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spk01: Please stand by. Your program is about to begin.
spk00: If you need assistance during the conference today, please press star zero. Good morning.
spk01: 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 speaker's remarks, there will be a question and answer session. If you would like to ask a question at that time, please press star 1 on your telephone keypad. If you should need assistance during the conference today, please press star 0. Thank you. I would now turn the call over to Mr. Eric Wasserstrom, Head of Investor Relations. Please go ahead.
spk21: Thank you, Katie, and welcome everyone 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 second quarter earnings press release and presentations. 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'll 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.
spk13: 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 in 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 4 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 I 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.
spk04: Thank you, Roger, and good morning, everyone. I'll start with our financial summary results on slide five. As Roger indicated, we reported net income of $1.1 billion, which was 35% lower year over year. However, I'd like to call out two items. The first is that in the second quarter of last year, we had a $729 million unrealized gain on our equity investments compared to a $42 million loss this quarter. Adjusting for these, our earnings would have been $4.07 per share in the current quarter. Second, The provision for credit losses increased from the prior year due to a $110 million reserve bill in the current quarter compared to a $321 million reserve released in the prior year. The current quarter reserve bill was primarily driven by higher loan receivables. Excluding the impact of these two items, our profit before tax and reserves would have been up 38% year over year. Moving to slide six. Net interest income was up $311 million, or 14%, driven by higher average receivables and improved net interest margin. NIM was 10.94%, up 26 basis points from the prior year and 9 basis points sequentially. On both a year-over-year and sequential basis, the increase in net interest margin reflects the higher prime rate and favorable funding mix. partially offset by increased promotional balances and higher funding costs. Receivable growth was driven by CARD, which increased 15% year over year from strong sales and robust new account growth last year and into this year. In the quarter, the payment rate increased 40 basis points and remains more than 500 basis points above the pre-pandemic level. We continue to expect that the normalization payment rate will be modest this year and will continue through the back half of 2023. Organic student loans increased 4% reflecting solid growth and originations. Personal loans were up 4% reflecting a return to growth. We view this as a validation of our approach to marketing, underwriting, and pricing of this product over the past several quarters, and we believe we are competitively positioned to grow, particularly relative to some non-bank originators. In terms of funding mix, our customer deposit balances were flat year over year and up 1% sequentially. Increases in our savings balances offset the runoff in higher cost CDs. Our strong asset growth may cause deposits to vary as a proportion of our funding mix, but we continue to target 70% to 80% deposit funding over the medium term. Looking at other revenue on slide seven, excluding the impacts of equity investments detailed earlier, non-interest income increased $105 million, or 19%. This was driven by higher net discount and interchange revenue, which was up $51 million, or 15%, reflecting strong sales and favorable sales mix, partially offset by higher rewards. Sales were up 18% year over year with growth across most categories. For the first half of the year, our sales growth was 20%. We estimate that inflation contributed between 200 and 300 basis points to this figure. Strong sales also drove higher rewards expense compared to the prior year. Our rewards rate increased six basis points year over year, reflecting two factors. Our standard 5% category, aligning with customer needs, included gas this quarter. Second, the substantial growth in new accounts over the past year increased the cost of our cash back match. However, on a sequential basis, the reward rate was up one basis point and up three basis points through the first half of the year. This is consistent with our expectations of two to four basis points of annual rewards cost increases. Loan fee income was up $37 million to 35%, primarily driven by an increase in late fee instances. Moving to expenses on slide eight. Total operating expenses were flat year over year and up 8% from the prior quarter. Compensation costs were up slightly year over year, primarily due to increased headcount and higher average salaries. Like many organizations, we are seeing salary and wage pressure which will likely continue through the balance of this year and into next year marketing expenses increased 79 million dollars or 45 as we continue to invest for growth in our card and consumer banking products we grew new card accounts by 39 from last year's second quarter this speaks to the strength of our brand the relevance of our value proposition and the benefits of our investments in targeting analytics. As Roger discussed, we closely track economic and competitive conditions, and we remain disciplined about our through-the-cycle approach to underwriting. This approach contributes to our confidence about investing in brand and acquisition. Moving to credit performance on slide nine. Net charge-offs remained low and were in line with expectations for continued credit normalization. Total net charge-offs were 1.8%, 32 basis points lower than the prior year, and up 19 basis points from the prior quarter. Total net charge-off dollars were down $27 million from the prior year and up $61 million sequentially. In the card portfolio, the net charge-off rate increased 17 basis points sequentially, or $50 million. Looking at our receivables, we are not seeing evidence of emerging credit stress at this point. Our delinquencies are virtually unchanged from the first quarter. And while we expect some increases in delinquencies over the back half, this is consistent with our outlook for steady credit normalization into 2023. Turning to the discussion of our allowance on slide 10. This past quarter, we increased our allowance by $110 million, largely due to higher receivable balances. Our reserve rate continued to decline, however, dropping 31 basis points to 6.8%. As a reminder, our reserves are based on our expectation of life of loan losses. On the macroeconomic view, we believe the balance of risk has shifted to include the potential for an economic slowdown resulting from Fed policy actions. For us, The most significant driver of loss is changes to unemployment conditions. As Roger mentioned, the current labor market conditions remain healthy. And as examples, the number of job openings still exceeds the number of unemployed people, and the unemployment rate remains low. But unemployment claims have started to creep up. As part of our reserving process, we consider the prospects of higher unemployment and in range of macroeconomic scenarios. Looking at slide 11, our common equity tier one for the period was 14.2%, well above our 10.5% target. The strength of our capital position is underscored by the recent CCARS regulatory stress test. Based on the CCARS results, our preliminary stress capital buffer should decrease by 110 basis points. which effectively lowers our minimum required CET1 ratio to 7%, the lowest possible ratio. We repurchased $601 million of common stock during the quarter and declared a quarterly common dividend of $0.60 per share. Concluding on slide 12, as we look into the Back half of this year, our perspectives for 2022 remains favorable. We are improving some elements of our expectations. We are revising our view on loan growth to low teens. Continued strong sales and new account acquisitions through the second quarter support our confidence in this outlook. There is no change to our view on NIMH. We continue to see five to 15 basis points of upside for the full year relative to the first quarter level of 10.85%. Our expectations for expenses remain at mid single digit growth versus last year. We still expect marketing costs to come in above 2019 levels with non-marketing expenses to increase by low single digits. We are improving our credit outlook. We now expect net charge-offs to be between 1.9 and 2.1% for the full year, and we intend to return to share repurchases at an appropriate time in the future. In summary, loan growth accelerated as we benefited from robust sales and strong account acquisition. Credit performance remained solid, reflecting our disciplined approach to underwriting and credit management. We manage operating expenses while investing in new account acquisition brand and digital capabilities, and our balance sheet and capital position are strong. The results demonstrate the resiliency 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, Katie, to open the line for Q&A.
spk01: Thank you. At this time, if you would like to ask a question, please press star one on your telephone keypad. If you wish to remove yourself from the queue, you may do so by pressing the pound key. We remind you to please pick up your handset for optimal sound quality. We will pause for just a moment to allow questions to queue. Thank you. Our first question will come from Moshe Orenbuck with Credit Suisse. Your line is now open.
spk11: Really thanks and really strong results in terms of accounts and loan growth. And maybe, Roger, could you just talk a little more detail about kind of as you see the competitive environment, you're adding a lot of accounts. I know you've talked about how you kind of originate them with a through-the-cycle approach. But just talk a little bit about both how you see the competitive environment and how you see any kind of tweaks you are making because of the current environment and, you know, talk about that in terms of the outlook. Thanks so much.
spk13: Sure, Moshe. Thanks for the question. You know, I would say the competitive environment remains intense. You know, 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. You know, from a credit standpoint, I would say we're roughly back to where we were pre-pandemic. But, you know, 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 from the brand and the product are really working well to drive growth, even in this competitive environment.
spk10: Great. Thanks.
spk11: And just as a follow-up, you know, on the student loan side, you know, given that this is the key quarter coming up in terms of originations, you know, last quarter you talked a little bit about how you expected to have some advantages versus markets. Obviously, there's, you know, you've got the issue that you've got from a compliance standpoint. You talked about how that could impact you from a, you know, from an origination standpoint, and if that does, you know, how long that could last you.
spk13: Yeah, 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, you know, 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.
spk11: Thanks very much.
spk01: Thank you. Our next question will come from Bill Carcacci with Wolf Research. Your line is now open.
spk08: Thank you. Good morning, Roger and John. You guys certainly have historically remained profitable through the cycle with risk-adjusted yields remaining quite strong even in a deeper session like we saw in 2008. And it makes sense that you're continuing to invest here against the backdrop that we're in. Could you maybe frame for us what it would take to curb your appetite for investing for growth and maybe just what it would take for you to have a pullback?
spk13: Yeah, 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, you know, 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 conservative in credit. And 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 looked at.
spk08: Thank you. And if I may follow up on that. Maybe could you also frame how you're thinking about the risk that the strength that we're seeing in the consumer and labor markets is in and of itself inflationary and could leave the Fed to have to do more? And since we know that monetary policy operates with long and variable lags, the increases in unemployment that follow those Fed hikes tend to be quite lagged. And so those effects could take some time to show up. Maybe, you know, could you just speak to that dynamic how that feeds if that feeds in any way into your reserving models you know we haven't had a significant inflation cycle in a long time and so there's some concerns that you know current underwriting models may not be picking that up would love to hear your thoughts on that thank you yeah yeah hey bill i'll take that one uh good good question we spent plenty of time thinking about it so uh inflation um unto itself is not
spk04: 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. 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's performing very, very well. 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, you know, that life of loan approach that we take, looking at broad macros as well as portfolio performance, you know, 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.
spk10: That's very helpful. Thank you, Roger and John. Appreciate it.
spk01: Thank you. Our next question will come from Sanjay Sakrani with KBW. Your line is now open.
spk12: Thanks. Good morning. I guess my first question is on the share or purchase suspension. Obviously, that decision was probably not something that was taken lightly. Could you just talk about the thought process in making that decision given all the positive news on your excess capital and stress capital buffers and such. Should we infer that the size and scope of damages could be pretty significant?
spk13: um thanks for the question sanjay i think i 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, you know, 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, you know, we hope to get back to the repurchase program as soon as we are able.
spk12: Okay. And then I guess a question for John just on NIMH. Obviously, I think, like, the Fed's posture has moved towards more rate hikes. I'm just curious, you know, your NIM expectation is sort of unchanged, but maybe you could just talk about what went into that and if you're seeing any changes in deposit betas.
spk04: Yeah. Thanks, Sanjay. So, you know, the NIM guidance gave a range benchmarking off the $10.85 range. and we said five to 15 basis points range of upside from that. You know, 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, a 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, you know, how that translates into betas, it's hard to call right now. But I would say, you know, the first part of the year, we had a very, very low beta. I would expect that to normalize as the funding environment migrates. Okay. Great.
spk12: Thank you.
spk01: Thank you. Our next question will come from Rick Shane with JP Morgan. Your line is now open.
spk06: Good morning, guys. Thanks for taking my question. When we look back at some of the changes over the years, like the promulgation of the Card Act, there were impacts that people thought would be cyclical that became secular in terms of loss rates, in terms of yields. I'm wondering when we look at payment rates today, if there's something that you guys might see that suggests that this is more of a secular change than a cyclical change.
spk04: Yeah, thanks, Rick. So, yeah, 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 um through our card good thing good thing for us from an interchange perspective but also you know that that cash that folks used to expend i believe there's some portion of it that is now going to pay down balances which um 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 asked to be given 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.
spk06: Got it. Yeah, it's helpful.
spk10: agree with that conclusion it just feels like um on a day-to-day basis we're all using less cash and i'm wondering if that's just driving more and more trans creating more and more transactors for you guys yeah uh thanks for the question uh anything else that's it thank you guys you got it thank you our next question will come from ryan nash
spk01: With Goldman Sachs, your line is now open.
spk05: Hey, good morning, John. Good morning, Roger. So, John, maybe a question on the allowance. You know, if I look, you know, I recognize that, you know, obviously this is a life of loan calc, but, you know, when I look at the level of reserve today, you're only modestly below where you were at March of 2020, call it low sevens versus high sixes. 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, you know, if we see a modest downturn, just given how healthier consumers are, like, you know, what could that do to both losses in the allowance over time? Thanks.
spk04: Sure. So, as I mentioned in my previous comments, you know, we looked at a number of different scenarios, but, you know, I can give you a couple of data points here. In terms of unemployment, You know, it ranged from a low of 3.3 at the end of 2022 to a peak of 5.8. And then as we look for 23, 3.5 to just about 5.5. You know, we're seeing a level of GDP growth slowing. you know, we haven't baked in a full recession, but certainly GDP does reduce and is near zero in one of the scenarios we ran. You know, the employment situation still is robust, and, you know, we certainly considered that as well. So as we look out into 23, you know, we're going to evaluate what the macro conditions are and the impact on life of loan losses. But, you know, for me, the portfolio performance is really, really strong. The job market is really, really strong. Uncertainty on the broad macros, and we conservatively modeled those. So, overall, I feel like, you know, we're – hundred percent consistent with how we've reserved in the past. You know, we've taken that through the cycle underwriting approach that has benefits through into the portfolio. And we've been conservative in our process to ensure that our reserves are fairly stated under GAAP.
spk05: 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 a 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.
spk13: Yeah, no, I am, to your point, limited in what I can say. You know, we can't really give you anything to expect in timing other than, you know, you know our views on capital. And so, as soon as we can, we hope to restart the buyback.
spk05: I figured I'd try. Thanks.
spk01: Thank you. Our next question will come from Mark DeVries with Barclays. Your line is now open.
spk16: Yeah, thanks. Just one more question on the buybacks. When you are able to resume, should we expect the cadence to kind of mirror what you did in the first half this year, or could you accelerate repurchases?
spk04: You know, we'll look at that, Mark. You know, certainly, you know, we have that broad authorization for the board. for over five quarters. It's 4.2 to 4.3 billion of repurchases. So, depending on the pause, we'll see what we can do because certainly, you know, we're over regulatory minimums. We're certainly over our internal target. And, you know, as we said previously, we're committed to stepping stepping the CET1 ratio down to 10.5. So we'll do what we can do.
spk16: Okay, great. And then maybe a question for Roger. I mean, just given kind of the pullback we've seen in FinTech valuations, is there anything that looks interesting here, you know, to deploy that capital inorganically?
spk13: Good question. You know, I think while valuations have pulled back, I'm not sure there are any bargains yet. But, you know, for us, we've tended not to focus on partnerships and potential investments as opposed to acquisitions. And, you know, a lot of capabilities, you know, given our great technology team, we feel like we can build ourselves. So, yeah, we have a good business development effort that was out there, but, you know, I wouldn't necessarily expect something.
spk16: Okay. Got it. Thank you.
spk01: Thank you. Our next question will come from John Pancari with Evercore ISI. Your line is now open.
spk20: Good morning. Morning. Good morning, John. Just, sorry, back to the back to the student loan issue. Just, I know you've given all that you can comment on, but there's also in the public, you know, we know that there's also a consent order related to this with the CFPB. It looks like 2020, and I believe it's even tied to a consent order from 2015. Did that impact, did that influence the suspension? And, you know, was there something new that develops that caused the internal investigation?
spk13: 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.
spk20: Okay. All right. Thank you. Thanks for helping there. And then separately, just on the, this is sort of related to it, but more around the expenses. I know you indicated that the the investigation is already contemplated into the expense guide and I appreciate that color. Does that mean that there were potential expense offsets that would help keep the expense guide unchanged or that getting back to your earlier comment that there is unlikely to be an expense impact?
spk04: Yeah. So, John, the way I would think about it is You know, 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. media, which contributed to the marketing increases. The rest of it is we consider it as, you know, part of the cost of our operation. And, you know, we're trying to make it as efficient as we can.
spk20: Okay. Thanks for that. If I could just ask one more on the credit side. I know the delinquencies edged up a little bit year-over-year for 2Q. Did you see any pressure incrementally in the lower FICO bands or any color around the modest increase in delinquencies that you saw?
spk14: Yeah.
spk04: So, you know, 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. You know, 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 some of the work we've done in terms of analytics that can optimize time to contact and collection strategies, and some of it could be just customer performance. There's really no takeaways from the portfolio other than, you know, it continues to perform very, very well and gave us a degree of comfort as we reduced the overall reserve rate.
spk20: Got it. Okay. Thanks for taking my questions.
spk01: Thank you. Our next question will come from Betsy Gracek with Morgan Stanley. Your line is now open.
spk18: Hi, good morning. Morning, Betsy. Just on the investigation one for me here, you know, you did mention that it is embedded in your full year guide on expenses, and I'm wondering if we should take that to mean that you expect the review will be finalized by the end of this year. Is that a fair conclusion?
spk13: I wouldn't necessarily link those two. I mean, I think what we can say is that we did not see anything that would change our view that non-marketing 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.
spk18: Right. And of The buyback restarting is a function of the investigation concluding. Is that fair? Rather than like a particular CET1 level?
spk13: Yeah. 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.
spk18: Okay, so it's a bit open-ended on our end, thinking about, you know, when to put it back in the model. I realize you understand that, so I suppose there will be a wide range of opinions after this call on that. Just on the business, can we talk a little bit about the interchange rate? The gross interchange rate has been really strong in recent quarters, and wondering if there's anything in particular driving that. you know, are there increases in competitors that you're matching or is there something else going on? Thanks.
spk04: Yeah, you know, the overall interchange has largely been a function of a robust sales volume. So we're up, our sales are up 20% through the first half of the year, 18% through the end of the second quarter. So that's driving overall interchange. Now, Mix does, does come into play in terms of the interchange rate. And obviously, you know, we don't spend a lot of time discussing that. But overall, you know, the solid business performance is driving interchange. And then maybe your follow-on might be rewards. You know, 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 is, we expect two to four basis points of inflation there. So interchange. In the aggregate, super strong interchange rate, very, very solid rewards coming in at expectations.
spk18: Got it. Yeah, and that was the follow-up, so appreciate it. Thank you.
spk01: Thank you. Our next question will come from Ming Zhao with Dolce Bank. Your line is now open.
spk09: Hey, good morning, guys, and thanks for taking my question. John, you mentioned I think sales grossed up 18% through the end of second quarter. I wanted to see if that was sort of holding through the first three weeks of the third quarter. And then, you know, are there any specific verticals you'd call out in terms of sales volume?
spk04: Yeah, so it is holding. So through Monday, it was up 17%. So, again, incredibly robust. You know, those figures actually have surprised me a little bit to the upside, which is nice. You know, 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 decreased versus everyday spend. So it's still positive year over year, but not not increasing at, at, uh, the same rate as everyday spend and other retail.
spk09: Okay. Got it. That makes sense. And then I guess, secondly, are you guys sort of seeing any, uh, change in consumer behavior in regards to the inflationary environment in terms of sort of any substitution effects or anything that any call there would be, uh, helpful?
spk04: Yeah. Um, we're, we're seeing a little bit of it. We, um, we believe that, uh, 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 inflation that you know consumers are going to make some choices and um and uh substitutions or decrease in consumptions uh will uh will likely happen okay great thank you guys thank you our next question will come from kevin barker with piper sandler your line is now open
spk15: Great. Thanks for taking my questions. Just one last follow-up on the student loan side. You had charge-offs ticked up, although they're fairly low still on student loans, but they're still higher than what we've seen from a quarterly run rate basis for the last few years. Is there anything related there to the investigation on why the charge-offs may have ticked higher just in this particular quarter? given credit metrics have been extraordinarily good within that portfolio?
spk13: Yeah, 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.
spk15: And then in regards to the outlook for NIM, I appreciate everything for this year, but as you look further out, just given the yield curve today, would you expect some reversion back to your longer-term outlook? NIM down to a low 10% just given deposit costs are likely to remain fairly elevated as we go into next year or maybe even continue to move higher just given the short end of the curve moving higher combined with maybe a flattening on the long end. Is there anything you're seeing there that would cause NIM to maybe start to soften as we move into the beginning of next year?
spk04: Yeah. Yeah. Yeah. Good question. So I would, I would say, say this. So my expectations is that is that NEM will, will peak this year. Um, and there are a number of factors, um, impacting it. Certainly, you know, you mentioned deposit costs, um, that's, that's going to, um, 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, you know, historical levels. Okay.
spk14: Thank you, Joe.
spk01: Thank you. Our next question will come from Miher Bhatia. with Bank of America. Your line is now open.
spk17: Good morning. Thank you for taking my question. Maybe I'll start with just on the competitive intensity a little bit. You're saying quite disciplined on rewards and operating costs, even as you drive growth. Could you talk a little bit about where your account growth is coming from? And the reason I ask is we've seen a few aggressive offers around cashback introduced in recent months. That's historically been your bailiwick. So I was curious if you are seeing any kind of impact from some of those offers out in the market.
spk13: Yeah, you know, 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, you know, someone will be $300, $500. You'll see different issuers doing very long-term balance transfers. You know, 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.
spk17: Okay. Thank you. And then, sorry, and I don't mean to be the dead horse here, but for me, just one question on the buyback suspension. Is that something that regulators require or encourage you to do while you get your arms around the servicing issues, or was the decision to suspend buybacks just solely driven by you internally at DFS and the board?
spk13: Yeah, the decision was made by Discover. Thank you.
spk01: Thank you. Our next question will come from Dominique Gabrielli with Oppenheimer. Your line is now open.
spk02: Hey, great. Thanks so much for taking my questions. I was wondering, how do you monitor want versus needs-based loan growth as the consumer might feel some pressure both on an individual and a portfolio level? How do you monitor that? Is there some internal data that perhaps we don't have access to that help you understand good borrowing behavior versus bad, bad borrowing behavior, you know, outside of delinquency trends. Thanks. Nice. Have a follow up.
spk13: Yeah, 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.
spk02: Okay, great. Thanks for that. And then, you know, I was just curious, how long out does your through-the-cycle loss expectation look out for changes in economic overlays? So does it include today, let's say through the fourth quarter of 2023? You know, given our analysis, we see that that's the rough timing where some of these macro dominoes might fall into place with possibly higher unemployment-related net charge-offs. So how does the weighting work from a timing perspective of when you think an event may actually begin to occur and affect either your growth algorithm or your loss algorithm? Anything you can provide on that would be really great. Thank you.
spk13: Yeah, 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 two and a half 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 know, 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.
spk02: Excellent. Thanks so much for all the help.
spk01: Thank you. Our next question will come from Bob Napoli with William Blair. Your line is now open.
spk19: Thank you, and good morning, everybody. You know, really solid fundamental results. Great to see. Just the network, leveraging the network, you know, partnerships. You know, you have the Ariba, Sezzle, but just having this global payments network and just any update you can on your efforts to leverage that That network, I know Ariba B2B payments. Is there anything else on the table there? I mean, that continues to grow nicely, but any just any thoughts there that make the network payments portion of the business a larger part of the company.
spk13: Yeah, 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, too, also generate volume and more cross-border volume for us. You know, 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.
spk19: Thank you. My follow-up was, I guess, rewards on debit. You know, it seems like a pretty good opportunity for Discover. Any updated information you can give us on, you know, cash back debit and the importance to your business over the next five years or potential benefits from that?
spk13: Yeah, 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. You know, 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.
spk11: Thank you.
spk01: Thank you. Our next question will come from Don Fidetti with Wells Fargo. Your line is now open.
spk03: Yeah, John, I was wondering on the funding side if you could talk a little bit about, you know, the ABS market. I know you've been a bit more active and so have other card issuers. Are you pleased with sort of the post-pandemic from a depth and pricing and leverage perspective? And also, you know, the same question in terms of brokered CDs and
spk04: Yeah, yeah, great question. So I'm going to kind of break it into two categories. So very pleased with the team's execution when we go into the ABS market. You know, 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, you know, something in the twos or threes right now. But, you know, 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 were competitive, that we're not a market leader in terms of pricing, deposit pricing decisions, but also not not having to kind of lean into more expensive funding sources. But you know, we'll continue to evolve there and make sure we're making good, efficient choices for the franchise. Thanks Joe.
spk01: Thank you. Our next question will come Aaron Saganovich, your line is now open.
spk07: Thanks. The stronger loan growth that you've seen recently in increasing your guidance for the full year, how much of normalizing of payment rates is included in that versus just the continued momentum that you're having acquiring new accounts?
spk04: Yeah, Aaron, thanks for the question. Very little. So we modeled out a sustained high payment rate. normalization back in through 2023. And frankly, if the payment rate should reduce, you know, that would provide some more energy for growth. You know, we haven't anticipated that. You know, 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 you know customers customers putting our our card top of wallet so we've been we've been really pleased and feel like the balance of kind of risk versus opportunity in terms of additional growth is probably more more on the opportunity side at this point okay thanks and then secondly the
spk07: The internal investigation, obviously, that's internal. Have you discussed this with the regulators already? Are they involved? I just want to know if there's, you know, another leg, so to speak, to drop with respect to this.
spk13: Yeah, 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.
spk08: Thank you.
spk01: 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.
spk21: Well, thank you all for joining us. The IR team is available all day, so please reach us with any additional questions and have a great day.
spk01: Thank you, ladies and gentlemen. This concludes today's event. You may now disconnect.
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