Discover Financial Services (DFS)

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Discover Financial Services (DFS)

Financial Community Briefing Conference

March 12, 2013 8:30 am ET


Bill Franklin

David W. Nelms - Chairman and Chief Executive Officer

Roger C. Hochschild - President and Chief Operating Officer

James V. Panzarino - Chief Credit Risk Officer and Executive Vice President

Harit Talwar - Executive Vice President and President of Us Cards

Carlos Minetti - President of Consumer Banking & Operations and Executive Vice President

Diane E. Offereins - President of Payment Services and Executive Vice President

R. Mark Graf - Chief Financial Officer and Executive Vice President


Sameer Gokhale - Janney Montgomery Scott LLC, Research Division

Craig J. Maurer - Credit Agricole Securities (USA) Inc., Research Division

Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc., Research Division

Ryan M. Nash - Goldman Sachs Group Inc., Research Division

Mark C. DeVries - Barclays Capital, Research Division

Bill Carcache - Nomura Securities Co. Ltd., Research Division

Christopher R. Donat - Sandler O'Neill + Partners, L.P., Research Division

Robert P. Napoli - William Blair & Company L.L.C., Research Division

William Ryan

Betsy Graseck - Morgan Stanley, Research Division

Christopher C. Brendler - Stifel, Nicolaus & Co., Inc., Research Division


Bill Franklin

[indiscernible] investor relation. Last year, there weren't enough seats for our point [ph] at the room, and now somebody is reporting standing in the back. And I remember after the event, Brian Foran published a research report talking about how the room was crowded. Discover was becoming a crowded long, but there was room for shares to go up. I'm happy to say his prediction was right as the shares are up more than 30% since our last financial community briefing. So it turned out right.

On the screen in front of you, I want to call your attention to disclosures concerning our use of non-GAAP financial measures and forward-looking statements in today's presentation. Let me also remind you that we switched to a calendar year-end basis, so all the numbers in the presentation will be December year-end numbers unless otherwise noted.

Our agenda today will begin with remarks by David Nelms, our Chairman and Chief Executive Officer, who is focusing on -- who will focus on how we have been building upon our successful strategy. Then Roger Hochschild, our President and Chief Operating Officer, will review 2012 achievements, strategic priorities and key initiatives. Our Chief Credit Risk Officer, Jim Panzarino, will then discuss our approach to Credit Risk Management, which has been so important in driving strong results at Discover. After Jim will be Harit Talwar, President of U.S. Cards, who will focus on how we are driving strong returns in cards and taking share. Carlos Minetti, President of Consumer Banking and Operations, will discuss how we are expanding our direct banking products. Diane Offereins, President of Payment Services, will discuss how we are working toward realizing the network potential. Then Mark Graf, Chief Financial Officer will discuss 2012 results, the financial drivers for the year ahead and capital.

Now it is my pleasure to introduce David Nelms, our Chairman and CEO.

David W. Nelms

Thanks, Bill. Welcome all of you today. Our team is very excited to talk to you about how Discover's doing and some of our plans for the future.

You have undoubtedly seen ads about Discover it around the country and here around New York City. The phrase It Pays to Discover has been a well-known Discover tagline for over 25 years. And originally, the phrase It Pays was associated primarily with our pioneering and innovative cashback credit card rewards program. Today, you'll hear from our senior leadership team about how our new and innovative Discover it card is designed to take our card business to the next level of market shares. You'll also hear how we're leveraging the magical it that we have created at Discover, including leadership and rewards, service, brand and credits to broadly and profitably expand in direct banking and payments.

We are achieving phenomenal returns because of our execution across direct banking and payments products that have higher growth and higher returns compared to our peers. Harit will cover the unique benefits, features and design that Discover it offers to our direct banking customers. We expect our new flagship card to help maintain our growth rate and accelerate our market share gains.

Our approach towards growth has been different than that of competitors, as we focus on sales that are more likely to drive prime loan growth. Over the past couple of quarters, Discover loan growth actually accelerated to be market leading, even as most of our competitors continue to experience loan runoff. It's also easier to grow loans from charge-offs here in the low 2% area in our card business and as we maintain extremely low voluntary customer attrition rates due to our superior customer service and rewards. Jim will speak about how we've leveraged our strong risk management capabilities into other areas like student loans and personal loans, which now together account for about 20% of total loans.

We are applying this disciplined profitable growth approach as we launch other direct products this year. In fact, we have an entire section on direct banking products that Carlos will speak to. But I want to quickly mention a few items about our new cashback checking accounts. I was personally quite involved with the creation of the product, and I'm very proud of the team's work on it. Over the past few weeks, I've had some great experiences using this product myself, paying my bills from my iPad using our online bill payment feature, withdrawing cash through our nationwide no-fee ATM partners, earning incremental cashback with my new Discover debit card and making deposits simply by taking photos of my checks with my phone.

Shifting to payments, we continue to be the flexible partner in the industry, and we're willing to work in nontraditional ways as we leverage our unique network assets to drive additional volume and revenue. Potentially, the most significant announcement in the payment industry in 2012 was our groundbreaking initiative with PayPal to help them pursue their off-line strategy. I think this will result in real innovation for the industry by bringing new technologies to the point of sales. I think one reporter said it well when he wrote, "Customers who like using PayPal online already will have another way to pay. PayPal gets more real world presence, and Discover will increase the volume of payments made on its network, which could convince more merchants to accept Discover cards." Diane will give an update on this and some other partnerships that we are excited about.

Lastly, we're generating a tremendous amount of capital, and we do have a very strong capital position. Mark is going to talk -- discuss how we are creating additional shareholder value through effective capital management.

Discover's strategic objective is to be the leading direct banking -- direct bank and payments partner. We have made great progress towards achieving this objective in the 5 years since we became an independent company, leveraging all of our unique assets and capabilities. We are successful and profitable in all of our businesses. We're growing faster than our peers, and we are causing people to think different about the Discover brand.

In many ways, we are defining what it takes to be a direct bank with leading rewards, a great brand, service and risk management capabilities. Our loyal customer base is the foundation both for growing credit card market share and for cross-selling additional direct banking products. We've also been rapidly expanding and leveraging our flexible payments network since the DOJ ruling in late 2004, which enabled us to begin partnering broadly in the payments industry.

Throughout the course of our presentation, we will focus on our core strengths and capabilities and how we will continue to build upon our strong foundation to achieve our priorities for 2013 and also to expand in new areas that will, over time, contribute to earnings growth.

I am more convinced than ever that direct banking is the future winning business model for consumer banking across the United States. The chart in the left illustrates how Discover's direct model is more efficient than the traditional branch banking model, as branches are very expensive to run. Our unique focus on higher-growth, lower-cost direct channel and direct products enable Discover to establish and maintain a sustainable competitive advantage.

Furthermore, as illustrated by the chart on the right, consumer preference is now clearly in favor of the direct model. Consumer preference has moved away from branch banking, and we support all the preferred banking channels except the one that is shrinking the most. In fact, today, you can do pretty much everything you would do in a branch either online, on the phone or at an ATM. And you can bank more conveniently 24 hours a day with Discover.

Some will argue that they can offer branch distribution as well as these other channels, just as traditional bookstores discounted Amazon's prospects or traditional computer companies with broad distribution channels wrote off Apple. We have seen this movie before. Scale can become slow-moving bureaucracy, full service can produce channel conflict and lack of focus and legacy assets can become fixed cost liabilities. The trends in consumer financial services are clear and accelerating, and the evidence strongly supports the benefits of a focused, differentiated strategy, which Discover is uniquely positioned to deliver.

In payments, we are the flexible alternative. Our hybrid closed loop model allows us to partner directly with merchants and indirectly through acquirers to offer customized reward programs that can enhance the cardmember experience and drive sales. Partnering closely with acquirers, both domestically and abroad, enables us to provide broad and cost-effective acceptance. We're also broadening our acceptance and increasing process volume through reciprocal network-to-network alliances. Additionally, we have over 100 issuers on our Discover and Diners Club networks and work with over 4,000 financial institutions through our PULSE debit network.

There are a lot of new and exciting technologies emerging in the payments industry, including mobile payments. And participants in this evolution are increasingly working with Discover due to our success in building a global network with unique capabilities and our proven willingness to be a great partner. We are also beginning to combine our bank lending and payments capabilities to offer partners unique, broad solutions to emerging opportunities.

Over the last 2 years, we achieved a 28% return on equity, nearly double our minimum ROE target and 4x the average ROE of our largest U.S. bank competitors. We achieved this by leveraging our capabilities in direct marketing, risk management and service. Our ROE outperformance was driven by our ability to target and execute well in higher-growth and higher-return direct businesses, as well as very strong credit performance. Our network strategy is bearing fruit as we leverage our acceptance efforts across thousands of partners to drive volume across our highly scalable networks.

I will be back later to conclude our presentation and answer some questions. But now, our President and Chief Operating Officer, Roger Hochschild, will summarize our 2012 achievements and frame our priorities and initiatives for 2013.

Roger C. Hochschild

Thanks, David. It is a great pleasure to be here with you guys today. I want to apologize for my voice. I am fighting off a cold, but I was not going to let that keep me from being here. And hopefully, what you'll catch is not my cold but my infectious enthusiasm for Discover and our prospects ahead. I will confess, last year at Investor Day, as I was talking about the year we put up in 2011, I was worried it would be hard to top that. But as I briefly go over our accomplishments for 2012, I think you'll realize we did just that. I'll also talk a bit about our priorities for 2013 and some key projects. You'll hear a lot more about those from Harit, Jim, Diane, Carlos and Mark, a management team that, to build on David's theme, really has their "it" together.

So with that, 2012 was a truly outstanding year, starting with record net income, $2.4 billion, and an ROE of 26% in what was one of the strongest levels of equity in all of financial services. On the payment side of our business, we saw record net volume, $307 billion across Discover, PULSE and Diners Club network, a growth of 9% year-over-year. On the card side, our investments in growth paid off as we grew our outstandings by over 5% year-over-year, and that growth did not come with any compromise in our prime lending standards as we also achieved an all-time low net charge-off rate of 2.24%. We continue with our direct banking expansion, both building on our existing products, originating over almost $1 billion in student loans, but also launching new products, such as Discover Home Loans, where we originated $2 billion of mortgages in our first 6 months. And then finally remained focused on using our shareholders' capital, returning $1.4 billion the shareholders in the form of dividends and buybacks.

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