Tim Schmidt - Discover Financial Services David W. Nelms - Discover Financial Services R. Mark Graf - Discover Financial Services.

Sanjay Sakhrani - Keefe, Bruyette & Woods, Inc. Donald Fandetti - Citigroup Global Markets, Inc. Christopher Roy Donat - Sandler O'Neill & Partners LP Ryan M. Nash - Goldman Sachs & Co. Eric Wasserstrom - Guggenheim Securities LLC John Hecht - Jefferies LLC Elizabeth Lynn Graseck - Morgan Stanley & Co. LLC Robert Paul Napoli - William Blair & Co.

LLC David M. Scharf - JMP Securities LLC Mark C. DeVries - Barclays Capital, Inc. Moshe Ari Orenbuch - Credit Suisse Securities (USA) LLC Henry J. Coffey - Wedbush Securities, Inc. Jason E. Harbes - Wells Fargo Securities LLC Bill Carcache - Nomura Instinet.

Good afternoon. My name is Chantelle and I will be your conference operator today. At this time, I would like to welcome everyone to the Discover Financial Services First Quarter 2017 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.

Tim Schmidt, VP of Investor Relations, you may begin your conference..

Thank you, Chantelle, and a sincere thanks to everyone on the call for joining us today. I'll begin on slide 2 of our earnings presentation, which you can find in the Financials section of our Investor Relations website, investorrelations.discover.com.

Our discussion today contains certain forward-looking statements 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-Qs which are on our website and on file with the SEC.

In the first quarter 2017 earnings materials, we have provided information that compares and reconciles the company's non-GAAP financial measures with GAAP financial information, and we explain why these measures 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 session, please limit yourself to one question, so we can accommodate as many participants as possible. Now, it's my pleasure to turn the call over to David, who will begin his comments on page 3 of the presentation..

Thanks, Tim, and thanks to our listeners for participating on today's call. For the first quarter, we reported earnings per share of $1.43, up 6% from the prior year, and we delivered a 20% return on equity.

Before I ask Mark to review the financial results in more detail, I'll begin with some comments on our vision and key focus areas and strategic objectives. In 2017, we're celebrating Discover's first decade as a public company.

Throughout those 10 years, we've made great progress towards realizing our vision to be the leading direct bank and payments partner. This vision guides the choices we make and the strategies we employ to achieve our ultimate goal of creating long-term shareholder value.

I mentioned some of our key focus areas and strategies for 2017 on our Q4 earnings call, and you can see them outlined on page 3 of our earnings presentation.

We've organized our strategies around two key focus areas, achieving a strong rate of profitable, disciplined asset growth in the near-term, while investing in capabilities that will create a firm foundation for future growth.

Growth is an underlying theme in both of these focus areas because profitable, sustainable asset growth is essential to create long-term shareholder value in our lend-centric business model.

We have recently returned to faster growth because we deliberately slowed loan growth for much of 2015 and part of 2016, when for instance we curtailed our use of aggregator sites as the cost to acquire new card accounts in that channel grow significantly.

In response, we developed and implemented several initiatives to return to the higher and more profitable asset growth you see today. These initiatives have spurred new account originations that are responsible for most of our recent credit card receivables growth.

I would also note that we have established a long-term track record of managing our credit risk in a disciplined fashion. With our focus on consumer lending, asset quality has a large and direct impact on our bottom line. That's one reason why prudent risk management underlies all we do.

In managing credit risk, we stay keenly attuned to changes in the credit cycle. While credit fundamentals remain favorable and the lending market has been expanding, we have been making more loans. We continue to focus on attracting prime borrowers and achieving strong risk-adjusted returns.

With that context, let's examine our recent progress in achieving the strategic objectives in these two key focus areas. As cited in the highlights on page 4, we made substantial progress in the first quarter. In the focus area of profitable, disciplined growth, we produced strong loan growth momentum across all of our primary lending products.

We achieved this asset growth without sacrificing revenue growth. As I noted earlier, we reported a 20% ROE, while growing revenue 5% from a year ago. We demonstrated growth in our payments business as well. Of note, PULSE volume returned to year-over-year growth in the first quarter and is well-positioned for further gains during the rest of 2017.

We also delivered on our second focus area by investing wisely for the future. For instance, we continued to invest in our Cashback Match program, which is approaching its second anniversary. This program has proven a worthy investment by generating sustained customer engagement beyond the promotion period.

Customers acquired through this program recognize the benefits enjoyed by all Discover it cardholders including an award-winning, all domestic customer service, innovative security features, pre-FICO scores, no annual fee and a competitive rewards structure.

We also remained productively engaged with our deposit customers, many of whom have another Discover relationship as well. We achieved strong annual balance growth while holding deposit rates steady. Finally, to see future growth, we continue to enhance our operating capabilities and manage our risks prudently.

Enhanced operating capabilities support features and benefits that serve our customers better, which in turn fosters growth through customer loyalty.

I'm particularly pleased that the Brand Keys Customer Loyalty Engagement Index ranks Discover card first in our industry for the 21st consecutive year, a feat unmatched by any of the 740 brands measured in their respective categories.

With respect to risk management, we remain good stewards of our shareholder capital and submitted our most recent CCAR capital plan to our regulators on April 5. Given our strong earnings and capital position, we expect to remain among the industry leaders in total payout ratio and shareholder yield.

In summary, I'm pleased with the achievements to date in our 2017 focus areas and our profitable and disciplined approach to generate long-term value for our shareholders. I'll now ask Mark to discuss our first quarter results in more detail..

organic growth, dividends and share repurchases, asset acquisitions and M&A, in that order. To sum it all up on slide 12, we're very pleased with our operating results, anchored by revenue growth of 5%, a double-digit margin and healthy 20% ROE. In addition, expenses remain well managed as evidenced by a 38% efficiency ratio.

Our balance sheet remains strong as total loans expanded 8% with significant contributions from all three of our primary lending products. We continue to fund these loans with an increasing share of consumer deposits while realizing the benefits of relatively low betas.

Credit fundamentals remain favorable relative to historic standards with provisions primarily driven by the seasoning of loan growth. And finally, we continue to benefit from a strong capital position that enables us to simultaneously invest in profitable asset growth while delivering a high payout ratio and total yield to our shareholders.

That concludes today's formal remarks. So, now I'll turn the call back to our operator, Chantelle, to open the line for Q&A..

Your first question comes from the line of Sanjay Sakhrani with KBW. Your line is open..

Thanks. Good evening. Appreciate the comments on the NIM, but I was just trying to get a little more clarity. Mark, you've talked about historically at least seeing some benefit from rate rises.

As we look towards future rate rises and one that happened later in the quarter, should we assume that that will benefit the aggregate NIM?.

Yes. So, I think there were a couple of things that saw the aggregate NIM not get a benefit this most recent quarter, Sanjay, and maybe that's a good starting place that'll let me talk to the quarter ahead as well a little bit. So, if you talk about just the benefit of the moving rate, we saw about 15 basis points of goodness to NIM.

The takeaways from that really were about a 5-basis point negative based on asset mix, promotional balances, transactors reengaging in the portfolio, and we also had a higher percentage of student loans that drive great risk-adjusted returns, but they don't have the highest yields associated with them.

So, in combination, that took about 5 basis points away. Another 5 basis points came off due to the increased charge-offs of accrued interest. Then you saw about 3 basis points come off based purely on funding volume. We did overfund a little bit for the quarter.

We were pre-funding for a potential portfolio acquisition we were looking at, that didn't come to fruition. So, we're lugging around a little bit of extra 10-year money that we'll grow into here. That was a piece of it. And then there was about 2 basis points as well that was really just netting of a whole bunch of positives and negatives.

So on balance, that's kind of how you ended up flat on a fourth quarter to first quarter basis. We'll still have some of the impact of that overfunding as we head into the second quarter a little bit, but on balance I feel really good about our margin guidance of slightly higher on a full year basis.

And we do indeed remain positioned to be asset sensitive..

Thank you..

Your next question comes from Don Fandetti with Citigroup. Your line is open..

Yes.

Mark, can you clarify what your card charge-off guidance is for 2017? I think you've been thinking 30 basis points to 35 basis points, and I could be wrong, but it looked like Q1 might have trended a little higher than what you were thinking and just can you talk a little bit about that?.

Yes. I think what we've said is – we didn't clarify card. We gave total charge-off guidance, said it was on the order of 35 basis points year-over-year, something like that. And I think it's really being driven by two different things, Don. It's being driven both by a growth component and I'll call it a normalization component.

The growth piece of the puzzle I would say every year since the crisis, we've had advantage of new accounts that's been larger than the one that preceded it and as you know well, new accounts season at loss rates they're above portfolio loss rates and that's part of the phenomena.

We also have engaged in some growth stimulating activities over the last couple of years in the legacy back book. We have some seasoning of some new line availability there as well. And then the normalization piece of the puzzle that I would say is really more just eight years or nine years post the crisis.

Folks have had the ability to encounter life events or get over leverage or whatever the case might be. So, as we've been saying, card books don't operate with low 2% charge-off handles on a normalized basis. I think we're just seeing some degree of that normal normalization creep into the book, but it doesn't feel like a cyclical turn.

All the macro factors continue to feel really strong and that normalization relatively modest. In terms of the first quarter move there, I would say – I think it was pretty well in line with the guidance that we gave on our fourth quarter call.

We said that it was going to look more and the first quarter would be lumpy and that we expected the increase in charge-offs to look a little bit more like the increase from third quarter into fourth quarter than what we were guiding for, for the full year.

So as I sit here right now, I don't see any reason to revise the thoughts we provided around the charge-offs on a full year basis. That 35 or so basis points directionally is correct. It could be a smidge higher or a whisker lower, but in that general ballpark is the way to think about it..

Got it.

And just to clarify, the potential portfolio acquisition, can you talk about which product that was in? Was it personal loans, cards and is that a source of potential loan growth going forward?.

No. I'd prefer to stay silent on that one, Don. I guess the one thing I would say is given we funded it with 10-year money, it probably wasn't cards, but I'll leave it at that..

Okay. Thank you..

Yes..

Your next question comes from the line of Christopher Donat with Sandler O'Neill. Your line is now open..

Great. Thanks for taking my question. Just wanted to ask one thing related to the net charge-offs. As we look at the data and look at your roll rates in card from 90-day delinquencies into net charge-offs, seems like that roll rate is increasing.

And then when we look at the data from your securitization which I know is a well-seasoned piece of business, but it looks like recoveries are coming down a bit.

We've talked in the past before about this, Mark, but we finally worked through some of the recoveries related to the financial crisis, but are we not yet picking up recoveries from some of your recent loan growth?.

Yes. So I would say on the latter point, most of the charge-offs that were generated during the crisis have now passed the statute of limitations. So while we don't stop trying to collect at that point in time, the collection percentage does indeed decline.

So I think, Chris, yes, you definitely are seeing and candidly that was the gift that kept on giving for an awful lot longer than it normally does, and to normally post a peak in charge-offs, you really have strong recoveries for 24 months to 36 months. This time we got them for bloody well close seven years.

So, it was definitely the gift that kept on giving. As far as the rolls are concerned, what I'd really point you to is if you look at the trends and delinquencies in the earlier stage buckets, all continue to be really favorable.

And that's really more I think the indicator of what's coming at you to be looking at and thinking about in terms of how we came up with our thoughts on our guidance on a full year basis. But in terms of just general loss development, it feels again, as I said earlier, like our earlier guidance from the last quarter's call.

For the full year, it still feels like it's in the relevant range..

Okay. And then just kind of curious – just a question on marketing, when I look back a year ago, you had a pretty low number and there was some talk about the timing of it.

I don't think $168 million should be a run rate for marketing but, I mean, we should expect typical seasonal increases in that number, right? It's not that you're not taking the foot off the accelerator on marketing, are you?.

No. I would say that we were growing a bit faster as you can see.

We're very pleased with the results of the marketing dollars and I would guide you to look at the rewards line and we do kind of think about, especially when we're thinking about promotional amounts, about where we get the best investments in marketing dollars directly, or in Cashback Bonus which attracts more customers more cost-effectively.

And you can see there, we have increased our investment, and we do expect to spend more in marketing this year than we did last year..

Okay. Got it. Thanks very much, David..

Your next question comes from the line of Ryan Nash with Goldman Sachs. Your line is now open..

Hey. Good evening, guys. Mark, maybe I can start off with expenses, so obviously they came in a lot lower than I think the Street had been looking for. David just referred to marketing expenses will obviously be up from this quarter and year-over-year.

But do you still feel the $3.8 billion of expenses is the right number in terms of what you'll spend for 2017?.

Yes, I mean, I guess, Ryan, as I sit here right now, still feel good about the $3.8 billion. We definitely have leverage over that number, and if we see other things working against us that we feel a need to pull at, we can pull at those.

And we've said all along, you've heard my three-engine aircraft analogy or the market's heard my three-engine aircraft analogy many times, and we can pull back on those throttles accordingly.

There is a lag between spend and results, right? So, a lot of the growth you're seeing this quarter, yes, a lot of it's rewards, but a lot of it is also marketing dollars that were invested last year, that really kind of produced the loan growth you see on, on to this quarter.

So I think there will be some seasonally adjusted marketing spend as we go through the year, but we will be very mindful on that expense line..

Got it. And maybe if I could ask one for David, many of us just got off another call where the outlook for loan growth is lower amid increasing consumer indebtedness, higher competition.

So maybe just in both card and personal, can you just talk about the decision to accelerate growth where you're actually seeing good opportunities for growth, and do you think that you could actually sustain these type of growth rates in both card and personal?.

Yes, well, if I start with card, we were growing two years ago, three years ago, four years ago, when the market was actually shrinking. And to some degree, it's a whole lot easier to grow when the market's growing than when it's purely share gain because the market is shrinking. So in some ways, the environment is better.

Now it is clearly more competitive and you're seeing us, particularly in the rewards space, invest more in rewards in order to remain competitive, and that's paying off in these results.

I did mention to you that in my prepared remarks, that a year ago we were pulling back from some areas where we weren't as comfortable with the returns, specifically some of the aggregator sites that had become very popular with some of our competitors, and that cost us a bit of growth last year, it gives us a little bit better comp for this year's growth, so that's also a piece of it.

But, generally, we see great opportunities in the prime credit card market, and I'm not sure, the fact that we're not a subprime player, in my observation, is that market has gone through a lot more gyrations, and so people that are exposed to that may have bigger swings than we have. But in the prime space, we're pleased with the opportunities.

More broadly, in the other products, you can see personal loans continues to grow very nicely, and when there's more loans outstanding, there's more loans to consolidate, and that is heavily a consolidation product, and so we're seeing strong opportunities there.

I would expect that as variable interest, variable priced interest rate credit cards reprice upwards, that opportunity may continue as we consolidate in. And of course, tuition continues to increase in schools, and so we continue to find good opportunities to grow in our private student loan program.

So I would say, all in all, while it's more competitive than it was, there's more opportunities than there were..

And I would just pile on to that quickly with just one little comment, and David noted that we did pull back on growth last year or the year before, when we saw that we weren't meeting our return thresholds. We wouldn't hesitate to do that again, just to be clear. I mean, right now we are getting good solid growth.

If anything, we've tightened credit recently, and we're still getting this really good solid growth. I think that's a key point, and I would also point out that as long as that's the case and we can make rational assumptions and drive good credit, loan growth is the key to compounding shareholder value in that lend-centric business model.

So we really feel good about the growth we're putting up right now..

Thank you, both, for the in-depth answer..

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

Yes, thanks very much. Mark, just on the rewards cost, typically there's a decent amount of seasonality in that, and yet this first quarter comes in more or less in line with the full year guidance.

So is this a change in the marketplace? Or is there something else occurring relative to the historical pattern?.

No. I think a big piece of it, Eric, really is the cadence on the rewards stuff, unlike a lot of the seasonality in the industry, is really under our control, right? So we can choose what programs we want to run for the 5% program in any given quarter.

It's really the management set rate for lack of a better term as opposed to cyclical or seasonal factors that affect it. So really it was a conscious decision more than anything else..

So does that suggest that at this moment your outlook is for more or less a sustained level of rewards expense?.

Yes. I would speak specifically because there will be peaks and valleys. So I'd speak specifically to the full year guidance of 1.26% to 1.28%. Still feel good about that guidance as we sit here right now..

Okay. Thanks very much..

You bet..

Your next question comes from the line of John Hecht with Jefferies. Your line is open..

Afternoon. Thanks very much.

Mark, you talked about how the rewards expense payout was consistent with guidance, but looking at historical patterns, it looks like your rewards in Q1 is seasonally a little lower than the other quarters, so I'm wondering is the seasonality changing? Or are we just keeping our eyes open to what might come of the rewards expense ratio?.

No. Again, I would say it's really a management set rate. It's not really a seasonal rate, historically. Like last year, sometimes gas is in there, sometimes gas isn't. So I feel good about the full year guidance of 1.26% to 1.28%, and the first quarter was really again just conscious decisioning..

Okay.

And then all else equal on credit, with an even economic backdrop, unemployment and wage expansion and borrowing the rates where we are, would you think that 2017 represents kind of the normalization year? Or would you expect loss rates to accumulate into 2018 before they flatten out?.

It's David. I think that we're likely to see them continue to rise a bit, at least into 2018. I don't see anything dramatic as long as – as you point out, the economic environment is actually quite good.

So with 4.5% unemployment and rising house prices, I think the normalization you're talking about is the driver as opposed to the beginning of a new cycle, but at some point, unemployment will start to rise and then that will start to impact as well.

So we're really going to have to see another cycle before we know what the new normal is, and I would say for us below 3% charge-off rates continues to be well under our long-term business model.

But I would also say that we think the long-term new normal is way below what it historically was before all the structural changes that happened with CARD Act and the consolidation and so on in the industry. So maybe a little bit of a long answer, but we're not providing guidance yet.

But I would expect 2018 to be somewhat higher than 2017 as I sit here today..

Very helpful. Thanks, guys..

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

Couple of follow-ups. Just one on the, what keeps you up at night kind of question.

It sounds like things are going really well and you are still investing in growth and just want to understand, is there anything out there that keeps you up at night and slows down the growth at all?.

No. I sleep very well. Thank you. But I would say over my career, I mean credit is probably the single most important thing that I think we have to be diligent on. And that has served us well and will continue to be the thing that we probably focus on the most. And I'd say secondly, being diligent on pricing, rewards, sustainable rewards structures.

One thing about credit cards is that – I mean our average credit card customer's been with us for 12 years, and so you really lock in a long-term relationship when you approve someone. And so it's important to take the long-term and not to get carried away by short-term fluctuations in the market.

And we took a little criticism a year ago when we slowed down and others were starting to speed up, and I think it's paying off with us as we continue to grow our EPS and others are struggling to do so and as we continue to have a 20% ROE. So I would say focusing on the basics.

I mean some people might point to technology changing or the competitive set changing. But I think people, when I observe what's gotten people into trouble over time, it's when they lose track of the basics of credit extension and pricing..

Okay. Thanks.

And then just a follow-up on balance transfers, did I hear you correctly in saying that, that impacted NIM in part this quarter?.

Promotional activity broadly did impact NIM a little bit this quarter, Betsy. So it was about 5 basis points was due to mix, was a detractor from NIM, and that was really three main components. It was partially – we saw transactors reemerge in the book to a larger degree than we expected.

We did see some higher promotional activity with our double Cashback Match as well as some BTs. And then student loans picked up a little bit as a percentage of the overall book, and they're simply lower yielding. You make up for it on a loss rate, but it does have a modest negative effect on them..

And the improvement that you saw in spend year-on-year, that's a function – I mean that's also an output.

Is that correct?.

Yes. The spend is really a function, I mean it was standard merch balances that drove the increase in spend. So it was regular way utilization of the card that we feel really good about..

Okay. Thank you..

You bet..

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

Thank you. The efficiency ratio continues to be very good.

As we look out over the next few years, is there still operating leverage left in this business? Can you drive that efficiency ratio lower over time? And if so, what's a reasonable way to think about that over the next few years?.

Bob, I think our business model's kind of established at that 38% efficiency ratio target that we came in just below this quarter.

And when you combine that with that other thought process that I shared earlier about the key to compounding shareholder value in a lend-centric business model is continuing to drive the right kind of quality loan growth over time. I'd be concerned about peeling back on muscle.

And it's one thing to cut fat, start thinking about cutting muscle, you have other effects on the business. So we will always look for opportunities to be more efficient. We will always look for opportunities to find ways to protect the customer experience while doing more with less.

But ultimately, I wouldn't propose to revise that 38% longer-term guidance that's there. That being said, that's kind of a separate question in one respect from the expense leverage because obviously, if credit does turn meaningfully against you, you have some giant geopolitical event, whatever the case might be.

You clearly do have expense leverage in the model that you could act and react accordingly and appropriately..

Thank you. That's helpful. And then on the payments businesses, you did have some acceleration this quarter, and I think you lapped, got easier comps as well. Any thoughts on the ability to try to accelerate that business further? I still think it's well below where you'd like to see it on a longer-term basis.

I mean the Diners Club had some pretty impressive acceleration..

Well, we do think there's opportunity to accelerate it past this. I'm really pleased that we returned to growth after a couple of difficult years mainly from the loss of one business from one very large customer. We don't have that kind of concentration anymore.

And PULSE had a long-term – for many years after we bought PULSE, it outgrew the industry and the last couple of years have been very difficult as we lost some share and so we're taking all the steps we can to try to regain share.

It's very tough when we got to deal with some of the things that a few competitors are doing, which are really hard to compete against without that level playing field, but I'm pleased that we're at least – that we're growing and looking to accelerate from here..

Okay. The tax rate for this year, is it – the 35% tax rate in the first quarter, is that what you'd expect for the full year or....

No. We had a couple of settlements, some open tax matters in a few states in the quarter, Bob. I think sort of that 36% to 37% range is the right way to think about the full year..

Great. Thank you. Appreciate it..

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

Yes. Good afternoon, and thanks for taking my question. Mark, I want to revisit – it's been asked a few different ways, but as you recounted the litany of puts and takes in NIM this quarter, you among other things mentioned transactors were reemerging in the book and a bigger part of the asset mix.

And I'm trying to get a sense for whether or not – in your mind, as you plan your rewards rates, I mean, is that a leading indicator or any kind of red flag that perhaps the rewards spend may be getting a little too high? I mean is the transactor mix, was it very modest on the margin or is it a sign that tells us from an ROE basis there's actually room to potentially trim back rewards at the end of the year?.

It's David. I'll take that one. If you look at the – our sales grew 6% and our loans grew 7% this time. And so I think if you have that concern, you'd see sales growing a whole lot faster than loans because you're getting transactors that aren't turning into loans which some of our competitors have been chasing.

So, I feel very pleased that our sales have gotten up very close to loans and that's been our target for a couple of years and we're hoping to maintain it and it doesn't – it more gives me a signal that our programs are working and we're moving to a nice balance as opposed to needing to change something from here..

Okay. That's helpful.

And switching to the credit side, notwithstanding the commentary on normalization, I'm wondering within the personal loan category, was that sequential rise in losses from Q4 to Q1? Was that in line with your expectations? I mean, it was steeper obviously than all the other categories and it's steeper than anything that took place seasonally a year ago.

Is there anything behind that?.

No. It actually was in line with our expectations. I think there's two pieces of the puzzle there. Piece number one is just simply the level of overall loan growth we generated over the period of time proceeding and leading up to that that really kind of goes through the peak seasoning and drives that, that's a piece of it, number one.

The second piece of it is we did run a small test of some potential to set up a marketplace business for lack of a better way of putting it. So, we did originate some stuff that was a little bit lower than we normally would've played. It was a very small portfolio test and control.

And that had an impact of adding a few basis points to what that reported rate was as well. It wasn't directionally the driver by any stretch of the imagination, but it was a small piece of it also. So, all consistent with our expectations and in line with our guidance for the full year as well..

Got it.

And just real quickly as a cleanup, on the reserve rate, is the level we saw at the end of the Q1 a good way to think about for most of the – balance of the year?.

Yes. We always set reserves on a forward-looking basis, so I'm going to have to – I bluntly couldn't even tell you what my reserve rate was. But I can tell you roughly where it was, but I couldn't tell you exactly because we can't manage to it. So we're setting on a forward-looking basis.

What I would say is, I – there's going to be that element of normalization that's taking place out there. It remains modest, but really it's going to be growth that are going to be the primary drivers of the growth in reserve and the provision expense as I look forward.

And we're not losing any sleep that we can't manage the credit situation we're confronted with right now..

Got it. Thanks so much, guys..

You bet..

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

Yes. Thanks. Mark, I know you've been pretty clear on the big drivers for the upswing in charge-offs around both growth and normalization.

Is there an element to which it's also being driven by a bit of a loosening in the credit box and maybe moving down FICO a little bit in your new growth, relative to what you've done, or have you really held the line on FICO scores and loss content?.

I think we've pretty well held the line. I mean, if anything, of the last quarter or two quarters, we've tightened credit, in terms of directionally where we've gone, as opposed to liberalizing it. So, feel pretty good about that.

If you go back a few years, we've talked to market in the past about, we will look to expand the credit box a little bit from time to time. And if you go back a few years, we did a little bit of it. I think that's all performing in line with our expectations and we're getting paid for it in the NIM as well.

So feel very good about that and if you think about it as the sundae, it wasn't the ice cream or the hot fudge, maybe it was the whipped cream or the cherry, is the way to think about it on the growth levels. So it was just marginal..

Okay. Got it. And then – sorry. One of your competitors in the student lending space reported slower growth, loan growth, for the quarter than they expect for the year, and they attributed that to kind of the disproportionate share of for-profit schools and the disbursement season for the spring.

Are you seeing any kind of uptick in your share of for-profit schools and if so, any kind of thoughts on implications for losses going forward?.

Well, it wouldn't be us because we don't underwrite for not-for-profit schools....

For-profit..

For-profit schools, I'm sorry. And the first quarter is not a big quarter for disbursement, so it's hard to get a read, but we're seeing that we had expected somewhat higher growth this year in that business, more originations this year than last year, and so far we're seeing that..

Okay. Got it. Thanks..

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

Thanks. It's been asked and answered, but I wanted to come back quickly just to the rewards side of things. And maybe if you could just, David or Mark, talk a little bit about how you might use that, whether it's the rotating category or some other aspect, to kind of drive, and, David, you said you're generally happy with the characteristics.

But are there any other ways that you can think about, kind of optimizing your performance in the coming year?.

Well, because we have quarterly categories, we're able to be somewhat strategic and see what else is going on in the industry, what performance we've had in the past.

And so, as has been talked about several times this time, we purposely went out with somewhat richer categories, the 5% programs, in this first quarter of the year, based on some of the things that we saw going on in the market, and you see the sales results in particular, show that those have been well received.

And so, I think the 5% program is the one that we can change the most. I think then, the second thing is, the Double is continuing to work very well.

We had originally put that in as a test, it worked, we've continued, and right now we have no plans to back off on that, and it's allowing us to get strong costs per account, strong engagement, and not be as wedded to some of the aggregator sites as some of our competitors are.

And then the third piece is we continue to work very hard on the redemption side and growing the number of partners who help fund and provide additional value to cardholders, leveraging our network in a way that's hard for our competitors to follow.

Now, it's not quite Cashback Bonus, but I'll just mention that we're really pleased that we're doing a program right now with Walmart that you've seen launch last week, I think. And we think programs like that is still rewards essentially, and it's cause marketing.

And we don't have results yet, but we're optimistic that, that kind of engagement with our customers, with our retailer partners will pay dividends..

So, please, use your card at Walmart and provide a free meal..

Just a quick follow-up. You mentioned, David, the 12-year kind of average tenure, but part of the Discover, it was to attract a somewhat younger demographic.

And can you talk a little bit about how that's going and what your success there has been because that's been kind of a hot (51:23)?.

Yes. I'd say it's working well, and all of our marketing results and brand tests show that we do particularly well with Millennials compared to almost any other card brand. And so I would say we have a double-edged strategy. One is to grow, especially with the Millennials, but grow through new accounts.

But the second is to retain our existing customers through better service, through lower charge-offs and through a strong rewards program. And it's that combination of not having a leaky bucket and then filling the bucket with new customers with a differentiated product with Discover it, specifically, that is working for us..

Thank you..

Your next question comes from the line of Henry Coffey with Wedbush. Your line is open..

Good afternoon, and thanks for taking my call.

This is probably overly simplistic, but when we look at the quarterly trends and quarterly charge-offs, do you think that there was a sort of "a jump" in the second half of last year which will make the quarter-over-quarter comparisons easier as we go into the second half of the year? And I know you talked about it in the past, but is it fair to think of the March quarter as a bigger reserve build relative to the rest of the year?.

I'll let Mark answer the reserve question. But on the seasonality, I guess the way I would look at it is first quarter of last year was a pretty low quarter of charge-offs..

It's the low point for delinquencies, early stage delinquency. Yes..

And so that essentially is what you're describing and is what you would expect in order to reach the roughly 35 basis points increase for the full year. We obviously would not reach that if we have kept up the same year-over-year, so we would expect the year-over-year to moderate from here. Mark, on the reserve..

Yes. On the reserve, we don't give provision guidance, so I'll steer clear of that one, Henry. But what I would say is we did give the charge-off guidance, and I think I can use that to answer your question. And really we did see a bigger bump in first quarter charge-off growth than we're guiding for in basis point terms for the full year.

So clearly, that low point of delinquencies in the first quarter of last year is entering into our thought process..

And then just kind of an unrelated question, but right now you have three core products that are driving the equation plus the direct bank.

Have you thought about adding a fifth or sixth product to the quiver? Or is it really, you're going to focus right where you are?.

Well, first I would certainly include the deposit products. I mean that's $37 billion of deposits from our customers, so I would look at it more like four. And even within deposit products, there's CDs, very different than money markets, checking, et cetera. But I would say home equity is the product that we are in. It's very small.

It's a very big market relative to many other markets. I think we're coming into a particularly good part of the cycle in which home equity will be in higher demand as people look to use home equity as opposed to refinancing their very low-rate first mortgage. We're in the early days of that.

We're still fine-tuning our infrastructure, our modeling and so on. So, it's not particularly significant today, but it is an area that we would like to grow further to create a, what I would call, a fifth product..

Insight into where the student loan market is likely to go relative to the federal programs, or....

We're not counting on any change today. I would hope that any changes that come in future years might be positive. To me, it is an unusual market and that 95% is provided by the federal government and only about 5% or 6% by private.

And so, if the government backs off any piece of that market, such as graduate loans as an example, it's a market that we would hope could accelerate, and we would take the position to take advantage of it. And we are in the final stages of converting our system.

We've talked about that in previous calls, and I think having a state-of-the-art proprietary system that's very scalable, I think could position us well for possible acceleration in future years.

I don't know if that would be 2018 or 2019, but it's a great market, it's by far the lowest charge-off market for any kind of installment loan that I'm familiar with, and you saw that was the one product that actually improved this quarter and was the lowest charge-offs of any quarter that we've had in the last two years..

Great. Thanks for taking my questions..

Your next question comes from the line of Jason Harbes with Wells Fargo. Your line is now open..

Thanks for taking my question, guys. Maybe just a quick one on the longer-term credit outlook. I think at the last Investor Day, you provided a longer-term charge-off ratios target of 3.5% to 4.5%.

Is that still a reasonable range to think about as we look ahead over the next couple of years?.

Yes, I think the most recent guidance we gave was back in January of last year and we said 3% to 4% is what we kind of expected normalize to be, so a little bit inside of that. I'd pick up on David's earlier comment, there's a bit of Kentucky windage in that estimate.

None of us have been here in a post-CARD Act world before, with our books kind of having gone through the crisis. And all the cleansing that took place from that, coupled with the discipline that's kind of brought in by CARD Act.

So we think that's a pretty good guesstimate of what new normal looks like through the cycle, but as David noted earlier, we're kind of going to need to ride through a cycle to validate that definitively..

Thanks for that, Mark. And then just a quick follow-up on the direct bank, looks like you guys have had some good success with your deposit-gathering efforts, while the deposit betas remain surprisingly low, at least thus far into the tightening cycle.

Can you maybe share your expectations for what you're expecting for the remainder of the year?.

Yes, I think we'll probably start to step into normalized betas over the next several rate increases, I think it's kind of really a stair-step function.

The money supply that's in the market has just got a tremendous amount of deposits in the system more broadly, and I think as the Fed begins to shrink its balance sheet, that'll have a bearing and an impact on that. I think to the extent loan growth continues across the industry, I think there will be demand for those deposits.

So I think you'll start to see some betas kick in, but I do think it plays out over time. So as opposed to going from a beta of essentially zero to normalized assumed betas, I think over the next two, three, four, I'm not smart enough to tell you exactly how many moves you kind of stair-step your way there..

Thanks, Mark..

Our last question comes from the line of Bill Carcache with Nomura Instinet. Your line is open..

My questions have been asked and answered. Thank you..

Okay. I believe that concludes the question-and-answer session on the call. I'd like to thank everyone for joining us today, and if you have any follow-up questions, please call the Investor Relations department. Have a good night..

This concludes today's conference call. You may now disconnect..