Discover Financial Services (NYSE:DFS) Q4 2023 Earnings Call Transcript January 18, 2024
Discover Financial Services isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good morning. My name is Todd, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter 2023 Discover Financial Services Earnings Conference Call. [Operator Instructions] Thank you. I will now turn the call over to Mr. Eric Wasserstrom, Senior Vice President of Corporate Strategy and Investor Relations. Please go ahead.
Eric Wasserstrom: Thank you, and welcome to this morning’s call. I’ll begin on Slide 2 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 that are subject to risks and uncertainties that may cause actual results to differ materially. Please refer to our notices regarding forward-looking statements that appear in our fourth quarter 2023 earnings press release and presentation. Our call today will include remarks from our Interim CEO, John Owen; and John Greene, our Chief Financial Officer. After we conclude our formal comments, there will be time for a question-and-answer session. During the Q&A session, we request that you ask one question, followed by one follow-up question. After your follow-up question, please return to the queue. Now it’s my pleasure to turn the call over to John.
John Owen: Thank you, Eric, and thanks to our listeners for joining today’s call. 2023 was a year of significant change for Discover, and we believe the actions we’ve taken position the company to continue driving strong long-term performance. When I stepped into the Interim CEO role, I had three priorities. My top priority was to advance our culture of compliance. We have made meaningful strides in our corporate governance and risk management capabilities. That said, this is a journey that will take time and continued investments over the coming years to further enhance our compliance and risk management capabilities. My second priority is to continue delivering a great customer experience at every touch point, which we do by providing our customers with award-winning service and products.
I’d like to thank our 20,000 employees for delivering a great customer experience to help our customers achieve a brighter financial future. In 2023, we were recognized for the first time as one of Fortune 100 best companies to work for. This award adds to accolade for working parents, women, people with disabilities and members of the LGBTQ+ community, and we’re proud to be an inclusive workplace. My third priority is to sustain our strong financial performance. We reported net income of $2.9 billion for full year 2023 and earnings per share of $11.26. This makes 2023 the third best year for EPS performance in our history. In delivering these results, we achieved several important milestones. We exceeded $100 billion in card receivables, grew deposits by 21% year-over-year, successfully launched our cashback debit account on a national scale, and we announced our intent to exit the private student lending business.
On December 11, we announced a new leadership and we’re excited to have Michael Rhodes joining us for our incoming Chief Executive Officer. Michael is an experienced leader with a deep background in the financial services industry. He has managed all aspects of our Consumer Banking business with deep experience in the credit card space, payments, online and mobile banking and served as Group Head of Innovation and Technology. His appointment marks the conclusion of a rigorous search process, and we look forward to Michael’s arrival. When Michael arrives, I will return to my prior role on Discover’s Board of Directors. In conclusion, I’m proud of the progress we made in 2023. Our integrated digital banking model, resilient financial performance and maturing risk management and compliance capabilities position Discover well for 2024 and beyond.
With that, I’ll now turn the call over to John Greene, who will review our fourth quarter 2023 financial results in more detail and provide some perspective on 2024.
John Greene: Thank you, John, and good morning, everyone. I’ll start with our summary financial results on Slide 4. In the quarter, we reported net income of $388 million, down from just over $1 billion in the prior year quarter. There are three broad trends to call out. First, we grew revenue 13%, reflecting 15% loan growth, partially offset by modest NIM compression. Second, provision expense grew by $1 billion. Charge-offs increased, but landed at the low-end of our expected range. Strong loan growth and higher delinquency drove the increase to our reserve balance. Finally, expenses increased 19% year-over-year, reflecting investments in compliance and risk management, a reserve for customer remediation and higher marketing expense to support our national Cashback Debit campaign.
We’ll get into the details of these topics on the following pages. Turning to Slide 5. Our net interest margin ended the quarter at 10.98%, down 29 basis points from the prior year and up 3 basis points sequentially. The decline from the prior year quarter was driven by higher funding costs and higher interest charge-offs, which were partially offset by higher prime rates and increases in revolving balances. For the full year, net interest margin was 11.07%, up 3 basis points from the prior year. This margin performance reflects the improvement in our funding mix over the past several years and a reduced level of balance transfer and promotional balances as we tightened underwriting. Receivable growth remained robust. Card increased 13% year-over-year due to contributions from the prior year new account growth and a lower payment rate.
The payment rate declined about 110 basis points from the sequential quarter and is now 100 basis points above 2019 levels. Overall, new account growth declined 9% as a result of credit actions. Sales were up 3% compared to the prior year quarter. Personal loans were up 23%, driven by continued strength in originations and lower payment rate versus the prior year. Student loans were flat year-over-year as we prepare for a potential sale of this portfolio we will cease accepting applications for new loans on February 1. Our Deposit business delivered outstanding performance in a challenging year. Average deposits were up 21% year-over-year and 4% sequentially. Our direct-to-consumer balances grew $3 billion in the period and $14 billion in the year.
Looking at other revenue on Slide 6. Non-interest income increased $74 million or 11%. This was primarily driven by an increase in loan fee income, higher transaction processing revenue from our PULSE business and higher net discount and interchange revenue. Our rewards rate was 137 basis points in the period and 140 basis points for the full year 2023, a decrease of 1 basis point on a full year basis. The decline reflects lower cashback match from slowing new account growth and our active management of our 5% categories. Moving to expenses on Slide 7. Total operating expenses were up $280 million, or 19% year-over-year, and up 22% from the prior quarter. Looking at our major expense categories, compensation cost increased $73 million or 13% from higher headcount.
Marketing expenses increased $59 million or 19%. Professional fees were up driven by continued investment in compliance and risk management capabilities, while other expense reflects a reserve for customer remediation. Moving to credit performance on Slide 8. Total net charge-offs were 4.11%, 198 basis points higher than the prior year and up 59 basis points from the prior quarter. In card, as anticipated, delinquency formation is slowing as more recent vintages season. We added a slide detailing some of the drivers of our credit performance in the appendix to the earnings presentation. Turning to the allowance for credit losses on Slide 9. This quarter, we increased our reserves by $618 million, and our reserve rate increased by 17 basis points to just over 7.2%.
The increase in reserves was driven by receivable growth and higher near-term loss content from higher delinquencies. Under CECL, reserve levels increase as you approach peak losses. We expect our losses to rise through the midyear and then plateau through the back half with some seasonal variation. In terms of our macroeconomic outlook, our view of unemployment was relatively unchanged, while household net worth projections increased slightly. These changes provided a small benefit to reserves. Looking at Slide 10. Our common equity Tier 1 for the period was 11.3%. The sequential decline of 30 basis points was driven largely by asset growth. We declared a quarterly cash dividend of $0.70 per share of common stock. Concluding on Slide 11 with our perspective on 2024.
These exclude the impact of a potential student loan portfolio sale. We expect end-of-period loan growth to be relatively flat, while average loan growth will be up modestly year-over-year. We expect full year net interest margin to be 10.5% to 10.8%. We’re currently anticipating core rate cuts of 25 basis points in 2024. This is two more rate cuts than in our forecast in December. Each cut reduces NIM by approximately 5 basis points subject to a deposit beta. We expect total operating expenses to increase by a mid-single-digit percent. This contemplates our expectation for compliance-related costs to be approximately $500 million this year. Total expenses may increase as incremental resources or remediation is required. We expect net charge-offs in the range of 4.9% to 5.3%.
Finally, regarding capital return. We will participate in this year CCAR’s process, and believe the results should help inform our view of capital management for 2024. Importantly, our capital management priorities have not changed and remain centered on supporting organic growth and returning capital to shareholders. To summarize, we continue to generate solid financial results. For 2024, we will continue to advance our compliance and risk management capabilities and invest in actions that drive sustainable, long-term value creation. With that, I’ll turn the call back to our operator to open the line for Q&A.
See also Best Malpractice Lawyers in Each of 30 Biggest Cities in the US and 30 Cheapest Places Across America Where You Will Want to Retire.
To continue reading the Q&A session, please click here.