Bill Franklin - IR David Nelms - CEO Mark Graf - CFO.

Ryan Nash - Goldman Sachs Sanjay Sakhrani - KBW John Pancari - Evercore David Ho - Deutsche Bank Eric Wasserstrom - Guggenheim Securities Chris Brendler - Stifel Bill Carcache - Nomura Mark DeVries - Barclays Moshe Orenbuch - Credit Suisse Don Vendetti - Citigroup John Hesh - Jefferies Betsy Grasek - Morgan Stanley Bob Napoli - William Blair David Scharf - JMP Securities.

Good afternoon, my name is Chantal and I will be your conference operator today. At this time I would like to welcome everyone to the Discover Financial Services Fourth Quarter Earnings Call. All lines have been placed on mute to prevent any background noise.

After the speakers' remarks there will be a question and answer session, [Operator Instructions]. Thank you. Bill Franklin, Head of Investor Relations you may begin your conference..

Thank you, Chantal. Good afternoon, everyone. We appreciate all of you for joining us. Let me begin as always with Slide 2 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 in an 8-K Report and in our 10-K and 10-Qs, which are on our Web site and on file with the SEC.

In the annual and fourth quarter 2016 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 David Nelms, our Chairman and Chief Executive Officer; and Mark Graf, our Chief Financial Officer. After Mark completes his comments, there will be time for a question-and-answer session.

During the Q&A period, it would be very helpful if you limit yourself to one question so we can make sure that everyone is accommodated. So, now it is my pleasure to turn the call over to David. Who will begin his comments on Page 3 of the presentation..

Thanks, Bill, and good afternoon, everyone. I'm going to review the full year 2016 accomplishments and 2017 key focus areas and then turn it over to Mark to cover fourth quarter results. 2016 was another strong year, as we delivered 21% return on equity and we accelerated loan growth.

This loan growth acceleration as well as net interest margin expansion drove strong revenue growth. Operating expenses benefited from the completion of the AML look back project, earlier this year and the exit of the home loan business last year.

Higher provisions from the seasoning of the last several years of loan growth, partially offset some of this positive operating leverage, but were in line with our expectations for credit costs. All-in our full year earnings per share rose 12% bolstered by almost $2 billion of share repurchases.

We accomplished a great deal in 2016 against our key focused areas, including as you can see on Slide 4, accelerating the pace of loan growth to nearly 7%. Above the 4% to 6% expectation we set a year ago. In total, we increased loans by nearly $5 billion, our largest organic increase in loan balances in 15 years.

Our card business was the largest driver of that growth. Reflecting on some cards specific accomplishments, we launched credit score card, which provide both current and prospective customers free easy access to their FICO score.

And we introduced the Discover it Secured Credit Card, targeted customers who are looking to establish or rebuild their credit history. Our credit cards continue to resonate well with prime revolvers, as we have [ph] a post-recession high number of new accounts for the year, which was the biggest driver of the loan growth.

We achieved this growth while maintaining our disciplined approach to underwriting and as the result the credit quality remains strong. Our total company net charge-off rate excluding acquired loans was 2.24% in 2016, 12 basis points above 2015, still very low relative to historical experience and among the lowest in the industry.

Moving to our other direct banking products on Page 5, personal loans set a record with originations of $4 billion, an increase of 31% over the prior year. Growth in originations was largely fueled by product enhancements and strong execution.

Product enhancements in 2016 included a higher maximum loan amount and improved mobile responsive Web site and application and security [ph] functionality. Which allows customers to review [ph] their interest rate and estimate monthly payments without impacting their credit score.

Student loans also set a record with 1.4 billion in originations, an increase of 9%. We expanded our student loan awareness efforts via marketing and our field sales force, as well as redesign of the application experience, resulting and a higher conversion rate and more satisfied customers.

In payments, the discover network continues to provide significant benefits to our card issuing business and network partners.

I am pleased that all PULSE Network Volume is stabilizing as shown on Page 6, after trending down for the last couple of years, due primarily to the competitive response related to the implementation of the Durbin Amendment in 2012. I believe PULSE is now poised for modest growth in 2017.

Internationally, we established a new partner shift with Elo, the largest resilient card network to allow Elo card holders to use their cards across our global network. Diners Club returned to growth are in FX adjusted or real basis a couple of years ago, but I’m happy to see volumes grew as well on a nominal basis in 2016.

As several of the new partners we’ve signed over the last few years are now growing nicely. Moving to Page 7, we’ve returned more than 2.3 billion to our shareholders in the form of dividend and share repurchases last year, which represents 99% of our net income. As a result, we reduce out saving shares of common stock by 8%.

This combined with net income growth of 4% drove our EPS to be 12% higher. You can also see in the chart on the right how our return on equity has remained above 20% for the last four years, much higher than other large banks. As we look back on 2016, we feel good about all we’ve been able to accomplish.

Now I’ll spend a couple of minutes discussing our key focus areas for 2017 before I turn it over to Mark to walk through the fourth quarter results. First, we will be focused on sustaining profitable growth.

In card we will continue to enhance our products by introducing innovative features and benefits and prudently adjusting reward offerings to drive greater customer engagement. Underlying all of our initiatives is our commitment to disciplined credit management and great customer service, which has historically served us well.

I think it’s fair to say that a number of competitors are pursuing growth for the sake of growth, which is generating some transactor sales share shift, but resulting in lower revenues for them. By contrast, you saw our loans and revenue grow at similar rates in the fourth quarter.

Our approach and execution have shown discipline and that is our continued commitment to shareholders. Building on our momentum in both lending and deposit products, we bore [ph] increased marketing to improve consumer awareness and consideration across products, as well as continue our efforts to increased product differentiation.

To do this, we will also invest in technology to enhance our products and processes. So that we can offer consumers what they want most and make it simple for existing customers to add additional products. In payments, we have a unique set of assets, which we believe presents many long-term opportunities.

Near term we are focused on getting the most from our proprietary network for our card issuing business, including increased acceptance and brand differentiation. Third party volumes stabilized at the end of the year and we continue to seek opportunities to defend and grow our PIN debit business and penetrate the signature debit market.

Additionally, we will continue to pursue new ways to partner, to better leverage our network and drive volume growth. In 2017, we will remain focused on enhancing our AML/BSA compliance functions. Continuing to invest in compliance and risk management strengthens our operations and supports our leadership position in customer service.

In closing, I want to thank our employees for serving our customers so well and producing strong financial results in 2016. I’m excited about the momentum we have going into 2017. And with that, I’ll turn the call over to Mark to cover fourth quarter results and provide some guidance for the year..

Thanks, David, and good afternoon, everyone. I’ll begin my remarks on Slide 8 of our presentation. For the fourth quarter we reported net income of $563 million and diluted earnings per share of $1.40. Overall, we delivered another strong quarter with EPS up 23% year-over-year and return on equity of 20%.

Turning to Slide 9, card and personal loans finished the year with a strong fourth quarter, accelerating total loan growth to almost 7% over the prior year. Card balances were driven by increased sales, which were up 3%, a higher revolve rate on merchandise sales and higher promotional balances.

Personal loans grew 18% over the prior year due to successful marketing initiatives and the product enhancements that David mentioned earlier. Student loans grew 2% as run-off in the acquired portfolios partially offset growth in the organic book.

Looking solely at the organic student loan portfolio, it increased 13%, with strong performance during this year’s peak season. Moving to our payment service segment, PULSE volume and network partners were relatively flat year-over-year while Diners Club volume increased 8%, driven by continued strong growth in the Asia-Pacific region.

Turning to Slide 10. Net interest income increased $160 million or 9% over the prior year driven by a combination of loan growth and a higher net interest margin. Total non-interest income decreased $7 million to $466 million. Net discount in interchange revenue was down 3% driven by a higher rewards rate year-over-year.

The rewards rate was up six basis points from the prior quarter and about eight basis points from the prior year. The increase over last year is driven by higher promotional rewards as well as a continuing [technical difficulty] Discover it, from our prior flagship cash back products.

The increase in promotional rewards is primarily due to better customer engagement with the rotating 5% category which was broader than last year as it included department stores, Amazon and warehouse clubs. The Cashback Match program, which helped drive strong new account growth this quarter, also contributed to the increase in promotional rewards.

In payment services, revenue was flat year-over-year. Overall, we grew total company net revenue by 7% for the quarter. Turning to Slide 11. Total loan yield of 11.88% was 39 basis points higher than the prior year, primarily driven by a 42 basis point increase in card yield.

The year-over-year increase in card yield was due to a greater percentage of card receivables being revolving in nature, higher rates in the portfolio, the impact of the December 2015 prime rate increase and a few basis points from last month's rate increased, the benefits of which will be more fully reflected in the first quarter.

On the funding side we grew average direct consumer deposits by $5 billion to make up 47% of our total funding. Our funding costs increased 10 basis points, driven by changes in funding mix as well as higher market rates. Overall net interest margin expanded 32 basis points from the prior call to 10.07%.

Turning to Slide 12, operating expenses were down $36 million over the prior year. But I would remind you that last year's results had $37 million in expense related to the AML look back project. Marketing expenses were down $20 million, due to lower deposit marketing, as well as a shift in the timing of credit card campaigns related to last year.

Professional fees fell $18 million, primarily due to the completion of look back related anti-money laundering remediation activities earlier this year.

Partially offsetting these expense reductions is a 90 million year-over-year increase in employee compensation, resulting from higher headcount to support compliance activities as well as the impact of higher average salaries.

Turning to provision for loan losses and credit on Slide 13, provision for loan losses was higher by $94 million compared to the prior year, due to higher charge-offs and a larger reserve build, both primarily driven by the seasoning of loan growth.

This quarter we increased reserves to $143 million, while last year we had a slightly smaller build of a $126 million. I would reiterate that loan growth is the driver here, on balance the credit back drop continues to remain benign with a modest level of normalization continuing.

Looking at card, the net charge-off rate of 2.47% increased by 29 basis points year-over-year, and 30 basis points sequentially. The 30-day delinquency rate of 2.04% increased 32 basis points year-over-year and was up 17 basis points sequentially.

Turning to private student loans, the net charge-off rate, excluding acquired loans, increased 12 basis points from the prior year due to seasoning of the organic book. Sequentially, the rate increased 40 basis points due primarily to seasonality.

Student loan delinquencies, once again, excluding our acquired loans, are up 31 basis points compared to the prior year and 35 basis points sequentially. The increase in delinquencies is primarily driven by a greater portion of the student loan portfolio entering repayment and the seasoning of loan growth.

Switching to personal loans, the net charge-off rate was up 42 basis points from the prior year and 7 basis points sequentially. The 30-day delinquency rate was up 23 basis points from the prior year and 14 basis points from the prior quarter.

The year-over-year increases in the personal loan charge-off and delinquency rates were driven by the seasoning of loan growth, and a higher mix of customers who drive strong risk adjusted returns that has slightly higher losses.

Across all three major asset classes card, student and personal loans credit performance continues to be generally in line with our expectations. Next, I'll touch on our capital position on Slide 14. Our common equity Tier 1 capital ratio fully phased in for Basel III declined 60 basis point sequentially.

The ratio decreased from the prior year due to the capital deployment in the form of loan growth, buybacks and dividends. In the quarter we repurchased 2% of our common stock.

Moving to 2017 guidance on Slide 15, first we've increased our loan growth target range for the next year to 5.5% to 7.5% above our long term target range of 4% to 6%, based on opportunities that we see to continue to drive disciplined profitable loan growth.

In order to support that higher growth target we expect operating expenses to rise to approximately $3.8 billion next year.

We've been saying for several quarters now that we would invest some of our NIM upside back into the business to the extent we could find profitable opportunities to do so, and we believe we have opportunities to do just that in 2017.

Another driver of the loan growth is higher sales, there we expect to continue with focused innovations around our rewards program to drive engagement and growth in our target segments. As a result, we expect the rewards rate to come in between 126 and 128 basis points for full year 2017.

Moving to our outlook for net interest margin, we expect it to increase slightly versus full year 2016's net interest margin. The prime rate increase from last month is not fully reflected in fourth quarter results due to timing. And that alone will result in NIM expansion in 2017.

Further rate increases would also result in NIM expansion due to the asset sensitive position that we built into the balance sheet. And we are currently expecting a couple of more rate increases this year based on the market implied forecast.

Somewhat offsetting the benefit provided by the rate environment will be the level of card promotional activity and modestly higher charge offs of accrued interest.

Finally, we expect the total net charge off rate this year to be modestly higher than the 2.16% net charge off rate we delivered in 2016 due largely to the seasoning of a growing portfolio. Let me reiterate the overall consumer credit environment continues to feel benign.

So to summarize we'll remain disciplined in our approach to loan growth, focusing on our core prime customers, while also identifying and targeting new customer populations when we believe there are opportunities for incremental growth with good risk adjusted returns.

It is the pursuit of these opportunities that is driving the higher operating expenses I discussed on the prior slide. Payments volume is stabilizing and we expect it to return to single digit growth.

We have a strong capital position that enables us to both continue to invest in the business to drive growth as well as deliver a strong payout ratio in total yield. And finally our business model continues to generate very strong returns on equity.

Before I pass the call back to the operator there's one more piece of information I'd like to share with you. For the past four years Bill Franklin has done a great job at the helm of our Investor Relations function, but now it's time for him to take on new responsibilities.

Effective February 1st, Bill will be assuming the role as our Assistant Treasurer, responsible for funding and rating agency relationships. Stepping into Bill's shoes will be Tim Schmidt who's done a great job serving in that Assistant Treasurer role that Bill will be assuming.

Tim is well known among debt investors and I'm looking forward to introducing him to the equity community as the conference and road show season kicks off. That concludes our formal remarks, so now I'll turn the call back to the operator, Chantal, to open the line for the Q&A session..

[Operator Instructions] Your first question comes from the line of Ryan Nash with Goldman Sachs, your line is open..

I was wondering if you could give us a little more clarity on the expense guidance, Mark you made some reference to a potential for higher marketing. In your remarks, I know David had made some comments about investing in some technology.

Could you just kind of contextualize how much of the spending you’re doing is to drive new growth versus core infrastructure build? And how should we think about the ongoing core growth rate.

Is this an elevated year, just because of the fact where you said you’re going to be reinvesting in the NIM and we should see expense growth essentially comeback down?.

Ryan, I would say that absolutely the driver of the expense growth this year is the investments in continuing to drive stronger growth rates across the portfolio. If you think about it on a core basis, we really pull out the look back on a prior year and compare it norm-to-norm.

I would say core expense growth is somewhere in the order of 2.5% plus or minus. So it feels very well control from my perspective. The remainder of that expense growth is discretionary investment that is directly related to driving stronger production where we found opportunities to do just that.

A big chunk of it is very aggressive marketing, we can always adjust that, if our returns don’t come in as we expected them to on those investment dollars or if the environment were to turn on us. But we see great opportunities right now, building off of the strength in the fourth quarter and we feel really good about making that investment..

Got it. And then just on your comment regarding the 5.5% to 7.5% leverage. You talked about new opportunities for customers with good risk adjustment.

Could you maybe expand on that front, are you guys dipping down below the historical levels of which -- of where you played in the card business and how should we think about the longer term impact on charge offs related to that?.

No, I would say Ryan, I think about these things as really incremental where we’re seeing great opportunities. So for example, if you think about a secured card for example.

That's somewhere where you're going to have a lot of these customers no FICO or very low FICO, but because you’re holding collateral, the risk adjustments return on that doesn’t look radically different than our traditional portfolio. So that’s just one example.

We always look for opportunities where we can expand the box a little bit, but I would say this really reflects more a deepening of the existing strategy that it does expanding the box and really going significantly down market in any way..

Got it. And congrats to Bill on the new role..

Your next question comes from Sanjay Sakhrani with KBW. Your line is open. .

Thank you, congrats Bill. I guess my question is around the NIM outlook assumptions.

Mark could you just talk about how much of this last rate benefit you’re actually incorporating into this guidance of slightly higher and then the subsequent rating [ph] prices that may occur in the future?.

Sure. So last year, if you think about and we had a very similar situation, where we had it December rate increase. And in Q1 that resulted in about 10 basis points of an improvement in NIM. We actually saw 20 basis points of Q1 improvement last year about 50% of that was due to portfolio mix, the other 50% of it was due to the actual rate move.

I think it will be rational to assume that that same 10 basis points plus or minus flowing through from the rate move we saw in December is not out of the realm of rational -- wouldn’t be out of the realm for a rational person to assume, is kind of the way I think about it.

As we move on through the year, I think that kind of a cadence would hold, based on the current curve and the current expectations for promotional activity in the portfolio and the current expectations for interest charge offs.

Right, so if you think about it the factors that are really going to influence it going forward are going to be, what happens market reach? What happens to the mix in the portfolio, both with transactors as well as with promotional balances? And then obviously charge offs have accrued interest flow through NIM, so that’s a piece of that.

And then the other piece that probably kicks in at some point Sanjay and I don’t think I’m smart enough to tell you exactly what it happens, but at some point in time deposit data [ph] will come back into existence. You know these first few rate moves, we haven’t seen, we've seen essentially deposit data [ph] of essentially zero.

At some point in time that will creep in a little bit, but I feel really good about the NIM positioning through the year ahead..

And maybe just one follow-up to a question I was asked previously. I mean cap ones talked about how the competitive intensity, domestic card lending is probably the highest it’s been, yet you guys are accelerating your growth expectation.

Can you just talk about why are being, why you're are so successful?.

Well, I think if you look at our fourth quarter results, we fairly matched the increase in loan growth with increase in revenue growth.

And I think that that is as I mentioned in my comments pretty different than what we're seeing in some other places, it’s really easy to give away your product in terms of rewards to transactors that doesn’t produce revenue or the dipping down credit [ph] that just gets eaten up in charge-offs.

But that’s not our focus, our focus is on getting more our products into the hands of our prime revolvers and getting more usage in our portfolio. And so I mentioned that the greater number of new accounts last year was a big part of the increase in growth rate and that’s everything from the new features, the advertising, the digital marketing.

The new products like the secured card or expansion in student cards. And so as I think about this coming year, I think it will be more of the same. We are putting in more money, for more marketing, for more new accounts as an example..

Your next question comes from the line of John Pancari with Evercore. Your line is open..

On the expense front, I know just you had indicated that the higher expense expectation is driven by the higher revenue growth opportunities. So on that, can you just give us your thoughts around where you think the efficiency ratio could go over time and how you may be looking at it for 2017. I know we're coming off a level of about 40% for '16.

I mean do you think it remains around there, do you think you could actually see some improvement? Thanks..

Yeah, I think you’ll see some improvement as you head into 2017, my current though process is we wouldn’t get all the way to the 38% target given the level of investment we're talking about driving this year, but I do think you get to a 39% handle next year, based on where I see the crystal ball right now.

Don’t take that as guidance, throughout the year that will change and our expectations there and everything else. But I think it’s a reasonable expectation to have as we sit here at this point in time and we’ll obviously keep you posted as we go through the year.

The other think I’d really reinforce to support that is that, a big chunk of this increase in expenses is directly related to aggressive marketing dollars and if we don’t see the returns on that investment that we expect, or if the environment turns on us, we won’t hesitate to pull that back and that would obviously have a positive effect on the near term efficiency ratio..

Okay great and related to that, the increase in the rewards cost that you see through '17, I mean does that imply any abatement in the level of marketing spend, is that -- are you’re going to lean on the accelerator there as well? Thanks..

Well I would say that, if you look at this past year, we had a similar order of magnitude increase in rewards cost and that is part of what produced the higher growth rate that we achieved this past year. So I think what we're kind of anticipating is some continuation of that trend.

Some of it is just going to tend to happened as we get more of our customers converting in to Discover it, which has a higher average earn rate then our previous flagship product.

And part of it is the continuation of our very successful promotional double match program and the 5% program that we're continuing to aggressively market and it's still a very good headline rate in a very good value to consumers who take full advantage for that..

And even the rewards isn’t an expense, it shows up as a counter revenue. We kind view that and the expense side as flip side to the same coin. They're both really about driving customer awareness, customer engagement, so we kind view marketing and rewards investments as inner changeable to integrate [ph]..

Your next question comes from the line of David Ho with Deutsche Bank. Your line is open..

Just want to talk about were the growth may be coming from a vintage stand point. I know you've done a lot of new customer acquisition with Discover it, it's been very successful for you.

Just want to understand the mix of growth as it relates to that and kind of implications on some of the seasoning of that growth in your guidance for credit for 2017? Thanks. .

Yes, David if you think back a few years ago, when we were talking at conferences and on conference calls, we were talking about roughly 50% of loan growth coming from new accounts and roughly 50% coming of the legacy back book. Defining new accounts is on the books three years or less for this purpose.

I would say today that mix looks more like, let's call it 75:25, 70:30, something in that range, skewing for the new accounts. So new accounts are a greater portion of the loan growth at this point in time and that does have some effect on the provisioning guidance.

That said, I view it as thinking with an intermediate and a longer term mindset, a very positive thing, because in a lend-centric business model the way you compound the value of the business is to actually grow loans.

And I think the seasoning of loan growth that comes from new accounts is just a natural function of the business, the attraction of new customers into the franchise and natural funds for the business so.

And I think I tried a really emphasize -- I think I really tried to emphasize at the end of it in my comments, that what we see is growth driven provisioning. As we look ahead growth driven credit drivers as we look ahead in the coming year. And not something that reflects any type of [indiscernible] in that credit environment..

That’s helpful, and then switching gears a little bit, back to the 5% rewards categories.

It's been very successful, you guys started that category really and others have copied, but do you think the value prop could get diluted a bit by some of those categories like Amazon and department stores essentially having some of the private label players and co-brand players provide kind of ongoing rich rewards in those categories and some of those customers are rotating out of your 5% into those ongoing categories that they provide..

Well certainly we continue to evolve how exactly, what's in the various categories, how we market it and we're going to continue to keep this program fresh, it's changed a lot from when we originally launched it a number of years ago with the 5% program.

And I guess I would say that it feels to me like notwithstanding a few examples like you mentioned more of the competitors seem to be moving to just the flat 1.5% than anything else.

So you know there's a few outliers, a few 5% there's you know, in one or two cases there is the 2%, but mostly it seems like it’s the 1.5% and our 5% program works well there, and I think the proof is in the results.

If you -- certainly the competition got a lot tougher last quarter and yet we accelerated growth and so we're going to continue to have that kind of focus to you know thrive in this competitive environment which I think is here to stay..

And we very focused on an overall value proposition as opposed to competing on the basis of headline and rate, right. So it's also about ease of redemption, dollar threshold to redeem, we removed all those things. So it's not just about the what's the headliner and it's a thing, you actually use it, right.

Then we also have merchant funded rewards as a result to having our own network, that kind of sit in there where we drive some incremental value that's funded by the merchants, [indiscernible] our P&L. So we feel the bias is fully going to be upwards, hence our guidance that we gave.

But we feel really good about our ability to compete in that space without chasing headline or rates..

Your next question comes from the line of Eric Wasserstrom with Guggenheim Securities, your line is open..

Two quick questions please Mark, and I know historically you guys have pointed to about half your growth coming from new accounts and half your growth coming from incremental lending from existing accounts.

So I'm wondering with the investment and growth in new accounts that you've seen over the past recent periods, if that ratio has changed at all?.

Yes, it's running right now somewhere 75-25, 70-30 somewhere in that range. I don’t have the exact number at my fingertips, but it's in that general range and as we continue to invest in and drive growth we would expect it to continue to remix slightly toward the new account side of the equation as well..

Great, and then just one question to follow up on NIM, how should we think about the sustainable NIM with respect to the current forecasted Fed funds, et cetera.

I know that in the past you've pointed to a 9-ish, on a 9% handle, has that moved sustainably higher in your view?.

I would say the nature of the business model we did not move our long term targets on any of our longer term stuff in our call today, including that margin guidance. The real reason there is because I don’t think, we can lose sight of the fact, we are at cyclical business and as we go through cycles, we will see NIM look different than it does today.

That notwithstanding I would say absent a cycle, triggering it would be a long path from here to that 9% longer term guidance..

Your next question comes from the line of Chris Brendler with Stifel. Your line is open..

A question on the NIM guidance again. I noticed what looks a bit, but the cash advance volume was up significantly quarter-to-quarter. Just want to know how much of the reinvestment and marketing is going to be on seasonally rate market in the card business.

And then also, I guess, I would think that personal loan portfolio doesn’t really get the benefit of higher risks [ph]. And with the buildup [ph] there is that also a drag on the NIM going forward? Thanks..

I would say, you are correct in the assumption that you had some higher promo rates in the -- prime promo in the mix in the fourth quarter, but it’s really more balanced transferred than cash advance, is what you saw coming in there.

Than I would say we pulled back significantly on our balance transfer programs early in last year, it’s part of what pullback our growth rates, because we weren’t finding the right time engagement out of these programs.

I think we’ve cracked the code or at least we believe we’ve cracked the code at this point in time to be able to come back into market with a more robust balance transfer offering, but I would say balance transfers are far from the lynch pin associated with the growth strategy we’ve laid out, they're a component of it.

But really focusing on merchandise sales, building balances the old fashion way of customers engaging with the card and using products remains the core piece of the puzzle.

As a results to NIM, I would say the current level of promotional activity, that is contained in our plan and then we are moving forward with I would say is more robust than what we’ve had years past, but that’s fully contemplated in the NIM guidance that we gave in the earlier thoughts on this call that I provided in response to an earlier question about the trajectory.

So I continue to feel very good about the way are our NIM is positioned, to be able to support both our growth initiatives, as well as create further value to our shareholder..

And the personal loan book? Any impact there was meaningful enough?.

I think you faded again Chris..

I just wanted to -- cards are mostly -- I would assume that personal loans are not variable rates. So you don’t get [indiscernible] as a NIM. You’re also growing that portfolio; it looks like pretty aggressively.

Is that a rate based strategy or is there an easy in competitive environment, that caused the spike in growth, it sounds like there were some strategic changes and some breakthrough maybe that help as well.

But it sounds like [Multiple Speakers] relative to guidance, so that’s going to continue in ’17?.

Yes. We do intend to continue growing the personal loan book as well, I think that’s fair. It is a fixed rate book, but it is a very short duration book.

It's somewhere two-three year kind of horizon if you will and we intend to -- well we don’t match fund, loan-by-loan, we do think about our businesses holistically as we fund the balance sheet and I would encourage you to think of us as really kind of match funding. That personal loan book is the way we think about it.

So and given the short duration and the correct turn in that book it really doesn’t have a deleterious effect on NIM to any significant degree. So I would say that again is contemplated in the guidance that we’ve got out there. In terms of where the growth is coming from, no it’s not rate driven gain.

I would say it's coming from some product enhancements that David alluded to in his earlier comments and I would say, it’s also coming from the fact that we have increased the maximum loan size we're willing to do there modestly, the maximum loan size we are willing to do there modestly at the $35,000 that’s a modest driver as well.

But it’s really more the features and benefits and some of the product enhancement that’s been the driver there..

Your next question comes from the line of Bill Carcache with Nomura. Your line is open..

The 10% year-over-year decline that we saw this year in your marketing and business development expenses that certainly support that you guys have indeed been more judicious with your investment spending relative to some other who've been stepping on the gas on marketing spend and perhaps not been getting as much return on that spend.

But now as we look ahead at 2017 and think about now this increase that you guys are talking about in marketing investments that you have planned. How do you ensure that you’re getting an acceptable level of bang-for-your-buck on your spending? Maybe are there any principles underlying your investment spending that you could parse out for us.

And I’ll ask my second question because it’s related, maybe if you could share any data points on how the cost per account acquired at Discover is trending versus the rest of the industry that would be great..

Well, on the first part of the question, Mark I'll let you do the second part.

We are very judicious in terms of looking at what the expected marginal return is for every effort we do and whether it’s segments that we're targeting in direct marketing or decisions that we're making in promotional rate duration or rewards investments, where we evaluate those and we do a lot of test and control, we back test to see how things are working and we decide whether to modify or extend things or curtail them.

So I think that the -- the thing that I’m noticing, and I’m sure other people do, somewhat the same. I think what someone of the mistake that I think sometimes people make is more transactors than expected, the interest income doesn’t come through as expected and you've still got the expenses in terms of marketing or rewards cost.

And I -- what I -- speaking from a lot of experience I think that’s somewhat what I’m observing elsewhere, where they’re driving volume but not revenue..

And with respect to CPAs, what I would say is we’ve seen very, very modest increases in CPAs maybe 1.5%, 2% over the course of the last 12 months let's call it. We are very focused on CPA, we've deemphasized some of the aggregator channels, because we saw some real run there shall we say.

So I think in that basis, if you think about a card account when you’re booking it and the long term value that card account, think of it like a NPV [ph] stream and that CPA that you’re booking upfront, the value that -- the net present value of that card account is highly dependent upon what you paid to acquire it.

So we are laser focused on CPAs and actively finding ways to drive growth in fashions that doesn’t cause us to make crazy terminal value assumptions to make the NPV [ph] on these card account acquisitions work..

That’s excellent.

Can you give the color on how that’s trending versus the rest of the industry, because in particular given the comments that you guys made maybe there are some cases where the customer account could be elevated, but that retention of the customers isn’t there and so any color relative to the industry, that you can give?.

So I would say, we don’t disclose our CPAs, so I have to be really careful in terms of how I answer it.

What I would say is looking at Argus [ph] and certain other data providers, who try and triangulate on us and estimate, I would say, if you exclude sub-prime, where the CPAs are very low, because these are very active credit secrets, right? So exclude sub-prime for second, focus on prime borrowers.

The data that I've seen out there anecdotally would say other CPA's are considerably higher than our, but that is anecdotal and I would not encourage you to relay on that..

Your next question comes from the line of Mark DeVries with Barclays. Your line is open..

I was just hoping you could provide a little more color on what you mean by modestly higher in terms of total net charge-offs, should we expect something along the lines with the 30 bips year-over-year increases on the first quarter?.

So I gave a lot of thought to how to answer this question, because we figured it was coming. I guess what I would say Mark is, your bunny seems to have a pretty good nose. The way I was going to describe it was to say, well last year we describe we expected a slightly higher increase and it ended up being 15 basis points year-over-year.

And the way I was proposing to answer this question was to say well modestly higher, probably means slightly higher than slightly higher. So I would say, you're probably in the right relevant range. Somewhere in that neck of the woods is, based on everything we see right now, the right way to be thinking about it.

And may be just the tad higher than that. But on balance again, its driven by the seasoning of the growth and not by a deterioration in the fundamental environment for credit that we see out there. .

Your next question comes from the line of Moshe Orenbuch with Credit Suisse. Your line is open..

I guess David, in most of the industry is actually growing spending volume several percentage points; 2, 3 percentage points faster than balances and you've actually got the opposite.

So could you talk a little bit about actually how you're achieving that? Is that likely to continue over the next couple of years, how do you sort of think about that? And then I got a follow up..

We look at -- you would understand a lot more in the industry if you could really see what's going on with transactors versus revolvers by issuers, because if you could look our sales growth in our revolving base, the sales growth is actually very similar to the loan growth in our revolving base.

So what's happening is, there is some people out there with very rich rewards that are attracting transactors and that’s why, you're seeing it not cost us revenue and not build revenue, where that generally were proportional to the sales growth that they're achieving.

So it's a remixing and it's a purposeful strategy on our part to focus on profitable business..

Just a follow up, and when you look at those 5% categories. I think there are some people particularly, our side of the world here, who think of that as an area in which card holders tend to gains that or would focus their spending in those categories.

So you're saying that you don’t actually see that? That isn’t like a source of, kind of excessive transactor activity?.

I would say that, we have had a 5% program for a number of years and have good experiences with it. I think we would find it problematic to give 5% on everything without restrictions because the economics just would not work.

And so we have been -- we have used it to help engage our customers to give rewards in rotating categories that has helped to encourage our customers to use their Discover card across many categories versus just being concentrated in one or versus just gaining it as you're saying.

But I think that -- look I mean we started -- we were the first rewards card there was back 30 years ago and so I'd say we have the most experience of anyone in the industry, we've seen people introduce things then have to pull them.

You know the original 5% program was actually, if you go back to the General Motors program which isn't around anymore and so you've seen some things that worked for a while in terms of volume, but didn't work from a profitability perspective and then they were curtailed.

You haven't seen that from us, you've seen us be able to maintain a viable program even with the higher rewards cost that we've been talking about last year, we grew earnings a lot and so we’re not -- we're balancing a great value for consumers and profitability.

The final thing I would say is you need to be careful, as Mark mentioned earlier, not to get hung up with just rewards.

It is more than just the rewards, it's great service, it's other features, it's how you work with credit and make sure you're going to people that don't get over extended, there is a bunch of pieces here and rewards is an important, but just one piece of the puzzle..

Thanks very much and congrats Bill..

Your next question comes from Don Vendetti with Citigroup, your line is open..

Yes, Mark, I was wondering if you talk a little bit about how you're thinking about capital return this year going into CCAR. I think you had made some comments about the debt rating agencies or debt markets being a binding constraint or the new binding constraint.

It seems like investors are a little cautiously optimistic that if you get higher payout ratios, can you just talk a little bit about that?.

Yes, I think you know, last year again we had one of the highest total payouts and I think the highest effective yield amongst the CCAR participants, so we feel very good about the fact that we've been prudent stewards and are driving responsible loan growth and also trying to return excess capital that we don't need as effectively as we can, we have taken up our payout request to the CCAR process every year we've participated in it so far.

I think it would be reasonable for one to expect we would not want to break that trend. So I think you should look for us to get more aggressive again this year.

We take with great happiness some comments that Governor Tarullo has made over the course of the last several quarters, where he's really talked about differentiating between the GSFVs [ph] and the -- what I'd call the mid-tier CCAR participant in terms of the expectations there and some thoughts around the qualitative process.

So I feel really good about what we've done in the past and I think you know we would look to get progressively more aggressive this year as well consistent with prior years..

Your next question comes from the line of John Hesh with Jefferies, your line is open..

Evening, thanks very much guys and congratulations Bill. Question, is the ending payout of rewards 127 is pretty consistent with the overall guide for this year.

So I’m wondering number one, do you think at least in terms of incremental changes, the worse is behind you with respect to rewards expansion [ph] or is there some season and I'll admit, we need to think about with respect to the guide?.

There is definitely a seasonal element associated with it. I would say, a big piece of it is what is going on with our 5% rotating categories and what we choose to include in this category. So we choose to include warehouse clubs for example in our fourth quarter program that haven’t historically been in there in the fourth quarter, in the past.

So we will make decisions around engaging, the customer to drive the kind of behaviors that build the loan volume that kind of drives the profitability in the long run. So that piece of the puzzle definitely flows through, so you will see variability based on that.

The other big drivers really are going to be, obviously, the cash back mash program that we’ve got running on new accounts is a piece that I would say that would be really more consistent -- be more consistent with the growth in new accounts, really just as we have every month another vintage that laps one year in the process and another vintage that's larger than the one that's leaving coming on, because thus far every year the vintage of new accounts has been larger than the ones that preceded it.

And then the last driver is really going to be our legacy more card product, when we launched Discover it, all the new account acquisition since that point in time have come on it. So you also have a natural migration in the portfolio.

A greater portion being it cards as opposed to more cards and they have a slightly more lucrative reward proposition associated with them. So those were really the drivers.

I'd echo David’s comment, the increase in a full year basis this year is about right in line with the increase on a full year basis last year, significantly below the headline earn rates that you're seeing out of others and we like that, we’re choosing to compete on our terms..

Okay. And then second question. Mark, I think you’ve referred to kind of long-term loss rates in the 3% to 4% range in the credit card portfolio. And we’re talking about moving -- it seems like you're moving towards 2.3% to 2.5% or some modest increase from last, this year.

Do you think long-term rates, loss rates have changed because of certain factors in the business or it's just going to take a long time to get to the long-term range based on a benign credit environment?.

Well, I think that we specifically didn’t update our long-term guidance and I think this has been a struggle for a while, because there were definitely some factors the changed after the card act, after the consolidation, after a number of structural changes in the industry. And we kind of gradually took down that long-term expectation.

Frankly, until we see a couple of cycles, we’re not going to really know, and so we’re hesitant to say what well the next cycle brings. But we are seeing this normalization that we’ve been talking about for a while. It is slow and we continue to characterize it as a benign credit environment.

And I think as long as unemployment rates stay very low and housing prices improve and the economy does well, you’re going to continue to see below whatever that new peak is.

There will be another turn and when it turns, then we’ll see what loss is go to in the industry, I don’t think it will be the previous weeks at all, but you almost have to see it to -- for anyone to really know how it’s going to behave..

Okay. I appreciate your perspective. Thanks..

Your next question comes from the line of Betsy Grasek with Morgan Stanley. Your line is open..

Hey, couple of follow-ups. One is on you touch about the payout ratios, capital distribution. Could you remind us of what the capital ratios that you think that you could operate at if you didn’t have the CCAR telling you what you needed to do.

I thought it was in the 10% range, but maybe remind us of that and is that something as a goal you think over hit over the medium term.

And the second question was just around mix between dividend and buyback and does your SKU change at all given how the stocks performed recently?.

Sure, so I will say with respected to target capital ratios, historically you are correct in that the binding constraint has been CCAR and that was on the order of a 11% Tier 1 comment [ph]. I would say an economic capital analysis would show you, we need something more on the order of nine -- let's call it 9.5% Tier 1 comment.

I think the ultimate binding constraint probably lies somewhere between those two experience, Betsy. And I don’t have a sniper rifle estimate for you today. But I do think it is really rating agency and debt investor driven. In terms of where that settles out.

I think somewhere ultimately with some kind of a 10-ish doesn’t feel altogether, maybe somewhere around 10, doesn’t feel altogether wrong. But it’s premature for us to really kind of revise guidance or kind of put that out there, but I kind of say that’s the way they generally think about it.

And obviously, we’ll be working with rating agencies as our crack investor relations executive moves over to tackle that challenge, try and move their perspective on us as well over time.

The other piece of the puzzle I would say with respect to the mix between buybacks and dividends I would say we run a pretty rigid analysis of our buyback program on monthly and on a quarterly basis really building on an efficient frontier and making sure the returns in those buybacks look solid.

I think given where we are right now we continue to feel good about a healthy buyback program. That said, we have said we do want to be a dividend achiever over time.

So I think you would expect to see us to the extent the economics allow for it, we would look to consistently increase that dividend on an annual cadence, again to the extent the economics allow for it..

Your next question comes from the line of Bob Napoli with William Blair. Your line is open..

Thank you, good evening and congratulations Bill.

On the regulatory cost, I was wondering if you could give us some feel for what -- how much of regulatory cost have been decreased from pre-recession levels and how much they could decline if you were to remove from regulatory costs, those costs that you view as probably not being beneficial -- incrementally beneficial to the regulatory side or to Discover?.

I would -- I think we're not prepared to give any kind of specific guidance on this. I would just say, I would characterize it as I feel like a lot of the build has occurred whether it's [indiscernible] specifically or regulatory CCAR, whatever.

It feels like this year is going to be a little more analyzation of some of those expenses as we continue to ramp up very quickly this past year. But I would caution on thinking that it is going to go back to anything close to what it was pre-down turn, at least for us and I think for anyone.

And frankly, I believe that some of it is going to be a big payoff for us. Because if we can have better quality controls to put in projects right the first time, to have things work more perfectly for customers every single time, to have better, more scientific understanding of our capital and what's important and what are the different scenarios.

It's a lot -- we've become much more sophisticated then that we used to be and I think there are -- we focus on the cost and yes, you have to do it because you have to do it. But I think that, what we need to do is pursue efficiencies, but also pursue the -- even more importantly pursue the benefits that come from better controlled process.

In much the same way, it's almost like, think about six sigmas [ph] in manufacturing. There is benefit that can come from this and we need to focus on that. .

Okay thank you, and just on your student lending business. Obviously, any thoughts on your discussions with your contacts in Washington DC on the potential dramatic expansion of the TAM available to you in that market or the potential for that to happen.

I mean you've seen obviously the student loans stocks go through the roof and continue to do so, and some of your competitors and you guys would obviously be a beneficiary if those stock moves are indicative of the opportunity to come?.

So to be clear you're talking about the student loan business, the addressable market?.

That’s right..

Well I would say that, if there is more room, I mean the private student loan market has become pretty small and I think that’s one reason that number of people exited from it and why there is only a couple of people left in it. And I think to the extent that, that there was a greater role for private lending.

I think we would be very well positioned and I think the fact that, I think it’s the round 6% or something of the total market and new loans are private and the other 94% or so are federal. And so it wouldn't take much in the way of federal backing of, to have a dramatically percent increase on the private origination side.

And it is a very specialized business, from a credit prospective it's unique, from an operational prospective it's unique, because its distributed through schools with tight controls for it being used for educational expenses. There is a lot of regulations specific to it.

And so I think it would be hard -- I think that we would feel really well positioned to take advantage of any possible increase in that market. Which I wouldn’t expect this year but may be in subsequent years.

I guess the final thing I would say is we've been investing a lot in the infrastructure, we’re converting to a new system a little later this year in that business, which I think would be very scalable and flexible to be able to take advantage of whatever opportunities may come in future years..

Thanks. Just a quick follow-up, this wasn’t clear to me.

Do you think rewards competition; do you see signs of it peaking or do you think it’s another -- there is another step-up from there? I mean obviously Sapphire cut their rewards pretty dramatically on the origination, on the new account side?.

I am seeing, for every sign of someone cutting back, I’m seeing something else that goes the other direction. I would just say some of these programs, whether you’re paying out a flat 2%, which uses all the interchange or you’re paying out a flat 5%, which uses over double what your income coming in is.

Some of these programs just don’t seem to make a lot of sense in the long-term to me. So I think the economics are going to causes this to be a peak maybe we're around peak now. I just, I feel like it’s already gone kind of further than I would think that the economics really support, for some of these programs.

But I think it’s going to be a while before people cut back and part of it, as rates go up and cost of float for transactors become non-zero and as people see that what the actual mix coming in, in transactors versus revolvers and what’s canalization of their own portfolios versus really new, people will than start to adjust and probably cut back some other programs to more reasonable levels..

Thank you. I appreciate it..

Your last question comes from the line of David Scharf with JMP Securities. Your line is open. .

Yes. Good afternoon and thanks for squeezing me in. If I heard correctly, it sounded like your NIM guidance is factoring in the expectation of more rate hikes later in the year. I’m just wondering switching to the regulatory side and as we think about your loss rate forecast.

Are you building in any expectations of using regulatory -- using in the collections front and how should we think about some of the developments there?.

The simply answer to that question is, no. We’re not building in any expectations there at all. And I think we tend to be a pretty conservative straight shooting bunch. And at the end of the day, I wouldn’t know how to create those expectations that I would feel comfortable laying into a loss forecast.

And I think as we get more clarity on some of the proposals that are out there in terms of regulatory reform and everything else, we’ll obviously be reviewing them and looking at them and trying to process where they all outcome together.

But I think we need decisively more clarity on where all those things end up before we can rely on them, let's put it that way..

Got it. And along those lines from a strict operational standpoint, one of the likely areas of change we seem to be hearing more or more about is with the new SEC nominee, is that the PCPA [ph] may reverse its ban on auto-dialing, predictive dialers, any automated technology for reaching cell phones.

I know some of the debt buyers and collection agencies tell us that that represents a much greater C-change the collection productivity than anything the CFPB [ph] has been weighing on them. Since all of -- you don’t sell any charge-offs, so since you’re operating, I assume all of your collection activities in-house.

If you were to -- if the SEC were to allow the use of auto-dialers and other automated technology for reaching cell phones, is that something that can be implemented rather quickly or is that more along the lines of, let’s say a year loan project?.

No. I think that could be implemented fairly quickly and easily. It would -- in fact we’ve had to spend a lot of money and go to a lot of trouble to restrict the normal operation of these things. And so it’s a lot easier to tale that out.

And I would say that one of the things we’ve been doing is moving very heavily to digital collections and so that’s less impacted by some of this. But it is definitely hard as so many people are using their cell phones as their primary phone.

They don’t have landlines anymore and the fact that we are required to have consent and then the fact that we've had to turn off our auto-dialers has introduced inefficiencies, which is driving up our expenses and it’s also frankly caused some of our customers to not be able to get into payment programs that we may offer or the assistance we can provide to them, help them get back on their feet.

So I think it would be a great thing for consumers, if we were able to reach them to help them stay current or get current, and it would be a great think for our operating cost and our collection results. So that would be a positive..

Got it. Thanks very much..

All right. That concludes our call. We’d like to thank everyone for joining us. And I’ve enjoyed working with all of you. If you have any follow-up questions, feel free to call the Investor Relations Department. Have a good night. .

And this concludes today’s conference call. You may now disconnect..