Discover Financial Services Management Discusses Q4 2012 Results - Earnings Call Transcript

Dec.20.12 | About: Discover Financial (DFS)

Discover Financial Services (NYSE:DFS)

Q4 2012 Earnings Call

December 20, 2012 11:30 am ET

Executives

Bill Franklin

David W. Nelms - Chairman and Chief Executive Officer

R. Mark Graf - Chief Financial Officer and Executive Vice President

Analysts

Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc., Research Division

Michael P. Taiano - Telsey Advisory Group LLC

Bill Carcache - Nomura Securities Co. Ltd., Research Division

Jason Arnold - RBC Capital Markets, LLC, Research Division

Mark C. DeVries - Barclays Capital, Research Division

Scott Valentin - FBR Capital Markets & Co., Research Division

Ryan M. Nash - Goldman Sachs Group Inc., Research Division

Moshe Orenbuch - Crédit Suisse AG, Research Division

Donald Fandetti - Citigroup Inc, Research Division

Richard B. Shane - JP Morgan Chase & Co, Research Division

Robert P. Napoli - William Blair & Company L.L.C., Research Division

Christopher C. Brendler - Stifel, Nicolaus & Co., Inc., Research Division

James E. Friedman - Susquehanna Financial Group, LLLP, Research Division

Sameer Gokhale - Janney Montgomery Scott LLC, Research Division

Christopher R. Donat - Sandler O'Neill + Partners, L.P., Research Division

Martin Kemnec - Jefferies & Company, Inc., Research Division

David S. Hochstim - The Buckingham Research Group Incorporated

Kenneth Bruce - BofA Merrill Lynch, Research Division

Operator

Welcome to the Q4 2012 Discover Financial Services Earnings Conference Call. My name is John and I'll be your operator for today's call. [Operator Instructions] Please note: this conference is being recorded. I will now turn the call over to Mr. Bill Franklin, Head of Investor Relations. Mr. Franklin, you may begin.

Bill Franklin

Thank you, John. Good morning, everyone. We appreciate all of you -- for joining us on this morning's call. 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, 2011; and in our Form 10-Q for the quarters ended August 31 and May 31, 2012, which are on our website and on file with the SEC.

In the fourth quarter 2012 earnings release and supplement, which are now posted on our website at discoverfinancial.com and have been furnished to the SEC, we have provided information that compares and reconciles the company's non-GAAP financial measures with the GAAP financial information, and we explain why these presentations are useful to management and investors. 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. After Mark completes his comments, there will be time for a question-and-answer session. [Operator Instructions] Now it is my pleasure to turn the call over to David.

David W. Nelms

Thanks, Bill. Good morning, everyone, and thank you for joining us today. This morning, I'm going to start off by discussing the fourth quarter and then walk through some highlights of our full year accomplishments.

Before the market opened, we reported quarterly diluted earnings per share of $1.07, up 13% over the prior year, driven primarily by loan growth and share repurchases. During the quarter, we generated return on equity of 23% and returned approximately $451 million of capital to common shareholders through repurchases and dividends. Our robust results, strong capital position and positive outlook led us to announce a 40% increase in our dividend to common shareholders.

This quarter, we accelerated our organic growth to 6% on total receivables. Card receivables growth for the quarter was the highest in over 5 years, driven by spin from the revolver segment of our card base. Our strong receivables and sales growth results demonstrate the effectiveness of our marketing programs, consumers' preference for cash rewards and our acceptance and awareness initiatives.

For the fourth quarter, our noncard assets, specifically our personal and private student loans, achieved a combined 11% year-over-year growth as we broadened marketing and added new schools and a fixed-rate product in student loans earlier in the year. Our Payments segment experienced 13% year-over-year purchase volume growth, driven largely by PULSE. Volume processed on our networks achieved an all-time high for the fourth quarter.

We also increased our level of investment to drive future growth and achieved the full potential of our Direct Banking and payment strategy. Important new initiatives included new domestic and global payments partners; a new core banking system; our first checking product, which we expect to launch in early 2013; and Discover it, our new credit card product that is testing successfully in select markets and will be launched nationally next month.

Our card net charge-off rate set another record low, but our over-30-day delinquency rate ticked up slightly due to seasonality. While the continued improvement in credit appears to be nearing an end, we don't believe we were -- we are at a point where charge-offs are poised to rise significantly.

Now, I'd like to share some thoughts on how we performed against our 2012 priorities. We had 2 principal priorities for our Direct Banking segment. First, we wanted to build on the momentum from 2011 and grow card sales and receivables. Second, we wanted to grow our noncard product offerings. During the year, we successfully grew card sales and receivables in a challenging environment by increasing our marked wallet share and achieving double-digit new account growth. We increased customer engagement through our rewards programs, marketing initiatives and by expanding online and mobile capabilities. We increased merchant participation in our rewards program, which also enhanced the value for our card members. For the full year, card receivables grew by $3 billion or 6%.

In our Direct Banking segment, we grew noncard assets and launched new products, including home loans and student loans focused on graduate and professional programs. By leveraging our expertise in unsecured underwriting and maintaining the customer-centric focus, we disbursed over $1 billion in private student loans and grew personal loan originations to $1.8 billion. Additionally, we originated over $2 billion in home loans since June.

In payments, we continued to build on domestic and international acceptance and successfully grew our network volume while dealing with competitive challenges. For the full year, volume for the Payments segment grew by 12%, and we achieved a record number of active merchants. Further in Payments, we positioned ourselves as a flexible and innovative partner for payment solutions with a number of new agreements, domestically with PayPal and internationally with new network and issuer partnerships.

Lastly, one of our top corporate priorities was to drive shareholder value through effective capital management. During the fiscal year, we returned a little over $1.4 billion through share repurchases and common dividends.

Our fourth quarter provided a strong finish to a record year. As we enter 2013, I am looking forward to maintaining the momentum in our Direct Banking segment and executing on our recently formed network partnerships as we continue to leverage our network assets. We look forward to providing you with an update on our 2013 priorities at our annual financial community briefing in March. Now, I'll turn the call over to Mark.

R. Mark Graf

Thanks, David, and good morning, everyone. Let me start by reminding you that as of January 2013, Discover will be converting to a December fiscal year end. We'll provide you with historical calendar year data in early March in advance of our financial community briefing.

That said, I'll begin my remarks on this quarter's performance, starting with the Direct Banking segment, which earned $827 million pretax this quarter versus $776 million last year. Net interest income increased $134 million or 11% over the prior year, driven by both asset growth as well as the net interest margin, which was 34 basis points higher than the prior year at 9.44%. Lower funding costs and lower interest charge-offs more than offset a 17 basis point compression in total asset yield from the prior year. Specifically, card yield declined 20 basis points from the prior year to 12.16%, due to more promotional balances and a decline in higher rate and default priced balances. Interest expense, as a percentage of average receivables, was down 49 basis points over the prior year to 2.11%, due to the continued benefit from refinancing maturing liabilities at lower rates. We expect to continue to benefit from this funding cost tailwind through 2013.

Over the next year, the combination of yield and funding cost trends should keep net interest margin above our long-term target of 8.5% to 9%. However, we do anticipate some compression, driven largely by card yield, which should continue to decline.

Other income for the Direct Banking segment was $50 million higher than the prior year, mainly due to the inclusion of revenue from Discover Home Loans, our mortgage business that we launched in June of this year, as well as a $26 million gain on the sale of a minority investment. The mortgage business was profitable for the quarter. However, I would remind you of my comments from last quarter's call that we continue to expect it to remain relatively immaterial to earnings for some time.

Continuing with other income, our rewards expense, a contra revenue item, increased to 106 basis points on card sales during the quarter, due to what was, in retrospect, a richer than expected 5% cashback promotion that generated very strong cardmember engagement. We do not expect this elevated rewards rate to persist into the calendar first quarter. However, I would point out that the current program runs through December.

Another component of other income, Protection Product revenue, was down from last year, and we continue to expect this line item to decrease over time. During the quarter, we did cease marketing these products to focus on implementing changes required by our consent order. We continue to service and maintain existing products and memberships and intend to once again make these products available to new customers next year.

Operating expenses for the Direct Banking segment were up $114 million over the prior year or 18%. There are several factors contributing to this higher level of expenses. First, we increased employee headcount as well as marketing and other expenses due to the Home Loan acquisition and the launch of our direct mortgage product, which contributed roughly $50 million to expenses in this period. Second, as evidenced by our strong receivables growth, we believe investments in marketing are bearing fruit in this environment. And as a result, we think the timing is right for us to continue to opportunistically drive new account acquisition and card utilization. Finally, our headcount information processing and professional fee line items grew further, as we laid the groundwork for launching several new products in the coming quarters and added resources to address new regulatory expectations. Some of these initiatives will also result in higher operating expenses next quarter.

Turning to credit. Sequentially, the credit card 30-plus delinquency rate increased 5 basis points due to seasonality, but the net charge-off rate declined 14 basis points to a new historic low. The over-30-day delinquency rate for student loans decreased 21 basis points and the net charge-off rate, excluding purchase loans, increased 22 basis points from the third quarter. The net charge-off rate reflects increased seasoning of the organic portfolio. We would remind you that as the portfolio seasons, we will see this rate rise past 1% and come back down over the long term. The credit performance of both our organic and purchased portfolios remains in line with our expectations.

The personal loan over-30-day delinquency rate was up 2 basis points, and the net charge-off rate was up 22 basis points sequentially as the portfolio continued to season. Over the course of the year, we have said that loan growth will eventually lead us to build reserves. This quarter's $38 million reserve build reflects the strong asset growth that we have realized.

One last thing I want to mention is that effective November 30, the company began including confirmed card transactions as parts of loans in process, which resulted in a $365 million increase to ending card receivables for the fourth quarter. This will have no impact on historic or future income statement items, including earnings per share, but will lower some ratios which use average card or total receivable balances in the denominator such as card yield and net interest margin.

Turning to the Payment Services segment, pretax profit decreased 21% over the prior year to $33 million. The decrease resulted primarily from higher expenses at Diners, which included marketing and incentives related to several new issuing relationships. Expense increases were partially offset by increases in higher margin point of sale volume for our PULSE debit network and higher Network Partners volume. Network Partners is our new name for what we formerly referred to as Third-Party Issuers. We've changed the name to better reflect our strategy of partnering to drive volume growth. However, the composition of the business has not changed. Segment volumes were up 13%, driven by strong increases in PULSE and Network Partners volumes.

Next, I'll touch on liquidity, funding and capital. Our on-balance sheet liquidity portfolio at quarter end was $9.6 billion. Total available liquidity was $27 billion, a decrease of $2.4 billion over the prior quarter. We opportunistically executed a $575 million, 6.5% perpetual preferred stock issue and a $500 million debt exchange offer that allowed us to broaden our regulatory capital mix. Also in November, we issued $250 million of 3-year Class B asset-backed securities with a floating-rate coupon of one month LIBOR plus 45 basis points. This is Discover's first Class B issuance since 2007. As we have said before, we'll continue to opportunistically fund our business by accessing all available channels. We ended the quarter with a 13.6% tier 1 common ratio, which was 30 basis points lower than the last quarter.

Let me conclude with some full year comments. We achieved record net income in fiscal 2012 due to improvements in credit, loan growth and a higher net interest margin. The payments business leveraged our network and acceptance footprint to achieve record network volume and entered into several key partnerships, which we expect to be drivers of future profitability. Lastly, we continue to deploy capital, as evidenced by today's announced dividend increase to $0.14, as well as our repurchase of over 6% of our shares over the course of the past year.

That concludes our formal remarks. So now I'll turn the call back to the operator, John, to open things up for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Sanjay Sakhrani from KBW.

Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc., Research Division

I'll ask my 2 questions upfront. Just the first on credit quality, I think David, you mentioned that you don't anticipate a significant rise in charge-offs. Could you just talk about the dynamics there, when we look a year out from now, especially when you -- when considering how you factored in to your provision? Do you assume flattish a year from now or up slightly? And then secondarily, just on operating expenses, I was just hoping to get some color from Mark, maybe. When we look out to 2013, is $3 billion roughly a good assumption to use as an annual budget for operating expenses? And then maybe on rewards costs as well, is 100 basis points still a good number, roughly?

David W. Nelms

Sanjay, on -- we're certainly in an environment that we've never experienced before on credit. So it is a difficult line to forecast. But it's my expectation that we're going to see, at this point, some flatness and more seasonal trends occurring. It wouldn't surprise me to see a slight increase over the coming 12 months. But as I've kind of indicated, we're certainly not expecting anything dramatic. And so if you look at the reserving, it's largely due to our loan growth, which I was very pleased to have achieved a 5-year high growth rate, and that leads to more reserving. And that's more of a driver as opposed to expecting a big increase in credit cost. Mark?

R. Mark Graf

Yes, I would -- I'd echo David's comment on that one. I mean, I think receivables growth is central to our business model. And as we've been saying, that growth would, at some point in time, cause us to begin to build reserves. And the growth in reserves you've seen is a direct result of the growth in loans over the course of the last several years. With respect to your expenses question, Sanjay, I would say a couple of different things. I think as we look forward to next year, that $3 billion number is a close number to utilize. It may come in a little bit higher than that, would be my general expectation, however. I think in terms of an operating leverage way of looking at things, if we were not investing in a number of these growth investments over the course of the next year, we would be reporting flat operating leverage for 2013. I think we will be slightly below that because of the investments in growth we're making. I think you all understand that when you're investing for organic growth, the expenses lead to revenues. But given the ROIs and the opportunities we see in these products, we're very comfortable going ahead and making those investments. With respect to the rewards rate itself, as I said in my prepared remarks, I think the 106 basis point level that you saw this quarter was higher than we expected it to be, quite honestly. That program was probably a little bit too rich, in retrospect. But it did drive fabulous cardmember engagement, which is great. I would say going forward, I would expect it to be closer to that 1% level is the right way to think about things. Though again, I would point out for the month of December, that higher program is still running.

Operator

Our next question comes from Mike Taiano from Telsey Advisory Group.

Michael P. Taiano - Telsey Advisory Group LLC

So I guess on the volume side, I was just curious, and I guess first, if you saw any impact from Sandy for the full quarter. I know you had that impact the first week or 2, but just wondering if that was anything material. And then secondly, looking out to next year, I know there's a lot of uncertainty around the fiscal cliff. But I was just -- it seems like, at least one thing that seems consensus from both sides is the elimination of the payroll tax cut that's been in place the last couple of years. I'm just -- was wondering if you could give any thoughts as to how that might impact your volumes looking out to next year.

David W. Nelms

Sure. I would say that, in terms of Sandy, we don't think it had a significant overall effect on our volume during the quarter. It's certainly had a regional impact, obviously, with timing. We saw some sub-components that changed around a bit. For instance, home improvement had been softer before Sandy and post-Sandy. There's been enough rebuilding needs that we've actually seen that component drive higher. So there've been some ins and outs maybe from Sandy, but I think the overall volume, not too affected. I think in terms of fiscal cliff, we don't have a separate plan for -- as I've heard some companies have. And we think that -- I don't expect a big impact. I do expect something to get resolved. I think the big wild card is what happens to consumer confidence. And I think as long as consumer confidence doesn't take a big nosedive, I expect our sales volume and so on to continue doing just fine. If consumer confidence, for whatever reason, went down significantly, then that's what would probably start affecting sales volume.

Michael P. Taiano - Telsey Advisory Group LLC

Great, and then just one follow-up. The CFPB, I guess, put out a notice yesterday saying they're going to kind of look at the impact of -- that the card hack has had over the last couple of years. I'm just curious to see if you had any thoughts as to whether that could be either positive or negative, just given it seems like there's been restriction in credit as a result of that. And I wonder if they may decide to make some changes. Just any thoughts you might have there.

David W. Nelms

I hadn't seen that, what -- it's a wait to see. I'd be surprised if there was a big impact as a result of a study like that, just from what you're saying. But I'll have to wait and see what’s up.

Operator

Our next question comes from Bill Carcache from Nomura.

Bill Carcache - Nomura Securities Co. Ltd., Research Division

David, on the rewards fund, and it seems like you guys are taking advantage of the spending growth and loan growth that you've been generating and just continuing to invest for growth and offering more attractive rewards. Can you share your outlook for investment spending for the new year, both for you and the industry? And specifically, do you expect some of your competitors to have a tougher time maintaining investment levels, given that many of them are still not seeing loan growth?

David W. Nelms

Well, certainly I think it's a very good opportunity for us to continue to invest in growth. We've been gaining share in loans over the last couple years, and that's accelerated this quarter. And so in Direct Banking, we're investing to continue to gain and accelerate loan growth in card, to broaden our other Direct Banking offerings in student loans, personal loans and other products. And then obviously, in the payments area, we're investing -- we're -- we've just got many more opportunities in front of us at this point. And we think it's time to really grab some of those and invest in that business, which will be great for the long term. I think, in terms of the competition, I think that's part of why investing is looking better for us. We have seen some competitors pulling back on, for instance, direct mail volumes and advertising. And I think we'd be foolish not to take advantage of that kind of opportunity.

Bill Carcache - Nomura Securities Co. Ltd., Research Division

And then finally, my last question is on your partnership with PayPal. It shows that you know how you guys are using your network in a way that's disruptive to how the payments ecosystem has traditionally worked. Is it reasonable to expect that we'll see more deals like that? You mentioned there are some things kind of in the works. So without obviously commenting on anything specifically, but I just wondered whether a similar kind of partnership to what we saw with PayPal where you turn on acceptance for them and all of your merchant locations is something that we could expect with say, like an MCX or others who are were kind of entering the industry and trying to be disruptive themselves?

David W. Nelms

I'd say yes and no. I certainly -- I think PayPal is in a fairly unique position and I'm really excited about that opportunity. There is no one else in the market that's exactly positioned the way they are. So what I expect is not other PayPal-like deals, but other deals that are also disruptive in different ways. And we are talking to a number of partners who see our flexibility and unique assets as a big opportunity. And so I am certainly hopeful that over the -- as we get into next year, that we'll have additional partners to be talking to you about.

Operator

Our next question comes from Jason Arnold from RBC Capital Markets.

Jason Arnold - RBC Capital Markets, LLC, Research Division

You've seeing strong loan growth in 2012 and particularly good performance here this quarter; clearly, a rarity in the financial sector, so keep up the good work. But just curious if you could give us an update on your loan growth outlook for the year ahead and perhaps also update us on the card side, in particular, with respect to how you're progressing on the card acceptance awareness, translating into more lending volumes.

David W. Nelms

Yes, I think that I'm really pleased with the 6% this quarter, significantly higher than the 2% to 4% that we had targeted and in our Investor Day discussions. And certainly, it's nice to see this kind of growth when the overall industry continues to decrease, so significant share gain. It's going to be tough to maintain it at quite the 6% level. So I'm not sure we'll be able to maintain that throughout the year. But I'm certainly hopeful to at least be at the high end of the range that we've targeted in cards. And I mentioned Discover it. I think a lot will ride on how successful that is. We've seen good results from the test markets, but it's -- we really have to push hard to have this kind of growth in a non-growing card overall market. I think the acceptance that you mentioned is part of what's allowing us to achieve this kind of growth, combined with the higher level of investment spending, cash rewards programs, new products, all the other things. It's hard to disentangle everything. But I'm certainly pleased with the growing acceptance, the awareness of acceptance, the deals we're doing with acquirers, and that is paying fruit for us, or resulting in some of this growth.

Jason Arnold - RBC Capital Markets, LLC, Research Division

I mean, could you just expand on the Discover it, kind of compare/contrast with your typical card offering as well?

David W. Nelms

Well, I won't go into a huge detail on this, because there's too many features to fully talk about. But I am very excited. It's a cash back, no-fee card with an extremely high level of service and unique features that are designed to save customers interest and fees, and also has a different look and feel in terms of the card itself, and in how we're delivering it to the customers. So we're -- we'll look forward to briefing you more at our Investor Day about it, and you're likely to see some stuff -- some marketing of it show up next month.

Operator

Our next question comes from Mark DeVries from Barclays.

Mark C. DeVries - Barclays Capital, Research Division

I've got a follow-up on credit. I don't know if there’s a fair way to frame it, but how do you think about the level of reserves relative to charge-offs going forward?

R. Mark Graf

Yes, I guess Mark -- this is Mark. I would say that from my perspective, I would echo David's earlier comment, in that the reserve build you see this quarter is largely due to the growth in loan outstandings. We don't see a fundamental inflection point in credit here, I guess is what I'd say, just to be clear about it. Going forward, I think, as we continue to grow our balance sheet, there will likely continue to be requirements for provisioning associated with some of that growth. You think about it, we've been generating strong growth for a while now. And I think David indicated we continue to expect to see good solid growth going forward, and so that will force us to continue to provide. The way we look at things is we use a forward-loss emergence period. Currently up to 12 months so that's kind of how we're looking at a forward window of what we see coming at it. And the growth that we have been generating over a period of time has reached a level, to the point where we're providing for it a little bit. But we do not see a fundamental inflection point in credit here.

Mark C. DeVries - Barclays Capital, Research Division

Okay. And what loss rates are you assuming on the receivables you're adding?

R. Mark Graf

I don't think we've provided that information historically, as part of our underwriting models. But I would say we are not underwriting to current loss rates. I would say we are underwriting to what we believe to be more normalized loss rates.

Mark C. DeVries - Barclays Capital, Research Division

Okay. I just had one question about the mortgage business. What should we be looking at, as far as when we're going to see that become a meaningful contributor to profitability? Is it an issue of market size or is it just more work you have to do to kind of integrate that and rightsize the expenses?

R. Mark Graf

Yes, I think it's a couple different things, Mark. I think, first, foremost and fundamentally, it's a new business for us. And consistent with the way we like to do things, we're going to test drive it a little bit before we jam on the accelerator. So I would say that's a piece of the puzzle. I would say another piece of the puzzle would be we said all along there is some optionality there. We wouldn't make any broader commitments to the business until we had further clarity around how some of the capital treatment and some of the GSEs, some of that was starting to evolve. I think we're starting to get some clarity there, but we're probably not all the way to the full clarity we would want to see, to really move things forward. That notwithstanding, I would say we don't enter things with an idea of playing at them. So my perspective is there's a great opportunity for us in the mortgage business. And as we get more comfortable with it ourselves, and make sure we understand the various levelers and all the risks, it probably will -- you should look for it to become a more significant contributor going forward.

Operator

Our next question comes from Scott Valentin from FBR.

Scott Valentin - FBR Capital Markets & Co., Research Division

Just quickly on the networks you've mentioned, you've signed a number of agreements with -- that are unique. And just wondering when will we expect to see some type of a bottom line impact on some of those agreements? It seems like some of them can be pretty sizable, like China UnionPay or the PayPal, or even, I guess, in the media, you've seen Google Wallet association.

David W. Nelms

What I would expect is that we've just signed a bunch of deals and next year is going to be a lot of implementation and costs related to that, and getting going. And so I would probably think more like in the 2014, and then certainly into the 2015 period, to see some, much more serious volume from those new agreements starting to hit and generate profits.

Scott Valentin - FBR Capital Markets & Co., Research Division

And then just a follow-up on the expense line. I mean, you mentioned investing now to drive growth later on. That's on the marketing side. You also mentioned some employment expenses associated with the mortgage bank. In the context of the $3 billion give-or-take number that Mark, you kind of referenced before or was mentioned before, how much of that is due to that kind of employment line? How much of this due to the marketing side?

R. Mark Graf

Yes, I would say it's combination of both. At this point in time, marketing will be a big driver of the launch of a lot of these new products, some of which we've talked about and some of which we haven't. So that'll be a big piece of it. Headcount expenses have been part of the equation, but they have not been the lion's share.

Operator

Our next question comes from Ryan Nash from Goldman Sachs.

Ryan M. Nash - Goldman Sachs Group Inc., Research Division

Mark, when you think about capital, I mean you bought back $1.2 billion of stock, grew loans 6% year-over-year, increased dividend, yet your capitals levels are up 40 basis points year-on-year. So can you talk about your outlook and priorities for capital returns into 2013? Could this be the year that we actually see a decent dent made in bringing down the capital levels?

R. Mark Graf

We would love to see that be the case. I'm happy to talk about capital. We are currently in the throes of our annual capital planning activities, both internally and with our own Board of Directors, and also preparing for submission in the first couple days of January to the Fed, as part of the CCAR capital process, our annual capital plan as well. I think you all know that any capital actions we propose to take need non-objection on the part of our regulatory body. I guess I'd say a couple of things. Number one, I don't think we feel that we were necessarily aggressive enough in our ask last year. So I think you should expect our ask to be somewhat more aggressive than it was last year; it was not objected to. I think the other thing I would say in this regard is we remain committed to being responsible stewards of that capital. And fulfilling that mission is going to be a combination of deploying it at ROE levels above our threshold 15% that we have talked to you about in the past, and finding ways to get that capital returned to our shareholders to the extent we don't have the ability to do that. So it's not lost on us that you guys would love to see an increase in the returns of capital, and we are working toward that end.

Ryan M. Nash - Goldman Sachs Group Inc., Research Division

Okay, and just as -- Mark, as a follow-up on the comments on the potential for negative operating leverage. Can you just talk about how you're thinking about that? Are you looking at it as including gross revenues? Are you thinking about rewards as a contra revenue or actually as an expense?

R. Mark Graf

Yes, I'm including it as a contra revenue, but it's going into the calculation in the way I'm thinking about it, Ryan.

Operator

Our next question comes from Moshe Orenbuch from Crédit Suisse.

Moshe Orenbuch - Crédit Suisse AG, Research Division

David, I was really kind of struck by the 6% growth in receivables. You had mentioned that, that being driven by increased spending on, from revolving customers. And yet, the quarter doesn't really include the bulk of the holiday spending period. And by the same token, I didn't notice that your payment rates have had declined or anything. So could you talk about -- I mean, it feels like it should persist then. I mean is there something I'm missing?

David W. Nelms

No, well of course, we're comparing like time periods. So we're looking at the same time period, prior year in terms of the percentage of the holiday season. I would say that we saw, probably higher sales growth during year-over-year in November than we're seeing so far in December, and we saw this last year as well. And I think that one of the things that's happening is that more and more of the retailers are having bigger sales around Thanksgiving and accelerating some of the holiday spending into that month. So that is a likely kind of thing. And I guess the second thing is we did get -- we have been getting some extra pop from the higher rewards investments and other investments we've made. And while that will likely carry through this month, and if I look -- if I think about full year, we're going to be pulling back a bit to more normal levels of promotions. And that can also affect that growth throughout the year.

Moshe Orenbuch - Crédit Suisse AG, Research Division

Right. And just to follow-up, I mean is there anything you're seeing from the consumer side in terms of their willingness to actually carry some more debt? Because that would be obviously a positive. And can you talk about that, maybe -- and maybe what you're seeing into December?

David W. Nelms

I would say I haven't seen a big change this quarter. But for the last few quarters, I've been saying that we've seen sales and receivables growing at about the same pace, which suggest to me that a lot of the leveraging that has taken place over the last several years has run its course. And so I just -- I think this quarter, it was more of the same.

Operator

Our next question comes from Don Fandetti from Citigroup.

Donald Fandetti - Citigroup Inc, Research Division

David, more of a business-type question on your marketing. How much of your marketing is mailing today, versus let's say, some of the newer channels like online as a percentage today, let's say versus 3 or 4 or 5 years ago? Can you talk specifically about how that might have changed or not changed?

David W. Nelms

Well, it’s certainly changed dramatically over the last several years. And Internet and online has become a very significant part of the marketing mix, and I think that'll only continue to grow. Direct mail is easier to track. And so sometimes when we look at level of marketing intensity, it's a little easier for us to compare statistics on mailings being up or down in relative mail share. But we see more and more of our business moving online because it's very cost effective. We already get the majority of our applications come in through online, as opposed to all other channels combined.

Donald Fandetti - Citigroup Inc, Research Division

Okay, and then, it sounds like you're pretty constructive on payments and opportunities for investment. You have a lot of capital. Would you make any type of sort of decent-sized acquisition in Payments? And would it be more likely domestic or international?

David W. Nelms

If we saw the right opportunity that gave us the right returns and fit with our strategy, I would love to be able to bulk up in Payments. Obviously, if you look over the longer time period, we bought Diners and PULSE, so we have made Payments-type of acquisitions. We've made some smaller investments in this space. But -- so I think it could be, for the right deals, it could be a great way to deploy some of this capital. But that being said, the prices of properties tend to be pretty high. These -- our assets are quite unique. And so I think that what we have been finding is that there are a lot more opportunities to partner with others, as opposed to buying others, and that's been true both domestically and internationally. And so I think that, that is a more likely scenario, is to see more partnerships as opposed to acquisitions.

Operator

Our next question comes from Rick Shane from JPMorgan.

Richard B. Shane - JP Morgan Chase & Co, Research Division

When we look at your card growth, it's starting to break even more from the pack. And I think we really want to understand what's going on there. When -- I know you don't provide account numbers. But when you look at the drivers of this, can you give us some sort of sense of a ratio between how much of it's being driven by existing customers increasing balances, and how much of it is being driven by net new accounts?

David W. Nelms

I would say that it's been pretty balanced growth. And we've both balanced between new accounts and more usage from existing accounts. We've got more from sales as well as more from balance transfers. And I would say we're getting impact from growing share within existing merchants as well as the new acceptance that we've been able to put in is also giving us. So each piece may be a percent or so, and you have to kind of add it up to get to the 6% loan growth that we're seeing in total. The one thing that I would say is that we are not sacrificing credit quality. And if you look at where the growth is coming from, it is coming from the medium to high FICO scores bands as opposed to from low FICO score bands. So the one thing that's consistent across all these channels is it's good prime credit.

Operator

Our next question comes from Bob Napoli from William Blair.

Robert P. Napoli - William Blair & Company L.L.C., Research Division

The acceleration in growth on your proprietary card this quarter, 3.5% last quarter, 6% spend growth this quarter, is that primarily driven by some of the new incentives, David? And you talked to -- you mentioned teaser rate product as it relates to the margin in the quarter. What are -- what is -- what are you doing in teaser rates today?

David W. Nelms

I would say there is some promotional aspects. We had a, as Mark mentioned, more aggressive promotions this year than we -- than last year. I'd say that was more to do with -- the difference between this year and last year during the quarter was much more the rewards program and the fact that we are offering up to 5% on both Internet and department stores than it was pricing, promotional pricing. So it -- I think it’ll likely pull back a little bit as we get into next year, just as we go back to more normal promotional promotions.

Robert P. Napoli - William Blair & Company L.L.C., Research Division

Okay. And then the investment that you made, the incremental investment in payments, and there was a big jump in the payment sector and your operating expenses, I think $12 million quarter-over-quarter. And -- I mean, is that primarily -- should we expect to see those expense numbers stay around that level? And is that primarily being driven by PayPal? Or what else that we -- what specifically are you doing in that sector that's driving up those expenses?

R. Mark Graf

Bob, I'd say there's a couple of things going on in the Payment space. Specific to the quarter, Diners expenses were responsible for about 2/3 of the year-over-year increase. And they were primarily related to several new issuing relationships that we have talked to you guys about in the past, that we established in the last quarter or so. And you should think about them more as onetime oriented in nature. I would say that being said, as David noted, we're looking for a number of other opportunities in this space and actively engaged in those. So there's possibility, as you look forward of other onetime expenses creeping in as a result of that. So the way I would think about the payments business in 2013 is I would think about it as a year of investments in building to reap real returns down the road. Don't read that as a big backpedal, but also, I wouldn't expect the payments business to be the primary driver of growth in revenues and earnings over the course of '13.

Operator

Our next question comes from Chris Brendler from Stifel.

Christopher C. Brendler - Stifel, Nicolaus & Co., Inc., Research Division

Just wanted to hit on the growth questions a little bit more and the promotional activity. Can you talk at all about the interim month trends in spending? Did you, like once the promotion kicked in, I believe it was October, was there a several hundred basis point acceleration in your spending growth number? And then, as I guess, more broadly, do you think with the loan growth we're seeing this quarter, are we seeing any early signs of a pickup in consumer demand in terms of response rates to mail and the one's that to revolve? Is there any of that going on? Or do you think at this point, it's mostly just the promotional activity you've had, both teaser rate and also any net purchase causing the balance growth to also tick up?

David W. Nelms

Well, I think I've already discussed the inter-quarter volume, with November being the strongest year-over-year, month of the year, and then less so in December. But I think that's not so much related to our -- any promotions we're doing, but related to pull forward of retailers broadly, sales and to earlier in the holiday shopping season. And I think in terms of the promotion, and I mean, we've got a promotion that ran the fourth quarter of -- fourth calendar quarter. So and it runs through December, there's nothing sort of inter-quarter...

Christopher C. Brendler - Stifel, Nicolaus & Co., Inc., Research Division

Take it through the March to the -- in August and September, or sorry, so it's September relative to October, is it just like a couple of hundred basis points of spending coverage you got from that program? Or was it just minor impact?

David W. Nelms

I think at that point, minor.

Christopher C. Brendler - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And I guess another question I have on that topic was, just in returns of response rates. And I have -- a follow-up question would be, on the fee income side, of the fee products, you saw, I think on a sequential deceleration in the fee products that the revenue's falling a little faster this quarter. Does that 7% or so decline, does that continue into 2013, as you wind those down? Are you mostly through the wind-down at this point?

R. Mark Graf

Yes, it's -- as you look at the fee products revenue line going forward, as I mentioned, we did see some marketing of the products during the quarter. We took a hiatus here to make sure we have everything in place to comply with our consent order. It's our intent we will begin reissuing or re-offering those products to our customers. But in terms of from a guidance standpoint, I would say, you had, what, a $5 million, roughly sequential decline in revenue related to those products. For now, I would say that's probably a good way to think about the continued impacts going forward.

Christopher C. Brendler - Stifel, Nicolaus & Co., Inc., Research Division

Oh, 2013, $5 million a quarter?

R. Mark Graf

Yes, I think that's probably a good way to be thinking about 2013 on Protection products at this point.

Christopher C. Brendler - Stifel, Nicolaus & Co., Inc., Research Division

Okay, and then just last, circling back, any pickup in demand, David, that you're seeing at the consumer level, in your fee service analysis?

David W. Nelms

I would say that we have seen some good results from our Discover it product, which is why we've made the decision to roll it out next month. And so we're looking forward to that launch.

Operator

Our next question comes from James Friedman from Susquehanna.

James E. Friedman - Susquehanna Financial Group, LLLP, Research Division

I guess I'll ask both my questions upfront. There was a slight deceleration in PULSE volumes this quarter, still good numbers. Was wondering if that's the mix shift of debit and credit, or if there's something more profound related to the FANF or the competitive environment? That was my first one. And then, Mark, you had mentioned that the offset that you had a $26 million gain on the sale of minority investment. I was wondering if you could share more details as to what that might been.

David W. Nelms

Yes, I think in terms of PULSE, I would expect a further deceleration in the next quarter. While I was pleased with the overall growth rate we experienced this quarter and the last few quarters on PULSE, that would have been even higher without some of the competitive challenges, I'll say. And one of those competitors is the Goliath in the industry. And as they continue to roll out some of these new kind of hijacked transaction actions, a lot of those were just being rolled out now, and will have an increasing effect on all the other competitors in the market, including PULSE.

R. Mark Graf

And then with respect to the $26 million gain, we don't disclose the specific names, but we do have a small portfolio of what I would call strategic minority investments that we make, as part of our Payments business, where we see opportunities either be able to acquire, or more ultimately partner with these folks, going forward. We'll sometimes take a stake in those opportunities. And when the strategic value either does not pan out the way we thought it would, or for other reasons we determine, it's just not the right direction for us to head, we typically look to monetize these investments. And I think this one falls into that latter category, and just shows that we do know what we're looking at in the Payment space, even though it didn't end up working out right for us.

Operator

Our next question comes from Sameer Gokhale from Janney Capital Markets.

Sameer Gokhale - Janney Montgomery Scott LLC, Research Division

I had a couple. I guess the first one is on your private student loan portfolio, you continue to show great credit numbers. But loans in forbearance, do you know how the statistics are, if you compare them year-over-year for the private student loan portfolio? And do you foresee making any changes to your forbearance policies as you look through the portfolio and credit quality in the economic environment? And then I have a follow-up.

David W. Nelms

Yes, Sameer, I think that our forbearance policies are pretty much dictated by what's allowable in terms of regulations, which have not changed year-over-year. And I think that the big effect for us is that we are going to be going through a seasoning where we've had a lot of growth, and we're getting -- we're going to have more of the students that we booked, who will be entering repayment for the first time. And most of the losses or about 1/2 the losses that you occur -- that occur over the life of a student loan occur the first 2 years after repayment. So as we get more of those people, we're going to end up having more people in forbearance, more losses, and then you get a maturing over time. And it, I would say, that business continues to perform on a vintage basis as we had anticipated.

Sameer Gokhale - Janney Montgomery Scott LLC, Research Division

And then, you've talked quite a bit about credit card loan growth and given some helpful commentary on that. But that's something, which I think is kind of an obvious question, but just be helpful to get additional perspective on that. When you look at the credit card business and the fact that there are, of course a few, small, a small number of large competitors in the business. And you are investing in rewards and trying to gain share, or you are gaining share of receivables, how do you think of it from a gain theory perspective? Because it strikes me that you invest on rewards. You get some share, then somebody else invests more in awards, and they take away some of the share from other folks. In terms of the natural growth rate, of -- underlying growth rate of the industry, doesn't it make sense to dial back on investments just because, if everyone starts doing that, everybody loses? I mean, how you think about that, at a high level?

David W. Nelms

Well, I think from a high level, I think of cards as being a slower growth business. And so if you think about it, that's a little bit more of a 0 sum game, our goal is to continue to gain share. So you've seen us gaining share in loans for now a few years. And what I see is that while it's a smaller number of sizable competitors today than in the past, the good news is, they're more rational competitors. So I think they're not going to be dropping credit standards to reach for growth, which is always the biggest concern you've got. And so what it comes to is us using our competitive advantages to gain share, so our advantage in service, our advantage in rewards, our advantage in growing acceptance, our advantage on differentiation, including with new products. And so we're going to be focused on -- from a game theory perspective, using all those competitive advantages, to gain share in the credit card market.

Operator

Our next question comes from Chris Donat from Sandler O'Neill.

Christopher R. Donat - Sandler O'Neill + Partners, L.P., Research Division

Two quick questions on the checking product. I thought that was something that you had intended to launch in fiscal '12. And I'm just wondering, first, if there's anything with the timing that's related to the conversion of your core banking system. And then secondly, if it does launch and does scale significantly, could it also be another tailwind to your cost of funds in '13?

David W. Nelms

Well, I would say that our core banking system's on track. I would have loved to have gotten the tracking -- the product out this year. And it looks like we're going to miss it by a couple of months, 5 -- 1 quarter. But I think what I would attribute more of that to is that it is a more -- it's probably a much more robust product and a better product than what I might have anticipated a year ago. And so we wanted to really kind of get it right from a consumer value proposition. And so I am really excited to the able to launch it early next year. In terms of the impact on cost to funds, that's, that is our reason for launching it. We don't expect this to necessarily make money as a product, except it's going to be, over time, a good low-cost, stable source of funds and an additional important core relationship. And I expect it to not have a material impact in the near term, because it's going to take some time. By definition, these are the sticky bank deposits. And so it's going to take some time for us to pry those sticky relationships into a direct banking relationships. But I'm excited about the technology and the value that we can offer to, over time, have that start to become a tailwind on cost of funds. But I think realistically, you're -- you'd have to look more in a -- 2014, 2015 and beyond that, just to really start seeing some movement.

Operator

Our next question comes from Daniel Furtado from Jefferies & Company.

Martin Kemnec - Jefferies & Company, Inc., Research Division

This Martin Kemnec in for Dan Furtado. Quick question on the promotional balances. I assume that in the low rate environment, that it's still positive from an NPV perspective. But curious, when these eventually start to come off their promotional periods, is it reasonable to expect that we could see, maybe some stabilization in card yields as those balances start earning fees? I think, David, you may have just mentioned, possibly reeling in there a bit, or would that not be, kind of meaningful enough to really move the needle there? And then on credit, Mark, your comments are very helpful. I just -- one, a kind of modeling question on the reserve rate. Is it safe to assume that kind of 3%, call it 315 basis points, is the correct reserve rate to model going forward until we kind of start to see credit inflecting?

David W. Nelms

So Mark, we'll give you more update on the promo rates at Investor Day, as we've done the last few years. But you're right. We are able to maintain good NPVs with more promo balances and lower rates in today's cost of funds environment than we would in different environments. And we're taking advantage of that now to be able to offer our customers some very good deals cost effectively. I guess I would -- I tend to think about as a little bit of a wash, that more -- less of being an opportunity. But more, as the rate environment changes, then you have to look at your promotional rates and what percentage are at promo, where's the duration and all of that, as one way to help mitigate some of the less benign rate environment over time.

R. Mark Graf

And as far as the reserve coverage ratio is concerned, it's -- we don't really track the reserve coverage ratio. It's -- I mean, we do follow-up, we don't manage to it. It's a rearward-looking metric, and we look forward. I'd say there's a bunch of factors that can affect it. So not prepared to give specific guidance on what that rate should look like going forward. What I would do is echo our earlier comments though, that we don't see a fundamental turn in credit at this point. And any reserving that takes place will really be driven in our view at this point, based on the seasoning of that account growth.

Operator

Our next question comes from David Hochstim from Buckingham Research.

David S. Hochstim - The Buckingham Research Group Incorporated

I wondered if you could share some additional thoughts about the dividends. I know you had a big increase this quarter, but it's been a year since the last one. And your payout ratio is still quite low, relative to other very large, well-capitalized banks. And I wondered, if -- well actually, if you could share your thoughts about payout ratio, and how soon you might look to make another change to the dividend, assuming the Fed signs off on what you'd like.

R. Mark Graf

Thank you for the qualifier at the end there. That's helpful. I guess from our perspective, it's pretty straightforward. We definitely see room to take our dividend payout ratio higher than it is right now. And I would also say that as we change our fiscal year, we may change our quarterly dividend payment dates to correspond a little bit to those of our peers. I would also say that we've been saying for a long time, we'll revisit our dividend no less frequently than annually. I would specifically reiterate that statement to you today.

David S. Hochstim - The Buckingham Research Group Incorporated

Would you consider reevaluating it more often than annually?

R. Mark Graf

I don't think I'm prepared to give any further guidance than I did right now while we're in the preparation of the capital plan. Let's just say we see room to take that dividend payout ratio higher, and one should not assume we're going to stay on a December cadence. How about that?

Operator

Our next question comes from Ken Bruce from Bank of America.

Kenneth Bruce - BofA Merrill Lynch, Research Division

I think when you look at credit over the last few years, it's been a tremendous positive driver for Discover. And I think it's understandable why you don't expect it to get any better. And I also understand why you'd expect the provisions to go up as the balances grow. And that, obviously, was very encouraging in the quarter. But what I'm interested in knowing is what do you think that it will -- what will drive loss rates or delinquency rates and ultimately loss rates higher on a percentage basis? Is it just a macroenvironment? Is it the seasoning that Mark, you just touched on? Is it lower recoveries? What are you -- do you think is going to drive delinquencies and losses higher?

David W. Nelms

Well, I would say a couple of factors. One is seasoning of the book. If you looked at the -- how much everyone pulled back during the financial crisis and very few new accounts were booked, we're now back into a more normal time period. And so as the new accounts that have -- are now being booked, start the season, that will tend to increase the loss rate a bit to more normal levels. I'd say a second thing is that as we get further away from the very large spike in charge-off rates, to some degree, people that were close to the edge all got recognized in a short period of time. So much like the bankruptcy law changed from a number of years ago, where there was a trough afterwards, and it took a few years, but eventually you get back to more normal levels. So I think as we get away from the spike, you're going to eventually start to normalize. And so those are 2 macro factors. Then you start getting back into the normal, unemployment, health care costs, divorces. These are the kinds of things that in prime business, tend to drive charge-offs, and you get back to more normal levels of all those, kind of life events.

Kenneth Bruce - BofA Merrill Lynch, Research Division

Okay, that's helpful. And could you remind us, what this, the timeframe of seasoning typically would be within your portfolio?

David W. Nelms

Typically, one thinks about 2 years, maybe about 2.5 years as being a peak charge-off, and then coming down after that point.

Operator

We have no further questions at this time.

David W. Nelms

All right. Thank you, everyone, for joining us. Hope you all have a happy holiday, and feel free to reach out to Investor Relations if you have any follow-up calls. Thanks.

Operator

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

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