Bill Franklin - Vice President-Investor Relations Roger C. Hochschild - President & Chief Operating Officer R. Mark Graf - Chief Financial Officer & Executive Vice President.

Sanjay Sakhrani - Keefe, Bruyette & Woods, Inc. Robert P. Napoli - William Blair & Co. LLC William Carcache - Nomura Securities International, Inc. David Ho - Deutsche Bank Securities, Inc. Ryan M. Nash - Goldman Sachs & Co. Moshe Ari Orenbuch - Credit Suisse Securities (USA) LLC (Broker) John Hecht - Jefferies LLC Sameer S.

Gokhale - Janney Montgomery Scott LLC Mark C. DeVries - Barclays Capital, Inc. Christopher R. Donat - Sandler O'Neill & Partners LP Matt P. Howlett - UBS Securities LLC Kenneth Bruce - Bank of America Merrill Lynch Richard B. Shane - JPMorgan Securities LLC Cheryl M. Pate - Morgan Stanley & Co.

LLC Eric Wasserstrom - Guggenheim Securities LLC Jason Arnold - RBC Capital Markets LLC Donald Fandetti - Citigroup Global Markets, Inc. (Broker) Chris C. Brendler - Stifel, Nicolaus & Co., Inc. Jason E. Harbes - Wells Fargo Securities LLC.

Good day, ladies and gentlemen, and welcome to the Discover Financial Services Third Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference is being recorded.

I would like to introduce your host for today's conference, Bill Franklin, Head of Investor Relations. You may begin your conference, sir..

Thank you, Michelle. Good afternoon, everyone. We appreciate all of you for joining us. Let me begin, as always, with slide two of our earnings presentation, which is in the Investor Relations section of discover.com.

Our discussion today contains certain forward-looking statements about the company's future financial performance and business prospects, which are subject to risks and uncertainties and speak only as of today.

Factors that could cause actual results to differ materially from these forward-looking statements are set forth within today's earnings press release, which was provided to the SEC today in an 8-K report, and in our 10-K and 10-Q, which are on our website and on file with the SEC.

In the third quarter 2015 earnings materials we have provided information that compares and reconciles the company's non-GAAP financial measures with the GAAP financial information, and we explain why these presentations are useful to management and investors. We urge you to review that information in conjunction with today's discussion.

Our call today will include formal remarks from Roger Hochschild, our President and Chief Operating Officer, and Mark Graf, our Chief Financial Officer. After Mark completes his comments, there will be time for a question-and-answer session.

During the Q&A period, it would be very helpful if you limit yourself to one question and one related follow-up, so we can make sure that everyone is accommodated. So now it is my pleasure to turn the call over to Roger..

Thanks, Bill. Good evening, everyone, and thank you for joining us today. Unfortunately David had a conflict and is unable to join us. I'll be standing in for him this evening, but you'll see David again soon at the Bank of America Conference on November 18.

For the third quarter, we delivered net income of $612 million, earnings per share of $1.38, and a return on equity of 22%. Our net income this quarter benefited from a continued favorable credit environment, resulting in record low card and total company net charge-off rates. We reported 2.6% card sales growth over the prior year.

However, our sales, excluding gas, increased 7% as card member gas purchases were down over 30% in the quarter. We believe this period had the largest impact from gas sales as the comparison to last year gets slightly easier in the fourth quarter. Despite these headwinds to sales, we once again achieved another quarter of solid loan growth.

Specifically, we grew card receivables by 4%, in the middle of our targeted range. We'd like to see this accelerate and are taking a disciplined profitable approach to drive new accounts and loan growth going forward.

To that end, we achieved the highest quarterly level of new accounts since the third quarter of 2007 despite the heightened competitive environment.

As we continue to focus on driving more new accounts and increasing wallet share with existing customers, we extended our promotional double rewards program for new accounts, and we introduced a new Apple Pay promotion to help drive mobile wallet adoption. And we had some big news this quarter.

We were ranked the highest for customer satisfaction with credit card companies in the 2015 J.D. Power survey for credit cards. This was the culmination of years of effort in every aspect of the customer experience, and I want to acknowledge the hard work of our nearly 15,000 employees.

Turning to other direct lending products, our organic private student loan portfolio increased 17% and personal loans grew 12% over the prior year. Both are on track for record originations in 2015, as we had a strong peak season in student loans and are seeing increased personal loan applications from the broad market.

Focusing on payments, total volume was down 3% as increases in our proprietary volume and growth in our business-to-business volume were not enough to offset year-over-year declines at PULSE. The decrease in volume at PULSE was mainly due to the previously announced loss of volume from a large debit issuer.

On a reported basis, Diners volume was down 3%. However, adjusting for the impact of foreign exchange rates, Diners volume was up more than 10% year-over-year, driven by strong results in several regions, especially Asia Pacific. On October 1, we completed the sale of our Diners Club Italy franchise to Cornèr Bank.

As we previously indicated, we do not plan to be the long-term owner of the business, and we look forward to working with our new partner going forward. In other global payments activities during the quarter, we signed several new agreements including a new net-to-net partnership with Elo, the largest Brazilian credit card brand.

All-in-all it was a good quarter. Now, I'll turn the call over to Mark and he'll walk through the details of our third quarter results..

Thanks, Roger, and good evening, everyone. I'll start by going through the revenue detail on slide five of our earnings presentation. Total company net revenues this quarter were roughly flat on a year-over-year basis as higher net interest income was offset by lower fee income.

Net interest income increased $47 million, or 3% over the prior year, driven by continued loan growth. Total noninterest income decreased $49 million to $503 million, driven primarily by runoff in mortgage origination and protection products revenue. Net discount and interchange revenue was down 2%, driven by a higher rewards rate year-over-year.

Our rewards rate for the quarter was 107 basis points. As reported, the rate was up 5 basis points year-over-year, due primarily to the elimination of the rewards forfeiture reserve in the fourth quarter of 2014. Sequentially, the rate increased 2 basis points driven by promotional programs.

As we've said before, we do expect some continued pressure on the rewards front, as it remains the locus of competitive intensity in the card space. Our current view is that the fourth quarter rewards rate will be in the neighborhood of 115 basis points.

Protection products revenue declined $16 million year-over-year as new product sales remain suspended, as they have been since the fourth quarter of 2012. Other income was down $21 million, largely driven by the decline in mortgage origination revenue as we exit the product.

Looking to the coming quarters, we expect this combination of factors will continue to produce lower year-over-year non-interchange fee income.

However, it's important to keep in mind that exiting Home Loan originations will be beneficial to the bottom line once shutdown costs are behind us, as operating expenses exceeded revenues in this business for the last year.

Moving to payment services, revenue decreased $9 million in the prior year due to the previously announced loss of volume from a large debit issuer. This loss will continue to impact year-over-year comparisons through the first quarter of 2016. Turning to slide six, total loan yield of 11.37% was one basis point higher year-over-year.

In terms of the components, credit card yield declined 1 basis point, while student loan yields increased 6 basis points.

Personal loan yields moved the most, decreasing 13 basis points from the prior year as a result of customers continuing to opt for shorter term loans, which price further down the curve and the effects of some select pricing changes we instituted earlier in the year.

On the other side of the ledger, funding costs increased 8 basis points on liabilities due to funding mix and higher rates. The higher funding costs continued to be the primary driver behind the decrease in net interest margin from the prior year to 9.62%.

Sequentially net interest margin declined 1 basis point, a bit better than we expected due to slightly less promotional balance activity and better credit. Our current view is for NIM to end the year at roughly the same level as the third quarter.

Turning to slide seven, operating expenses were up $55 million over the prior year, driven primarily by one-time and ongoing compliance costs. Employee compensation increased $17 million due primarily to higher head count to support regulatory and compliance activities.

Marketing expenses decreased $14 million due to the timing of spend within the year. Professional fees increased $49 million due in part to approximately $28 million in look-back related anti-money laundering expenses, as well as higher costs associated with technology and compliance investments.

For the quarter, our total company efficiency ratio was about 40%, slightly higher than our 38% target, as it continued to be impacted by several extraordinary items we've discussed throughout 2015. Even at this elevated level, we remain among the most efficient large banks in the U.S.

However, since we don't expect these extraordinary costs to recur in 2016, we provided an adjusted operating efficiency ratio to better reflect the efficiency of our core business.

This ratio excludes $28 million in anti-money laundering look-back expenses for the quarter and $23 million in expenses for the quarter, associate with the wind down and exit of our Home Loans business.

Adjusting for these items, the efficiency ratio was about 38%, essentially in line with our long-term target, although I'll point out that our efficiency ratio tends to be a bit lower in the first and third quarters. We still believe reported operating expenses will be right about $3.6 billion for 2015.

Turning to slide eight, provision for loan losses was lower by $22 million, compared to the prior year, due to a smaller reserve build. This quarter we built reserves by $8 million. We recorded a $30 million build in the same period last year. This quarter's build was driven by card loan growth, partially offset by a reserve release in student loans.

The credit card net charge-off rate decreased by 24 basis points from the prior quarter and by 12 basis points year-over-year to 2.04%. The 30-plus delinquency rate of 1.65% increased 10 basis points sequentially and declined 6 basis points relative to the prior year.

The private student loan net charge-off rate, excluding purchased loans, decreased 20 basis points from the prior year, as we continue to benefit from more efficient collection strategies as well as the introduction of several new payment plans over the last year.

Student loan delinquencies, once again excluding purchased loans, increased 10 basis points to 1.88%. Switching to personal loans, the net charge-off rate was up 7 basis points from the prior year, and the 30-plus delinquency rate was up 5 basis points to 80 basis points.

The year-over-year increase in the personal loan charge-off rate was primarily driven by the seasoning of loan growth. To close things out, I'll touch on our capital position on slide nine. Our common equity Tier 1 capital ratio decreased sequentially by 10 basis points to 14.3% due to loan growth and capital deployment.

During the quarter, we repurchased $435 million of common stock, or nearly 2% of our outstanding shares. We continue to believe that on a combined basis our buybacks and dividends are driving the highest total yield among CCAR participants.

In summary, expenses have been and will continue to be elevated in 2015 as a result of some items we don't expect to recur next year. However, on a core basis, we are operating roughly in line with our long-term efficiency ratio target.

Delivering strong credit performance has helped offset some of the higher expenses, and the credit environment continues to feel relatively benign. As we close out 2015 and plan for 2016, we'll continue to focus on driving long-term value for our shareholders as we grow our business. That concludes our formal remarks.

So now I'll turn the call back to our operator, Michelle, to open the line up for Q&A..

Our first question comes from the line of Sanjay Sakhrani with KBW. Your line is open. Please go ahead..

Thank you. I guess my first question is just on loan growth. You guys talked about wanting to accelerate the growth rate but remaining disciplined in the competitive environment. Could you talk about how that affects your growth outlook into next year and also the rewards rate? I've got one follow-up after that..

Sure, Sanjay. As you look across the products, let me start with student loans and personal loans. We're seeing very strong growth and are on track for record levels of originations.

On the card side, growth is still within our range, but we are seeing an impact from sales and a lot of it coming from gas sales, but are continuing to invest, and I'm excited to see the level of new accounts and how well Discover it and the new features and innovation we're bringing to market, how well that's doing.

So I think that's a positive sign. Keep in mind, though, that a lot of our balances with new accounts are built through sales as opposed to balance transfer, so it takes a bit of time for those new accounts to translate into overall loan growth..

And, Sanjay, just in terms of your rewards rate, what I would say is the expectation for the fourth quarter, as we noted in our prepared remarks, is 115 basis points. As we look to 2016, I'm not prepared to give specific guidance yet.

What I will say is, I think on a full-year basis, it's likely to be higher than what you've seen in 2015, but we fully intend on remaining disciplined in terms of how we spend those dollars..

Great. I guess my follow-up question is on the BSA/AML overhang.

At what point do you think you're not affected by them? And how do you think you can benefit from that, outside of lower expenses?.

I'll cover the overhang and when I think it goes away, and then I'll let Roger talk about the business benefits. So what we have guided folks toward is that the expenses related to the look-back requirements of the AML/BSA situation would be about $75 million on the full year this year. There's about $28 million roughly in the quarter this year.

Currently, I think that the look-back expense is likely to come in more on the order of about $85 million in total. We will cover that additional $10 million through other operating efficiencies, so not changing our overall expense guidance. I do believe we'll be completed with the look-back this year. I feel comfortable with that.

What I would say is there will be ongoing compliance costs that will be in the model, Sanjay, going forward, but we are essentially covering those costs with efficiencies elsewhere in the operating model. And, Roger, I'll let you speak to the other element..

Yeah, and, Sanjay, in terms of overall business benefits, I wouldn't expect anything significant. I think it's a nice complement in terms of the new models. It's a complement to what we're already doing in terms of fraud prevention. But I wouldn't expect to see a material improvement in the fraud rate from these new investments..

And as far as deploying excess capital?.

So I think the deployment of excess capital, Sanjay, I assume what you're alluding to is inorganic opportunities to deploy that excess capital..

Right..

I think that will depend upon the lifting of the AML/BSA consent order or at least significant progress toward that end on our part. It's hard for me to handicap that one for you because I feel good about the progress we're making.

But we have more ground to cover in terms of where we need to go, and there's a regulator who will ultimately control – a series of regulators who will control when it's lifted, so it's hard for me to handicap for you..

All right. Thank you very much..

Thank you. And our next question comes from Bob Napoli with William Blair. Your line is open. Please go ahead..

Thank you. On the marketing spend and the number of new accounts, I mean you said there was timing on the marketing being a little lower, so I would imagine you're looking for an uplift in the fourth quarter? But you also said you put on a record number of new accounts.

What is the quality level of those new accounts? And where are they coming from? How are you hitting a record level of new accounts with less marketing?.

So in terms of the record level of new accounts with less marketing, sometimes there's a bit of a lag. And so we did talk about the second quarter being our probably top tick in terms of marketing expense for the year, and so that translates into bookings in the following quarter. In terms of quality, we are very pleased with the quality we're seeing.

We have not made any significant changes in terms of our credit criteria. We're seeing very strong activation rate, more retail sales with less of an emphasis on balance transfer and attractive costs per account. So we're very excited about the quality of the new accounts we're booking..

So that by definition should lead to an acceleration in loan and spending growth were that to continue ....

So there are a lot of factors that go into overall loan and sales growth. Certainly what happens in – with gas prices has shown us all what can impact. And clearly overall retail sales, the holiday season, the other efforts we do stimulating our portfolio, those all add up.

But I would say it's a positive indicator in terms of how well our product is competing in a very competitive marketplace..

All right. Thank you..

Thank you. And our next question comes from the line of Bill Carcache with Nomura. Your line is open. Please go ahead..

Hi. Thank you for taking my question. I wanted to ask on credit, the provision as a percentage of average loans appears to be in that sub-2% range, well below the 2.5% that you guys guided to earlier in the year. And I think at the time you guys gave that guidance, you might have been closer to 2.3%.

And so given the kind of growth that we're seeing, are you guys likely to stay – is it reasonable to expect that you stay in that kind of 2% level? Can you maybe just give a little bit of perspective around that looking ahead to 2016?.

Yep, happy to do it, Mr. Carcache. So year-to-date, the provision rate, as you noted, is around 2% give or take. And on last quarter's call, we said it would be lower than our original 2.5% guidance for the year. I think that's pretty much a given at this point in time. We see continued benign credit markets out there generally.

So while I'm not prepared to speak to 2016 at this point in time in terms of exactly what our expectations are, I think it's definitely a foregone conclusion that we will be well inside of that 2.5% at this point in time based on everything I see right now this year.

Credit continues to feel exceptionally benign, and it's a good environment from that perspective..

Great. Thank you. And then my follow-up is on the other income line.

Can you help us think through a little bit more specifically some of the moving parts there? Perhaps if possible, breaking down for us how much runoff and mortgage origination revenues and payment protection contributed to the decline and the rate at which those will attrite going forward? Just trying to get a sense of what the other income line, you know, could look like in 2016..

Yeah, so mortgage revenues were roughly $17 million lower give or take; something on that neck of the woods. Protection product revenues were lower by roughly $6 million give or take. That's the way to think about that line item.

Protection products revenue I think there's another – there's a product we're going to actually be sunsetting here in the next quarter or two, so that should result in a little bit of acceleration in the decline of protection products revenue but not anything significant.

And ultimately, I would expect mortgage revenue to be essentially gone here in the fourth quarter. So protection products will continue to attrite somewhat. I think we still believe at some point in time we may consider re-launching those products in a regulatory compliant fashion, but it wouldn't be this year, that's for sure..

That's very helpful. Thank you..

Thank you. And our next question comes from the line of David Ho with Deutsche Bank. Your line is open. Please go ahead..

Good afternoon. Just wanted to talk about the NIM outlook a little bit; given the potential that higher rates may be pushed out.

Does that change your funding costs strategy a bit? How are you positioned for asset sensitivity? And can you talk a little bit about where you see your credit card yields trending, given elevated pay down levels but the mix still pretty attractive?.

So I'll tackle the NIM part of the question. What I would say is as I said in our prepared remarks, we expect it to be pretty flat fourth quarter from where we ended the third quarter. And I think what we've said historically about 2016 is that we expected 2016 to remain at or above 9.5%.

I think given what we're seeing right now, I would lean towards the above as opposed to at 9.5% for 2016. In terms of funding strategy, David, when I look at how we're positioned vis-à-vis our primary competitors as well as the regional banks, we're positioned about the 45th percentile or so of asset sensitivity.

That doesn't feel like a decidedly bad place to be. It feels like we're right in the middle of the pack. That feels very comfortable place for us. We did stop several quarters back building any additional meaningful asset sensitivity into the book.

So I think what you're likely to see us do is to the extent it's cost effective to do so, really more essentially maintain that positioning as opposed to anything else..

Okay. Thank you.

And just separately on capital, were you surprised that a major competitor – not competitor, but there was – another card issuer was not required to be a part of the CCAR process? And does that have an impact on your view of potentially capital deployment in the next CCAR process?.

Yeah, I'm not going to speculate as to competitors and why they were or weren't included in certain things or not included in certain things. I think we worry about what we're held accountable for, doing it well and making sure we're driving great returns for our shareholders, and that's where we're going to stay focused..

But I don't think we read anything into that that led us to believe there would be changes for us..

Got it. Thank you..

Thank you. And our next question comes from the line of Ryan Nash with Goldman Sachs. Your line is open. Please go ahead..

Hi. Good afternoon, guys. Mark, maybe just one quick question on expenses; I think the core came in better than some of us had expected, and I know you tried to dissect the expense base a number of different ways. When I go through the numbers I get about $200 million year-to-date of one-time expenses.

If I look at this quarter's core annualized, it's well below or at or below $3.4 billion.

So I guess, how do I think about what you consider to be a more normal growth rate in the expenses outside of all the noise that's going on under the hood with the AML/BSA costs and some other one-time items?.

It's a big question, Ryan. I'll do my best to address it concisely. But it's probably going to take me just a second there.

So first of all in terms of annualizing this quarter's numbers for our run rate, I would not suggest you do that because, again this was not a particular high watermark from a marketing expense quarter, and I would say we always have some lumpiness to the expense level. So I would not suggest doing that as the right way to think about it.

So while we think $3.6 billion is still a good number for this year, I think what we said is we expect it to be lower next year.

The best advice I would have is go back to where we were in 2014, anchor to those levels, have some smart young analyst in your shop do a regression to take a look at what bank expense growth rates have been on an annualized basis over the course of the last two years, grow 2014 at that rate, and it will get you into the right ballpark for thinking about our expenses I think over the course of 2016.

We'll give you more specific direct guidance on our fourth quarter earnings call..

Got it. And then maybe if I can ask one question to Roger, when I think about the spend volume, despite the fact that we have seen an impact from energy prices, it seems like you actually saw an acceleration this quarter, which surprised me given some of the macro disruptions that we saw.

And I guess, maybe a comment on what you think is driving the acceleration that you're seeing in consumer spending.

Is it just easier? Is it just the comps getting easier, or is there something else that you saw?.

I think the – consumer spending in general is reasonably soft. As we get out, go out talking to our merchant partners, I'm not sure anyone is expecting a blowout holiday season. For us if you look at overall sales, clearly the biggest impact is coming from the gas prices.

We do a lot of work to stimulate our base and to grow sales, and the new accounts again are contributing to sales at a higher rate than prior vintages. But I would not sort of call a robust comeback for the U.S. consumer at his point..

Got it. I'm going to start on the regression..

Thank you. And our next question comes from the line of Moshe Orenbuch with Credit Suisse. Your line is open. Please go ahead..

A lot of the questions that I was thinking about have been asked and answered, but as you look at your ability to kind of grow accounts with low marketing spend expense but still have an increasing rewards, I mean, do you think of it as actually kind of transferring that expense from spending it on account acquisition to actually the rewards function? I mean, is that a good way to think about it?.

Yes. I would say that a big part of what is for us funding the double promotion is reduced promo rates in terms of durations for balance transfer as well as purchases, as well as it's generating a lower cost per account. And so we look at all those factors. But another key component is having a differentiated offer in the marketplace.

And that's where for us at least having a proprietary network, having distinctive features like the free FICO and Freeze, all of that also adds up to giving us very attractive new account economics..

I guess my follow-up really is given that you do have a differentiated offer, given that you do have the J.D.

Power designation, your own brand and lots of other things, I guess when should we expect you to actually develop and generate some of your own fee-based products, so that you can recover some of the revenue that you've been losing for the last several years?.

That's something that we are looking at. There's a lot of focus on building out compliance functionality and risk management across the entire spectrum of our businesses. We will probably return at some point in the future, but there are a lot of other priorities.

And I think we're getting a lot of value from some of the functions and features we're putting out there that don't cost anything. So if you look at free FICO, that's something that a lot of issuers and even third parties used to charge for.

We see a lot of value in giving that away for free and getting the benefit in terms of customers coming to Discover and carrying balances on their cards..

Yeah, I don't disagree. It just feels like given your positioning, you'd be in a better shape to do it than some others..

Could be..

Thank you. And our next question comes from the line of John Hecht with Jefferies. Your line is open. Please go ahead..

Thanks very much. Actually most of my questions have been asked. I guess I have one out of curiosity. It's a little bit about your opinion of where you think we are in the credit cycle. On one level, you guys are running very low losses, very low delinquencies. You may be even more comfortable signing up new accounts.

On the other hand, we've got more mixed economic data. I think there's an emerging concern that we're at a tail end or at least the latter part of the credit cycle. I'm just wondering what do you guys think about that.

And what do you do to balance those offsetting thoughts as you kind of enter next year?.

So you can rest assured that when we sign up new accounts, we are not assuming that peak losses are in the 2% range. So there's a big difference between the models we use in booking new accounts and where the overall portfolio is now. What I would say though, and Mark made it clear, it is a remarkably benign environment.

And if you look at things such as our 30-day delinquency rate, it looks pretty calm as far out as the eye can see. Now there's a lot of work that goes into managing those losses, both in terms of underwriting as well as the work supporting our customers when they get into challenging circumstances.

But again, I think that the environment continues to look very, very good as we look forward. That doesn't mean we're being any less disciplined in how we're booking new accounts, whether that's in card, student loans, or personal loans..

Thanks very much..

Thank you. And our next question comes from the line of Sameer Gokhale with Janney Montgomery Scott. Your line is open. Please go ahead..

Great. Thank you. I think this is a question for Roger. You talked a bit about new accounts and better activation on those new accounts.

But what I was curious about is if you look at your more seasoned accounts, isn't that where the opportunity lies for increased activation? And if you could talk about activation rates on those more seasoned accounts, how they've trended year-over-year.

And then what your outlook might be as you try to maybe gain more activation from those accounts looking at the next 12 months. Can you talk about that? Because that seems to be where there could be more of an opportunity, unless I'm completely mistaken..

Well, yeah, I did not mean to suggest that with our focus on new accounts we're ignoring the existing portfolio. Traditionally our loan growth comes almost 50-50 between new accounts and stimulating existing accounts. Frequently it's not the inactive existing accounts, it's the ones that have a low level of activity.

So we're the second card in the wallet and we want to become first card.

We do a lot of different promotions, whether it's leveraging our network to do specific merchant offers, the rotating 5% program encourages them to spend perhaps in categories where they haven't spent before, even promotions like we're doing with Apple Pay encourages them to put Discover card top-of-wallet for mobile payments.

So there's a tremendous amount of activity stimulating the portfolio, as well as booking new accounts..

So can you give us a sense for how much additional activity has been stimulated on those existing accounts with your marketing activity over, say, the last 12 months just so we have a sense for that?.

I would just say traditionally our loan growth has come about 50-50 between growth from new accounts. Clearly, we benefit from having a lower attrition rate and very low charge-off rate. So in terms of driving growth from existing accounts, there's less of a hole to make up.

But I think beyond that rough 50-50 mix, we don't more precisely disclose where the growth comes from..

Okay. And then just a quick one on the rewards rate. Again you talked about that, the expected increase in Q4. Didn't give any sort of expectation for 2016 yet. But I was curious about the interplay between rewards rate and yield, because it looks like card yield has held up pretty well relative to the rewards rate going up.

So is it basically just the post-CARD Act function where the limitations on re-pricing that have maybe made it less feasible to maybe price lower on the rate, relative to giving more rewards? Or is it just the rewards resonate more with borrowers compared to lower loan rates? I'm just curious about that. Thanks..

I think that's right. Post-CARD Act, it's a lot more challenging to compete in terms of the go-to rate on cards, because you've lost your ability to change that. There's still competition around balance transfer, promotional rates, but in general, you see less competition for those go-to rates.

I would say also benefiting the net interest margin is the low charge-off, and so that's helping support a higher NIM. But I think we are seeing a lot of competition in rewards these days.

It's a combination of, to your point, the CARD Act impacts, as well as I would say some issuers that are pursuing a spend-based model where a lot of the focus is on very rich rewards..

That's helpful. Thank you..

Thank you. And our next question comes from the line of Mark DeVries with Barclays. Your line is open. Please go ahead..

Yeah, thanks. I've got another follow-up for you on card loan growth.

Are there any other specific investments you're making or promotions you're going to be running in the fourth quarter looking forward on top of, Roger, which you already mentioned, the extension of the promotional period, the Apple Pay, to help accelerate loan growth here?.

In terms of the ones that are driving the rewards rate, it is largely coming from – we do have the seasonal 5% program, the double cash promotion, and then what we're running with Apple Pay. Those are the biggest drivers.

We do have as always a lot of marketing activity planned, everything from new account solicitations to continuing to stimulate the existing portfolio..

And as we look into the first quarter or the early part of next year when you normally would seasonally see a drop-off in your reward expense, should we expect that to be a little bit more elevated as you look to continue to kind of reaccelerate loan growth?.

Yeah, Mark, what I would say there, again as I'm not prepared to speak to 2016 in specifics. But I would say on a full-year basis, you're clearly going to be looking at a higher rewards rate I think than you'll see for a full-year basis in 2015..

Okay. Got it. And just one last clarifying point.

Mark, did you indicate earlier that for 2016, you would expect provisions inside of the 2.5% that you guided to for this year?.

No. I was speaking to what we expected for 2015. We'll give our 2016 guidance on the fourth quarter call..

Okay. Fair enough. Thanks..

Yep..

Thank you. And our next question comes from the line of Chris Donat with Sandler O'Neill. Your line is open. Please go ahead..

Good afternoon. Thanks for taking my questions. Just first wanted to circle back on some of the stuff you talked about recently, Mark, on EMV expenses.

Is this something that is going to be mostly done in 2015 or will it creep into 2016 and beyond? Can you just give us some color of how recurring EMV transition is in its nature?.

So I think the EMV expenses that we specifically called out earlier this year were really more what I would call the one-time oriented expenses associated with tokenization and pushing out EMV. So I would not expect those expenses to recur.

I do think a little bit of that $35 billion total is likely to bleed into the early part of next year as opposed to fully being spent this year. What I would say is I would just remind everybody that reissuance costs for EMV cards are higher than reissuance costs for a mag-stripe card.

So in a run rate reissuance world that probably has a little bit of impact, but from the standpoint of the one-time costs I called out, no, I do not expect to see those increase beyond the levels we have called out..

Okay. And then sort of similar question on Home Loans, you had $23 million of expenses in the second quarter, another $23 million this quarter for wind-down and exit.

Are we pretty close to the end on that one, or is maybe a little bit more to come also?.

It's going to be a little bit more to bleed through in the fourth quarter. So GAAP requires some of the charges you take – you actually can't take until you actually shutter the doors and turn off the lights. So it will be smaller than this quarter's number.

But there will be a little bit bleeding through in the fourth quarter, and then it will be over..

Got it. Thanks very much..

You bet..

Thank you. And our next question comes from the line of Matthew Howlett with UBS. Your line is open. Please go ahead..

Thanks for taking my question.

Just on the loan loss reserve, it looks like the $10 million release on the student lending and the personal lending, I'm not sure if those parts were the PCI but I guess getting back to your charge-off comments before, the credit looks stable in both those asset classes, but it doesn't appear that long-term that's the run rate that's sustainable, you're growing those balances.

I guess if there's any indication will we need reserve building if that continues to grow at the rate they're growing at?.

So I guess what I would say is a lot of moving parts and pieces there. Let me try and tackle them all. On the student lending piece specifically, the release was relatively small as you noted. It was driven by better expectations for future losses on loans that are currently in deferment. So that's what drove that piece of the puzzle.

In terms of looking forward, it's just hard to say, quite honestly, how much – we've called now for two years in a row for growth in the portfolio to outstrip remaining goodness left in the portfolio and just to be intellectually honest with our good friends, we've been wrong twice. Credit has continued to improve over that period of time.

I think it just highlights what Roger alluded to earlier, and that is that in our working lifetimes, none of us have ever seen a credit environment that looks like this. CARD Act got implemented at the same time the crisis ripped a lot of forward charge-offs into a current period. So it's – I have used the analogy a few times now.

If you think about it like the GPS in your car, in normal times it gets you to the street address. Today it's getting you to kind of the ZIP code.

So I feel comfortable with the results we're getting, but in terms of the precision you're looking for, I'm not going to try and convince you that we've got it, because I don't think anybody does right now..

Right. Gotcha. The credit looks extremely stable, there's no signs of deterioration. Just on the percentage, they're going to grow faster it looks like than the cards for a while.

Is there any target? I mean, long-term target that you sort of think that this is going to get to and that's sort of the critical mass, is it 25%, 30%? Could it keep on just growing making a bigger percentage to the balance sheet longer term out?.

I do think just given the relatively – the different sizes of our asset classes, you'll continue to see faster growth in personal loan and student loan. But luckily we are in the capital position where we can support growth across any of those.

And so where we can find good growth that meets our profitability and credit hurdles, we're investing across all of our asset classes..

Great. Thanks, guys..

Thank you. And our next question comes from the line of Ken Bruce with Bank of America Merrill Lynch. Your line is open. Please go ahead..

Thanks. Good afternoon. My first question relates to basically what your anticipation would be in terms of loan growth from a timing perspective. You know, you point out that the sales volume is ultimately going to lead to balance growth. You've had a good pickup in cards, you had a good pickup in spending ex-gas.

How long do you think it takes for that to ultimately percolate into balance growth?.

It's hard to pin down precisely because there are a lot of other factors. I would point out we are still seeing healthy balance growth in our card business as well as very strong loan growth across the personal and student loan side. Where holiday sales go will be a factor as well.

I would point to the new accounts as well as the easier year-over-year comps on gas as two helpful factors. Beyond that, I wouldn't want to put out a number in terms of where growth is going to go any time soon..

Okay. Just maybe two follow-up questions, or one follow-up and one new question. Is there a natural horizon that you would expect balances to grow after a new card acquisition? That would be the first question.

And then separately, this is a bit of a sensitive topic, I know, but just in terms of the value that you all ascribe to the payments business in the closed loop that you operate, obviously there's been a lot of focus on unlocking value in transactions that ultimately would possibly value that business higher outside of Discover.

And you pointed to – Mark, you discussed it in terms of optionality at a recent investor conference, and I'm wondering what factors you would need to see in order to start to exercise some of that optionality? Thank you..

Yeah, so let me start with maybe the second question. I think when you think about our payments business, it's important to keep in mind it's not just the payments segment, but rather the network that our proprietary card runs on.

And I talked about the benefits we get in terms of differentiation in terms of the ability to work directly with merchants. Quite frankly you're seeing one of the largest card issuers out there head the other way in terms of trying to build their own proprietary networks.

So I think if you look, for example, at the returns that we and American Express generate, both in different ways, but generate within the card issuing business, I don't think it's a coincidence that the two of us are generating the highest returns, but also have a proprietary network.

Now we believe our partnership strategy and working with partners, such as SAP and Ariba, such as PayPal, such as all the global networks around the world, we think that one is the right one to maximize shareholder value and are committed to pursuing that. But again I think it's not as simple as just looking at the payment segment.

You've got to keep in mind the value that we see for the card issuing side of the business..

And I guess – well maybe to retort that a little bit, it's not as obvious that there's any value ascribed in the stock for that and I wonder how you would see or think about trying to, I guess, maximize shareholder returns versus just the value to you of the network itself?.

So, Ken, what I would say is that the management team, not just on this topic, but across the board, I mean I think we've proven ourselves to care greatly about driving great returns for our shareholders, putting 20% north ROEs looks pretty darn good.

I think at the end of the day, you shouldn't take us as believing that we don't ever question our own approaches. We question them regularly and we look at options regularly.

So I think you should take Roger's comments as that we've spent a lot of time looking and that we believe very strongly, we're pursuing the right strategy based upon what we see right now..

Great. Thank you..

Thank you. And our next question comes from the line of Rick Shane with JPMorgan. Your line is open. Please go ahead..

Hi, guys. Thanks for taking my questions. They've actually all been asked and answered..

Hi, Rick..

Thanks, Rick..

And our next question comes from the line of Cheryl Pate with Morgan Stanley. Your line is open. Please go ahead..

Hi. Good afternoon. I just wanted to circle back to the loan growth that we've talked about several times here.

I'm just – I realize there's a lot of different moving pieces here, but I was wondering maybe there's some perspective you could share in terms of maybe what you've seen historically as to the timing and trajectory from marketing spend to new account growth to loan growth? Is – maybe you can just help us size the – have you seen that been more of a couple-of-quarter event? Is it more of a year lag? Just if you can help size that a little bit from historical experience?.

Sure. And that was actually a part of – I got distracted with the second half of Ken's question. Usually for new accounts in the prime segment, the balances will build over the first two years. What can really change that is how focused you are on balance transfer, because if you're building it for retail sales, they'll continue to build.

If you're using a lot of balance transfer, they'll build very, very quickly, and then pay down when the balance transfer expires. And depending on the issuer, that can be 12 months, 18 months. I think there's some people who will even go out 24 months.

Given our focus on rewards, on all the other value components on service and what I talked about in terms of backing off the promotion durations, I think these new accounts, we do expect balances to continue building for the first two years..

Okay. That's helpful.

And then just as a follow up, in terms of the new card account growth this quarter, maybe you can help us think about how has the – still relatively new – but how has the travel card been resonating within that and driving account growth?.

So the Miles Card is doing well. It's exceeding our expectations, but it's still a pretty small part of our overall new accounts. It's really – our core product is Cashback and the Discover it Cashback. For those people who prefer miles, we have the Discover it Miles, but it's a much smaller component of our overall new account origination..

Okay. Great. Thank you..

Thank you. And our next question comes from the line of Eric Wasserstrom with Guggenheim. Your line is open. Please go ahead..

Thanks. Just to follow-up on two small topics, one, Mark, I actually did that regression and I came up with sort of a growth CAGR of 7%, which is somewhat higher than what I would have guessed before I did the math.

And I'm wondering if that – or speculating rather that a lot of it includes that many of your peer group also had elevated compliance costs.

But does a high-single-digit figure seem like a reasonable number or perhaps maybe too high end?.

I think that's too high end. The number I'm using looks more like a mid-single-digit number, probably a slightly lower mid-single-digit number is the way I'd think about it..

Okay. Thank you for that.

And just to follow-up on the cost of funds, how should we think about the cost of funds going forward? Should it – will it appear similar to this quarter in terms of some of the incremental costs seeping through? And how are the pricing dynamics offsetting that on sort of a forward basis to sustain this very solid margin?.

So in terms of the overall cost of funds, I think Mark had talked on previous calls about how we've positioned the balance sheet. You know, clearly the rate increases seem to be pushing out more and more, so we do expect some good stability in terms of NIM as we look forward..

Yeah, I guess what I would say is, you know, we said at or above 3.5% (sic) [9.5%] through 2016. What I would echo today is that I would be much more comfortable with above 3.5% (sic) [9.5%] in 2016 than I was when we said at or above 3.5% (sic) [9.5%]..

You mean 9.5%.

9.5%. Sorry..

Great. Thanks very much..

My apologies..

Thank you. And our next question comes from the line of Jason Arnold with RBC Capital Markets. Your line is open. Please go ahead..

Hi, guys. I was just wondering if you could update us on your views around mobile payments. I mean, Apple Pay gets most of everyone's attention these days, but technology moves pretty fast. So just curious if you could give us some big-picture views there, please..

Sure. We are working with Apple Pay as well as other mobile wallets out there. I think it's a space that continues to evolve. We see some attractive benefits in terms of what we can do by being a card issuer as well as having our own network. So a lot of flexibility in terms of how we put it together.

There are some investments, and I think it will take a while to see who the winners and losers are. But I think as part of our partnership strategy, when the market is evolving this quickly, you want to put quite a few chips down. You know, but I would say clearly Apple Pay is off to an early lead.

And we're seeing very strong results in terms of take-up on our offer..

Okay. Terrific. Thanks. And then we haven't talked about this in a while, but I was just curious if any news, any updates you could provide on the checking product..

Sure. So we are continuing to market the checking product but only to our existing base. We're not offering it to the broad market. So it's really just cross-sold to our card base. I think we're in a complete AML/BSA build-out and some other components before we take it to the broad market.

It's a product that we're very excited about, but realistically it will take a while before it has a material impact on our overall funding costs.

And I would also focus beyond checking though, we are working aggressively in terms of our savings account, our money market, our CDs, so there's a big part of our direct-to-consumer deposit business beyond checking..

Excellent. Thanks so much for the color. I appreciate it..

Thank you. Our next question comes from the line of Don Fandetti with Citi. Your line is open. Please go ahead..

Thanks. Mark, some of the data that we track for card mailings has gotten a little more volatile lately. And I was just curious over the last 12 months or so how your digital mix has shifted in your card business.

And also could you talk a little bit about the mix in how you approach your personal lending from a mailings versus digital perspective?.

Sure. It's Roger. I'll cover this one. Digital continues to grow, but direct mail remains very important for the card business. And there's a difference between what you send out and how people respond. So actually we get more applications from mobile devices than we do mailed back through the mail. But, again, I would say digital continues to grow.

For personal loans, by and large up until this point, our marketing has been by invitation only. So whether it's cross-sold to our existing customers or going out to the broad market, we target specific profiles from the bureau data. So given that, our mix has been very heavily weighted towards direct mail or other cross-sell channels internally.

About two quarters ago, we started opening that up, but it's still in transition. So I think you would expect to see the non-direct mail solicitations grow on the personal loan side. It's actually that broad market response that is helping drive record levels of origination..

Got it. Thanks..

Thank you. And our next question comes from the line of Chris Brendler with Stifel. Your line is open. Please go ahead..

Hey. Thanks. Good afternoon. Just one more on the card loan growth side. Thanks for all the color earlier. Attrition, like it seems to me like the pressure on the card business at this point is a lot of competition in the reward space.

Can you talk about attrition rates? And have they increased or stabilized recently that would give you a little more confidence that we're close to a bottom? Thanks..

So for us, attrition rates have been very stable and amongst the best in the industry. And that's where I think you see the benefits of what won us J.D. Power in terms of hundred percent for our employees' customer service, a great customer experience, across every aspect.

So if you look at our customers and how they recommend Discover to a friend, their satisfaction, very, very high. So we have seen very stable and very low attrition rates..

Okay. One more quick follow-up.

Any change directionally in the competitive pressures from the alternative lenders, the online lenders, in the either the card business or the student personal loan businesses?.

We don't see the alternative lenders as much on the card side. On the personal loan side, they are aggressive competitors. They put a lot of mail out in the marketplace. In general, they target a much broader credit spectrum than we do. And operate a lot outside of the prime space.

But given our brand, given our value proposition, I think that's even in this competitive environment, we are seeing record levels of origination..

That's great. Thanks, Roger..

Thank you. And our last question comes from the line of Jason Harbes with Wells Fargo. Please go ahead. Your line is open..

Yeah, hi. Good evening. Most of my questions have already been answered.

But maybe just to follow-up on the NIM outlook, you know, the stable NIM expectation, I guess my question is to what extent is that a function of potentially rising interest rates over the next 12 months or so?.

So I would say it's a reflection of where we see the forward curve right now more so than anything else.

If we actually do get some movement in the rate environment, we are positively levered to that based on our current asset liability positioning and would actually see margin expansion through the first several hundred basis points of rate increases..

Okay. Thanks for that.

And then just to follow-up on a comment you made, I think, last quarter around the tax rate, is that still going to be a little bit lower here in the fourth quarter?.

Yeah, I think I would describe it probably as in line, maybe slightly lower but generally in line with the third quarter is the way I think about it..

Okay. Thanks a lot..

You bet..

Thank you. We have no further questions. And I'd like to turn the call back over to Bill Franklin for any final remarks..

All right. Thank you, everyone, for joining us. If you have any other follow-up questions, feel free to call the Investor Relations team. Have a good night..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great evening..