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Discover Financial Services Q1 2022 Earnings Call Transcript


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Presentation

Operator

Good morning. My name is Ashley, and I'll be your conference operator today. At this time, I would like to welcome everyone to the first quarter 2022 Discover Financial Services Earnings Conference Call. [Operator Instructions]

Thank you. And I will now turn the call over to Mr. Eric Wasserstrom, Head of Investor Relations. Please go ahead.

Eric Wasserstrom
Head, Investor Relations at Discover Financial Services

Thank you, Ashley, and good morning, everyone. Welcome to today's call. I'll begin on Slide two of the earnings presentation, which you can find in the financial section of our Investor Relations website, investorrelations.discover.com. Our discussion today contains certain forward-looking statements that are subject to risks and uncertainties that may cause actual results to differ materially. Please refer to our notices regarding forward-looking statements that appear in our first quarter earnings press release and presentation.

Our call today will include remarks from our CEO, Roger Hochschild; and John Greene, our Chief Financial Officer. After we conclude our formal comments, there will be time for question-and-answer session. [Operator Instructions]

And now it's my pleasure to turn the call over to Roger.

Roger C. Hochschild
Director, Chief Executive Officer and President at Discover Financial Services

Thanks, Eric, and thanks to our listeners for joining today's call. In my comments this morning, I'm going to address three topics: our strategic and financial highlights for the first quarter, the expected impact of the current environment on our 2022 results and some of the exciting advancements we've made around our DE&I and ESG reporting. Starting on Slide three. We had another quarter of outstanding results with earnings of $1.2 billion after tax or $4.22 per share. Our earnings this quarter were the result of consistent execution on our business priorities against the backdrop of complex economic and geopolitical conditions.

Consistent with our expectations, our loan growth accelerated to 8% from the prior year as we benefited from continued strong sales and investments in new account acquisition last year and into 2022. Year-over-year Card sales were up 23% with improvement in all categories. There's been a lot of discussion about the impact of energy price inflation on consumer spending. We believe that higher prices at the pump were a relatively small contributor to sales volume, adding approximately 200 basis points to our first quarter volume growth. We also continue to lean into account acquisition and new accounts grew 11% year-over-year with particular strength in the prime cashback segment, reflecting our attractive value proposition.

Credit performance remains strong with credit losses normalizing in line with our expectations. This is an outgrowth of our consistent focus on prime lending and our strong credit management throughout the pandemic along with robust labor market conditions. Importantly, we have not seen evidence of credit stress beyond the moderate pace of normalization that we anticipated coming into the year. In fact, as John will address later, we're narrowing our expectations for credit losses to the low end of our prior range. We continue to effectively manage expenses while making investments for profitable growth, analytic capabilities and product enhancements.

As our account growth demonstrates, we're making significant investments in card growth. But we're also focused on innovation in our non-card offerings to further enhance our full suite of digital banking and lending products. In early April, we launched our Cashback Debit product. This product is digitally native including a mobile-first customer experience. It provides features like early access to paychecks as well as items that others will struggle to match, including no fees, 1% cash back on debit transactions and our industry-leading service. We plan on investing more for the growth of this product with broad market advertising later this year. Now let me talk about how we expect the current environment to impact Discover.

We provide some views on macro conditions on Slide four. The most pressing issue is Russia's invasion of Ukraine. Naturally, our primary concern is for the resulting humanitarian crisis and the well-being of the Ukrainian people as well as for our employees and customers with close ties to this nation. From the more narrow perspective of our business, we currently have no activities in either country, and we do not anticipate any material impacts on our business from the war. We have indefinitely suspended our efforts to open an office in Russia. And while we have temporarily paused our certification of a Diners Club bank issuing partner in Ukraine, we plan on moving forward as soon as we can.

The war in Ukraine and the resulting sanctions against Russia have also raised concerns about the risk of recession globally and domestically. We don't see any evidence of this across our consumer lending portfolio. Our credit metrics remain good, and there is nothing we're seeing in terms of consumer spending or borrowing behavior that suggests that a broader downturn is imminent. Another concern has been the significant elevation and flattening of the yield curve given the anticipation by the rates market around aggressive monetary policy from the Federal Reserve to stem high inflation.

Because we are modestly asset sensitive, the potential for a greater number of Fed rate hikes has improved our outlook for spread income, which John will discuss momentarily. And while we're not immune from the effects of inflation, our business model has somewhat of a natural hedge as the pressure that inflation may create on elements of our expense structure are partially offset by the contribution inflation makes to our sales volume.

In summary, while macro conditions are much more fluid than we had thought coming into this year, we're positioned to benefit from the combination of strong sales and receivables growth, expanding margin and slowly normalizing credit. These trends give us confidence in our outlook over our forecast horizon.

Finally, I want to point out our new ESG-related disclosures. In March, we produced our first diversity, equity and inclusion transparency report which highlights our commitment to supporting a diverse workforce that reflects our communities and customers. We also recently published our first ESG summary that includes details on our greenhouse gas emissions among other items. The data in our new reports is encouraging, but we intend to do more to reduce our impact on the environment and to advance diversity and equity in our organization and communities.

With that, I'll turn the call over to John to review our financial results in more detail and provide an update to our expectations for the rest of 2022.

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

Thank you, Roger, and good morning, everyone. Once again, our results this quarter reflect strong execution on our business priorities with accelerating loan growth and solid credit performance.

I'll begin with our financial summary results on Slide five. There are a few things I'd like to call out here. The first is that our net income is lower year-over-year because of our reserving actions. In the first quarter of last year, we had an $879 million reserve release while this quarter included a $175 million release. Adjusting for reserve changes, our profit before tax and reserves would have been up 19% year-over-year. Second, our reported total revenue net of interest expense increased to $107 million or 4% from the prior year. However, this included $162 million net loss in equity investments. Excluding this loss, total revenue increased 10%. These points underscore the strength of our core earnings power even in a fluid economic environment. Let's turn to the details of the quarter.

Looking at Slide six. Net interest income was up $149 million or 6%, driven by improved net interest margin and higher average receivables. NIM was 10.85%, up 10 basis points from the prior year and four basis points from the prior quarter. The year-over-year increase in net interest margin reflects lower funding costs and a favorable shift in funding mix partially offset by a higher mix of promotional rate balances. We made further progress on our funding mix with consumer deposits now making up 71% of total funding.

On a sequential basis, the modest increase in NIM was driven by slightly improved revolve rate on credit card loans, partially offset by increased funding costs. The better revolve rate reflected a 70 basis point decline in the payment rate quarter-over-quarter. This helped boost sequential loan yields by five basis points. However, the payment rate remains nearly 500 basis points above pre-pandemic levels. We continue to expect that the normalization in the payment rate will continue through the back half of 2023. Receivables were higher driven by Card, which increased 10% year-over-year from the continued strong sales and robust new account growth last year and into this year. Organic student loans increased 4%, reflecting solid originations through the 2021 peak season. Personal loans were down 1% due to a sustained high payment rate.

Looking at other revenue on Slide seven. Excluding the $162 million loss in equity investments, noninterest income increased $120 million or 26%. This was driven by net discount and interchange revenue, which was up $79 million or 33%, reflecting strong sales. Sales were up 23% year-over-year, with growth across all categories. Inflation drove a modest portion of the growth in the quarter, and we expect that inflation will remain a benefit to sales growth over the short term. Strong sales also drove higher rewards expense compared to the prior year. However, the rewards rate was down two basis points year-over-year. We still anticipate the full year rewards rate to increase two to four basis points. Loan fee income was up $33 million or 31%, primarily driven by an increase in late fee instances.

Moving to expenses on Slide eight. Total operating expenses were up $49 million or 5% year-over-year. Excluding marketing investments, expenses increased just 1%. Compensation expense was slightly down year-over-year on lower bonus accruals and headcount, which was partially offset by higher average salaries. We expect some degree of salary and wage pressure in 2022 and possibly into 2023, as we take steps to remain competitive.

Marketing expense increased $38 million or 25%. We continue to invest for growth in our card and consumer banking products, including support of our relaunched Cashback Debit product. Information processing increased $16 million or 15% year-over-year versus a low level in the period a year ago. This expense was flat sequentially. Going forward, we will continue to prioritize investments in analytics to support growth, innovation and generate operating efficiencies.

Moving to Slide nine. Net charge-offs remained low and were in line with our expectations for modest credit normalization. Total net charge-offs were 1.61%, 87 basis points lower than the prior year and up 24 basis points from last quarter's record low. Total net charge-off dollars were down to $160 million -- $169 million from the prior year and up $55 million sequentially.

Moving to the allowance for credit losses on Slide 10. This quarter, we released $175 million from reserves and our reserve rate continued to decline, dropping 17 basis points to 7.1%. The reserve release primarily reflects the sustained strong credit performance in our portfolio, partially offset by loan growth. Looking at the macroeconomic environment, the pandemic now has a lesser impact on our outlook. The primary sources of risk have shifted to the impacts of inflation and a potential slowdown from Fed actions. While the risk has shifted, the economic view of the U.S. consumer remains healthy.

Looking at Slide 11. Our common equity Tier one for the period was 14.7%, slightly lower than the prior period and still well above our 10.5% target. We repurchased $944 million of common stock during the quarter, executing on our remaining authorization. Our Board of Directors also approved a new $4.2 billion shares repurchase program that expires on June 30, 2023, and increased our common stock dividend by 20% to $0.60 per share. This repurchase authorization represents our largest ever over a five-quarter horizon. It is evidence of our commitment to returning excess capital to shareholders while sustaining our investments in strong organic growth.

Concluding on Slide 12. Our outlook for 2022 remains favorable, and we are improving some elements of our expectations. Starting with loans, spending trends through the first quarter and a modest decline in the payment rates improved our conviction for high single-digit growth. We are revising our view on NIM. We now see five to 15 basis points of upside for the full year relative to the first quarter. This view includes five Fed rate hikes at 25 basis points each. Our prior view reflected two-rate hikes of the same magnitude. If the Fed increases rates beyond this, it would provide modest upside to net interest margin.

Despite inflationary pressures, there's no change to our guidance for operating expense. Marketing is expected to be above 2019 levels with nonmarketing expenses up low-single digits. We are improving our credit outlook. We expect losses to be between 2.2% and 2.4% for the full year. While there's still some uncertainty about the back half of this year, our current credit performance and delinquency trends give us confidence in a tighter range. And as previously mentioned, our Board recently approved a new share repurchase program and increased our dividend.

In summary, loan growth accelerated, as we benefited from robust sales and strong account acquisitions last year and into 2022. Credit performance reflected our disciplined approach to underwriting in credit management with moderate normalization as expected. We manage operating expenses while investing in new product, features and functionalities. And our highly capital-generative model enable us to increase our dividend and share repurchase authorization while supporting strong organic asset growth. These results demonstrate the resiliency and flexibility of our integrated digital banking and payments model, and I'm confident that we are well positioned for continued profitable growth through a range of economic conditions.

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


Questions and Answers

Operator

[Operator Instructions] We'll take our first question from Bill Carcache with Wolfe Research. Please go ahead.

Bill Carcache
Analyst at Wolfe Research

Thank you. Good morning, Roger and John.

Roger C. Hochschild
Director, Chief Executive Officer and President at Discover Financial Services

Good morning, Bill.

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

Good morning, Bill.

Bill Carcache
Analyst at Wolfe Research

Competitive intensity and elevated expense pressures are leading your peers to report negative operating leverage, but you just reported over 500 basis points of positive operating leverage and your results certainly stand out. That degree of positive operating leverage was much stronger than I think anyone was expecting. Can you frame for us whether an efficiency ratio here in the 37% range is sustainable?

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

Bill, thanks for the question. So certainly, we were pleased with the execution in the quarter. In terms of the specifics around efficiency ratio, what we've guided to in the past and we're still holding there is that over the medium term, we would expect an efficiency ratio in the upper 30s. Now this quarter certainly demonstrated some progress on that front. There's a bit of timing there. We did -- we kept our marketing guidance as we indicated before, which would bring that above 2019 levels.

So there's a slight skewing towards the back half of the year. We continue to invest for growth. There will be some upper funnel or broad market advertising as well. So we're watching every dollar and making sure we get an appropriate return for our shareholders, as we invested whether from an expense standpoint or from a loan -- lending standpoint. So I don't want to get over our skis here on that efficiency ratio, strong execution, and we're going to continue to kind of work towards the medium-term target.

Bill Carcache
Analyst at Wolfe Research

Understood. That's helpful. If I may follow up on capital from the 14.7% CET1 level that you're at today, would you expect capital consumed through loan growth and the $4.2 billion authorization that you announced to be enough to get you down to that 10.5% target over the next five quarters? Or would you still expect to be sort of running above 10.5% at that point? And how much flexibility do you see in that $4.25 billion, is there some chance we could see you take that higher depending on how things play out?

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

Yes. So in terms of the CET1 ratio, we're sticking to 10.5% target. There is about 175 basis points from CECL transition still yet to impact that CET1 ratio. So then that still puts us over 200 basis points above the target I just expressed. So our thinking is that over the next two, three, perhaps four years depending on investments and the broad economy to close down to the 10.5% target. But in terms of the repurchase authorization, our Board just approved it. So it would be way premature to talk about any changes to that.

Bill Carcache
Analyst at Wolfe Research

Great. Thank you for taking my questions.

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

Of course. Thanks, Bill.

Operator

And we'll take our next question from Sanjay Sakhrani with KBW. Please go ahead. Your line is open.

Sanjay Sakhrani
Analyst at KBW

Thanks. Good morning. So Roger, you talked about the fluidity of the macro. And obviously, you've been through a number of these cycles as of you, John. I'm just curious, I know you're not seeing anything right now, but what's the playbook from here? I know you guys are leaning into growth, but if things suddenly change, how are you -- how would you react?

Roger C. Hochschild
Director, Chief Executive Officer and President at Discover Financial Services

Yes. Thanks, Sanjay. So in terms of leaning to growth, I would say we're pleased with our growth but it remains balanced. In terms of the investments we're making, I expect our prime cost per account to be down from last year. So we're not in any way overinvesting. By and large, our credit policies are back to where they were pre-pandemic. But as we said at that time, it was late cycle. So we're not exactly letting credit go. So we're still executing on a model of a disciplined growth even as the economic environment, especially the U.S. consumer remains strong.

Sanjay Sakhrani
Analyst at KBW

And I guess maybe just following up on the interest rate sensitivity. John, could you just talk about what you're seeing -- any -- I know you raised the NIM expectations, but any changes in sort of industry behavior around chasing rates from competitor banks and such? Maybe you could just talk about deposit beta.

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

Yes. Sure, Sanjay. So in terms of competitor behavior. So we have seen the competitor set that we benchmarked ourselves against recently through this quarter, this past quarter increased rates and into this quarter. We -- as you observed our behavior in the pandemic, we moved fairly aggressively down. As a matter of fact, we led our competitive set on the interest rate movements downward. Now that we're in a rising rate environment. My expectation is we're going to be disciplined around that. So the principles are that we want to ensure we have a fair customer proposition. We also seek to kind of manage our interest costs as effectively as we can. So a combination of funding needs and competitive dynamics will dictate how we -- how and when we take deposit pricing actions.

Sanjay Sakhrani
Analyst at KBW

Okay, great. Thank you.

Operator

And we'll take our next question from Moshe Orenbuch. Please go ahead. Your line is open.

Moshe Orenbuch
Analyst at Credit Suisse Group

Great. Thanks. I guess I was hoping for, Roger, if you could talk a little bit about the competitive environment. And obviously, there's been a lot going on from some of your competitors. You talked about an 11% kind of growth in new accounts and your marketing expense was pretty much under control. So can you just talk about what it is that allows you to kind of do that and be comfortable in terms of your account growth going forward?

Roger C. Hochschild
Director, Chief Executive Officer and President at Discover Financial Services

Sure. Thanks, Moshe. I think it really comes down to having a balanced and distinctive value proposition. The Discover brand is one of the most trusted brands in financial services. We provide a leading customer experience, both through the phone and digitally, which helps with retention as well as booking new accounts. We spent a long time building our skills around managing cash rewards, not just paying the higher rate but focused on every part of the process.

And then continuing to innovate with new features and functionality, and you saw we just launched another one around helping protect your information from people reselling it on the web. And so that, I think, allows us to succeed in just about any environment. I view the card business is always competitive. Occasionally, there's a lull in the depths of a recession. But beyond that, it's our job to execute for our owners and grow, and you're seeing that this quarter, and I'm confident we'll be able to keep it going.

Moshe Orenbuch
Analyst at Credit Suisse Group

Great. Thanks. Maybe just a follow-up in a completely different direction, and that is you talked about the Debit product. Can you just talk a little bit more about how much in resources you're putting behind that, how big it could be? And are there any other areas in which you can kind of leverage the network in the coming year? Thanks.

Roger C. Hochschild
Director, Chief Executive Officer and President at Discover Financial Services

Sure. So the network does give us advantages for both our credit card issuing business, but also in terms of being able to support the 1% cash back on debit purchases, which is a real differentiator in the marketplace and builds on the Discover heritage with cash back in a new direction. So we'll work our way into it. As John mentioned, we'll start broad market advertising for that product later this year. But we intend to sort of scale it gradually and build for the long term.

Over time, we expect it to be a key part of our business. And then we see advantages on our core card issuing business. Good example is our ability, as we roll out SRC to pre enroll our customers in a way that will be much more challenging for issuers on a third-party network. And finally, we remain focused on the Payment Services business, monetizing our network investments through attracting third-party volume.

Moshe Orenbuch
Analyst at Credit Suisse Group

Great. Thanks very much.

Operator

And we'll take our next question from Betsy Graseck with Morgan Stanley. Please go ahead. Your line is open.

Betsy Graseck
Analyst at Morgan Stanley

Hi. Good morning.

Roger C. Hochschild
Director, Chief Executive Officer and President at Discover Financial Services

Good morning, Betsy.

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

Good morning.

Betsy Graseck
Analyst at Morgan Stanley

Nice growth in the quarter and a really nice pickup especially as we moved into end of period here. And I just wanted to get a sense as to how you're thinking about funding that continued strong growth, as we move through the year, given that you've got Fed shrink the balance sheet and probably some deposits growth slow down. I looked at the liquidity balances, it looks like they're down to pre-pandemic lows, which -- well, during the pandemic, I should say. So I'm just thinking through deposit growth versus liquidity utilization versus wholesale funding, how should we think about how you're planning on funding the loan growth?

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

Yes. Great. Thanks, Betsy. So in terms of loan growth, we're going to take a balanced approach. So we talked about the target of 70% to 80% of our funding needs coming from OSA or deposits from our customer base. There's always the opportunity to go into the market and execute on brokered CDs if liquidity needs to dictate that. We also issued an ABS transaction this past quarter at -- in a rising rate environment at pretty compelling rates overall.

So we're going to take that balanced approach. And you will see or we did -- if you haven't seen it, you'll see a little bit more of it. There'll be a little bit more broad market marketing on deposits and then also targeted marketing on deposits. And we're going to try to balance kind of the rate and the marketing in order to get the most effective cost of funds as we can. So that's essentially the strategy in a nutshell. So we actually just went through a review from the Fed on our liquidity controls, and it's come out very, very strong. So we're pleased with the position of the business and the processes around it.

Betsy Graseck
Analyst at Morgan Stanley

Okay. Great. And then just as a follow-up, you indicated, I think earlier, John, that the outlook that you have for NIM includes five rate hikes from the Fed. And maybe you could help us understand as we go to that six, seven, eight, nine rate hike that's expected. How does that -- how does your asset sensitivity change, if at all? Or should we just take what's in the 10-Q and apply that to whatever comes after Fed rate hike 5?

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

Yes. So the math on it would be for 25 basis point increase somewhere between three and five bps to NIM on an annual basis. Now there's a bunch of other dynamics that obviously impact that, right? So you touched upon it earlier. So deposit pricing could impact that as well as the revolve rate, payment rate and then the credit impacts coming through the net interest margin. So there's a lot of dynamics there, and that was why we were conservative in terms of the number of hikes that we baked into this updated guidance. If there are more hikes and we're able to kind of effectively manage our liquidity, credit remains as we expect, we would certainly see some upside from that guidance we provided.

Betsy Graseck
Analyst at Morgan Stanley

But in the same like three to five bp range per 25?

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

Yes.

Betsy Graseck
Analyst at Morgan Stanley

Okay. All right. Thanks.

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

And that's an annual basis.

Betsy Graseck
Analyst at Morgan Stanley

Yes. Yes, I got that. Thanks John.

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

You got it.

Operator

And we'll take our next question from John Pancari with Evercore. Please go ahead. Your line is open.

John Pancari
Analyst at Evercore ISI

Good morning. As a follow-up to, I think it was Sanjay's question earlier just around deposit beta, could you just tell us, do you -- what is your deposit beta assumption that's baked into your NIM guidance that you just mentioned?

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

Yes. So thanks, John. So I don't really kind of think about this in terms of the deposit beta. What I do here is think about it in terms of broad principles. So the principles are that we're going to have an attractive proposition for our customers, and then we're going to manage interest costs as low as we can, while still maintaining that proposition I just talked about. So I gave the point in terms of our actions during the pandemic when we had plenty of liquidity that we were a price leader down. And what I said in this rising rate environment, we expect that we're going to manage that interest costs very, very tightly in order to hopefully drive overall cost low, increase NIM and benefit shareholders. So I don't want to kind of tag to a specific beta because they tend to be -- the numbers tend to be kind of off a month from now so...

John Pancari
Analyst at Evercore ISI

Okay. All right. That's helpful. And then separately, just regarding the broader economic backdrop, given the Fed's efforts here to tame inflation and slow the economy and then it looks like this morning, we're getting a probably a disappointing print here on GDP. I'm curious, does your 2022 outlook factor in a slowdown in card spend at all?

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

It does. So actually, it's -- the 23% for the quarter was higher than we anticipated. We're frankly happy to see that, but there is a modest stepping down through this year. Effectively, it's hard to envision year-over-year kind of sales growth to continue in the upper 20s.

John Pancari
Analyst at Evercore ISI

Got it. Okay, great. Thank you.

Operator

We'll take our next question from Ryan Nash with Goldman Sachs. Please go ahead. Your line is open.

Ryan Nash
Analyst at The Goldman Sachs Group

Hi. Good morning guys.

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

Good morning, Ryan.

Ryan Nash
Analyst at The Goldman Sachs Group

John, maybe to follow up on a couple of the questions that have been asked. I think the focus has been on the liability side of the balance sheet as it pertains to rate sensitivity, but maybe we could talk a little bit about the asset side. I'm just curious, obviously, a lot has changed over the last few years. So maybe can you unpack a little bit for us have we seen significant changes in terms of floating rates relative to the last time rates rose. How much more improvement do you think we could see in revolve rates? And I guess, lastly, are we now back to more sustainable BT level such that we can see the asset yields improving with benchmark rates? And I have a follow-up.

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

Okay. Thanks, Ryan. So there's a lot there. So revolve rate actually increased mildly in the quarter as the payment rate decreased by the 70 basis points that I spoke about. And by the way, that payment rate decline was essentially in line with how we built our original guidance. So as we think about inflation or other impacts that could drive payment rate lower, we've essentially derisked our guidance for loan growth. So we could see additional upside subject to payment rate and a bunch of other factors. The other pieces there in terms of kind of overall asset growth, what I would do is I would break it down into kind of the three categories or primary products.

So Card, you saw the double-digit growth there. Student loans at 4%, so we'll have another peak origination season coming in 2022. We hope to be able to execute there and continue to take market share. And personal loans, the growth was down 1%, but originations were up strong double digits. So we had a high payment rate impacting personal loans that we'll expect to moderate over time, given some level of loan growth in that product. So I guess your question had a number of elements. Hopefully, I'll give you enough detail to be able to lease together the information you're trying to glean.

Ryan Nash
Analyst at The Goldman Sachs Group

Yes. And maybe as a follow-up on Credit, it was good to see you lowering the high end of the range. And I understand you probably have about six months of visibility, so the fourth quarter is probably still hard to predict. But just looking at some of the credit metrics, delinquencies remained really, really benign, they're only up 20 basis points on the bottom. So can you maybe just talk about what's included now in the Credit expectations? And do we have the potential to see Credit come in towards the bottom end of the range over the course of the year?

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

Yes. So when we gave this initial guidance, we gave a pretty broad range, and we batted around internally whether or not tightened it. And as the quarter unfolded, our conviction around that tighter range and perhaps the lower end group. So as you said, there's three months. The fourth quarter, we don't have perfect visibility in terms of kind of roll rate performance. But our modeling analytics have been actually surprisingly accurate and we have a high expectation there. So we'll see how the rest of this quarter plays out. And hopefully, we can give updated guidance in a subsequent call.

Ryan Nash
Analyst at The Goldman Sachs Group

Thanks, John.

Operator

And we will take our next question from Mark DeVries with Barclays. Please go ahead. Your line is open.

Mark DeVries
Analyst at Barclays

Thank you. So your reserve rate is still about 100 basis points above CECL day one. Can you just talk about what assumptions are embedded in that? How we should think about that ratio of recession happens in the near term as some are expecting? I mean it would seem these levels that's almost already in the reserve. And alternatively, where could it go if some of this macro uncertainty clears?

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

Right. Thanks, Mark. So yes, the reserve rate came in at 7.1% CECL, day one was 6.1%. So some context around CECL day one. So it was an accounting adjustment reflecting new guidance provided by the FASB, right? So we did our best to capture life of loan estimates of what losses would be and embed them in over reserve rate. Now the macro environment at the time -- today has certainly changed. Portfolio dynamics have changed. As a matter of fact, our -- the upper end of our kind of credit quality for the balance sheet is stronger than it was CECL day one. But there's still a degree of uncertainty that we are managing through. So as we've said in prior quarters, we're conservative on this.

We want to make sure that we're appropriately capturing reserve rates under GAAP. If the broad macros are positive and the portfolio performance is positive, we could continue to step down through a combination of growth or reserve releases. And if the recession likelihood continues to increase, the broad macros could warrant either holding or perhaps even increasing. But overall, I think the takeaway here should be, Mark, that the portfolio performance is really, really strong. There's no view of any damage to the consumer. There's no view that job losses are going to increase in the -- definitely through this year and likely through the first half of next year. So all those factors are positive from a credit and reserving standpoint.

Mark DeVries
Analyst at Barclays

Okay. Got it. And then just a clarifying question on the opex guidance. You indicated no change there despite what seemed like kind of growing wage inflation pressures that you've indicated you're not immune to. Should we assume that as that pressure kind of builds in the second half, that what happens as you flex down kind of other non-marketing, non-wage expense to maintain some kind of a targeted operating leverage?

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

Yes. So here's how we think about it. So -- and I've tried to articulate this over the past 2.5 years. We're going to be really disciplined in terms of how we spend our dollars. And Discover has got a long history of that. We've done some stuff to kind of drive both accountability and visibility of the expense base, which my sense is it has helped. It's important to note that as we see opportunities, we're going to continue to invest. We also are -- as you paraphrased, we're seeing inflation coming in on salary and wages. We're also seeing it in our third-party spend. So we will effectively manage that in order to be able to deliver to the guidance we provided. And if we see incremental opportunity either for growth or otherwise, we'll invest to -- and we'll create transparency on that in order to drive long-term shareholder returns.

Mark DeVries
Analyst at Barclays

Okay. Great. Thank you.

Operator

And we'll take our next question from Kevin Barker with Piper Sandler. Please go ahead. Your line is open.

Kevin Barker
Analyst at Piper Sandler Companies

Thank you. When you consider this rate environment versus the last rate cycle, do you feel that the deposit betas that are going to play out in this cycle are going to mirror what we saw in the last cycle? Or -- and is that your base case, when you think about funding costs despite what might be a much more aggressive Fed this time around?

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

Yes. Last time, I would take out as a proxy, but there's a couple of things that are different, right? So the pace of inflation is a heck of a lot higher here, right? We're at record levels of inflation. The other thing that is different is the savings rate coming into this inflationary cycle, much higher. So those two dynamics could create some offsetting impacts. But it will be subject to kind of liquidity and loan growth across the industry and who's got a competitive proposition. And we're very comfortable with our proposition in terms of the customer experience, the kind of the rate. And if you take a look at our rate versus a brick-and-mortar bank, I could find it ironic that anybody keeps any excess cash in those institutions whatsoever. So we're going to be diligent on it.

Kevin Barker
Analyst at Piper Sandler Companies

Okay. And then you mentioned that you're very disciplined on how you spend your dollars. You're pretty consistent on that commentary. Are you seeing anywhere where some of your competition may be a little exuberant in how they're spending in dollars just given the opportunity set in the market today?

Roger C. Hochschild
Director, Chief Executive Officer and President at Discover Financial Services

Yes. I would say, in general, in this business, you get diminishing returns on incremental investments in marketing. And so you have seen cycles in the past where people spend heavily after a while they look at the returns they got and maybe less happy with that. So we feel good about both what we're investing on the rewards side and the guidance we provide there of only two to four basis point increase. But also that we'll see cost per accounts at an attractive level. You're certainly seeing very heavy levels of investment out there that I would wonder whether or not they're going to be sustainable.

Kevin Barker
Analyst at Piper Sandler Companies

Thank you for taking my questions.

Operator

And we'll go next to Don Fandetti with Wells Fargo. Please go ahead. Your line is open.

Don Fandetti
Analyst at Wells Fargo & Company

Yes, good morning. I know home equity is a small part of your business, but I didn't know if there was maybe a growing opportunity as a lot of the sort of cash out refi activity could potentially slow? And then secondly, I think you have a partnership on account-to-account payments. I was just curious if you think that will take off a point of sale in the United States?

Roger C. Hochschild
Director, Chief Executive Officer and President at Discover Financial Services

Yes. So in terms of our home equity business, we do think a rising rate environment will be very constructive. Perversely, many households, their greatest asset could be their 3% mortgage. So while we're excited about it, it also isn't that huge. On the payment side, we're excited about our partnership, but I don't see tremendous disruption coming to a point of sale and existing means of payment point of sale anytime soon. But we're excited to work with a broad range of partners and different fintechs who want to leverage our network capabilities.

Don Fandetti
Analyst at Wells Fargo & Company

Thank you.

Operator

And we will take our next question from Rick Shane with JPMorgan. Please go ahead.

Rick Shane
Analyst at JPMorgan Chase & Co.

Thanks everybody for taking my questions this morning. Can you talk a little bit behaviorally about the stratification you're seeing in terms of borrower behavior, both in terms of credit performance and also in terms of spending behavior, discretionary versus nondiscretionary ships across the portfolio?

Roger C. Hochschild
Director, Chief Executive Officer and President at Discover Financial Services

Sure. Seeing strength across all categories, revolver sales growth is probably a little higher than transactors growth, but that reflects our lend-focused model. But -- and that sales strength is continuing into April, where through, say, the 24th sales are still up 23% year-over-year. So consumer is good and breadth across all categories. In terms of different segments, from a credit standpoint, you do tend to see normalization occur faster at the lower end segments. But again, we're very pleased, and John mentioned that in his comments that the normalization is very much in line with our expectations.

Rick Shane
Analyst at JPMorgan Chase & Co.

Got it. And Roger, are you seeing any in that lower FICO band, any shift in terms of spending behavior from category to category?

Roger C. Hochschild
Director, Chief Executive Officer and President at Discover Financial Services

Not necessarily. There's been a lot of volatility just as pandemic restrictions come and go, certainly, travel growth is up compared to what it was. But I'd really point towards breadth and growth and spend across all categories.

Rick Shane
Analyst at JPMorgan Chase & Co.

Great. Thank you very much guys.

Operator

And we'll take our next question from Robert Napoli with William Blair. Please go ahead. Your line is open.

Robert Napoli
Analyst at William Blair

Thank you. Good morning and congratulations, a really good quarter. I mean, Discover has been a model of consistency over the last decade plus, so it's just good to see. Just on your Cashback Debit product, just thoughts on the growth of that business, the penetration rate? Any comments on some of the other banking like products in early paycheck, what kind of demand you're seeing for that product? And then economically, how you're going to monetize these banking products over time?

Roger C. Hochschild
Director, Chief Executive Officer and President at Discover Financial Services

Sure. It's still early days. So I probably won't provide much in the way of forecast, but we're very excited about the demand we're seeing. We think the product is positioned well to compete both with some of the newer fintech, neobanks but also with any traditional branch player that's out there. And over time, the balances build slowly, but a lot of opportunities to cross-sell both other deposit products such as savings accounts and CDs, but also our broad range of card products and provide really a different entry point into the Discover franchise. So our -- very much our focus is on building this for the long term. And as we said earlier, you'll start seeing more broad market advertising later this year for that product.

Robert Napoli
Analyst at William Blair

Great. And then just any thoughts, Roger, on the competitive positioning of Discover today versus, say, five years ago -- pre-pandemic five years ago, your ability to maintain or gain share while maintaining returns, I mean you've done so very nicely, but just any thoughts on the competitive position today versus, say, five years ago?

Roger C. Hochschild
Director, Chief Executive Officer and President at Discover Financial Services

Yes. I mean, I'd go back to the very kind comments you made at the beginning around 10 years of consistency, right? Even five years ago, a brand value proposition that's for trust, for a superior customer experience and for innovation on the feature side. Back then, it might have been the ability to freeze your card, now it's some of the things we do for our customers in terms of protecting their information online, but the focus remains the same. A very strong cash rewards program that competes well with anything out there. You're pricing a little more intensity in the cash rewards space as some of the changes on Miles programs through the pandemic. But we still compete very much the same way, but also still feel as good about our competitive position.

Robert Napoli
Analyst at William Blair

Thank you. Appreciate it.

Operator

And we'll take our next question from Mihir Bhatia with Bank of America. Please go ahead. Your line is open.

Mihir Bhatia
Analyst at Bank of America

Good morning, and thank you for taking my questions. Firstly, obviously really solid results here this quarter. So I guess some congratulations on that. But maybe to -- maybe you could just talk a little bit about Washington. Were you hearing more noise out of from there, both from the CFPB on the late fees, in which, I guess, to a certain extent, kind of plays into your brand, about less fees and being consumer-friendly, but still, obviously, will have an impact for you to the extent I think yesterday, he announced -- or this week he announced he's talking about reopening the card act and the fees there. But also just on the student loan forgiveness side too, we're hearing more rumblings on that. So just -- what's going on with Washington, your views on the situation?

Roger C. Hochschild
Director, Chief Executive Officer and President at Discover Financial Services

Yes. Sure. So on the fee side, first, I'd say we have good relationships and enjoyed working closely with all of our regulators and by and large, are aligned in terms of wanting the consumers to be protected. As you've seen, it's a pretty small percent of our revenues. We waived the first late fee for our Discover customers anyway. Right now, we're set at the safe harbor to the extent that, that changes we can change accordingly, but don't expect it to have an overly material impact.

Certainly, on the deposit side, the fact that we have no fees on any of our deposit products, positions us very, very well compared to our competitors, and it's a key part of our value proposition.. In terms of student loans, we probably have seen some pressure on the payment rate just given the ongoing payment holidays that people have seen on their federal loan. It's important to realize that there's a big difference between the federal loan program and ours just in terms of who they give loans to, the types of educations they fund. As an example, we do nothing in the for-profit sector. So we'll wait and see what comes out of Washington, but we don't expect it to be overly disruptive for our own student loan business.

Mihir Bhatia
Analyst at Bank of America

And then just turning back to Credit for a second. Obviously, you're improving the outlook for this year. But -- how much of that is just a function of you gaining increased confidence based on the 1Q outperformance maybe versus any kind of change? I guess really what I'm trying to understand is, is the path to normalization changing? Or is the curve like from here like a little less steep than what you had maybe expected it to be -- like when do we get back to a normalized state? Is it the front half of 2023, the back half of 2023, 2024?

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

Yes. Thanks for the question, Mihir. While we said previously, as we expected normalization through 2023, now it's really hard to kind of predict anything when you get out in the kind of 2024 time frame. What I would say here is in terms of narrowing the range, that was a function largely of increased confidence around our forecast with, frankly, an internal expectation that we're going to come in at the lower end of the range. So we're still giving ourselves some wiggle room here. But if things proceed as we expect them to, we'll be around the lower end of the range.

Mihir Bhatia
Analyst at Bank of America

Thank you.

Operator

And we'll take our next question from John Hecht with Jefferies. Please go ahead. Your line is open.

John Hecht
Analyst at Jefferies Financial Group

Thanks, guys. Most of my questions have been asked. But I guess -- turning to the student lending business. I mean it's important -- I know it's small but important overall. But your results have been pretty consistent there, but I'm wondering maybe if you just have any thoughts on the moratorium, its impact on your business. And more importantly, when the moratorium expires, is there any broader effect that you would expect to see on overall credit trends even outside that specific segment?

Roger C. Hochschild
Director, Chief Executive Officer and President at Discover Financial Services

Yes. We've modeled it pretty carefully. We don't expect it to have a significant impact on Card or personal loans. And as you think about student loans, it's important to look at how we underwrite those, right? For our undergrad loans, the vast majority are cosigned by the parent, very strong FICO scores. So we've seen probably a modest benefit on the credit side, but also a modest negative on the payment rate as students have more liquidity to put towards paying off their private student loans. And again, I'd go back to the federal student loan program in terms of who participates, the amount of debt they have and the nature of the education they finance is dramatically different than our portfolio.

John Hecht
Analyst at Jefferies Financial Group

Okay. Makes sense. Thanks.

Operator

And we will take our last question from Meng Jiao with Deutsche Bank. Please go ahead. Your line is open.

Meng Jiao
Analyst at Deutsche Bank Aktiengesellschaft

Great. Thanks for taking my question. Just a quick question on the personal loan portfolio. I guess are you sort of tightening standards there just given the pristine early stage and loss rates that we've seen there. But I'm also looking at the sequential sort of seven-quarter decline in yield. So just wanted to get your thoughts there? Or is it just sort of primarily the elevated payment rates that's driving that?

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

Yes, it's a couple of factors that are playing out here. So the first piece was when we came in -- prior to coming into the pandemic, we were pretty tight. And then we hit the pandemic and we tightened the personal loan product more stringently than any other product we had. What -- and then we also -- we doubled down on our underwriting, including 100% verification of all loans. So we were super careful. That had an impact on growth levels. we have since reduced our manual underwriting.

So it's back to kind of pre-pandemic underwriting standards. And we also opened up the credit box because what we are seeing is the loans that were in there were pristine. And we're now in a situation where we've got a high-returning asset. We're looking at the competitive dynamics. We've made some conscious choice to reduce yield for the benefit of very profitable growth. And as I said earlier in my comments, the expectation is that the payment rate will subside, and we'll see growth in loan balances in that product. Originations have been positively strong, as I said earlier as well.

Meng Jiao
Analyst at Deutsche Bank Aktiengesellschaft

Great. Thank you.

Operator

And there are no further questions.

Eric Wasserstrom
Head, Investor Relations at Discover Financial Services

Great. Thank you, Ashley. And with that, I think we'll conclude. If you have any additional questions, please feel free to follow up here in Investor Relations, and have a great day.

Operator

[Operator Closing Remarks]

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