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Good morning. My name is Todd, and I will be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter 2023 Discover Financial Services Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there'll be a question-and-answer session. [Operator Instructions] Thank you.
I will now turn the call over to Mr. Eric Wasserstrom, Head of Investor Relations. Please go ahead.
Thanks, Todd. And good morning, everyone. Welcome to this morning's call. I'll begin on Slide 2 of our earnings presentation, which you can find in financial section of our Investor Relations website investorrelations.discover.com. Our discussion today contains certain forward-looking statements that are subject to risks and uncertainties that may cause actual results to differ materially. Please refer to our notices regarding forward-looking statements that appear in our second quarter earnings release and presentation.
On our call today, we'll include remarks from our CEO, Roger Hochschild and, John Green, our Chief Financial Officer. After we conclude our formal comments, there will be time for a Q&A session. During the Q&A session, we ask that you pose one question followed by one follow-up question. After your follow-up question, please return to the queue.
Now, it's my pleasure to turn the call over to Roger.
Thank you, Eric, and thanks to our listeners for joining today's call. I'll begin by reviewing some of our highlights for the quarter and then discuss the regulatory matter that we've disclosed in our press release. John will then take you through the details of our second quarter results and our updated perspectives on 2023.
Last night, we reported second quarter net income of $901 million or $3.54 per share. The quarter was characterized by strong asset and deposit growth, while credit is performing right in line with our expectations. Importantly, we advanced several operational priorities this quarter. One key milestone occurred in May when we relaunched our cash back debit product. We're excited by the positive early results we're seeing so far. In the first few weeks, we opened over 30,000 new accounts and plan to begin national marketing in support of this product in the fall. The relaunch advances our goal of becoming the leading direct bank and over time we expect cash back debit will be a significant entry point into the Discover franchise.
We also continue to expand the Discover Global Network. This quarter, we announced five new partnerships in the Asia Pacific region and added a new partnership with Guavapay in the UK. These strategic partnerships underscore our commitment to building out our international acceptance. And lastly, we continue to invest in our human capital. We're honored to have been recognized as the 2023 Best Places to Work for People with Disabilities. This builds upon our recent recognitions as one of Fortune's 100 Best Companies to Work For, Best Workplaces for Parents, and Best Workplaces for Women.
As you may have read in our press release last night, beginning around mid-2007, we incorrectly classified certain card accounts into our highest merchant and merchant acquirer pricing tier. We are taking actions correct this card product misclassification going forward and are preparing a program to compensate affected merchants and acquirers. While the financial impacts of this misclassification are not material, it underscored deficiencies in our corporate governance and risk management. We're in discussions with our regulators regarding these matters.
We have received a proposed consent order from the FDIC in connection with consumer compliance, which does not cover the misclassification topic. We believe additional supervisory actions could occur. I want to emphasize that we take our business practices and compliance very seriously. We've made significant progress and investment in this area and look forward to working with our Board and our regulators to achieve further advancement.
Now I'll hand it over to John to review our results and updated outlook in more detail.
Thank you, Roger, and good morning, everyone. I'm going to open by addressing the financial implications of the card misclassification. We have established a liability on our balance sheet of $365 million to accrue for estimated compensation owed to merchant and acquirers. In establishing the liability, we adjusted retained earnings by $255 million net of tax. $11 million was taken this quarter and is reflected in discount and interchange revenue. The first half 2023 impact was $22 million.
With that, I'll transition to our financial summary results on Slide 4. From this, you can see that the financial performance of the business remains solid. In the quarter, we reported net income of $901 million, which was 18% lower year-over-year. Our results reflect strong revenue growth partially offset by a provision increase driven by receivable growth and higher expenses. The trends for the quarter were robust loan growth, a low efficiency ratio even as we invested in compliance management and technology, and strong capital and liquidity positions. Further details are reflected on Slide 5.
Net interest income was up $567 million year-over-year or 22%. Our net interest margin ended the quarter at 11.06%, up 12 basis points from the prior year and down 28 basis points sequentially. The benefits from higher prime rates were offset by higher funding costs and increased promotional balances. Receivable growth was robust. Card increased 19% year-over-year, reflecting a lower payment rate versus the prior year and modest sales growth. The card payment rate remains stable quarter-over-quarter and about 200 basis points over 2019 levels.
Sales volume grew 3% in the quarter. Through mid-July, growth continued to slow and was up about 1%. Turning to our non-card products. Personal loans were up 27% driven by strength in originations over the past year. We continue to experience strong consumer demand while staying disciplined in our underwriting. Deposit growth in the quarter was solid, with average consumer deposits up 20% year-over-year and 4% sequentially. Our direct-to-consumer balances grew $2 billion and consumer deposits made up 66% of our total funding mix. We continue to target 70-plus-percent of funding from deposits.
Looking at other revenue on Slide 6. Non-interest income increased $98 million or 16%. This was partially due to a $42 million loss on our equity investments in the prior year quarter compared to a $1 million gain this quarter. Adjusting for these, our non-interest income was up 9%, primarily driven by loan fee income.
Moving to expenses on Slide 7. Total operating expenses were up $181 million or 15% year-over-year and up 2% from the prior quarter, primarily driven by our investments in our compliance management systems. These investments impacted several of our expense line items. Looking at our major expense categories, compensation costs were up $73 million or 14%, primarily due to increased headcount. Marketing expense increased $14 million or 6% as we prudently invested for growth, particularly in our deposits and personal loan products. Our commitment to disciplined cost management has not changed and we continue to target an efficiency ratio in the high 30s.
Moving to credit performance on Slide 8. Total net charge-offs were 3.22%, 142 basis points higher than the prior year and up 50 basis points from the prior quarter. Consistent with our expectation, we are seeing credit normalization across all of our lending products. Looking ahead in card, we continue to expect the seasoning of new accounts vintages and normalization of older vintages to result in higher losses through the back half of this year and into 2024.
Turning to the allowance for credit losses on Slide 9. This quarter, we increased our reserve by $373 million, driven by our double-digit loan growth. Our reserve rate remained flat at 6.8%. Our outlook on the macro economy has improved modestly. We continue to monitor economic conditions and will make adjustments to our expectations as needed.
Looking at slide 10, our capital position remains robust. Our common equity Tier 1 for the period was 11.7%, well ahead of regulatory requirements. The cumulative impact of the correction to the financial statements related to the card misclassification reduced our CET1 ratio by approximately 20 basis points. In the quarter, we repurchased 6.8 million shares of common stock and declared a quarterly common dividend of $0.70 per share. As Roger indicated, we are reviewing our compliance, risk management and corporate governance and are in discussions with our regulators on these topics. While this is ongoing, we have decided to pause share repurchases.
Concluding on Slide 11 with our outlook. There has been no change to our loan growth expectations to be in the low to mid-teens. We are updating our NIM expectations to be around 11% for the full year, reflecting a combination of slightly lower asset yields driven by promotional mix and higher funding costs. We are raising our guidance for operating expenses to be up low double digits. As previously indicated, we are seeing upward pressure on expenses from the build-out of our compliance management systems. And we are lowering our expected range of net charge-offs to 3.4% to 3.6% based on our current delinquencies and roll rates.
To wrap up, our business model continues to generate solid financial results and our capital, funding and liquidity positions remain strong. We continue to invest in actions that drive sustainable long-term performance, enable us to achieve excellence in all parts of our business.
With that, I'll turn the call back to our operator, Todd, to open the line for Q&A.
Thank you. At this time, we will open the floor for questions. [Operator Instructions] We'll take our first question from Rick Shane of JPMorgan. Please go ahead.
Thanks guys for taking my questions this morning. Look, I'd love to understand a little bit the link between what you identified in terms of the miscalculation and then how that precipitated the sort of inquiry into governance and consumer tracking?
Sure. So the FDIC matter is not linked to the misclassification. And so the misclassification is a separate issue. The FDIC matter is broadly around our compliance management system. It doesn't mean that the misclassification may not result in further regulatory action, but I don't want to speculate on that.
Got it. And is the expectation, when we've seen these in the past that they result in things like memorandum of understanding and can do things like either constrain growth limit, repurchases and capital actions, how do you see this playing out? And most importantly, I think what everybody really wants to know is what is a reasonable timeframe to get some further clarity here?
Yeah, it's -- I don't want to speculate on the timeframe of regulatory actions. I would say to your point though, they can take many forms. And so we're working through the draft with our regulators and we'll make more information available and the consent order will itself be public once that's completed.
Got it. Okay. I realized there's -- you have to be pretty circumspect about what you say here. So, thank you.
Thanks.
Thank you. We'll take our next question from Betsy Graseck with Morgan Stanley.
Yeah, hi, thanks. This is Jeff Adelson on for Betsy. Just appreciate all the sensitivity around this and understand you're pausing the buyback. I guess, this is -- this is some similar to what we saw last year in terms of regulatory issue and getting ahead of the buyback or freezing the buyback. Just wondering maybe if there's a way to speak to how these two issues kind of compare to the last year student loan servicing issue, maybe in terms of scoping complexity?
Yeah. I'll cover that piece and then maybe John can talk a bit about the buyback. So I would say the consent order in student loan servicing was a compliance matter. And so I think there's a link between that and the broader focus on our compliance management system. With that, maybe I'll let John talk a bit about the buyback.
Great. And -- thanks Roger. And as it relates to the buyback, we had robust conversations internally whether or not to pause the buyback. And what management recommended to the Board was that we pause the buyback as we work through the details of these compliance and risk management issues and are in conversations with our regulators. I want to reiterate the following though. Our capital allocation priorities remain consistent. So first invest in the business and growth and certainly through this year and into next year into compliance and risk management. And second, the priority will be to return excess capital to shareholders.
So no change in terms of the two primary capital allocation priorities. I also want to focus your attention onto the strong capital generation that the business delivered in the quarter and has delivered historically. So we're hoping that we kind of work through these issues in an expedited fashion, but timing, I can't be specific on. So with that, the buyback will provide us much clarity on the timing of resumption when we have information on that.
Okay. Thank you. And just maybe shifting gears a bit here. Just wanted to see if we could get an update on what you're seeing in the consumer in your book today. Could you maybe also give us an update on the spend trajectory you've been seeing so far in July? I know you've talked about the growth rate slowing down to 3% in recent months. Wondering if we're seeing something similar from here?
Yeah. So it has slowed down further so far in July, so probably closer to 1%. Not necessarily as bad as it sounds in terms of the health of the consumer because you've got some very challenging comps compared to last year's growth as well as the very, very high level of new accounts we put on last year. And I think overall in terms of payment side, delinquencies and losses as John said are sort of normalizing right on the path we thought they were. And here I think that the strength of the job market is very constructive for our sort of prime consumer base.
Got it. Thanks for taking my questions.
Thank you. We'll take our next question from Ryan Nash with Goldman Sachs.
Hey, good morning guys.
Good morning.
Roger, again, I know that we're probably limiting what we could say here on the compliance side, but I guess just a broader question. Can you maybe just help us understand, what are the areas that you feel that the company has underinvested in? And maybe just give us a framework for what you guys are doing in internally to fix these. I understand that John had talked about raising costs, but you -- can you give us a little bit more color in terms of what the investments you're making and what you think the timeline is to get these done?
Sure. John can maybe provide more color on the timeline. I would say it's a multi-year, but it's also something that we have been investing in over the last couple of years. So as you think about your compliance management system, it's everything from risk identification, sort of process mapping, building controls or change management processes, the resources you have around risk management in the first line, the resources you have in the second line in terms of the compliance function, testing, the internal audit, your governance processes.
And so we are determined to be as strong on the compliance side and it's excellent there as we are around customer experience, data and analytic, every other aspect of our business model. So this is our top priority and the investment is both on the technology side, outside consultants, but also in terms of headcount here at Discover. John?
And then, Ryan, on the trajectory, and so I made this comment publicly about 1.5 months ago. 2019 to 2023, we increased our spend in compliance and I'll say some gentle items to ensure compliance works as we wish it to work. I indicated it was about an increase of $250 million as we relooked at it. We were going to accelerate that spend to probably $300 million increase from 2019 and a $200 million increase ‘22 to ’23. Now the implications for that on ’24, where we sit today, we expect once we achieve that level in ‘23 to be relatively consistent into ’24. And then as we kind of shape this piece of our business into something that we desire, our regulators desire and our shareholders deserve, we expect that expense burn to reduce.
Really appreciate all that color. And then maybe just on credit, I think Roger might have talked about the normalization of the front book as well as expectations for the back book to continue to normalize. But you took the credit loss range down a bit. So can you maybe just talk about one where you're seeing the improved performance in, John? As you look out, maybe just talk about your confidence in the curve on losses bending as we approach sort of the midpoint of next year? Thanks.
Yeah, great. So yeah, the tightening in the range was reflective of a couple of things. So first, as time moves on, we get more and more comfort with our forecasting on it. And to date, our forecasting has been right on top of actuals, our actuals have been right on top of the forecasting. So that gave us comfort. Second is, as time goes on, we can move from the analytical model to a more kind of traditional roll rate model that gives us a greater level of comfort around the charge-off and delinquency rates 30 day -- 30 days out to 180 days out. So that gave us comfort to tighten that range. And then on top of that, certainly the jobs -- jobs data and the forecast around employment gave us additional comfort.
In terms of what we're seeing with the portfolio, exactly what I said in the prepared comments. So the newer vintages seasoning to expectation and older vintages basically normalizing to kind of 2019 levels. In terms of the shape of the curve, what we expect charge-offs to do in the back half of this year is the acceleration in terms of the rates of charge-off to begin to slow. And currently, we're expecting, kind of, charge-offs to peak in the second half of ‘24. It may push a little bit into ’25, but right now we're seeing it in the second half of ‘24 and then reach the level, which likely will stabilize that for two to three quarters after.
Great. Thanks for all the color.
Thank you. We'll take our next question from John Hecht with Jefferies.
Morning, guys. And thanks for taking my questions. First one is that we talked about you giving us some sort of good trajectory of the normalization of the credit trends, which I guess occurs later this year, early into next year. I'm wondering given kind of the comps and stabilization of inflation and so forth, when do you expect to see normalization of loan growth and your guys opinions, what is the -- what is kind of the normalized level of loan growth?
Yeah. So certainly real robust loan growth in the first half of this year and the last quarter of 2022. We expect the rate of increase to slow certainly in the third and fourth quarter and also against really, really strong comps from 2022. And traditionally what this business has delivered is loan growth somewhere between 2 times and 4 times GDP growth. Now, we don't know what GDP is going to look like right now into ‘24, but I would say this. We did cut the edges on the lower credit quality, which is -- will impact new account growth in card for the balance of this year. We're seeing, as Roger indicated, and I mentioned in my comments, sales growth to slow and probably stabilize in the single digits. So that will also impact loan growth for the balance of this year and into next year. So the stabilized number is a multiple of GDP typically unless there's some change to the macros that indicates it's a good investment to either open up credit or appropriate to tighten credit.
Yeah. That's a helpful framework to think about. And then with respect to the expense guide, I think you talked about some investment in compliance and some investment in technology and so forth. I'm wondering is there -- is there, maybe talk about the competitive climate at this point relative to the past few years. Is there any spending required from a competitive perspective or do you have any -- can you characterize the overall competitive environment as well?
I think we continue to see good results from the way we put to work on the marketing front in terms of our cost per account. Obviously, we've talked about the relaunch of cash back debit. We'll put some money against that, including the mass market campaign in the fall, but have been excited with what we're seeing in terms of the cost per funded account there. So while -- yeah the competitive environment is always intense across all of our businesses, we feel good about how our value proposition is competing out there across all of our consumer products.
All right, guys. Thanks very much.
Thank you. Our next question comes from Don Fandetti with Wells Fargo.
Hi. John, I was wondering if you could talk on the merchant miscalculation. Was that found internally or was that brought to you by a regulator or third party?
It was found internally.
Okay, great. And then on NIM, it sounded like the trajectory was pretty good in general. And now it's going to be around 11%. Is there more promotional than you thought or more deposit competition, can you talk a bit about that?
Yeah. The -- it's a little bit of both actually. So we ended ‘22 at 11.04%. We said that we would be -- initial guidance up modestly. And then in the first quarter call, we said NIM has likely peaked and then it would begin to move downward and what I'll say normalize, likely to a higher level than it has been historically. So in the quarter, the reason that we tweak that guidance was we are -- we are investing in promotional balances. So attracting new customers or building balances with existing customers. Now, the returns on those offers are fantastic. The impact on NIM in the short term and the promotional period, it's minor. But given our activity there, it took a few points of net interest margin out. And we thought that was an important impact to communicate.
Second, in terms of deposit competition, we had said that we thought that the beta would come in somewhere around 60% to 70%. What we've seen in late in the first quarter and into this quarter was our competitive set being more aggressive in terms of price increases. And as I've communicated in the past, we don't seek to be a price leader here. We try to compete on our brand, our customer offering, our digital assets that are first class in order to attract deposit customers. And we've been very successful as you can tell by the numbers there. But part of the proposition is also price. So what we're seeing now is betas likely to be north of 70% which is impacting net interest margin to the extent I just talked about in the guidance point. So those two factors are playing most substantially on the revised outlook.
Thank you.
Thank you. We'll take our next question from Sanjay Sakhrani with KBW.
Thanks. Good morning. I have a follow-up on a couple of points made on the consent order. Maybe the first one, just on the share repurchase pause. Is that action taken in terms of prudence or out of an abundance of caution? Or do you think that there could be a material impact to your capital position? And I guess secondly, just on, John, you talked about the pressures on expenses into 2024. I guess, like, are there -- is there a leverage on other expense lines to sort of moderate the overall implications for the year?
Yeah. Thanks, Sanjay. So the decision on the share repurchase was out of prudence. We have done a number of tests internally, stressing a number of factors, so that for example, the CCAR process we go through includes extreme stress. We dusted that off and ran some simulations. And the output of that was that both capital and liquidity, even in an extreme situation, remain well above regulatory requirements. So we feel comfortable about our capital and liquidity. The issue on the share repurchase was again out of prudence given what we have going on in the organization and we wanted to make sure that our actions are consistent with the right message in terms of being conservative and dealing with the first level of priority. In terms of…
Okay.
In terms of expense leverage, we continue to look at all of the lines and all of the investments we make in our expense base and the incident management situation we're dealing with in terms of resources to get that under control. That's a significant investment. Some resources supplement technology, people and consultants, certainly an investment. On the indirect side, we continue to leverage our procurement organization and ensure that, first, we concentrate on demand management and then, second, on making sure there's a fair value exchange. So that's the plan right now and will be the plan through the balance of this year.
Okay. I guess follow-up just for Roger. I know you've gotten this question in the past and I'm just thinking about the higher teasers and such. I mean what makes you comfortable growing sort of mid-teens, high teens above the really strong lapping of very strong growth a year ago? I mean, I'm just thinking about just the complexion of the accounts you're bringing in that makes you very comfortable here because it's obviously having some implications on the NIM.
Yeah. Good question, Sanjay. You have seen that growth start to slow a bit. And I think it isn't necessarily that far out of line with what you're seen from our other, I'd say sophisticated prime focused competitors. It is really strong demand for the product. And as we've been clear, we have been tightening, not loosening credit, and are watching the accounts we book very carefully. And so we're always ready to make adjustments whether it's in the card product, the personal loan or elsewhere. But again, we feel good and are closely monitoring the performance. Within the credit, we're making adjustments continuously both on the portfolio side and the new account side. But these are very strong new accounts we're bringing in. And I think part of it is the differentiated value proposition that Discover offers continues to resonate well with our target customer.
Thanks.
Thank you. We'll take our next question from Kevin Barker with Piper Sandler.
Great. Thanks for taking my questions. I just wanted to follow-up on the expenses in particular. You said you continue to target efficiency ratio in the high 30s. Could there be a time where you may have to make additional investments, particularly around compliance that would have you go above the high 30s efficiency ratio for a short period of time before returning back to it, just given the near-term impacts of both additional marketing spend on debit account and the compliance issues? Thank you.
Sure. So as we sit here today, we feel comfortable with what we shared in terms of low double digit expense growth this year. We've taken a preliminary look at next year. We'll share -- we'll share that at appropriate time after -- after we kind of review and get our plan approved by our Board. But I'm feeling like it's very, very achievable. And that's why we -- we enunciated that target or that goal. But I would say this. As we see opportunities to grow profitably and not -- no contradiction to Roger's point earlier about the demand for our products, but we'll continue to take a look and invest for the medium term and longer term. And we're going to do that on the growth side. We're focused right now on the compliance side and we'll dial each of the expense levers in order to ensure we achieve results that our shareholders want, that our Board expects and that the management team expects.
Are there any particular areas where you see the most opportunity to create efficiencies, whether it's marketing or headcount or anything out there that you see that can allow you to continue to hit your goals?
Yeah. So we're investing in advanced analytics that we're driving efficiencies in our rewards cost. We continue to look at third-party spend and have achieved great results in terms of year-over-year reduction in unit cost. The situation this year is that we've invested heavily in resources, people. So we're up -- we're about up about 3,000 people this year. So when you bring on additional people, both in collections and customer service as well as salary personnel, there's other costs that go along with it.
So as we manage through this situation, I continue to believe there will be opportunities to drive efficiencies by combining like activities, taking a look at how resources are deployed to organizational structures and over time optimizing that. But right now, with the situation we're in, we've decided that the first priority is get the right resources in to focus on the issues we've talked about. And then we're going to be able to drive efficiencies in the future.
Okay. Thank you for taking my questions.
Thank you. We'll take our next question from Mihir Bhatia with Bank of America.
Hi, good morning. Thank you for taking my question. Wanted to start maybe just on the business and the application quality of new applicants that you're seeing. I think you mentioned in response to John's question tightening underwriting. I guess, firstly, was that a new action you took in the second quarter? And then just related to that tightening of underwriting and application quality, I was wondering just if you -- I know you've talked in the past about monitoring -- actively monitoring the health of the consumer and the portfolio. Was there -- is there something you're seeing that is flashing red or caution that's making you tighter underwriting further here or just trying to understand who is the demand environment who is applying for a new loan currently, what's driving some of the underwriting changes?
Yeah. Good question. So the tightening was not in the second quarter and was not in response to something we're seeing. And actually in terms of applicant quality, whether it's for home equity, personal loans, student loan or in card, where we're seeing very stable characteristics in terms of average FICO, in terms of the custom scores we use. So it was a series of changes we made, I would say, in prior quarters. But a lot of stability in terms of the quality of applicant over the course of this quarter.
Got it. And then maybe switching gears to the debit product that was relaunched. Can you talk just longer term strategically, what is the, I guess, the thinking behind that product, what is the goal, is the idea there, this is -- the opportunity to deepen relationships with customers and lower and how will that benefit you? Will it be through better NIM because if they're offering rewards, you can -- you don't necessarily need to offer as higher interest rates? Like, just talk a little bit more strategically about why the product makes sense to invest in for Discover and how you expect the growth trajectory of that product to go over the next few quarters here?
Yeah, great question. So, our aspiration is to be the leading digital bank. And so when you think about a digital bank, you think about the core DDA or debit product. And because we have a proprietary network, we can offer rewards in debit in a way no other large bank can. And it builds on our heritage around cashback and as the inventor of credit card rewards. So it's not just to cross-sell to our card customers. We think that this can pretty quickly become a significant entry point into the franchise for new customers. And then over time, much as we've done on the card side, if you can provide a superior value proposition and customer experience, they will want to buy other products from you whether that's a savings account and savings accounts where you also have the checking account and to have a lower beta or the card product. So again, a very important initiative for us, I think over time, will help continue transforming Discover. And we're excited for the potential and you'll see significant marketing against it this fall.
Got it. And then just my last question. Just coming back to the compliance issue, look, I appreciate it's difficult provide too many details right now. But maybe just on the timing, give us some frame of reference, like, given that this is -- it sounds like the FDIC consent order also is related to compliance issues. You have the student loan issue. Now you have this issue. Does that entail a much longer review period or do you think this can go pretty quickly here like a quarter or two to go through?
Again, I'm not saying when you resume buyback but at least like when you expect the review to be complete, what are you trying to -- how quickly are you trying to complete the review internally? And then I understand maybe the buyback discussion probably involves regulators and could be -- it's a little bit harder to cite. But at least the review maybe you can tell us, what your target is for like when you're trying to complete the review?
Yeah. And to frame the compliance issue, I would not over-focus on the regulatory portion. This is something where we as a team know we are not where we want to be and it is our top priority. So it is aligned with the views of the regulators, but our focus is taking many forms, from simplifying our architecture, automating manual processes, streamlining and standardizing business processes, bring on some great new talent as John talked about into the firm. And we know that the result will not just be better compliance but a better customer experience and more efficient organization.
So the regulatory piece is important, but I would say what most -- is most important is the commitment from me, the team, the Board on achieving excellence in this area. That will be a multi-year initiative. But again, I think critically important to the future of the company and one that we as a team are very excited about. I would also separate that from the buyback. But again, it will be a journey on the compliance side, but one that we are 100% committed to.
Okay. Thank you.
Thank you. We'll take our next question from Erika Najarian with UBS.
Hi. This is Nick Holowko on for Erika. Thanks for taking my question. Just one more around the consent order and compliance issues. As you think about the operational complexity of the businesses you operate in and as you go through your view looking into these issues, do you feel like there may be an opportunity to take a closer look at some of the businesses you operate in, whether that might be student loans or anywhere else? Thank you.
Yeah. I'll talk maybe more broadly about operational complexity and then John can talk about the businesses. I think there's a great opportunity to simplify, whether it's -- we may have a similar process that is done differently. And again, we have a much more, I would say, homogeneous set of business is than just about any other bank or size. So we think there are significant opportunities to simplify, and again, those won't just help from a compliance standpoint over time once the investments are made, it will also help on the efficiency side.
Yeah. And then regarding our businesses and products, we think about this in line with our capital allocation priorities, our connections to our customer base and what we can manage and manage well. So we didn't start today. Historically, we've looked at all our products, our returns and as we look at those, we've made decisions to invest in order to drive growth or achieve compliance excellence. So we're going to continue to look at that. And if something's below our return targets, then we'll fix it and invest or we'll look at other alternatives. But certainly, the focus today is to take our existing products, make sure they're good offering that we can deliver those in a compliant way and drive a good return for our shareholders.
Got it. Thank you for taking my question.
Thank you. We'll take our next question from Bob Napoli with William Blair.
Thank you, and good morning. And I -- just from a big picture perspective with the competitive environment, the compliance environment, Roger, as you look at your business, what is your confidence that Discover can deliver the types of returns that it has that investors have come used to over the last 10 to 20 years? Is there -- are you confident in delivering those returns with the higher compliance bar or the competitive set?
Yeah. I'd start by saying yes, right? This is an investment we need to make. It is the top priority for the company, but one that I think we will be able to do to fix. And again, over time, we'll see benefits not just in compliance, but in a better customer experience as well as more efficient. If you step way back, I've never been more excited about Discover's business model and how it compares. I think you're seeing the strength of our deposit franchise at a time when many banks are being tested, we have the scale and resources to compete with anyone. We're making the investments to be at the leading edge around data and analytics, are winning awards for our customer experience on not only just the card side, but also our deposit products. We have the re-launch of cash back debit.
So in terms of the business model, and the returns we can give to our owners, in my 25 years at Discover, I've never been more excited. To get to all of that though, we need to get to where you need to be on the compliance standpoint. That's a critical part of operating a bank, a financial services organization. We are not where we need to be and we are going to get there.
Thank you. And a follow-up, just on compliance, having followed Discover for a very long time, coming out of the great financial crisis, there was a lot big investment in compliance across the industry including -- at Discover. Has it become more difficult? I mean, I know there's been a number -- quite a few consent orders put out by regulators, but has it become -- maybe give us some color on what you're investing in compliance today. I don't know, if it's people or percentage of expenses versus historically, and how has it become a lot more difficult?
Yeah. It certainly is a challenging environment, but I'm not going to blame that, right? As I look back, I do believe we under invested and that's something I take accountability for, but we are very focused on it now. And as John, I think, highlighted, that investment takes many forms. Right? From bringing in some highly talented folks within the compliance area, building out our monitoring and controls, investments on the technology side to standardize, simplify, automate manual processes, as you think about it, compliance, a lot of the folks, it's risk management, right? And traditionally, we've been very strong around credit risk management, around liquidity risk management, but have not necessarily made the investments we needed, especially as the complexity of our business increased. As we got into more new products, I think there was a gap there in terms of our capabilities and that's what we're focused on now.
Thank you.
Thank you. We'll take our next question from Arren Cyganovich with Citi.
Thanks. On the net charge-off peak that you highlighted for -- into second half of ‘24 and possibly into ’25, is that an expectation that it would go north of kind of your normal underwriting charge-off rate?
Thanks, Arren. No, I mean, we gave charge-off range. Now there's a numerator and denominator impact on that calculation, of course. But our underwriting is focused on prime revolver. Prime revolver behavior in our targeted segments looks very, very consistent to where it's been historically. And our return expectations remain high and we've been able to deliver on that. So in terms of is it going to be north and where it was historically, we have seasoning of those new vintages. But our credit box has been relatively consistent, our analytics to kind of target customers and understand kind of risk factors, I feel like has improved over the four years I've been here and certainly a longer journey than that. So the trajectory to me looks very, very comfortable in terms of continuing to be able to deliver high returns and generate capital.
Okay. Thanks. And then just to clarify on the expense commentary, it sounds like you're not planning to pull back on marketing opportunities as your compliance costs are rising. And then if you could just clarify the numbers that you gave earlier, are those annual numbers? I think you said like $50 million up to $250 million and then $350 million and then down to $200 million. I'm just a little confused on the -- on the trajectories there.
Trajectory of the compliance management cost? Was that your question, Arren…
Yeah.
…or overall? Yeah. So I'll start with marketing and I'll focus on the client second. We haven't made a decision to pull back on marketing. We still see opportunity to generate positive returns from the customers that we're targeting in that prime revolver segment. And we're also putting money towards helping people understand our deposit products and hopefully find that we're compelling there. We also have the campaign on the cash back debit program slated for the second half of the year. So the marketing dollars, how we thought about them at the beginning of the year remains consistent with where we are today.
And frankly, I think it would have been short-sighted to pull back in order to manage to a particular number given the high returns we're able to generate there. In terms of the compliance cost, what I was referencing was 2019 to where we are in 2023. And so about a month ago in a public forum, I said that that increase from ‘19 to ‘23 was about $250 million. As we've looked at the work in front of us, we are dedicating an incremental, call it, $20 million to $30 million, maybe as much as $50 million over and above that here. So it could be the delta from ‘19, not $250 million, but maybe as much as $300 million, year-over-year, so ’22 to ’23, we're up about $200 million in total compliance and related cost. Does that provide clarity?
Yes. Yes, I got it. I got it now. Thank you.
Great. Thank you.
Thank you. We'll take our next question from Dominick Gabriele with Oppenheimer.
Hey, great. Good morning, everybody. So When I look at your loan growth guidance, you talk about low to mid-teens. And to me, that means 14% basically. And so if you think about 14% or that range that you're discussing, it would indicate the second half loan growth would be roughly 7% and given the trajectory of loan growth in general, it would end spending being at 2.5% this quarter moving to 1% in the most recent month. It would suggest the fourth quarter's loan growth would be probably low single digits or something along those lines to make that guidance range. And so I was just curious if that's the right math that you are thinking about or roughly? If we could talk about that, that'd be great.
Yeah. I learned a long time ago not to give quarterly guidance because I found that I was not as accurate as I would have liked and other people would have liked. So the range of, kind of, the double digit growth that we talked about, you can take a look at the portfolio. We made some comments on what was driving it. So new accounts and certainly new account growth ‘22 to ‘23 has slowed. Sales, while still very robust at an absolute level, have slowed into July. We're doing targeted promotional activities to drive high generating, high returning accounts. And the comp in the fourth quarter of ‘22 versus prior quarters is certainly a tougher comp. So your math is certainly your math and I don't want to get into any more specifics than what I just did.
No problem. Thanks a lot. And then, there are some signs that the national unemployment rate could start to move higher if you look at some of the state data. If you saw a seasoning and the unemployment rate rising at the same time, could it have a more additive effect for ultimately higher net charge-offs than otherwise to book without the seasoning effect? And maybe just to relate to that, your loan fee income has been quite robust in its growth and it beat our expectations by quite a lot this quarter. Is that kind of an indication of the seasoning effects that are going on with the late fees in that bucket?
Yeah. So --
Thanks so much.
Yeah. Arren, the answer to both questions is yes. So the loan fee income, typically late fees and NSF fees. And in terms of employment levels, if unemployment was to increase, that would certainly impact net charge offs. But I would say this. In the cohort of folks that we typically target, there -- what we've seen is if they are impacted by a job situation, their time of recovery is pretty quick. So by recovery, I mean, finding a new role. So the fact that this cohort of prime revolvers isn't in the upper tier of income levels allows them to have a greater opportunity to find jobs of equal pay -- equal or more pay in the current environment. So the employment -- early indications of employment or some challenges in some states, we don't see any sign of that translating into a credit situation for us.
Okay, great. I'm going to sneak one more in here. Is there -- Discover spending growth is typically matched its loan growth trajectory over time given the stability of your business model. If we don't see a normalization of -- and meaningful fashion of payment rates, is there any reason that the spending growth and loan growth trajectories would be uncorrelated as they have been in the past?
Yeah. So we'll look at -- we'll look at kind of opportunities to drive loan growth. And part of that is the sales data or the spending data from consumers and reflect that in our next set of guidance that we provide. But specifically in correlation, in this form, I'm not going to get into.
Okay. Thanks so much. Appreciate it.
Thank you. We'll take our next question from Bill Ryan with Seaport Research Partners.
Hi, good morning and thanks for working me in here at the end. Question on the personal loans business. Last quarter, you talked about that there was some marginal tightening that you did, but you had fairly robust loan growth this quarter. Could you talk about the market opportunity that you're seeing there? And also the mix of new versus existing customers, I believe the historical mix was about 50-50, just curious if that's still the case?
Yeah. So in terms of overall competition, I'd say there's been a little bit of a pullback on the supply side from, I would say, markets and others as they pulled out. But there are a good number of competitors. A lot of them are much more broader spectrum than us in terms of how far down they go. I think what you're seeing is really strong consumer demand as rates have gone up and our product is primarily used for debt consolidation, people are looking to consolidate and pay down their credit cards. And so we're seeing very strong demand that is giving us ability to tighten credit and even at the margin, raise our prices and still see strong demand. So it's a product where underwriting and credit is everything. The mix is largely new, but a good amount are cross-sold to our existing cardholder base. So its customers where we also have experience with them.
Okay. Thank you.
So I think we are going to conclude our call there. Thanks very much for joining us. If you have any follow-ups, please reach out to the IR team and we wish you a very good day. Thanks very much.
This does conclude today's Second Quarter 2023 Discover Financial Services Earnings Conference Call. You may disconnect your line at this time, and have a wonderful day.