Discover Financial Services Q4 2023 Earnings Call Transcript


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Participants

Corporate Executives

  • Eric Wasserstrom
    Senior Vice President, Corporate Strategy and Investor Relations
  • John B. Owen
    Director, Interim Chief Executive Officer, and President
  • John T. Greene
    Executive Vice President, Chief Financial Officer

Presentation

Operator

Good morning. My name is Todd [Phonetic] and I will be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter 2023 Discover Financial Services Earnings Conference Call. [Operator Instructions] Thank you.

I will now turn the call over to Mr. Eric Wasserstrom, Senior Vice President of Corporate Strategy and Investor Relations. Please, go ahead.

Eric Wasserstrom
Senior Vice President, Corporate Strategy and Investor Relations at Discover Financial Services

Thank you, and welcome to this morning's call. I'll begin on Slide 2 of our earnings presentation, which you can find in the Financials section of our Investor Relations website, investorrelations.discover.com.

Our discussion today contains certain forward-looking statements that are subject to risks and uncertainties that may cause actual results to differ materially. Please refer to our notices regarding forward-looking statements that appear in our fourth quarter 2023 earnings press release and presentation. Our call today will include remarks from our Interim CEO, John Owen, and John Greene, our Chief Financial Officer. After we conclude our formal comments, there will be time for a question-and-answer session. During the Q&A session, we request that you ask one question, followed by one follow-up question. After your follow-up question, please return to the queue.

Now it's my pleasure to turn the call over to John.

John B. Owen
Director, Interim Chief Executive Officer, and President at Discover Financial Services

Thank you, Eric, and thanks to our listeners for joining today's call. 2023 was a year of significant change for Discover. And we believe the actions we've taken to position the company to continue driving strong long-term performance. When I stepped into the Interim CEO role, I had three priorities. My top priority was to advance our culture of compliance. And we have made meaningful strides in our corporate governance and risk management capabilities. That said, this is a journey that will take time and continued investments over the coming years to further enhance our compliance and risk management capabilities.

My second priority is to continue delivering a great customer experience at every touch point, which we do by providing our customers the award-winning service and products. I'd like to thank our 20,000 employees for delivering a great customer experience to help our customers achieve a brighter financial future. In 2023, we were recognized for the first time as one of Fortune 100's Best Companies to Work For. This award adds for accolade for working parents, women, people with disabilities, and members of the LGBTQ+ community, and we're proud to be an inclusive workplace.

My third priority is to sustain our strong financial performance. We reported net income of $2.9 billion for full year 2023 and earnings per share of $11.26. This makes 2023 the third best year for EPS performance in our history. In delivering these results, we achieved several important milestones. We exceeded $100 billion in card receivables, grew deposits by 21% year-over-year, successfully launched our cashback debit account on a national scale, and we announced our intent to exit the private student lending business. On December 11, we announced a new leadership and we're excited to have Michael Rhodes joining us for our incoming Chief Executive Officer. Michael is experienced leader with a deep background in the financial services industry. He has managed all aspects of our consumer banking business with deep experience in the credit card space, payments, online and mobile banking. He served as Group Head of Innovation and Technology. His appointment marks the conclusion of a rigorous search process, and we look forward to Michael's arrival. When Michael arrives, I'll return to my prior role on Discover's Board of Directors.

In conclusion, I'm proud of the progress we've made in 2023. Our integrated digital banking model, resilient financial performance, and maturing risk management and compliance capabilities position Discover well for 2024 and beyond.

With that, I'll now turn the call over to John Greene who will review our fourth quarter 2023 financial results in more detail and provide some perspective on 2024.

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Thank you, John, and good morning, everyone. I'll start with our summary financial results on Slide 4.

In the quarter, we reported net income of $388 million, down from just over $1 billion in the prior-year quarter. There are three broad trends to call out. First, we grew revenue 13%, reflecting 15% loan growth, partially offset by modest NIM compression. Second, provision expense grew by $1 billion. Charge-offs increased but landed at the low end of our expected range. Strong loan growth and higher delinquency drove the increase to our reserve balance. Finally, expenses increased 19% year-over-year, reflecting investments in compliance and risk management, a reserve for customer remediation and higher marketing expense to support our national cashback debit campaign. We'll get into the details of these topics on the following pages.

Turning to Slide 5. Our net interest margin ended the quarter at 10.98%, down 29 basis points from the prior year and up 3 basis points sequentially. The decline from the prior-year quarter was driven by higher funding costs and higher interest charge-offs, which were partially offset by higher prime rates and increases in revolving balances. For the full year, net interest margin was 11.07%, up 3 basis points from the prior year. This margin performance reflects the improvement in our funding mix over the past several years and a reduced level of balance transfer and promotional balances as we tightened underwriting. Receivable growth remained robust. Card increased 13% year-over-year due to contributions from the prior-year new account growth and a lower payment rate. The payment rate declined about 110 basis points from the sequential quarter and is now 100 basis points above 2019 levels. Overall, new account growth declined 9% as a result of credit actions. Sales were up 3% compared to the prior-year quarter. Personal loans were up 23% driven by continued strength in originations and lower payment rate versus the prior year. Student loans were flat year-over-year. As we prepare for a potential sale of this portfolio, we will cease accepting applications for new loans on February 1.

Our deposit business delivered outstanding performance in a challenging year. Average deposits were up 21% year-over-year and 4% sequentially. Our direct-to-consumer balances grew $3 billion in the period and $14 billion in the year.

Looking at other revenue on Slide 6. Non-interest income increased $74 million, or 11%. This was primarily driven by an increase in loan fee income, higher transaction processing revenue from our PULSE business, and higher net discount and interchange revenue. Our rewards rate was 137 basis points in the period and 140 basis points for the full year 2023, a decrease of 1 basis point on a full-year basis. The decline reflects lower cashback match from slowing new account growth and our active management of our 5% categories.

Moving to expenses on Slide 7. Total operating expenses were up $280 million, or 19% year-over-year, and up 22% from the prior quarter. Looking at our major expense categories, compensation costs increased $73 million, or 13% from higher headcount. Marketing expenses increased $59 million, or 19%. Professional fees were up driven by continued investment in compliance and risk management capabilities, while other expense reflects a reserve for customer remediation.

Moving to credit performance on Slide 8. Total charge-offs were 4.11%, 198 basis points higher than the prior year and up 59 basis points from the prior quarter. In card, as anticipated, delinquency formation is slowing as more recent vintages season. We added a slide detailing some of the drivers of our credit performance in the appendix to the earnings presentation.

Turning to the allowance for credit losses on Slide 9. This quarter, we increased our reserves by $618 million and our reserve rate increased by 17 basis points to just over 7.2%. The increase in reserves was driven by receivable growth and higher near-term loss content from higher delinquencies. Under CECL, reserve levels increase as you approach peak losses. We expect our losses to rise through the midyear and then plateau through the back half with some seasonal variation. In terms of our macroeconomic outlook, our view of unemployment was relatively unchanged, while household net worth projections increased slightly. These changes provided a small benefit to reserves.

Looking at Slide 10. Our Common Equity Tier 1 for the period was 11.3%. The sequential decline of 30 basis points was driven largely by asset growth. We declared a quarterly cash dividend of $0.70 per share of common stock.

Concluding on Slide 11 with our perspective on 2024. Please exclude the impact of a potential student loan portfolio sale. We expect end-of-period loan growth to be relatively flat, while average loan growth will be up modestly year-over-year. We expect full-year net interest margin to be 10.5% to 10.8%. We're currently anticipating core rate cuts of 25 basis points in 2023. This is two more rate cuts than in our forecast in December. Each cut reduces NIM by approximately 5 basis points subject to a deposit beta. We expect total operating expenses to increase by a mid-single-digit percent. This contemplates our expectation for compliance-related costs to be approximately $500 million this year. Total expenses may increase the incremental resources where remediation is required. We expect net charge-offs in the range of 4.9% to 5.3%.

Finally, regarding capital return. We will participate in this year's CCAR process and believe the results should help inform our view of capital management for 2024. Importantly, our capital management priorities have not changed and remain centered on supporting organic growth and returning capital to shareholders.

To summarize, we continue to generate solid financial results. For 2024, we will continue to advance our compliance and risk management capabilities and [Speech Overlap] actions to drive sustainable long-term value creation.

With that, I'll turn the call back to our operator to open the line for Q&A.

Questions and Answers

Operator

[Operator Instructions] Our first question will come from Rick Shane with J.P. Morgan. Please, go ahead.

Richard Shane
Analyst at J.P. Morgan

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

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Hey, Rick, John Greene here. That is organic loan growth. So all of the guidance excluded the impact of a potential student loan asset sale.

Richard Shane
Analyst at J.P. Morgan

Okay. That's it from me. Thank you, guys.

Operator

Thank you. Our next question will come from Moshe Orenbuch with TD Cowen.

Moshe Orenbuch
Analyst at TD Cowen

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

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Sure. Thanks, Moshe. So the components of loan growth sales, new account generation, payment rate trends. And so what we're anticipating for sales given the slowdown through 2023 in terms of sales, although, we did have a pretty strong holiday season, is that sales will be relatively flat year-over-year. New account generation relative to last year, certainly down, but overall positive new account growth. And payment rate, what we've tried to do here is kind of derisked the forecast. So, we assume that 100 basis points of payment rate that's elevated versus 2019 will remain elevated. So those three components reflect -- end up coming in and reflecting on our projections.

Now, loan growth could actually come in higher if payment rate continues to decline. But overall, our basis for guidance loan growth, net interest margin and charge-offs was to give a range and then also be relatively conservative in terms of the expectations on those ranges.

Moshe Orenbuch
Analyst at TD Cowen

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

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Sure. Yeah. So there's a couple of different components that are driving that. So if you go back in time, we had about two years of unusually low charge-offs and delinquencies, so from the pandemic. And that process of normalization typically will take about the same amount of time, two years. The vintages, '21 and '22 are seasoning, and that's why we expect it to plateau. The '23 vintage actually was relatively large, but too early to call whether it's going to outperform our expectations, but certainly a highly profitable vintage from our vantage point today.

So, what you're actually just seeing is a period of normalization. My expectation is that charge-offs will plateau, and then -- and beginning in '25, I would expect those to step down. Now you will know from this past year and the prior year what we've tried to do in terms of the guidance is be conservative in terms of the range. And throughout 2023, we tightened the range and actually came in at the low end. So my hope is that we'll be able to do the same thing in 2024.

Moshe Orenbuch
Analyst at TD Cowen

Great. Thanks.

Operator

Thank you. Our next question will come from Ryan Nash with Goldman Sachs.

Ryan Nash
Analyst at The Goldman Sachs Group

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

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Yeah. Thanks, Ryan. So our approach in in '23 and then early into '24 was that we took a look at underwriting and performance of what I'll say buckets within our underwriting box and essentially tightened -- and we tightened throughout 2023. What you're seeing here in terms of account growth, at least projections today, is us getting back to 2018 and 2019 levels as we continue to watch the '22 and '23 vintage perform. And six months from now, we may end up stepping in a little bit more aggressively, but what we wanted to do, certainly was let kind of get further confirmation that the delinquency trends that we have seen in terms of slowing rate of delinquency formation continue to persist and the charge-offs, the forecasted come in at or better than our expectations. If those two factors are at play, there'll be an opportunity to be more aggressive in terms of new account growth.

Ryan Nash
Analyst at The Goldman Sachs Group

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

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Yeah. Thanks, Ryan. So good news, so it is actually progressing to schedule. So a matter of fact, last evening, we signed a servicing agreement with Nelnet to become the servicer of this portfolio. So, that was great news. It was a competitive process and certainly Nelnet showed that there is a commitment to continue to dedicate resources and service that portfolio at a high level.

The next step will be to continue to servicing migration activities. We expect those activities will take around six months. We're -- conservatively, it may take a month or two longer. And then as as we're doing that, our advisor will begin to market the portfolio. So our expectations are that it will sell in in the second half. And the implications for the business are as follows. So there's $9.5 billion of receivables. That equates to risk-weighted assets of about $10.8 billion. We expect that, that will be -- the exit of that will be -- have a positive impact on net interest margin by somewhere between 10 bps and 20 bps on a full-year basis. Charge-off rate could tick up mildly, so under 5 bps. And as of 12/31, we had $858 million of reserves. So whether it's successful exit, those reserves will drop. And the sale price, the market will determine that, but we expect it to to go above par.

Ryan Nash
Analyst at The Goldman Sachs Group

Thank you for all the color.

Operator

Thank you. Our next question will come from Mihir Bhatia with Bank of America.

Mihir Bhatia
Analyst at Bank of America

Hi. Thank you for taking my question. Wanted to start with loan growth also. And I just wanted to go back to the building up a bit. I think you essentially said in terms of the building blocks, you're expecting payment rates to be elevated, like flat to stay at consolidated level and sales to be flat, you are also adding a comp. So I'm just like trying to understand like I guess, what's the bad guy, like how does loan growth stay flat given -- you had 15%? I'm just trying to understand like what -- there's some piece I'm missing I feel like, and I'm just trying to understand that.

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Yes. So let me try to give a little bit of color that hopefully gets folks comfortable with our view of loan growth today. So, in 2023, really, really strong loan growth. Much of that was driven both by new account growth, but also a slowing payment rate. That payment rate, in our assumptions, is holding flat. And as a result, what we expect to see is the 2023 vintage will begin to kind of build in terms of assets. But there's likely going to be some impact from sales. And then also as we cycle through the 2022 vintage, we're not expecting significant new balance builds from that vintage. Now, maybe there will be, but overall, what we've tried to do here is reflect our view of our underwriting box today, not reflect any potential openings of our underwriting box in the later part of 2023. And if we out-deliver on loan growth, that'll be fantastic.

The other element that has come into play here is we pulled back on balance transfers and promotional balances in the second part of 2023. We don't anticipate significantly increasing that level of balance transfer, promotional balances. Now, if we do, that'll certainly be accretive to loan growth as well. So what you're hearing in the guidance is that our expectation is that there's an opportunity to deliver better. But certainly, we position both the guidance and the business to be conservative, at least for the next quarter or two.

Mihir Bhatia
Analyst at Bank of America

Got it. And then I wanted to go back to the expenses and the reserve for customer remediation that you mentioned that you took this quarter. Can you just provide some more color on that? Like is that related to the merchant mispricing issue? How much was the reserve this quarter? Where does that leave the reserve overall? I think you had $365 million in 2Q. I'm just trying to understand, has the estimate for the cost related to that issue changed? I think you also mentioned it could be higher, expenses could be higher in '24, if you need to take more reserves there? Like where are we with that investigation? Just give us an update on that merchant mispricing issue, too.

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Yeah. Okay. So, let me start with the reserve, so -- and the remediation reserve that we put up. So they're unrelated. So the merchant tiering reserve, we booked $365 million as a liability. That has moved. It is now about $370 million, just as we've had some payments and other flows in through the interchange that we had to correct manually for. So the progress there in terms of discussions with our merchants is positive. We'll -- we don't have enough data points to make a material change to that reserve level yet, but it's progressing, my view, positively through the end of the year and today, as we speak.

Now separately, we put up $80 million for a, as we described it, remediation reserve. Now, some context to that is as part of this compliance journey, we put in a significant number of resources to help us identify and correct issues. And as we prepare the business to continue to move forward to drive organic growth, we're getting much, much better at identifying issues and we identify an issue. What we've done here is if we think there's -- it's appropriate to refund customer payments, we're going to do that. So we identified a particular issue largely within servicing for our student loan business. Although there was a tangential impact in another business line, we continue to look across our business. But the lion's share of that reserve relates to student loans. And essentially what we're doing is trying to position the business and that product for successful exit.

Mihir Bhatia
Analyst at Bank of America

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

Operator

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

Sanjay Sakhrani
Analyst at Keefe, Bruyette & Woods

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

John B. Owen
Director, Interim Chief Executive Officer, and President at Discover Financial Services

Yeah. This is John Owen. I'll take part of that and John Greene will take the capital part. What I would tell you is over the last 18 months or so, we've made significant progress improving our risk management and compliance capabilities. We've increased our investments on risk and compliance in 2022 to 2023 up to about a $500 million level. And as John mentioned earlier, we think expense growth and that will be in the mid-single-digits, in line with other guidance we've given. We've made improvements in the risk and compliance, but we still have quite a bit of work to do. One thing I'd point out, the FDIC consent order, which we did get and was made public, does not include the misclassification issue in that scope of work. We're working closely with our regulators on that topic and really don't have anything further to add on that topic at this point in time.

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Okay. Sanjay, I feel like your question is a five-part question, but we'll do our best to answer it. So the loan growth aspect that you asked, it is completely unrelated to any regulatory issues. So nothing to connect on that point. In terms of capital return, our commitments to capital return and capital allocation have not changed. So first, to invest in profitable organic growth, and second, to return excess capital to shareholders. So as we kind of progressed through the fourth quarter, we remained on pause with our buybacks. And given we've got a new CEO coming in, we are contending with a number of different compliance and risk management matters, got the merchant tiering reserve. We don't have any feedback from our regulators on that point. We decided that it'd be most appropriate to remain conservative in terms of our guidance related to buyback. We will go through CCARs, as I said in my prepared remarks. That'll form a view of capital under significant stress, as it always does. And then we're going to have the exit, or hopefully, the exit from the student loan business, which will provide -- free up at least $2 billion worth of capital.

So, what you're hearing here, hopefully, is some indications that, one, we're committed to returning excess capital to shareholders; two, that there will be excess capital generated and available; and three, we're going to go through a diligent process internally, share it with our board, and then take the board's direction in terms of buybacks.

Sanjay Sakhrani
Analyst at Keefe, Bruyette & Woods

The consent order...

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

And...

Sanjay Sakhrani
Analyst at Keefe, Bruyette & Woods

...with the loan servicing, like does that move?

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Yeah.

Sanjay Sakhrani
Analyst at Keefe, Bruyette & Woods

[Speech Overlap] yeah.

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

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

Sanjay Sakhrani
Analyst at Keefe, Bruyette & Woods

Okay. Then my follow-up just question is -- sorry, to my five-part question, is the reserve rate -- Moshe sort of asked about a little bit, but how should we think about that reserve rate migrating over the course of the year given the charge-off rate plateaus? Does the reserve rate start coming down? And where does it come down to in a normal environment? I'm just trying to think about how we model that, because that's really important.

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Yeah, thanks for that. We were hoping that, that question would come out. So, the -- let me talk about the reserves for the quarter, and then I'll give some perspective on '24 and what could potentially happen there. So we grew receivables in the quarter, $5.7 billion. Now, some of that was transactor balances that are reserve-light. But one thing that we've been consistent on in terms of our communication is that as we approach peak losses, reserve levels increase. And what we've said previously is typically, we hit the highest reserve rate level one to two quarters before peak losses. So that's the path we're on. Let me provide some details on some assumptions that were used to set the reserve levels this year at year end, and then I'll give a perspective on what could happen in 2024.

So the macro is relatively benign. So unemployment levels, we ended the year at 3.7. What we've assumed is an unemployment level of 4.2. So a mild increase. Household net worth, mild decrease. Savings rate, mild increase. And GDP to be -- in 2024, to be about 1.3%. So relatively conservative, but not overly optimistic set of assumptions.

Now, what will come into play in 2024 is obviously the macros, which will continue to be important, the portfolio performance. And by the way, it is tracking to our expectations with month-over-month delinquency formation declining. The credit quality of the book remains relatively consistent with what we've done historically. So our expectation is that assuming the macros remain consistent and the portfolio performance remains to our expectation that there will be some level of opportunity to reduce the reserve rate in 2024.

Now, that's subject to a significant amount of governance, and we're going to make sure that we comply with our internal processes and generally accepted accounting principles. So they're my caveats. But there's a lot of things that are different today than day one. So this step-down will be aligned with those points I just mentioned.

Sanjay Sakhrani
Analyst at Keefe, Bruyette & Woods

Okay. Great. Thank you very much.

Operator

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

Bill Carcache
Analyst at Wolfe Research

Thank you. Good morning, and thanks for taking my questions. John, I wanted to follow up on your credit commentary, given that it is such an important area of focus for investors. You've been saying all along that you didn't move down the credit spectrum, but the concern for many investors had been that other card issuers also experienced outsized growth as we emerged from COVID, and they had also experienced some normalization headwinds. But they were now starting to see delinquency formations start to roll over as Discover's DQ rate formations as recently as prior months, data showed that your formations remain on an up until the right trajectory. So I guess the question is, does the new disclosure on Slide 14 confirm that your delinquency rate formations are indeed now also starting to roll over? And if so, does that really just reinforce your confidence that we could see peak NCOs hit in 2024, all else equal?

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Yes, and thanks for the question, Bill. So just to give you kind of the benefit of some data here, from September through December this year, so the 30-plus delinquencies have declined month-over-month. So in September, we peaked at an increase month-over-month of 26 bps. What we said in the fourth quarter is we expected that to decline. October formation increased 20 bps, so relative decline to the prior month, November 15 bps, December 11 bps. And our expectation is that, that will continue to decline. Where it becomes negative, we're not going to get into that because it'll be subject to a number of different things, including kind of our origination path and broad macros.

So to get to the essence of your question, we do have a level of confidence regarding kind of what's happening in the portfolio and the trend. And as we progress in 2024, that'll be reflected in hopefully tightening guidance and then also tightening guidance to the lower end and then also hopefully reserve rate changes.

Bill Carcache
Analyst at Wolfe Research

That's helpful. Thank you. And following up on your expense commentary, I believe you said that expenses may need to increase further potentially. Maybe if you could frame the possibility of there being, what you would view as another step function higher from here? Or, how should we think about the risk of further increase in expenses? And how are we -- how should we think about your sustainable long-term efficiency ratio? I think as we look at historically, Discover has been very -- very much had lowest efficiency ratio in the industry. To what extent, is that still something that we can expect?

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Okay. Yeah. Thanks, Bill. So, our expectation is that the long-term efficiency ratio will be sub-40%. So, there's still a view that, that will happen. The reason we put the, what I'll call is the caveat in the 2024 expense guidance, was a number of different institutions, when they've been on this compliance and risk management journey, have not been able to call what the actual compliance and risk management spend would be. We had that remediation reserve in the fourth quarter. There were some indications that we might have to put something up for that. But we didn't know. There's still some level of unknowns. And I wanted to make sure we're clear to the people listening to this call that there is some level of risk to the expense guidance. Now that said, 5% on our expense base is a significant amount of dollars. We feel like we have nearly a full complement of resources around risk and compliance today, which is good news. Our issues management capabilities significantly improve. Our path to improving overall governance is certainly on the right trajectory. So, those factors give me confidence that we're not going to have a huge surprise. But there could be. Just -- we just don't have enough certainty given where we are on our compliance journey.

Now, the rest of the cost base, there's a couple of things to keep in mind here. So right today, we have nearly 3,000 resources dedicated to risk and compliance management. A significant amount of those resources are dedicated to issues related to student loan servicing, which with a successful exit and transfer, it'll give us an opportunity to scrutinize the cost base in a different way. So that's certainly on the list of planned activities for the second quarter, third quarter, and then hopefully, we begin some execution in the fourth quarter.

So, overall, I feel comfortable with the expense guidance that we've provided and we're going to do our best to make sure that every dollar we spend is wise and that the shareholders get the benefit from that.

Bill Carcache
Analyst at Wolfe Research

Very helpful. Thank you for taking my questions.

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

You're welcome, Bill. Thanks.

Operator

Thank you. Our next question will come from John Pancari with Evercore ISI.

John Pancari
Analyst at Evercore ISI

Good morning. Regarding the new $80 million remediation charge, did all of that remediation relate to the student loan business specifically? And was that, in part, tied also to the July '22 disclosure around the student loan issues that surfaced then? And did any of that $80 million relate to the other business that you point -- that you mentioned that could have had a tangential impact? And what was that business? Thanks.

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Yeah. So, the $80 million was related to servicing issues. The lion's share of that, the significant share of that was related to student loans. There was a small amount that we put up related to personal loans. Upon reviewing that, there may be an opportunity to release that reserve. Very small, though. The $80 million is not connected to the issues that we discussed in July. So, what I tried to do is provide as much context as I could. We've dedicated a number of resources to identifying issues to help us on this consumer compliance journey as -- with any company, as you dedicate resources, they come up to speed, they are going to get more effective at identifying issues and correcting issues. This is symptomatic of that progress. So -- but we've got folks that are combing through every single bit of our business to make sure we're executing consumer compliance at a high level. An issue was found, cross-functional team reviewed it, and we made an election that we were going to accrue something at year end to cover potential remediation payments.

John Pancari
Analyst at Evercore ISI

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

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Yeah. So, what we disclosed in July was a broad program around risk and compliance management activities. The specifics of the particular issues weren't discussed in any details. And what I've shared with you right now is probably as much information as I'm going to share at this point. So the takeaway should be is that we're progressing on the risk and compliance management activities. We're getting better at identifying issues. When we find an issue, we're going to deal with it. And we found an issue, we've put up a reserve for that issue, and we're going to work through further details on it in order to ensure that consumer compliance is where we want it to be.

So, with that, I think I'll probably close this particular item out, if you don't mind.

John Pancari
Analyst at Evercore ISI

No, that's fine. Thank you for that. And my last thing was a very quick one on the loan growth guidance, you guided the average balances for '24 up modestly. Can you help maybe quantify the up modestly? If you could maybe help frame it. Thanks.

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Yeah. So 5% to 6% on average.

John Pancari
Analyst at Evercore ISI

Okay. Great. Thanks, John.

Operator

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

Donald Fandetti
Analyst at Wells Fargo & Company

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

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Yeah. The later-stage buckets are kind of modestly improving. So, we're seeing improvements across every bucket. The first bucket is really the key one. And then as you get into later and later buckets, the ability to cure just becomes more challenging because of the situation that the consumer is in. But we are seeing mild improvements there. So, that also is encouraging.

Donald Fandetti
Analyst at Wells Fargo & Company

Okay. And the '23 vintage, can you talk a little bit about what your early read is on that?

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Yeah. The net of it is that it's early, so it's performing profitably, and we're going to continue to keep our eye on it.

Donald Fandetti
Analyst at Wells Fargo & Company

So, does that mean it's not really trending that well relative to your expectations, or is it kind of in line?

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

No, I didn't say that. It's just it's early, so it's performing generally in line with expectations.

Donald Fandetti
Analyst at Wells Fargo & Company

Okay. Thanks.

Operator

Thank you. I'll take our next question from Jeff Adelson with Morgan Stanley.

Jeffrey Adelson
Analyst at Morgan Stanley

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

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Yeah. Thank you. Yeah. So, our baseline is that it's going to come in at the low end. Now, I shared the information in terms of the macros that we use for reserves, pretty consistent in terms of what we used for our, what, I'll say, the second-half view of charge-offs. So what could make that worse? Certainly, a change to the macros, a -- some servicing issues, which highly unlikely, or a miss in terms of forecasting. I'm comfortable with our forecasting team. I'm comfortable with our servicing team. And we've got a number of programs and we've dedicated a lot of dollars in terms of analytics, in terms of call frequency and best time to call. And we've worked on our call scripts to ensure they're compliant, but also effective in terms of prioritizing payments. So I feel good about that.

So the range just reflects a level of kind of broad uncertainty that we're going to tighten.

Jeffrey Adelson
Analyst at Morgan Stanley

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

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Yes. So, a good question. So, let me start off with 2023 and then the fourth quarter of 2023. So, as a business, my view is great execution in terms of being able to kind of manage net interest margins, so year-over-year, we were up. I think we're an outlier in that -- from that standpoint in financial services. What we saw in the fourth quarter was cost of funding increased as lower-rate CDs term out and higher-rate CDs would come in. Our OSA rate remains competitive. And the expectation on beta is that it'll be in the mid-70s in a declining rate. And I hope that the beta on the declining rate is higher. Also, something that's not baked into the elements of the guidance, but certainly with the exit of student loans or the proposed exit from the student loan business, that's going to throw a lot of liquidity back into the business. That'll give us an opportunity to be slightly more aggressive in terms of deposit pricing. That -- again, that'll be a second-half activity.

So, the four rate cuts that we put into the baseline assumption, again, two more than what we had forecasted in December. It could be as many as six, which if it is, that'll certainly impact deposit betas and deposit pricing and consequentially net interest margins. So, the guide here, I think, is appropriate, perhaps a little conservative. And our baseline expectation is that we're going to deliver to the upper end of the guidance range.

Jeffrey Adelson
Analyst at Morgan Stanley

Okay. Thank you for taking my questions, John.

Operator

Thank you. We'll take our next question from Terry Ma with Barclays.

Terry Ma
Analyst at Barclays

Hey, thanks. Good morning. Maybe just want to touch on the loan growth guide for '24 a little bit. Aside from the balance transfers and promos, how much control do you actually have on growth, because going from 15% loan growth to 0% just seems like a hard pivot to me? So maybe can you just talk a little bit more about that?

Then my second question is just what needs to happen before you can actually grow again? And is there a way to think about what that growth rate looks like as we look out toward 2025 and beyond? Thank you.

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Okay. Thanks, Terry. So I think it's important to take a look at the quarterly trends on loan growth versus the total year, because each quarter, what you will see is that the amount of loan growth decreased quarter-over-quarter. And that was partly due to payment rate, partly due to underwriting standards, and partly due to kind of sales activity slowing as well. So, in 2024, we've guided to loan growth to be flat. Again, payment rate is 100 basis points higher than it was in 2019. That could be a positive. If it holds where it ended the year, it's not going to impact loan growth. So, I feel like what we've tried to do here is put something on the table that's reasonable, that doesn't reflect a level of undue risk-taking in a time where consumer behavior is actually changing relatively dynamically. If you think back 2.5 years ago, coming out of the pandemic to kind of where it is today, and also the impact of inflation, that hit certainly all consumers. But certainly, in terms of our prime revolver consumers, the lower third of those consumers were impacted fairly significantly by inflation.

So, we do want to kind of watch, as I said previously, watch delinquency formations and our other metrics before we press on the gas on generating a high level of new accounts in 2024.

Terry Ma
Analyst at Barclays

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

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Yeah. I would go back to kind of historical growth rates. The company has typically delivered somewhere between 3% and 8% year-over-year growth. And then, we feel like our underwriting and credit and the opportunity to lend profitably at a rate higher than that, we will do that. So, what -- an important thing for our investors to remember is we seek to generate high returns over the short, mid, and long term. And that's essentially what this plan is seeking to deliver.

Eric Wasserstrom
Senior Vice President, Corporate Strategy and Investor Relations at Discover Financial Services

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

Operator

Thank you, sir. We'll go next to John Hecht with Jefferies.

John Hecht
Analyst at Jefferies Financial Group

Good morning, guys. Thanks for taking my question. And I know you've answered a lot on credit, so I apologize for one more, but your '18 and '19 charge-off levels were in the low-3% range. And I think we've all kind of said that was a good environment, but a relatively normal environment. You're guiding toward a high -- relatively higher, closer to 5% charge-off rate this year despite low unemployment. I know you've kind of called out the 2022 vintage is something to think about there. But maybe can you talk about the attribution of the difference in charge-off rates between that period and now? I think the kind of reason for the question is just to give us some sort of level of understanding of where we are in the credit cycle and give us comfort that things will stabilize if not improve from here.

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Yeah, happy to, John. So, a few points. So, we're in a significantly different environment today than we were back in 2018 and 2019. So, we're coming off of two years of abnormally low losses, so sub-2%. We had an incredibly high payment rate in -- going back two years ago. That is normalized. What we're seeing is that consumers had significant amount of savings. Those savings levels have been depleted. You had a spending pattern with the consumers across the board that was reflective -- reflecting kind of pent-up demand. And as savings rate came down, the consumers needed to adjust their spending patterns. Some did successfully, some did not. And then you're also seeing inflation. If you go back 1.5 years to 2 years ago, inflation significantly outpacing wage growth. And that puts certainly the lower quartile of the consumers in a significant amount of stress. And that's across all sectors of the economy. So, not specifically to our prime revolver segment. And on top of that, you also had in '21 and '22, two very large vintages. And so, you put all those together, what naturally is going to happen is you're going to have charge-offs, what I'll say is peak, before they normalize back to levels that you're accustomed to seeing from Discover.

So, my sense is that given real wage growth, our consumers will end up in, frankly, a better spot in '24 and '25 than they were in '22 and '23. And our charge-off forecast and reserves reflect a view that the consumers will manage through this and delinquency formation will continue to slow.

So, anyway, I hope that this color is helpful.

John Hecht
Analyst at Jefferies Financial Group

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

John T. Greene
Executive Vice President, Chief Financial Officer at Discover Financial Services

Yeah. The only piece of information I'm going to give is in the fourth quarter, we expect student loan charge-offs to be significantly lower, because we're exiting.

Thank you.

Eric Wasserstrom
Senior Vice President, Corporate Strategy and Investor Relations at Discover Financial Services

All right. Well, I think we're going to conclude the call there. Thank you for joining us. I know there was a few of you still in queue who we didn't get to, but feel free to reach out to the IR team. We'll be around all day and available to answer additional questions.

Thanks for joining us, and have a great day.

Operator

[Operator Closing Remarks]

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