Discover Financial Services (DFS)

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Discover Financial Services (DFS)

Q2 2011 Earnings Call

June 23, 2011 11:00 am ET

Executives

Craig Streem - Vice President of Investor Relations

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

David Nelms - Chairman and Chief Executive Officer

Analysts

Robert Napoli - Piper Jaffray Companies

Richard Shane - JP Morgan Chase & Co

Michael Taiano - Sandler O’Neill & Partners

Craig Maurer - Credit Agricole Securities (USA) Inc.

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

Jason Freuchtel

Brian Foran - Nomura Securities Co. Ltd.

Betsy Graseck - Morgan Stanley

Ryan Nash - Goldman Sachs Group Inc.

Bradley Ball - Evercore Partners Inc.

Donald Fandetti - Citigroup Inc

Jason Arnold - RBC Capital Markets, LLC

Christopher Brendler - Stifel, Nicolaus & Co., Inc.

David Hochstim - Buckingham Research Group, Inc.

Bill Carcache - Macquarie Research

Mark DeVries - Barclays Capital

Presentation

Operator

Welcome to the Second Quarter Earnings Conference Call. My name is John, and I'll be your operator for today's call. [Operator Instructions] Please note that the conference is being recorded. I will now turn the call over to Mr. Craig Streem. Mr. Streem, you may begin.

Craig Streem

Thank you very much, John. Good morning, everybody, and welcome to today's call. As normal, let me begin by reminding all of you that the 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 furnished to the SEC in an 8-K report, in our Form 10-K for the year ended November 30, 2010, and in our Form 10-Q for the first quarter of 2011, both of which are on file with the SEC.

In the second quarter 2011 earnings release and supplement, which are now posted on our website at discoverfinancial.com and have been furnished to the SEC, we've provided information that compares and reconciles the company's non-GAAP financial measures with the GAAP financial information, and we explained why these presentations are useful to management and to investors. And we urge you to review that information in conjunction with today's discussion.

Our call this morning will include formal remarks from David Nelms, our Chairman and Chief Executive Officer; and Mark Graf, our Chief Financial Officer and, of course, the Q&A session at the end. And now it's my pleasure to turn the call over to David.

David Nelms

Good morning, everyone, and thanks for joining us. Before the market opened this morning, we reported all-time record quarterly earnings of $600 million or $1.09 per share, driven by continued improvements in credit as well as outstanding fundamental performance in both of our business segments. Our results this quarter reflect the Discover business model, delivering exceptional results despite a slow and uneven economic recovery. There are 2 items in our result this quarter that really stand out for me: first, our 30-plus-day delinquency rate for the card portfolio reached 2.79%, the lowest level at any point in our 25-year history; and second, Discover Card receivables grew almost $650 million from the first quarter. The very positive trends in delinquencies suggest that charge-offs will continue to decline while our reinvigorated marketing efforts are now resulting in cards receivables growth as well as accelerating sales and revenue growth.

We continue to have a very positive outlook for profitable receivables growth in all of our lending businesses and feel very good about the outlook for our Payments business, which, together with ongoing improvements in credit, should lead to continued consideration of excess capital. As a result, on June 15, our board authorized a $1 billion share repurchase program, reflecting the strength of our capital base and our intention to be responsible stewards of our shareholders' capital.

Looking at our results for this quarter, I was very pleased with our 5% growth year-over-year in total revenues and receivables. This contrasts sharply with what you see for most of the traditional banking industry which has been struggling to generate revenue and receivables growth. We believe this speaks very well of our Direct Banking model versus the approach being taken by most of the banking industry.

Now let's take a look at some of the key drivers of our record results this quarter. First, in our Direct Banking segment, Discover sales volume was 200 -- was $24.8 billion, up 9% year-over-year. An important contributor to the growth in sales has been providing greater value to our card members through rewards, marketing programs, increased brand presence and the benefits of increasing acceptance. We are seeing healthy growth in our active and primary card base, leading to gains in wallet share. Also, we significantly grew new accounts in the quarter.

Continuing the trend we have seen in previous quarters, the number of active merchants grew 8% from last year as we continue to push towards rounding out our U.S. merchant coverage. The very positive trends in merchant activation and card usage have been in place for some time now and we expect them to continue contributing to future receivables growth.

Increases in balance transfer [BT] activity have also been a factor in our cards receivables growth. Our emphasis with BTs has been to grow balances with our existing customers through spending and credit performance are well understood, but we are also carefully using balance transfer strategies to originate profitable new account relationships.

In addition to wallet share gains and balance transfer activity, receivables growth has also been positively impacted by trends in principal charge-offs with the card portfolio net charge-off rate decreasing almost a full percentage sequentially to 5%.

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