter results are the strength of our balance sheet and the quality of our earnings. Our increase in revenues this year has been largely driven by our strong receivables growth with loans up 17% year-over-year. This growth was driven largely by elevated sales volume and the increased number of new accounts weâve added since mid-2021. We continue to use a through-the-cycle approach to underwriting, which considers all stages of a credit cycle, including downturns. As part of our conservative credit management, we marginally tightened our new account underwriting criteria this quarter. Given these factors, we consider our growth to be consistent with current macroeconomic conditions. Naturally, discussion of â session of elicits concerns about credit quality, but the credit performance of our loan portfolio at this stage does not suggest anything other than gradual normalization. Nonetheless, a late-cycle environment requires a particular awareness of changing conditions and underscores the importance of our strong financial condition. We also continue to advance our strategic priorities. As a few examples, in August, we expanded our global presence with the signing of Woori Card of the largest issuers in South Korea. The extension of this relationship as well as the number of new network partnerships weâve announced this year highlight our focus on expanding our international presence. We continue to demonstrate the value of our network and our growing relationships with fintech partners. As an example, we announced in October that we will facilitate payments for TYDEiâs new healthcare vendor management system, which will digitize and streamline payments in an industry where legacy purchasing is still primarily manual. Finally, this summer, we announced the opening of our new Advanced Analytics Resource Center at our downtown Chicago location. The first cohort of 75 individuals, which we selected from over 1,000 applicants has already started, and we intend to grow the program with an additional cohort in 2023. This follows the grand opening of our customer care center in the South Side neighborhood of Chatham earlier this year and underscores our commitment to bring additional jobs to Chicago while supporting great customer experiences. Iâll now turn the call over to John to review our results in more detail.
John Greene:

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

Thank you, sir. Weâll take our first question from Ryan Nash with Goldman Sachs. Your line is now open.
Ryan Nash:

Hey, good morning guys.
Roger Hochschild:

Good morning.
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. Iâm 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?
John Greene:

Great. Okay. Thanks for the question, Ryan. Thereâs a lot there. So, let me start with the fundamentals that weâre seeing. So the liability side of the balance sheet is certainly subjected to increases in deposit funding costs as a result of competitive actions and general needs across the market to attract some deposits. With that said, the 11% plus we delivered in the third quarter; we do expect some upside from that as a result of the Fed hikes in September. So certainly, sequentially into the fourth quarter, weâll see further improvement. Now, beyond the â excuse me, beyond into the fourth quarter â weâll see improvement. Beyond the fourth quarter at this point, weâre going to reserve any commentary. But what I would say is, we donât expect any specific, Iâll say, seismic changes to net interest margins in 2023 based on the stability of our funding base and turn access to multiple sources of funds.
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 youâre making to underwriting? And what do you think this might mean for growth over the intermediate term? Thanks.
Roger Hochschild:

Sure. So, I would start by saying, in general, it remains a very good environment. Weâre seeing cost per account on the prime side below what we had last year. The value proposition is resonating well. For the new account space at the margin, we tightened some of those segments that will be most volatile in a downturn. So, I think the lower end of prime. And weâre ready to take further action on new accounts or the portfolio side. But again, Iâd say overall, a very good environment, and thatâs part of why youâre seeing such strong growth.
Ryan Nash:

Got it. Appreciate the color.
Operator:

Thank you. Our next question will come from Moshe Orenbuch with Credit Suisse. Your line is now open.
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 youâre 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?
Roger Hochschild:

Yes. So it is hard Moshe to know what individual competitors are doing. I would say in general, most of them are much broader spectrum lenders than we are. And so my guess is weâd be seeing some stress at the lower ends of their books. For us, a rising rate environment creates a lot of focus on debt consolidation, which is the primary use of our personal loans. So, weâre maintaining a very disciplined credit criteria by seeing strong originations in that segment.
Moshe Orenbuch:

Got it. Thanks. It is interesting. I mean, I think weâve seen that for others that are at the higher end of the credit spectrum where the stress youâre 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 youâre still well above. Just talk about, I guess, the appetite for that given â and does the kind of macro environment figure into that? Just talk about the appetite for the buyback once that restarts? Thanks.
John Greene:

Yes. Sure. Moshe, Iâll take that. So from a overall capital level, we are very well capitalized, right? So, weâre 13% approaching, 14% on the CET1. Our target is 10.5%. The credit book has been very, very stable. Itâs normalizing, but overall, very, very stable. So the capital allocation priorities through the firm remain in place. So first is to invest in strong organic growth, second would be a return of capital, and then third, perhaps a bolt-on acquisition, and weâre going to do that will likely be in the Payments segment. So overall, those priorities didnât change. So the suspension remains in place, but weâre hopeful that it will resume â buybacks will resume here in the fourth quarter.
Moshe Orenbuch:

Thank you.
Operator:

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

Thanks. Good morning. John, I wanted to just walk through the expense guide increase. You mentioned itâs a blend of marketing and comp costs. Could you just parse apart what part is â how much of each sort of contributed to the increase? And Iâm 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? Iâm just trying to figure out what changed in terms of the comp cost?
John Greene:

Yes. Yes, happy to help with that, Sanjay. So let me provide some context upfront here. So year-to-date total expenses are up 7%. Comp expense is up 5%, and excluding marketing, our expense base year-to-date is up 2%. So actually really, really what Iâll say first half of the year and into this quarter some strong fundamentals. Now, we did have a significant growth in the asset base, which of course, means that there are accounts that weâre going to have to service. And you might have seen a press release that came out that indicated we were hiring about 2,000 servicing agents through the balance of this year and into next year depending on the balance sheet and our customer value proposition and metrics. So overall, the strong growth and the strong acquisition has necessitated investments in our people. Weâll continue to do that. Weâve also made specific investments in information technology, specifically around resources advanced analytics in order to further position us to be able to grow profitably and then also enhance underwriting and customer targeting. So, we believe all those investments make perfect sense for the long term. And what youâre seeing here in the third quarter is a combination of what Iâll say is a tough comp as a result of some turnover last year. And then us coming on with backfilling resources, what Iâll say is salaried resources as well as the investments I talked about in terms of customer service. So hopefully, that provides some context and color to your question.
Sanjay Sakhrani:

Okay. Thatâs very helpful. And then I know weâre trying to read between the lines in terms of the student loan servicing inquiry or investigation thatâs 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 itâs just a matter of timing. Is that a correct statement?
John Greene:

Yes, that is a correct statement. So no change. Obviously, when we have some news to share, weâre going to share it. The expense guidance we provided and the updates reflect those items I discussed on your previous question and no specific changes related to expenses related to the buybacks as mentioned.
Sanjay Sakhrani:

Okay. Great. Thank you.
Operator:

Thank you. Our next question will come from John Hecht with Jefferies. Your line is now open.
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 â just because itâs a topic that we havenât really talked about in detail recently your perspective on rewards and the competitive environment around rewards and what that means for the intermediate term?
Roger Hochschild:

Yes. Sure. So a lot of the most intense competition on rewards is in the super prime segment, and weâve talked over the last year or two, how we think some of the propositions issuers are putting out arenât necessarily sustainable in the long run. As John mentioned, our rewards costs are moving up exactly as we forecast. We havenât felt the need to make any structural changes to our program. So as you can see from the growth in the new accounts, our value proposition competes very well in that prime revolver segment. And so while the market is always competitive, we bring a differentiated value proposition that resonates well with consumers.
John Hecht:

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

Yes. I would say more recent vintages are performing exactly in line with our expectations, right? I mean every vintage got distorted during the pandemic. So you saw it cut across the curves. But again, we feel very good about the performance.
John Hecht:

Okay. Thank you guys.
Operator:

Thank you. Our next question will come from John Pancari with Evercore. Your line is now open.
John Pancari:

Good morning.
Roger Hochschild:

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 youâre 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 Greene:

Yes. John thanks for the question. So, what we said in the past and what weâve told our Board and what weâre targeting is an efficiency ratio in the high 30s . And through this year, weâve done a pretty good job in terms of being able to deliver that. Certainly the really strong growth and the great performance through the first half on expense â on the expense base. And then the third quarter reflects some investments and despite those investments, still below 40%. Weâre going to continue to make investments where we see an opportunity to drive great returns for our shareholders. And as we approach 2023, we are aware that the economic environment is a little tougher. We do feel like we have remaining tailwinds in terms of asset growth and we do have investments weâre going to continue to make. So, I would say for 2023 specifically, we will come out in January to give more specific details. But the overall commitments remain in place, commitment to positive operating leverage and efficiency ratio south of 40% and expense discipline while investing for growth.
John Pancari:

Okay. Thank you. Thatâs 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 youâre 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 youâre looking at the economy, the impact on the economy plays out? Thanks.
John Greene:

Yes. Great. Yes, thanks for that question. So a little bit of context there. So, we put on about $5.5 billion to $5.6 billion worth of assets in the quarter. Our reserves increased by $304 million. So, as we look at the portfolio and the macro environment, weâre seeing the portfolio continuing to be very, very stable but normalizing. The macro environment indications of a recession are certainly increasing. Roger mentioned in his comments about some mild â in his comments about some mild tightening. So in terms of expectation around reserves, weâll continue to take a look at the macros. Weâll run multiple scenarios and then make sure the balance sheet, the portfolio specifically continues to perform as anticipated and will make appropriate calls for reserves under GAAP. Itâs really tough to give any specific guidance on that other than weâre going to be mindful of the macros, continue to watch the portfolio, and that prime revolver targeting we do, tends to add high-level stability. As matter of fact one other point that may be useful not specific to reserves, but rather charge-offs. You have to go all the way back to the second quarter of 2011 to see charge-offs that â charge-off rates that is north of 4%. So, weâre seeing great stability this year, and we expect it to be stable next year as well.
John Pancari:

Got it. Okay, thanks for taking my questions.
Operator:

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

Hi, good morning.
Roger Hochschild:

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 youâre thinking â and I know you just detailed a little bit, but how youâre 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 youâre thinking about that trajecting as we continue to go through a Fed rate hike period here?
John Greene:

Okay. Yes. So thereâs a lot there. And as you know, itâs fairly complex Betsy, but Iâll do my best to create some transparency here. So â and let me start with the loan yields. So 80% of our book is floating rate of the asset side. So as the Fed increases, that creates the opportunity to move the contract rate up with the Fed changes. And correspondingly, if the Fed were to come down, the contract rate would come down. So, what weâre seeing there is in a rising rate environment. We still expect 3 basis points to 5 basis points of yield improvement. So net interest margin yield improvement over a 12-month period. So, we saw significant increases in September. It looks like based on the forward curve, thereâs another maybe as much as 125 basis points of further Fed action this year, and then next year, depending on the economy, there could be a couple more or thereâll be a pause. I donât think there will be much in the way of Fed rate reductions until maybe as late as 2024. So what that means is, weâre going to get the benefit from the Fed rate increases into the portfolio. Weâre seeing deposit pricing continue to go up. We havenât been a price leader on that. Certainly, weâve been a follower to make sure we have a positive value proposition for our customer base. And then the next question would be around betas and what do you think about betas. So, Iâm going to try to address that right now. So as thereâs greater disparity between our rates from a deposit standpoint and the brick-and-mortar banks. It creates plenty of opportunity for us to market into those customers and theyâll find an attractive value proposition, which should help dampen the impact of further rate increases. So, we do think the combination of the Fed increases, us being able to manage the deposit book, but in a rising rate environment, stability from a credit standpoint, but normalization, which will create a bit of incremental interest reversals impacting net interest margin. And then ultimately, the pricing decisions weâre going to make where we have that flexibility to make sure weâre making good decisions for our customers and for our shareholders. So ultimately, it nets out that we expect relative stability over net interest margin through 2023.
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 youâre 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, thereâs no obligation to put a notification into the market that you can resume. Thanks.
John Greene:

Correct. There isnât an obligation, but we would likely put an 8-K out.
Betsy Graseck:

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

Yes.
Operator:

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

Yes. Thank you and good morning. So, I just following up on â it was good to hear to resuming the buybacks. I guess that would suggest that the review is behind you. But would you expect them to get your to go towards your 10.5% target capital ratio? And over what time frame would you like to do that? Or what kind of a buffer do you want above that 10.5%?
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 weâre hopeful, but thereâs ultimately, it will be a decision that the Board helps with. So in terms of the 10.5% target, so weâve been well north of that for quite some time, thereâs â 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 weâre 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.
Robert Napoli:

Thank you. And the follow-up, just on normalization of credit losses. As we think about normalized credit losses there, looking back over history, credit cards, high-3s, I guess, or mid-3s to high-3s personal loans in the 4% range. Is that the way we should think? Is there anything thatâs changed? Should we continue to think about normalized credit losses in that kind of an area?
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, Iâm 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 â 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 Iâd say you should apply when youâre working through your forward-looking outlooks.
Robert Napoli:

Thank you.
Operator:

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

John, personal loan growth was pretty strong this quarter. Just wanted to get your thoughts on the outlook there and growth. And also any updates on your home equity lending initiative?
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. Weâve been â we set strength in the underwriting for that product, and itâs given us greater confidence to be able to market that product, and thereâs been a high level of appeal to it. So, weâll continue to be mindful of the product in the face of a tougher economic condition. But certainly, we feel like itâs a good product and its meeting customer needs, and thatâs helped drive the growth. In terms of kind of forward-looking guidance, Iâm 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, thatâs portfolio is relatively small. So itâs actually not moving the dial at this point from an earnings standpoint. But what weâve seen is a great level of interest in the second lien product, and weâre also originating a first lien product as well. So both products are performing well and nice appeal.
Don Fandetti:

Thanks.
Operator:

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

Good morning. Thank you for taking my question. Maybe I just wanted to start with â if you just take your guidance for NIM and loan growth, and I think that works out about four point effectively works out of fourth quarter NIM of at least 11.2% and $3 billion plus NII. Is that the right way to think about it and frame the exit rate for NIM? And then should NIM, NII just increase from there given loan growth and your comments about NIM stability. Am I thinking of that correctly?
John Greene:

Yes. So Mihir, thanks for the question. And Iâm certainly appreciate the specificity. What Iâve said about NIM is probably as far as Iâm 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.
Mihir Bhatia:

Okay. And then just wanted to ask about losses normalizing. A little previously, you had talked about it being in 2H 2023 is when we get to a more normalized loss rate. But I think there was talk that it could maybe push into even 2024 later. Any update on that? Thank you.
John Greene:

Yes. So normalization through 2023 and the macro environment will help us determine whether it pushes 2023 into 2024. But where weâre sitting today, weâre 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.
Mihir Bhatia:

Thank you.
Operator:

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

Thanks everyone for taking my question. Look, your customer base really represents a great sample of the domestic population. Iâm curious when you look at spending on a category level basis, if thereâs anything that youâre seeing that is a cause for concern, not asking are people spending more of the pump thatâs obvious with the inflationary pressures. But are there categories where youâre seeing people use their cards that are signals for something we should be thinking about?
Roger Hochschild:

Yes. Great question. So our base probably does skew a little upwards, so more in the prime, but weâre seeing continued strength in sales in October. So, Iâd say, year-over-year in the low teens. Some of the trends youâve 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 weâll switch categories, weâll 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.
Rick Shane:

Got it. Thank you very much.
Operator:

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

Thank you. Good morning, Roger and John.
John Greene:

Good morning.
Bill Carcache:

You mentioned that operating conditions are consistent with late cycle expansion historically. Fed hiking cycles have typically ended in slowing loan growth, but youâre already exceptionally strong loan growth seems to be accelerating, and certainly, the whole industry is enjoying strong growth. Can you share any thoughts around how youâd expect the late cycle expansion to end? And Iâll just layer in my follow-up now. And if you can give any commentary around what level of unemployment is implicit in your reserve rate and what a change in unemployment would mean for the reserve rate, that would be very helpful?
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 thatâs 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, itâs not a time probably to be widening credit. Weâre 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 weâre 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, weâll 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 Iâll pass it to John for part two.
John Greene:

Yes. Hey, Bill and in terms of kind of fundamental assumptions for kind of reserve setting. So, as I said earlier, we used a number of different scenarios, which included kind of non-recession scenario as well as the recessionary scenario. The recessionary scenario that we modeled. We certainly didnât wait as much as the non-recession and also the view in terms of the unemployment rate, thereâs pretty wide range right now, right? So some forecasted going north of 6% in a very, what Iâll say, a dark scenario. The more optimistic scenario is 4%. And so we looked at a complete range of scenarios and weighted it more towards stability with increasing unemployment. GDP, not as big a driver, but certainly an indication for the economy. Today, weâre at about 1%, and in 2023 in a recessionary scenario; there would be mild contraction, not deep contraction. So we think, overall, there will be general stability despite a tougher macro.
Bill Carcache:

Thank you.
Operator:

Thank you. Our next question comes from Kevin Barker with Piper Sandler. Your line is now open.
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 itâs the lower end of prime or other parts or maybe even certain vintages of customers that are on your books?
Roger Hochschild:

Yes. I mean all the vintages are performing well. As John said, I think weâre seeing the normalization occur faster and pretty close to fully normalized for the lower end of prime. While the payment rate has softened a bit and come down by about 70 basis points, it remains 400 basis points higher than 2019 levels. And so I think that speaks to the fact that thereâs still very strong employment market out there, people can find jobs, can find extra hours. And so a good amount of liquidity that is supporting the deferred for our segment.
Kevin Barker:

Okay. And then I know itâs a fluid situation, but the student debt repayment is supposed to restart here maybe early next year or who knows, given whatâs happening with the fighting in the courts, but do you expect any incremental impact to credit with a lot of student debt payments. Obviously, thereâs 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?
Roger Hochschild:

Not necessarily. Weâve watched it closely. I mean I think we have experienced an elevated payment rate, which has a dampening impact on loan growth as students have put more of their payments towards their private student loans. But we donât see anything that would have a significant impact on credit.
Kevin Barker:

Okay, thank you for taking my questions.
Operator:

Thank you. Our next question will come from Mark DeVries with Barclays. Your line is now open.
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?
John Greene:

Yes. I would just simply say that we will take a look at the opportunities we have in front of us, and weâll make what I hope will be great long-term decisions for our shareholders. And weâre going to be very, very mindful around discretionary spending and around employment decisions. So overall, we hope weâre good stewards of the company.
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 youâve got more of the 5% categories this quarter.
John Greene:

Yes. I wouldnât necessarily assume that what the point of the guidance between two and four is thatâs what we had said previously still within the range, and we wanted to keep it within the range. So that 2% to 4% is something that weâve seen historically, and to an extent, managed to, and weâll continue to do that. So I wouldnât lean on any particular information to assume the fourth quarter is going to be extraordinarily high or low.
Mark DeVries:

Okay, got it. Thank you.
Operator:

Thank you. Our next question will come from Bill Ryan with Seaport Research Partners. Your line is now open.
Bill Ryan:

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

No. So, I would say itâs pretty balanced in terms of cross-hold to the card base versus broad market. Probably the biggest change has been just the continued advancement in analytics and the underwriting approach there but very, very conservative. So a lot of employment verification, et cetera, heavily manual processes just to make sure we get it right because as opposed to the card business where you can manage credit as you go, you get one shot in personal loans. But again, I would say that the performance remains very, very strong there and itâs a lot of it thanks to that disciplined approach.
Bill Ryan:

Okay. And just one follow-up on the promotional balances, thatâs 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.
John Greene:

Yes. Thanks. Itâs stabilized in the third quarter, basically approach stabilization into the second quarter and itâs very close to where it has been historically.
Bill Ryan:

Okay, thanks for taking my questions.
John Greene:

Youâre welcome.
Operator:

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

Hey, thanks so much for taking my questions. Throughout the call and throughout other calls, youâve kind of laid out your playbook and pieces in particular on the credit side for a slowing economy. But maybe, Roger, you can just provide us with a more holistic idea of what discover would change across various pieces of the businesses to protect profitability in a, of tougher economic environment? And then I just have a follow-up. Thank you.
Roger Hochschild:

Yes. Iâd start by saying we donât 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 Iâve 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 weâre always in a recession, always be conserved on credit or was be tied on expenses, thereâs 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.
Dominick Gabriele:

Okay. Great. Thank you. And I think itâd be really helpful to understand what your â both of your views are on the normalization of the personal loan portfolio net charge-offs versus the credit card portfolio. Consensus has such a huge ramp on the personal loan side versus credit cards for 2023 and â not looking for specific guidance, but is there any reason why there would be such a difference in faster normalization on the personal loan side versus credit card as far as basis point movement as a percentage of loans? Thanks so much guys.
Roger Hochschild:

Yes. I mean we havenât put out product-by-product guidance. But I would say that given how we underwrite the personal loans, Iâm 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 wouldnât â that isnât necessarily behavior I would expect.
Dominick Gabriele:

Great. Thanks so much.
Eric Wasserstrom:

All right. Well, thank you everyone for joining us. And thank you, Katie. And if thereâs any additional follow-ups, please reach out to the IR team. Weâll be here and looking forward to speaking with you. Thanks, and have a great day.
John Greene:

Thank you.
Operator:

Thank you. Ladies and gentlemen, this concludes todayâs event. You may now disconnect.

Discover Financial Services Q3 2022 Earnings Call Transcript

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Discover Financial Services
Q3 2022 Earnings Call Transcript