Craig Streem - IR David Nelms - Chairman and CEO Mark Graf - CFO.

Sanjay Sakhrani - KBW Ryan Nash - Goldman Sachs Bill Carcache - Nomura Instinet Rick Shane - JP Morgan Don Fandetti - Wells Fargo Chris Brendler - Buckingham Research John Hecht - Jefferies Chris Donat - Sandler O’Neill Betsy Graseck - Morgan Stanley Moshe Orenbuch - Credit Suisse Ken Bruce - Bank of America Merrill Lynch.

Good afternoon. My name is Julie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Discover Financial Services Third Quarter Earnings Conference 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]. Craig Streem, you may begin your conference..

Thank you, and welcome everybody to today’s call. Moving on slide two of our earnings presentation, which you can find in the financial section of our Investor Relations website, investorrelations.discover.com.

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

In the third 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. And of course we urge you to review that information in conjunction with today’s discussion.

Our call today will include remarks from David Nelms, our Chairman and Chief Executive Officer covering third quarter highlights and developments and then Mark Graf, our Chief Financial Officer will take you through the rest of the earnings presentation. After Mark completes his comments, there will be time for a question-and-answer session.

During the Q&A session, I’d ask you to please limit yourself to one question and one follow-up, so we can accommodate as many participants as possible. Now, it’s my pleasure to turn the call over to David, who will begin on page three of the presentation..

Thanks, Craig, and thanks to our listeners for joining today’s call. For the third quarter, we delivered net income of $602 million on revenue growth of 10%. Earnings per share were $1.59, and a return on equity of 22%. I’m particularly pleased with the strong growth, we achieved across all product lines.

We drove total loan growth of 9% as we continue to focus on delivering profitable prime loan growth. In payment services, total volume grew 16%, our fastest growth in more than six years. Looking specifically at card, loan growth was split about evenly between new accounts and growth of existing customers.

While the third quarter of last year was highly competitive characterized unusually aggressive offers on new products from a number of competitors, this year some of the issuers has appeared to fall back a bit. However, our strategy and discipline remain unchanged.

We continue to innovate and enhance our flagship product the Discover card and offer unique features like cash back match with allows new card members to earn double the cash back bonus in their first year and creates meaningful benefit for us to sustain customer engagement.

Our consistent approach and a slightly less than tense competitive environment have created more opportunity to drive both sales and receivables growth without a significant increase in marketing and expenses. Overtime, strong customer engagement drives lower voluntary attrition and enhanced growth.

For Discover attrition has remain consistently low among prime revolvers reflecting the loyalty of our customer base. The foundation for our strong performance is our commitment to outstanding customer service and a unique and expanding feature set in our Discover card. In our advertising, we remind customers that we treat you like you treat you.

Customers are loyal to us in part because we serve them well which includes providing the helping hand in response to unexpected events. The Equifax data breach and the increased potential for personal identity theft it has created have been on the forefront of consumers’ minds.

The breach resulted in an increase in call volume from customers but highlighted that we have been on the right path and focusing on features and innovations that help consumers to monitor their credit. In July even before we became aware of the Equifax breach, we introduced a free alert service available to all Discover card members.

Enrolled card members will receive an alert if we find their social security numbers on any of thousands of risky websites. We will also monitor their credit reports and notify them of any new account openings.

This feature is the latest example of our ongoing investment to provide our card members with the simplicity and innovative features they expect from us. The number of enrollments in this feature has already surpassed our goal for the full year. Our new alert features is one element of our continued investment in technology.

As a direct bank differentiation and technology is critically important for us. Our innovative features like Freeze It and our new alert service further differentiate Discover in a competitive marketplace. The appeal of these features was recognized by JD Power last quarter when our mobile app was ranked highest in customer satisfaction among all U.S.

credit card companies. We continue to invest in new digital and mobile capabilities that enhance customer experience as well as advanced analytics and machine learning technologies that will provide a sustainable credit and operating efficiency benefits.

Turning to credit for a moment, while credit costs have risen, our performance remains largely in line with our expectations and our card portfolio loss rate remains below the industry average. The prime consumer remains healthy, buoyed by a robust labor market, rising home prices and manageable debt service levels.

The Federal Reserve recently released its survey of consumer finances which serve medium debt to income and payment to income ratios at their lowest levels since the early 2000s. Moreover, the share of heavily indebted consumers those whose payment to income ratios above 40% fell to its lowest level since 2001.

I would add that in October, consumer sentiment reached its highest level in well over a decade. The U.S. consumer continues to feel positive about future prospects for their personal finances and employment.

Given our commitment to growing prime receivables it makes great sense for us to continue to drive quality loan growth because the economic and competitive environment remains conducive to creating long-term shareholder value.

Of course, we remain attentive to emerging credit data and in fact over the last year have reduced exposure by cutting back open lines in some segments of the card portfolio.

Mark will talk more about it later, but one area where we’re taking similar significant action is in personal loans, where we’re scaling back the volume of origination sourced through broad market channels. While the environment remains favorable for most, a number of our customers were unfortunately affected by hurricanes Harvey, Irma and Maria.

For our 1.8 million customers in areas most impacted by the hurricane, we offer a range of proactive benefits such as suspensions of late fees and collection activities. Additionally, we and our customers provided support to these communities by donating $3 million to the American Red Cross.

In summary our differentiated approach and relentless focus on serving customers will continue to drive strong revenue and loan growth along with a robust return on equity. I’ll now ask Mark to discuss our financial results in more detail.

Mark?.

Thanks David and good evening everyone. I’ll begin by addressing our summary financial results on slide four. Our 10% revenue growth in the third quarter was driven primarily by a combination of strong loan growth and margin expansion.

The increase in provision is largely consistent with ongoing supply driven normalization in the consumer credit industry, as well as the seasoning of our last several years of loan growth. The only exception to this is contained in a limited portion of the personal loan book, that we alluded to last quarter.

Operating expenses rose 6% year-over-year as we continue to invest for growth. EPS was up $0.03 to a $1.59, including coincidently $28 million of income tax benefits in both the current and the prior year. And in terms of returns, it was once again a very strong quarter as evidenced by our return on equity of 22%. Turning to slide five.

Total loans increased 9% over the prior year driven by 9% growth in credit card receivables. Growth in standard merchandise revolving balances drove much of this increase, spurred by strong sales growth particularly among revolvers. Promotional balances contributed to growth as well.

We also achieved strong loan growth in our other primary lending products.

Personal loans increased 18% from the prior year, thanks to active consumer engagement with our simplified application experience and expanded digital presence, this growth rate is down 4 percentage points from last quarter, as a result of our tightening of certain underwriting standards in our unsolicited channel and we expect that these changes will lead to a further deceleration in personal loan growth in the coming quarters.

Private student loan balances rose 2% in aggregate, but our organic portfolio increased 11% year-over-year. As a result of expanded marketing efforts with a focus on digital contest, we are on track for another year of record originations in our student loan business in 2017.

Moving to the results from our payments network, on the right-hand side of slide five, you can see that proprietary volume rose 6% year-over-year, driven primarily by an increase in active Discover card accounts. In our Payment Services segment, PULSE volume grew at a faster rate during the third quarter with an increase of 17%.

Diners Club volume rose 9% from the prior year on strength from newer franchises. And finally, Network Partners volume rose 15% driven largely by AribaPay [ph] volume. Moving to revenue on slide six.

Net interest income increased $225 million or 12% from a year ago, driven by a combination of higher loan balances, market rates and our balance sheet positioning.

Total non-interest income was down $1 million as higher discount and interchange revenue was more than offset by increased rewards expense resulting from greater customer engagement in the rotating 5% category we opted to feature this quarter.

I would remind you that we have previously said that you should expect an uptick in our rewards rate in the second half of this year and this result is completely consistent with our full year guidance of a 126 to 128 basis points.

As shown on slide seven, our net interest margin rose 29 basis points from the prior year and 17 basis points sequentially ending the quarter at 10.28%. relative to the third quarter of 2016, higher prime rate and a lower proportion of student loans bolstered the margin offset in part by higher charge-offs and an increase in promotional balances.

Total loan yield increased 33 basis points from a year ago to 12.15%, driven by a 30-basis point increase in card yield, and a 43-basis point increase in private student loan yield. Prime rate increases partially offset by higher charge-offs and a shift portfolio mix towards promotional balances drove card yields higher.

Higher short-term interest rates were the driver of the increase in student loan yields. On the liability side of the balance sheet, we once again generated robust growth in our consumer deposits. Average balances increased $3.4 billion or 10% year-over-year.

Consumer deposit rates moved slightly higher during the third quarter, rising 8 basis points sequentially and 11 basis points year-over-year. We expect deposit betas will continue to rise gradually toward more normalized levels with any future rate rise. Turning to slide eight, operating expenses rose $53 million or 6% year-over-year.

Employee compensation and benefits was higher driven primarily by higher headcount to support business growth and compliance activities, as well as higher average salaries. Professional fees were also higher as we invested in the technology initiatives that David spoke of earlier.

I would point out that even as we made these investments in growth, our expense discipline and strong revenue growth produce positive operating leverage of 4% in the current period. I’ll now discuss credit results on slide nine. David highlighted for you the assistance we provided to customers in areas affected by the hurricane.

While we provided relief to these customers by not aging their accounts, we did from an accounting point of view accelerate the recognition of $17 million of likely charge-offs in hurricane affected areas.

That said, the ultimate impact on the hurricane maybe somewhat greater than this amount, primarily driven by the more recent and severe impact of Hurricane Maria on Puerto Rico. Total net charge-offs rose 61 basis points from the prior year and fell 8 basis points sequentially.

As we spoken about in the last several quarters supply driven credit normalization along with the seasoning of loan growth in the past few years have been the primary drivers of the year-over-year increase charge-offs. Credit card net charge-offs rose 63 basis points year-over-year and fell 14 basis points from the prior quarter.

Private student loan net charge-offs rose 44 basis points year-over-year and 29 basis points sequentially. The increase in student loan net charge-off rate is principally due to seasoning of a large vintage. Personal loan net charge-offs increased 56 basis points in the prior year, and 1 basis point sequentially.

As we indicated last quarter, we’ve identify a sub-segment of the broad market personal loan book that’s not performing in line with expectations and taken actions to curtail those originations. This quarter, you can see the impact in our reserve build.

In future quarters, the personal loan net charge-off rate will rise as these loans flow through the charge-offs. We expect the future exposure of this sub-segment will not exceed $30 million over the remaining lives of the assets.

Of course, for the total personal loan portfolio, the net charge-off rate will also be impacted by the denominator effect associate with the pulling back on originations in the effective segment. 30-day delinquency rates were up sequentially across all of our primary lending products.

Looking at total loan receivables, our 30-day delinquency rate increased 12 basis points sequentially and 26 basis points year-over-year.

Looking at capital on slide 10, our common equity Tier 1 ratio declined 50 basis points sequentially as loan balances grew and we returned $667 million of capital to shareholders through common stock dividends and share repurchases. Looking ahead to the fourth quarter, we may have an opportunity to refinance our existing preferred shares.

It currently appears though this would be a beneficial trade. However, if executed it would be diluted in the fourth quarter to the tune of $0.05 to $0.06 per share. This dilution would result from two factors. First, we would have a period of overlapping dividend payments.

And second, we would need to take a charge to retain the earnings for the capitalized fees incurred when we issued the existing preferred shares. To sum up the quarter on slide 11. We generated 9% total loan growth with significant contributions from all three of our primary lending products.

Our consumer deposit business posted equally strong growth at 10%, while deposit betas remained low.

With respect to credit, while our charge upgrades have risen static conditions normalized in loan season, it remain below both historical norms and the industry average and we’re continuing to execute on our capital plan with strong loan growth and the leading payout ratio helping to bring our capital ratio closer to target levels.

Our commitment to disciplined profitable growth fueled strong operating performance with 10% revenue growth, NIM expansion and a healthy 22% return on equity. In addition, expenses remain well managed as evidenced by one of the best efficiency ratios in the industry. That concludes our formal remarks.

Now I’ll turn the call back to our operator Ruth, to open the line for Q&A..

Certainly. [Operator Instructions]. The first question comes from line of Sanjay Sakhrani from KBW. Your line is open. .

I was hoping Mark, you could give us a framework for future allowance builds and provisions and the charge off rate as we’re go into 2018, because I know there is a lot going on with the growth inflection that you have seen over the last year and half. Thanks. .

Yeah, I would say I’m going to stay away from 2018 guidance at this point, Sanjay. I’m going to make you wait until the January call where we talk about the year ahead.

I guess what I would say is the provision build that we’re experiencing at this point in time, if we take that small sub-segment of the personal loan book and set it aside, the provision builds we’re seeing is completely consistent with the normalization of credit we’re seeing from the standpoint of that supply side phenomenon we spoken about a number of times as well as the seasoning of the growth that we’re seeing.

And as we have continued to find ways to drive very strong profitable growth in that prime segment, the 9% loan growth this quarter, it will drive increases in provision. I mean there is just a mathematical equation that takes place there.

What I would tell you is any place we have seen the returns on that growth not meet our expectations we’ve demonstrated the willingness to fill back on that. We did it in the aggregator channel in the card space a few years ago when the cost of acquisition got too high.

And you have heard us talk about it in this broad market segment at the personal loan business where credit costs are running a little bit high quite honestly. So, I think the discipline is there such that we feel comfortable.

While provision expense has been growing it’s been growing for the right reasons as we’re investing and building shareholder value for the long-term. .

Okay. And my follow up on NIM. I guess what drove the sequential move higher on a year-over-year basis, if you got what I mean. And I was wondering if there was any hurricane impact in the revenue yields. .

Yeah there hasn’t been a significant amount of hurricane impact that we can identify in the revenue line at this point in time Sanjay. In terms of the walk of the margin from Q2 to Q3, it depends already because it’s a bunch of things this time around. The biggest piece is market rates contributed about 7 basis points give or take.

Credit contributed about 2 basis points, the receivables rate contributed about 2, the funding rate contributed about 2, and then the mix of receivables was about another 2 and funding mix was about another 2. So, if you add those all up, you get that 17 basis-point quarter-over-quarter increase in the margin. So, it feels again very strong.

We’re benefiting from that positioning of the balance sheet to be asset-sensitive. And then, I think we’re also seeing just good prudent management of the funding of the assets and the nature of the assets that are coming on as well..

Your next question comes from Ryan Nash with Goldman Sachs. Please go ahead. .

I guess, just a different question on the reserve build this quarter.

Can you maybe talk about how much of the reserve build was due to growth versus how much was from credit normalization? And I guess related to charge-offs, if you look at the breakdown of the 60 that you are up year-over-year, can you maybe contextualize how much of that is from the supply side seasoning versus maybe losses that you are seeing in the back book? Thanks..

A lot in there, Ryan, I’ll try and touch on it all and I will give you credit for one quick follow-up, just in case I miss any of it. I would say a couple of different things. First of all, the primary driver of the provisioning is the growth.

That has been and continues to be the primary driver of the provisioning but then normalization factor is material. I don’t want to downplay that too much, just to be clear.

I would say, if you think about the nature of build, if you take glimpse at the supplement which you can see is about a $111 million of that build was specifically related to the card business.

There was an outsized build in personal loans to tune of $34 million, $35 million this time around, reflecting that small book that we talked about a second ago and getting ahead and getting a provisioning for that out of the way. And then, I would say the student loans piece of the equation, you saw uptick in the charge-off rate this quarter.

That’s really related to that seasoning we talked about earlier, that higher vintage as well as we had a conversion that we went through on the student loan system on to our new platform, bringing [ph] the course to quarter end, probably weren’t as diligent about working delinquencies for a couple of days in there too, probably drove a little bit of that delta is my guess.

But, if you look at the reserve rate there, you can see it’s up only 3 basis points. So, at the end of the day, I would say, it really continues to be where we are seeing the strongest growth with the exception of the DTL [ph] portfolio is where we are seeing the greatest provisioning..

Got it. And maybe if I could just ask a quick question on personal. You saw loan growth on a year-over-year basis come in at about 400 basis points, yet it does look like the quarter-over-quarter growth did increase, maybe there was some seasonality in there.

So, could you maybe just expand on your comments about pulling back and how do you expect growth rates to progress in that business? Thanks..

Yes. I would expect you would see growth rates continue to slow further in that business, as a result of the actions we have taken and continue to take in that affected segment. The good news is, it’s a very defined and identifiable piece of the book and it’s not gigantic. So, I think from that standpoint, I am not overly concerned about it in any way.

I would expect though you would see growth rates continue to decelerate in that regard. I don’t think we are permanently abandoning the sub segments in question. I think we just need to figure out a way to go back to looking at them in a constructive fashion. And that will take us a little bit of time to look at models and do some further work..

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

Thank you. Good evening. Mark, we saw the year-over-year change in your delinquency rate to decelerate last month.

Was there a hurricane benefit underlying that improvement or would we have seen an improvement anyway?.

You would have seen a bit of a seasonal improvement any way. I would say….

I’m sorry. I mean, year-over-year. Sorry, sorry, Mark. I mean, year-over-year change….

Okay, got it. On a year-over-year change, yes, you would have seen benefit there is the honest answer, absent to hurricanes. I do think the rate of delinquency formation has slowed again with the exception of that small sub segment in the personal loans. Just to be clear, we’re carving that one out here.

But delinquency rate formation has definitely slowed. And absent the hurricane impact, which was relatively modest for us, you would have seen improvement..

Okay. And as a follow-up, your reserve rate in card increased to 3.29% this quarter that now exceeds net charge-off rate of 2.87% -- or sorry, 2.8% by the greatest amount that we’ve seen and allow.

So, should we start to see the rate of increase in that reserve rate start to slow here, particularly driven that deceleration in DQ formations that we just talked about?.

What I would say, Bill, is that the way I think about it, when I parse it up, is charge-offs are kind of looking what’s already happened, reserves are really looking what we expect to happen. And while the rate of delinquency formation has slowed, the rate of growth has increased. The rate of growth in the absolutely underlying level off assets.

So, if we’re going to have a higher level of assets going through that seasoning process with seasoning being the greatest piece of the driver, part of that is what you’re seeing there. So, you’re seeing that increase to reflect that increased growth that we’re seeing roll-on quarter-over-quarter-over-quarter.

So, it’s not the 9% this quarter just a driver, it’s the stronger growth from a couple of quarters ago, as that comes up into the seasoning curve, that’s really driving that..

Your next question comes from Rick Shane with JP Morgan. Please go ahead..

Mark, look, I understand not wanting to provide guidance on provision into 2018. But I’d love to think about it a little bit more conceptually, which is, can you help us think about the lag between when loans are added and the loss curve and when you would be reserving for that.

Given the steady loan growth throughout the year, that might help us think about how to model provision into 2018?.

Yes. From a pure seasoning impact as opposed to that normalization element of it, Rick, I absolutely can. So, the way I think about it is, you think about a normal seasoning curve for a normal vintage or card loans, you typically tend to take peaks losses about 24 months after you originate that vintage, give or take.

So, think about a bell curve that starts at zero losses, it increases to peak about 24 months out and then it drop offs on the back end of that to stabilize at the portfolio loss rate somewhere three years or shortly thereafter. It’s kind of really the way to think about the way the card loan, the seasoning impact of the card loan would work.

Student loans interestingly enough follow a very similar pattern; it’s just that vintage curve doesn’t kick in until the loan comes out of deferral. So, student graduates or drops out.

You have a six months deferral period; that deferral period ends, that’s when that basically that same curve would kick in with peak losses occurring 24 months thereafter. And if you think about it, it’s logical, because the biggest losses are taken when a student comes out and is unemployed or underemployed. So, it’s pretty logical process.

Personal loans follow a similar curve, they tend to peak just a tad bit earlier, maybe kind of like 18 to 20 months out is really the way to think about them, but again, a very similar process. So, as you think about loan growth, it’s really that area under that peak of the curve you’re providing for.

And every year since the crisis, our vintage of new credit has been larger than the one from the year that preceded it. So, while it’s not mathematically correct, [indiscernible] in the crowd like me, what I would say is [ph] visualize it as the area under the peak of that curve is growing.

You have a larger and larger and large vintage coming into replace it at 12 months to replace the one that’s falling off at 36..

You’ve done a nice job painting that picture. And just to refine us a little bit, because you’re reserving 12-month in front of that, the reserve build actually starts around month 12..

That is -- it actually begins before month 12, but it kicks in, in earnest somewhere around month 8, 9, 10, somewhere in that range as you climb the peak of that curve. That’s correct.

So, if you really think about it just mathematically, the absolute peak is going to be somewhere between month, call 18 and month 30, right, is when you’re going to have the bulk of the losses under the peak of that curve be recognized..

Your next question comes from Don Fandetti with Wells Fargo. Please go ahead..

David, you talked a little bit about this early in the remarks, but it stuck, investors continue to just ask why is Discover growing so much in their card portfolio at this point in the cycle? You clearly have a lot of excess capital and you see good returns as competitors have pulled back.

Can you just drill down a little bit because sometimes I have a hard time answering that question?.

I would say, for one thing, the market is growing faster now than it was certainly two years ago, three years ago. And one year ago, it’s probably when we saw the really absolute peak of competitive intensity, particularly around cash reward programs.

And so, that impacted some of our response rates a year ago and it also impacted where we invested because some things were getting just too expensive. And that’s actually our cost per account has dropped even with -- at the margin tighter credit this year than last year.

So, our growth rate basically, it’s almost as same store sales kind of thing a little bit, because last year it was when we were -- had really slowed growth. And so, we’re looking back at that period. Competitors have pulled back. We’ve been consistent, maybe a little bit more aggressive with some of our new features and so on.

But it’s appealing to consumers. So, there is no dramatic new product launch, but we had a lot of new feature launches and the combination. And it’s not just new accounts. We had a little bit more attrition a year ago, given some of those over the top and often promotional offers, specifically targeting cash back bonus..

Got it. That makes sense. And then, one of the large banks actually this quarter were saying how they were shifting acquisitions a little bit away from transactors more to revolvers. And it’s hard to -- you see some plus and minus data points on competition.

Do you still feel like competition is kind of peaked in your business or?.

Well, it’s still the best thing going in banking. So, I wouldn’t characterize it as anything but robust competition. But, it was over the top a year ago. So, I think some of the craziness probably has passed. And we frankly couldn’t really understand why everyone else seems to be going after transactors and paying up higher rewards than interchange.

And if you have no interest income, you can’t make that up on volume. I mean, it’s by definition a money-losing preposition and I think a few competitors properly have noticed that. It is focusing on prime revolvers has been our strategy over a decade. So, we’re continuing to pursue that consistent strategy..

Your next question comes from Chris Brendler with Buckingham Research. Please go ahead. .

Hi, thanks. Good evening. The NIM walk through was really helpful. I had my pencil ready, but I was hoping if you could, Mark, just comment briefly on how those will trend going forward directionally. I can imagine that they’re all positive as we continue on.

Obviously, market rates are going higher but can you talk about the funding rate and the loan mix and the funding mix? How does that look going forward, if you could give us directional help that would be great..

Sure. So, I think at the beginning of the year we gave NIM guidance on the full year to be, I think this is slightly higher and I think I defined that as probably 15 or so basis points. Full year last year was 9.99. I would tell you, I would expect our fourth quarter this year to have an increase in NIM but not by very much.

So, you’d have some further expansion but really more modest in nature, so maybe you close out the year at 20, 21, 22 basis points higher than that 9.99 on a full year basis reported last year. So, it would be the real way to think about it.

We continue to be positioned in an asset sensitive fashion and plus or minus 2% is kind of what we target in this environment asset-sensitivity, and feel really good about the work that the treasury group has done to get the balance sheet position that way but also that the deposits business is done continuing to put up pretty strong growth in that channel, which is our least market rate sensitive channel.

So, feel good about the trajectory at NIM..

Okay. And then, a follow-up on personal loans. I may have missed it.

Did you size the portion of the portfolio that you have decided you don’t look at this point? And also, related, do you expect personal loans to continue to grow or it was just negative potentially?.

So, I would say, we would expect personal loans to continue to grow. I would guess, as a result of pullback, you might see a slightly smaller vintage overall next year than you will see this year. But on balance, the affected portfolio is really small. We didn’t size it but if I did, it would be low single digit percentage points.

It’s a very small portion of the book. It is principally behind us at this point in time in terms of the provisioning impact. I think what we said earlier in the prepared remarks is there is probably $30 million at economic risk over the remaining lives of those assets associated with them..

Your next question comes from John Hecht with Jefferies. Please go ahead. .

Yes. Thanks very much. I guess following a little bit on sort of Rick Shane’s questions about the nuances of credit. I guess, you guys are about the fourth quarter, you are entering the fourth quarter where you are starting to see accelerated growth.

I’m wondering, at this point in time, can you tell us, how you look at the loss content of the latest vintage, this year’s vintage versus last year’s vintage, say? And how you look at that both on a gross and net basis, because it looks like recoveries have come down a little bit as well?.

A lot in there, I’ll try and answer simply and just kind of say, if you think about that vintage curve we spoke about earlier, in the card book that curve still peaking lower than we have seen it in a pre-crisis environment.

But what I would say is, it is every year successively getting closer and closer and closer to that normalized vintage seasoning process. So that’s the way I would think about it, the vintages are performing better than pre-crisis historic norms, but the gap to that pre-crisis historic norm continues to shrink every year.

Kind of consistent if you think about what we said. We said that loss rates have been unsustainably low. We continue to see opportunities to put things on the books that season below normalized expectations. And as David alluded to earlier in his response to earlier question, I think that’s the key to compounding value in a lend-centric model.

We don’t really charge fees, it’s kind of inconsistent with our business model; that will be leg one of the stool. Margin is already pushing 10/30. So, I mean, I don’t think, it’s a lot more produced [ph] in margin probably. Expenses, we’ve got the lowest efficiency ratio of any of the general purpose issuer.

So, I think the third leg of the stool, expenses is in pretty shape. So that fourth leg of the stool is how you compound value with quality loan growth. And I think our pullback in DTL [ph] this year, our pull back in card growth a few years ago demonstrates that when we don’t see the quality we need to have, we will pull back on that loan growth.

But to the extent we can put quality on the books that makes sense that’s good for shareholders, we believe it’s the right thing to do in this environment..

And second question, you guys talked about and we’ve heard this quarter commentary through others that everybody is expecting deposit betas to move up. So, I’m wondering, can you just talk about, the tenure of the duration.

Where have you been focused on issuing deposits and how might that impact the overall betas especially next year?.

Yes. So, I think we are particularly focused on the indeterminate maturities. We find those to be the stickiest of all of our deposit base. So, I think that’s an area that we tend to pay an awful lot of essentially to.

As we think about the retail CD product, I would say, we tend to move around a bit there and we tend to emphasize those products that are the greatest need and the funding profile, given upcoming maturities and other things we look at as we look to stagger out and stack the funding profile.

And then, if you think about the brokered CD product, some of the suite products that we access as well, those really get aspiration. Most of those things we tend to focus well out of the curve, because they are one of our most cost effective solutions as rate issuer to getting duration in the funding profile..

So, taking all that, is the duration now consistent with what it was, say, six months ago?.

It’s a little longer actually..

Your next question comes from Chris Donat with Sandler O’Neill. Please go ahead..

Mark, you mentioned in your prepared remarks that balance transfers are one source of growth. I was wondering if you could -- I know, in the past you’ve done this, you’ve quantified the amount of your portfolio that is balance transfers. It looks to me like the amount of balance transfers might have been up by 20% year-on-year.

But anyway, I’m just trying to get a sense of how big they are in your loan mix?.

No. I mean, I think when you look at the card book in general that’s a pretty good guesstimate. It’s somewhere right in that range, actually a hair below. We would have a 19 handle on it, would be the way to think about it.

And they continue to be, as we look at them a very good way, not only to attract new customers but also to reengage legacy customers who’ve chosen to deprioritize us in their senior wallet, get them back active again with the product.

So, we’ve got pretty disciplined process around the returns on that and they have continued to produce great returns for us. So, your guesstimate is pretty good..

I hope I qualify then as a [indiscernible], Mark. And then, wanted to ask something maybe a little forward-looking. And David, I don’t know if you -- how much you’ll opine on it. But with the Supreme Court deciding that they’re going to rehear or hear the MX case against the -- brought by the Ohio Attorney General.

Just how you think about your discount rate, if in environment where merchants would be allowed this year? I’m imagining that you would not -- I think it’s a phrased used before actually, steering pilots, that you might do something like that.

But you’re not going to jump in whole hog and you’d only do something if the cut in discount fee would be more than offset obviously by a pick-up in volume.

However should we think about what steering might mean for you strategically from your discount pricing perspective?.

I think that -- I think it’s really premature to comment on this. It would be speculative. We’ll see what happens. And if there are is an actual change, then I’m sure we’ll have more comments after that..

Okay. I’ll be patient then. .

Thanks..

[Operator Instructions] Your next question comes from the line of Betsy Graseck with Morgan Stanley. Please go ahead..

Couple of follow-ups here. One is just as we’re thinking about reward cost, I know you mentioned second half of the year is little bit higher. I think that’s a seasonal pattern, but we’ve also seen a little bit of pullback in some of the competitive dynamics around rewards.

Could you give us a sense as to how you’re thinking about your rewards offering, where you feel you are in your lifecycle of the current rewards that you have out there and give us a sense as to what you’re thinking going forward?.

I’ll let David speak to the lifecycle comment, but I will I’ll speak directly to the kind of what we’re thinking, what we’re seeing. So, the third quarter was a particularly attractive quarter in terms of 5% rotating category. Betsy, we chose to run restaurants in that quarter.

Whenever throughout the year we choose to feature restaurants, we tend to see a very high level of engagement with that because it’s pretty easy to max out in that category, spending $1,500 over the course of three months. So, that would be the driver of what you saw in that quarter.

This quarter, what you’ve got is principally Amazon is the big driver. We typically tend to do that as a fourth quarter promotion around the holiday season. It tends to also be more costly than what you would have seen really in the first half of the year.

So, I would say, based on the level of engagement we’re seeing right now, we’ve been running these programs for a while; we’re generally pretty good at getting our arms around where we think we’re going come in. I am not losing any sleep whatsoever about coming in certainly in line with that 126 to 128 guidance..

And Betsy, I would say that while there still will be some upward bias going forward as we continue to have a higher mix of Discover it customers versus discover more customers in the portfolio. We really kept our discipline a year ago.

And so, what you are seeing is, if the competitive intensity slowed just a bit in this category, we stayed the course and we are seeing the benefit with the better marketing results and less attrition as some of the crazy stuff comes away.

Our absolute -- my guess is, we’re probably 50 basis points or more below a number of cash back competitors and in terms of cost. And so, I feel it’s a very sustainable place to be and we’re just happy that we’re able to drive revenue and stay the course..

Okay. And then, just separately, Mark, you mentioned about the potential to refi the press in 4Q.

Could you just give us a sense as to what’s going to drive your go, no-go decision? And then, what the benefit is to EPS? I know you outlined the healthy EPS in the fourth quarter but the forward ongoing benefit, if you could speak to that as well?.

Yes. So, what would drive the go, no-go decision would obviously market conditions Betsy and just having an open window, where we didn’t have something that would cause us to not be able to issue; some type of a corporate event or corporate news or something can also end up closing windows.

I would say, at this point in time, I don’t have in front of me the full run rate EPS impacts. What I would say just on a pure coupon basis, the last numbers I saw would show we benefit at least 100 basis points in the coupon. So, it’s a pretty significant pickup in benefit.

The first call date that we have available to us is December 1, on the existing pref. And so, we’re studying it intensely, and obviously keep your eyes on a Bloomberg and if we end up doing something, you will see it there first..

Your next question comes from Moshe Orenbuch with Credit Suisse. Please go ahead..

Great, thanks. Could you talk a little bit about the kind of the tax drove the loan growth in the card business.

I mean, has it primarily been existing customer? As you mentioned a couple of questions ago about the promotional rate piece, I mean how much of it is coming from new customers and kind of any other details you would be willing to provide?.

I’ll give you some pretty concrete data on that one, Moshe. I would say from my perspective couple of different things. This quarter, it’s about 50-50 from new customers and from the legacy back book. We view that -- we like to keep that bouncing somewhere between, call it 30-70, 70-30; 50-50 sounds just about perfect, if you could always end up there.

It tells me that the customer is -- the new customers are coming on board and seeing value and the offering, it also tells us that the legacy back book customer is choosing to continue engaging with the Discover product on top of the wallet fashion. So both of those are critically important because in the long run, our existing customers will die.

Not to sound morose, but they will. So, you have to attract the new customers. By the same token, if you just have a revolving door trying to get new customers, because your legacy customers disengage, you have a problem. So, feel really good about the health there.

I would say by far the way the biggest driver of the volume growth this time around for both categories was standard merchandise spend, Moshe. So, yes, promos are piece of it. We’ve actually used promos a little bit more aggressively to stimulate the back book, but even there standard merch spend is a big piece..

Got it. Follow-up, I guess particularly since Discover is responsible for couple of the large personal loan portfolios that are out there in the industry, maybe just a little more detail about the -- what distinguish these customers that you kind of decide -- I know, it’s a small -- single-digit percentage.

But, where they at one end or the other of credit spectrum where they acquire in a particular channel? What brought them to your attention….

Yes. You got to be a little bit quiet on that notion for competitive reasons. We really don’t want to say specifically it was exactly this? I think what we have said is, it was the broad market channel where we see these folks. It wasn’t a cross market, a cross sold channel, so we highlight that.

The other thing, I think, we have said not on the call today, but we mentioned it earlier in the quarter, so I would highlight that again, is I think, we said, one specific factor, we’ve seen, it there was a tag of underperformances where somebody already had taken out another personal loan.

So that was one characteristic [multiple speakers] would be one piece. Beyond that, I would give you comfort in saying, the size of the book here that’s affected is pretty darn small. Again, I think, I said earlier it didn’t size, but if we did, it would be low single digit percentages, the overall book.

And we think we have the issues largely behind us and certainly we have it ring fenced. But for competitive reasons, I don’t think we want to say exactly it was this and this and this..

Your next question comes from the line of Ken Bruce with Bank of America Merrill Lynch. Please go ahead..

My question first question relates to growth. I guess, there has been a lot of discussion around folks pulling back and the market becoming a little less competitively intense. You look around and at least most of the large issuers are still growing well above what the industry is.

I’m always little perplexes to exactly kind of where this growth is coming from.

If it’s the cut back has been, maybe the lower end of the prime and this is just really kind of the reengagement of revolving credit by prime borrowers, if there is any kind of change in the composition of what the market looks like today?.

No. It’s a fairly, I mean the top six issuers represent a high percentage of the total business. So, I would say -- you average them together, you’re going to get pretty close to the industry average. So, I’d say, few people have slowed down their growth. But, where we’ve seen the bigger change is probably how much marketing and what the marketing was.

And frankly, I think there were some crazy offers out there that was leading to a year ago, a lot more shifting of people from one issuer to another. So, it was maybe a little bit of zero sum game where people were just paying more rewards and moving balances between them.

And so, I think that if we look at the level of what the bidding for terms on the internet marketing are, it’s come down this year versus the year ago, direct mail volumes, particularly in the cash back segment. And the sub-prime segment, which we’re not in have had probably the two greatest reductions in new account offers.

And then, you’ve also seen some well publicized headlines and some people that have pulled back from some offers that I think they’ve actually admitted were too rich. One of the things that happened a year ago is there was a lot of -- lot going on in the warehouse club space.

And you had both Costco, the people that were losing that relationship were fighting hard; and the people who were gaining that relationship were fighting hard. Visa was accepted at Sam’s Club for the first time. And that particularly impacted us, because at one point it wasn’t exclusive. So, some of those headwinds have abated for us.

And that probably helps. It’s not that the market has slowed, actually the market has kind of kept up and that makes it easier for us to grow, but there is less shifting and our market is more effective relative to the others..

Yes, we actually tightened our credit criteria for cards at the end of last year. So, we’re actually upgrading a tighter box down than we were last year..

Right. That’s -- we hear that basic tenet from others as well. And that’s why it’s a little curious as why everybody is growing faster today than it would appear the average is, but I understand David’s point, there is a couple of high profile slow growers out there.

My follow-up question I guess relate to little bit to -- as I follow up to the comment around the personal loan risk layering where you saw. You referenced something similar a couple of quarters ago on the credit card with late stage delinquencies, you’ve seen higher levels of indebtedness.

Can you maybe kind of step back and give us any sense as to whether you think there is parts of the consumer business whether your own or just can more broadly that you see this increase in leverage that’s occurring?.

I think the increase in leverage is really across the consumer spectrum broadly. I think it’s most prominent in the sub-prime space where we don’t really play. But if you think about it in the prime revolver space, it was a Fed study out there. I don’t know exactly where to point to say number exactly when it was.

But it basically took a look at coming out of the crisis indexing levels of consumer indebtedness to one, and then kind of showing by product what those levels are at today. And I think card was like at 1.06. I think autos, personal loans and federal student loans were the principal drivers of that increase in leverage.

But I think it’s a driver when we look at our portfolio across the board, our incidence rates that is the number of account -- expresses the number of accounts close to number of balances. Our incidence rates to delinquencies are darn near flat across the book. We really don’t see meaningful movements there.

What we’re seeing is increases in severities because when a customer does go bad, they’re more indebted and therefore higher losses. So, maybe the arithmetic way to think about it would be the probabilities of default really haven’t changed much. The loss given the default has changed just as consumers are carrying more leverage.

But, it’s still below the levels that you would have seen pre-crisis. And meaningfully, the debt to income ratios, the consumers are in far better shape now, they don’t have exploding arms that are going to be ticking time bombs. The levers they have built up is more largely a fixed rate product.

So, it feels, while the leverage is there, it feels healthier..

The thing I would add from industry perspective is a year ago, we were seeing very high growth rates in auto loans and that’s really flattened out from last year to this year. We have been seeing several years of rapid growth on federal student loans and that has flattened out.

Credit cards hadn’t grown that much on loans, single digit levels, but credit card lines outstanding have been really and quite rapidly for a couple of years as people were chasing some of those transactors in particular. But this year, we have seen very flat, total cumulative credit card loans for the industry.

And so, I think all of those things show that there was kind of a recovery after some releveraging, some recovery on both supply and demand for a couple of years and then this year it’s really flattened out..

Thank you for your comments..

Bruce, are we ready to wrap.

There are no further questions at this time..

Hey, thanks everybody for your interest, your questions and of course, we are available for any follow up that you have. Thanks. Good night..

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