Bill Franklin David W. Nelms - Chairman and Chief Executive Officer R.

Mark Graf - Chief Financial Officer and Executive Vice President

Ryan M. Nash - Goldman Sachs Group Inc., Research Division Betsy Graseck - Morgan Stanley, Research Division Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc., Research Division Craig J.

Maurer - CLSA Limited, Research Division Christopher C. Brendler - Stifel, Nicolaus & Co., Inc., Research Division Donald Fandetti - Citigroup Inc, Research Division David S.

Hochstim - The Buckingham Research Group Incorporated Sameer Gokhale - Janney Montgomery Scott LLC, Research Division Bill Carcache - Nomura Securities Co. Ltd., Research Division Kenneth Bruce - BofA Merrill Lynch, Research Division Moshe Orenbuch - Crédit Suisse AG, Research Division Christopher R.

Donat - Sandler O'Neill + Partners, L.P., Research Division Richard B. Shane - JP Morgan Chase & Co, Research Division Mark C.

DeVries - Barclays Capital, Research Division James E. Friedman - Susquehanna Financial Group, LLLP, Research Division Robert P.

Napoli - William Blair & Company L.L.C., Research Division Daniel Furtado - Jefferies LLC, Research Division

Thank you, Larissa. Good afternoon, everyone.

We appreciate all of you for joining us on this afternoon's call. Let me start on Slide 2 of our earnings presentation, which is on our website and we will be referencing during the call.

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 furnished to the SEC today in an 8-K report and in our Form 10-K for the year ended November 30, 2012 and in our Form 10-Q for the quarter ended March 31, 2013, which are on our website and on file with the SEC.

In the second quarter 2013 earnings materials, which are posted on our website at discoverfinancial.com and have been furnished to the SEC, we have provided financial -- we have provided information that compares and reconciles the company's non-GAAP financial measures with the GAAP financial information and we explain why these presentations are useful to management and investors. 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. After Mark completes his comments, there will be time for a question-and-answer session.

Now, it is my pleasure to turn the call over to David.

Thanks, Bill. Good afternoon, everyone, and thanks for joining us today.

After the market closed, we reported quarterly diluted earnings per share of $1.20, up 21% over the prior year, driven primarily by loan growth and share repurchases. During the quarter, we generated return on equity of 23% and returned approximately $440 million of capital to shareholders through repurchases and common dividends.

Our Direct Banking business again delivered strong results during the second quarter. Slide 4 of the earnings presentation shows Discover total loan growth at 6% over the prior year.

This organic growth was driven by a 5% increase in card receivables and a combined 10% increase in private, student and personal loans. Card receivables growth continues to outpace our primary peers.

This strong growth was driven by increased wallet share with existing customers and also new accounts. Discover it, our new flagship card product drove strong new account growth in the quarter, even while relying less on promotional balance transfers.

Discover it's position in the market continues to be highly differentiated with superior customer value and service and the early results of our advertising campaign are positive. This campaign, Discover it, other card marketing initiatives, and our strength and rewards have not only helped us grow new accounts, but have also encouraged our large loyal customer base to spend and revolve with us.

Also in card, I want to announce that Discover has become the exclusive affinity card issuer for 5 universities, including the University of Nebraska. We are excited about the affinity channel for long-term new account and sales growth, as we leverage our cash rewards and customer service.

Next, I want to address the recent developments in our Payment Services segment. As Mark previously disclosed at an investor conference last month, we have been monitoring the economic situation in Europe and working with our Diners Club franchises during these tough times there.

To minimize any disruption to cardholders and partners that rely on our network for international acceptance, we acquired the Diners Club franchise in Italy, are providing financial assistance to facilitate the acquisition of the Slovenian franchise by a European bank, and impaired certain loans to European Diners franchisees, all of which resulted in a segment pretax loss for the quarter. To be clear, our international strategy remains unchanged.

We are a global payments network that operates through local partners. However, the situation in Europe prompted us to selectively become more directly involved in what are primarily corporate card Diners Club franchises.

Payments segment year-over-year total dollar volume growth slowed as PULSE volume decreased by 3%. The debit environment remains dynamic and certain competitor actions are negatively impacting volume and revenue.

Due to these developments at PULSE and Diners in Europe, as well as potential pressure on network partners volume as certain legacy contracts are rebid, the near-term outlook for Payment Services is more muted than our previous expectations. During the second quarter, we announced a business-to-business payments partnership with Ariba, an SAP company.

With this partnership, which is scheduled to begin in 2014, we will leverage our existing network infrastructure to facilitate low-cost B2B payments. Also after the quarter, we announced another Discover signature debit issuer.

We believe that these and other recently signed partnerships collectively present significant long-term opportunities. However, I'd like to remind you that it will be some time before they have a meaningful impact on our quarterly results.

Overall, our results for the quarter were positive, as credit improved to an all-time low delinquency rate, card loans again grew faster than peers and net interest margin expanded. Now I'll turn the call over to Mark, who will walk through the details of our second quarter results.

Thanks, David and good afternoon, everyone. I'd like to start our discussion by going through the revenue detail on Slide 5 of the earnings presentation.

Net interest income increased to $116 million or 9% over the prior year, driven by loan growth and a higher net interest margin. Net discount and interchange revenue increased by $35 million year-over-year or 13%, due to Discover card sales volume growth and a lower rewards rate.

The sequential decline in the rewards rate from 92 to 86 basis points was driven by the timing of promotional cash back programs. Going forward, you will likely see continued quarterly fluctuations in the rewards rate due to the timing of promotions, as we look to further engage our customers and to drive profitable sales.

Our target rewards rate for the full year remains around 100 basis points. Protection product revenue declined by $14 million over the prior year due to the discontinuation of new product sales in late 2012.

Other income increased by $49 million primarily due to the inclusion of Discover Home Loans, which was launched in June 2012 and originated approximately $1 billion in direct mortgages during the quarter. We did see a slowdown in June as mortgage rates increased, which will impact origination volumes for the back half of the year.

However, I would remind you that the mortgage product is relatively immaterial to our earnings. Payment Services revenue decreased 8% year-over-year, mainly due to lower transaction processing revenue for PULSE.

Turning to Slide 6. Total loan yield of 11.24% declined 21 basis points over the prior year, mainly due to card yield compression.

This compression was split between an increase in promotional rate balances and a continued decline in higher-priced balances. Lower funding costs and lower-than-expected interest charge-offs more than offset this yield compression, resulting in a 16-basis-point increase in net interest margin over the prior year to 9.44%.

We continue to expect net interest margin to expand somewhat in the second half of the year due to higher rate funding maturities, more than offsetting yield compression. Let me take a moment to comment on interest rate sensitivity, as there's been a lot of questions on this topic in light of the recent increase in the 10-year treasury yield.

Over the last several years, we've taken measured actions in our deposit book to reduce our repricing sensitivity and in the last 6-or-so months, we've begun to extend the maturities of our funding. This has resulted in a balance sheet that remains slightly asset sensitive.

Total operating expenses, as shown on Slide 7, were up $62 million, or 8% over the prior year. Marketing expenses were up by $64 million or 53%, due to initiatives that continue to drive new account growth, card utilization and loan growth, as well as the inclusion of our Direct Mortgage business this year.

The 13% increase in employee compensation over the prior year was primarily related to the home loan launch and somewhat higher headcount in other areas of the business. Other expenses were down $42 million or 23% lower than the prior year.

You will recall that the second quarter of 2012 included a $90 million addition to legal reserves. This level of legal accruals did not occur in the second quarter of 2013, but we did realize $40 million in other expenses related to Diners in Europe.

Total pretax Diners charges were $55 million, which consisted of the $40 million I just mentioned plus $15 million in reserves established against loans to select European franchises. Due to these charges, as well as some additional investments that we'll be making in card marketing, we expect total company operating expenses to be somewhat greater than $3.2 billion for the full year.

Turning to provision for loan losses and credit on Slide 8. Provision for loan losses decreased $22 million from the prior year, driven primarily by lower charge-offs due to continued improvement in credit.

The $78 million reserve release recorded in the quarter is net of the $15 million reserve build I noted a moment ago related to loans previously extended to certain European Diners franchises. Our outlook for -- our credit outlook for cards remains relatively stable.

Sequentially, the card charge-off rate declined 2 basis points to 2.34% and a 30-plus day delinquency rate decreased 19 basis points to a new historic low of 1.58%. The private student loan net charge-off rate, excluding purchase loans, increased 76 basis points from the first quarter, due to both seasonality, as well as a larger portion of the portfolio entering repayment.

The upward trend for the quarter was in line with our expectations and we should see the rate move back down next quarter. Student loan delinquencies, excluding acquired loans, continued to perform very well.

They came in down 10 basis points sequentially to 1.38%. Switching to personal loans, the net charge-off rate was down 6 basis points sequentially and the over 30-day delinquency rate was down 12 basis points.

Before I move on to our capital position and 2013 outlook, I want to discuss our liquidity position. Our on-balance sheet liquidity portfolio at quarter end was $9.7 billion, $2.8 billion lower than the prior quarter and total available liquidity was $28 billion.

Our liquidity portfolio decreased sequentially, as favorable capital markets conditions in the first quarter led us to issue term funding at attractive pricing levels to pre-fund second quarter maturities. Moving to Slide 9, we ended the quarter with a 14.6% Tier 1 common ratio.

In terms of the impact of Basel III, we're still digesting the voluminous rules, but our current expectation is that it will have an impact of approximately 10 basis points on the Tier 1 common ratio and the impact on the total risk-based capital ratio would be around 50, 5-0 basis points. During the quarter, we repurchased $340 million of our stock and we expect to continue at roughly this pace over the remaining 3 quarters of this year's capital plan.

In summary, our overall results were strong with an ROE of 23% despite facing some challenges in our payments segment. Looking forward, the credit environment remains relatively benign, margin will increase from here in the back half of the year and we'll continue to remain disciplined with our investments for growth.

That concludes our formal remarks. And now, I'll turn the call back to Bill before we open things up to Q&A.

Thank you, Mark. We will now start the Q&A session.

[Operator Instructions] If you have any additional questions after the Q&A session, the Investor Relations team will be available after the call. Larissa, please start the Q&A.

Mark, just a first question on expenses. So we're going from $3.1 billion to $3.2 billion, and I guess, obviously, some of that is related to the Diners charge.

But how should we think about the reinvesting for growth opportunities here? I know you mentioned some more direct mail.

But could we actually see -- how do we think about the payoff with these investments? Should we actually -- could we actually see growth coming in above your 2% to 5% target range given these investments that you're making at this point?

Yes. I think, Ryan, a couple things.

You're right. Over half the increase we expect to see is coming out of the Diners onetime charges that we discussed in our prepared remarks a moment ago.

The remainder of it is going to be increased marketing expenses. I guess when we sit and look at the performance we're delivering right now, we're out delivering in receivables growth both in terms of wallet share gains, as well as new customer acquisition.

And the efficiency of our marketing spend right now is measured in terms of CPA, cost per account acquired, is about as good as we've ever seen it. And we're driving great ROE's through that all.

So it seems to us like this is a pretty good time to continue to make hay while the sun shines, to reinvest, to compound the value of the business over time, and that's what we're doing.

Great. And then if I could ask one follow-up.

Just, when you think about capital, I know you'd mentioned the current quarter's buyback as a good run rate. And If I run it through the model, that seems to see that you guys are going to continue to be accreting capital.

And you're about to enter your first year as a CCAR bank. I guess the question I have is, does -- are you -- is there -- are you changing at all the way you're thinking about your appetite to use your capital in a more strategic way?

I know historically you guys have done a lot of small deals and grown the businesses over time, but is there appetite for some small asset acquisitions increasing at this point, given your desire to leverage some of the excess capital?

Ryan, I'd say we're always in the market looking for opportunities. I think the key take away I would have, is those have to be the right opportunities at the right price.

And I've said it a number of times, we won't try and make deals that make sense, we won't try and make them make sense. So we're always out there looking.

I would say, we clearly understand that our shareholders are looking for returns of capital and we're working diligently toward that end. And we'll also look for great opportunities to deploy it.

So if we can find the right situations at the right prices, sure.

So a couple of questions. One is on the outlook slide where you indicate credit outlook remains relatively stable.

Could you just give us what that translates into, with regard to both NCOs and reserve, release or build or how you're thinking about that?

Well, Betsy, I'd say if you look at the record low 30-plus delinquency rate, that certainly bodes well for the future. And obviously, the reserve release during this quarter is indicative of an improved forward outlook for losses versus what we were expecting a quarter ago.

But that being said, we think we're approaching a level where card charge-offs are about as good as they possibly can get. And so I certainly wouldn't be counting on a lot more reserve releases or for credit to trend much further from here.

And I think what we described it as, is maybe some stability at this point, which would be a great thing.

Yes, stability in the NCOs and then reserve, release just flipping to neutral, no release, no build? Or is there a build in the future?

Betsy, I would say at this point in time, as dynamic as this environment is, and I think you've heard me say before, in 50 years of history as a credit card as a product, we've never seen a situation like we have today. And so the precision with which models predict is not as good as it would be in normal times.

So I want to be a little bit hesitant to call terms here. One way or the other, I think what I'd say is, mathematically, there's only so much better credit could get, if it can improve.

What we don't see at this point in time is we don't see any signs of a deterioration in the environment in our crystal ball, as we look to establish our reserves. So I would say that.

And then I'd just remind you that we are generating some meaningful loan growth as well and at some point in time, that will cause us to return to a build-in provision even if the credit environment doesn't.

I'm going to ask a couple of questions right upfront. Just on the share buyback.

I guess I'm a little surprised you guys are targeting a level of buyback that's not much higher than last year, yet fundamentals seem to be stronger. I was just wondering if you could just talk about the rationale and potentially, having the opportunity to amp that up a little bit more.

And then second, on the NIM, I know, Mark, you said, the NIM probably is slightly higher in the second half. I'm assuming -- you're assuming a continued decline in the default bucket.

And I think -- is it kind of safe to assume that, that bucket continues to pay down at this lower rate than what you've anticipated?

There's a bunch in there, Sanjay, I'll try and make sure I get it all. If not, come back at us here.

But I would say first of all, with respect to the buybacks. I would say, history being revisited a little bit is the answer there, Sanjay, you have to plan the buy outs in terms -- the buybacks, in terms of payout ratios, and then you have to plan them in terms of dollars repurchased, not number of shares repurchased.

So at the end of the day, credit has gotten better than we expected it to when that capital plan was filed and as a result, the payout ratios are lower than we expected them to be at the time that capital plan was filed. With respect to margin.

I would say that there's a number of different factors that are kind of driving my thought process there. This quarter, it exceeded our expectations kind of on all fronts.

Charge-offs of accrued interest were lower than we expected, funding costs were better than we expected, and the current yield came down less than we expected. A portion of that being slower attrition in that high rate bucket that you alluded to earlier.

Looking forward, I would say we continue to see credit being relatively benign and funding costs, obviously, being a meaningful good guy here in the back half of the year.

Just one quick follow-up on the share buyback. I mean, is there an opportunity to go back and potentially ask for more, given the improved outlook on credit?

Theoretically, there is that ability to go back and ask for more. Sanjay, I would say, at this point in time, as close as we are to kicking off the cycle for the next capital planning process and the like, I think our judgment, our assessment, at this point in time, is we'll wait until the capital planning process comes back around again.

I was hoping that you could provide a little more detail on what's going on in Europe. Are these banks or franchisees that you're supporting, I mean, are they looking to walk away from Diners without an increased level of support?

And is this a drag we could see increase if Europe doesn't begin to start turning the corner any time soon? And secondly, is there anything that you could fathom from tomorrow's regulatory release that you could imagine impacting the Diners business?

Yes. I would say that we have a mix of bank and nonbank franchises in Europe.

And some of them assumed the franchises after Citi exited, being the owner of the franchises and some of them have had some liquidity or funding challenges just as so many small businesses and businesses generally across Europe have had recently. And I couldn't generalize across Europe because we have some very strong major banks who are franchises in some countries and obviously, they don't need the same type of support even in the same environment.

We, I'd say, this quarter, we certainly took the ones that were on the problem -- deepest on the problem list we dealt with this quarter. So we do think that this is a one-time, with respect to certainly this magnitude.

But on a much smaller scale, we would certainly expect this to be an ongoing, but smaller, operational drag for some period of time in Europe. Now, Diners Club Europe is about 3% of our total payments volume and about half of that is corporate, a little over half of that is corporate volume, which may not be impacted by the recent legislation as much as credit and debit is likely.

But we will certainly be spending some time understanding the impact of that on the general market in Europe. So bottom line is, I don't see Europe turning around real quickly, but I also don't see it being a major drag in the big scheme of things for Discover.

Yes, I would just add to that one that of the total Diners volume, the volume sitting in troubled franchises is only about 5% of the total volume, so it's not significant.

I wonder if you could just talk about the growth opportunity in credit cards as we go forward? Another solid quarter this quarter, it seems like you're doing a little better than the industry but just given the recent macro indicators, it seems like we have this potential for better organic growth.

And I would also like if you could potentially give us any metrics or performance updates on your "it" campaign and how that's going.

Sure. Well, I think the most important growth measure for us is loan growth in cards and I'm pleased that we, once again this quarter, we're at the high end of our 2% to 5% year-over-year growth in card receivables.

And against the backdrop of pretty much no growth in the industry, I feel very good about that. I think that when I think about the impact of "it," I would most point you to that metric.

Our "it" new accounts and campaigns are not the only thing driving loans up but they're certainly a very important factor. And I think the differentiation, the focus on rewards and service, I think, is paying off and is causing us to gain share in cards, even with a lack of loan growth in the market generally.

So going forward, on the one hand, we're going to be dealing with some tougher year-over-year comparables for our loan growth in the next few quarters, but I certainly hope that we can stay towards the high end of that range. I have not yet seen statistics that show that the overall industry will really return to growth.

If it did, that would obviously benefit us. But everything I see so far suggests, maybe, the deleveraging has stabilized or stopped.

But I haven't seen anything that has turned around the other way to cause consumers to start growing credit card loans at this point.

Okay. And then a follow-up.

Any material changes in the competitive environment? It seems like credit cards, despite the incredible returns you're generating across the industry now and record losses and low funding costs, competition doesn't seem to be anything more than it's been in the most recent history, relative benign.

Any changes there and any comments you have on your balance transfer programs? It seems like it's relatively stable, I just want to make sure you're not seeing any changes there.

I'd say generally stable, competitive intensity. As we've said before, I think this year, we've seen -- and probably in the last few years, we've seen more intensity on the competition on rewards and reward cards, probably more so than people doing crazy things on either price or credit.

And so certainly, I've been pleased with our ability to grow even while keeping our rewards cost at a reasonable level. With regard to balance transfer, one of the benefits of Discover it, is that we have been more focused on some of the differentiated features and the rewards program and the service levels.

And while we certainly offer balance transfers, we're seeing a lot more retail activity and less balance transfer activity on those new accounts. And so I'd say that our growth is being driven more by non-balance transfer activities than it has been in the past, which is causing that percentage, that promo, to somewhat stabilize and that is in turn, somewhat helpful to the higher net interest margin that we reported today.

Yes, if you look -- just add a little color to that, if you look at the year-to-date, the loan growth that we've posted, somewhat less than 40% of that loan growth has been related to balance transfers. The rest has all been standard merchandise.

David, I was wondering if you could talk a little bit about where you are with the PayPal initiative, if there's any update at all? And then also, card spend into July, has that been generally pretty steady from what you've seen in Q2?

Sure. Well, I'm pleased with the progress we're making on PayPal.

We've signed over 50 acquirers and we're actually processing some transactions more on a test basis, but it's working. But there's still a lot of work ahead of us.

We've got a lot of acquirers to sign, a lot of merchants to sign and board. And so this will take us some period of time before we see PayPal do their big launch and that will really be their decision as to exactly when.

So progress, but a lot -- the majority of the work, I'd say, is still ahead of us. In terms of card spend.

The last 6 or 7 weeks have been a bit encouraging, I guess, if I look at our volumes. We saw a little bit higher year-over-year growth in the last month of the quarter, which kind of contrasts from the first quarter where our best quarter was January -- or best month was January.

So on the one hand, it feels like we might have a little more momentum building. On the other hand, you still see a lot of mixed economic data coming in, and so I think we'll need to see if that continues and really forms into a trend over the coming months.

And Don, I think, just to add some metrics around what David was saying earlier. I think right now, we signed up a little bit, somewhat north of 50 acquirers in the PayPal transaction.

And there's about somewhere north of 250,000 merchant outlets that are now accepting PayPal as well.

I wonder, could you talk a bit about the opportunity in Affinity? And kind of how does it -- how does what's being offered today compare to what was common when you were at another company in the past?

Are the economics better for you today? Or are you offering rewards?

Are you having to pay somebody to help you find partners?

Well, I think now that we're up to 6 Affinity groups, I'm not sure I would compare that so much to MBNA, which had thousands at one point. We're still in the early days here.

I think certainly, the fact that you just saw us launch 5 more suggests that we're reasonably pleased with our first one, which was Ducks Unlimited last year. But I'd say we're going to take a measured approach.

And I would say it will be quite some time before we see any material number of new accounts or growth coming from this channel. The vast majority of our marketing is going to continue to be "it" and then to it -- Discover it, and to a lesser degree, our gas and airline cards, some of the others.

But over time, I think this could be an important channel for us. We've seen competitors really back away.

We've seen a lot of dissatisfaction with service. And service and rewards are what we are very good at and is what is really important to Affinity groups.

So I think we are entering, at this time, because there seems to be a real market demand and a fit with our skills. And we hope to gradually build this into a another leg to the marketing stool over time.

And then could you just update us on where you stand you think, in terms of increasing merchant acceptance in the U.S.? Are you very far along, are there still lots of opportunities, do you think, or...

Well, obviously the opportunities are diminishing as we sign those holdout merchants. We -- I can't give you the name right now, but we just recently signed, probably the largest single holdout merchant.

And by the end of this year, we'd hope to bring that merchant on board. And we continue to work with all the acquirers with some great activation and boarding programs to get, not only acceptance, but signage and activation of merchants.

So it is something that I -- that we continue to focus very much on to close those last acceptance points. One of the newer sales pitches we have is frankly, the potential for some of the newer partners to provide more usage whether it's PayPal or next year, as we launch Ariba, obviously we'll be focused on some of the more business-oriented acceptance points that may have an interest, given Ariba's strength in that space.

So I think leveraging all these new partners to get the -- those final outlets signed is something we're very focused on.

I just had a question in terms of your provisions again. If I look back in Q4, I think the provisions were higher than expected, and you've given commentary on why those were lower, I think in Q1, there was some element of the newer vintages.

As the seasons were coming on at lower losses than what you had originally expected. So as you think about your new accounts and you're booking them, the question I had was are you booking the provisions for those newer vintages to the newer lower curves, or are you allowed some sort of fudge factor, if you will, for lack of a better word, to take into account some of the uncertainty and the fact that we're in this low charge-off rate environment, as you think about your provisions for losses?

I wish we could use more judgment, Sameer, on setting reserves than we're actually allowed to, but GAAP is prescriptive on this one for us, so we are setting them based on what actually our credit loss forecasting model shows us we should be expecting. So they continue to be better than we expected.

That bump up in the fourth quarter was really because we thought we were expecting a bit of a return to normalcy over the course of this year at that point in time and that was factored into our models. Removing that when that became clear that, that was not indeed materializing.

And that has resulted in where we are in right now. No, no, please go ahead.

Okay, and then just another question. Another topic was on your utilization rates.

And it seems like, based on David's commentary also, it doesn't seem like there's much of a definitive styling of anything that consumers are levering up again or borrowing more and as you said, you're growing faster than the industry. But I guess the assumption would be that your utilization rates have not picked up.

And when you price for your balance, your teaser rate offers and you think about utilization rates, I mean, do you assume a meaningful pickup in any of the utilization rates on those accounts, or are you being conservative there? Because I guess, the concern is that as these accounts roll off with a teaser, and you have some sort of assumption that utilization rates will pick up and the economics of those accounts would maybe improve over time.

Those may not materialize. I mean, how do you think about utilization rates, given the kind of environment we are in at this point?

Well, you've got a lot in there. I think in terms of overall -- I don't see higher utilization rates right now in the industry.

I'm not seeing total loan growth growing at this point. I think that if I look at Discover it, and that's where the vast majority, or most of our new accounts are coming from today, if I look at their utilization rates, they are actually markedly different than some of our previous vintages.

And within that, I'm seeing higher activation rates, higher retail spending per account and lower balance transfer per account. And I would say that one of the things that we were counting on, that we tested last year with the product and then has borne out so far this year, is that we could get enough increase to activation and usage to be able to back off a bit on balance transfer and to offset some of the loss of income for some of the -- not repricing if someone goes delinquent or to post payments as current, if we get them by midnight through any channel.

So less late fees. So it's a better value proposition for consumers and so there's higher utilization that we think will offset that.

And we believe that is largely playing out, that we've got pluses and minuses. But on net, given what's going on in the industry, we have to gain share and we're doing that through a highly differentiated product in Discover it.

I'm trying to make sure that I understand all the commentaries surrounding the Diners charge. Mark, I thought that I'd heard you, when you've talked about it previously, kind of characterize it as one-time in nature.

But David, I thought I'd heard you say during your comments tonight that you expect an ongoing operational drag from Diners in Europe. And then I guess when you combine that with the fact that you guys added a line item to the Payment Services segment called provision for loan losses, where, in the past -- it's a little bit kind of confusing to me because in the past, I've always looked at this as a line where there was no credit risk.

And so I guess, when you put all that together, are we to kind of expect that there's going to continue to be a number here, going forward in future quarters for future reserve builds or future provision relating to this segment. Could you maybe just give some commentary around that?

Yes, no problem, Bill. I guess what I would say is a couple of things.

Number one, the $55 million charge we're taking this time is clearly one-time in nature. And I would say, is there an operating expense drag associated with bringing these franchises on to our books, Italy and the processor that comes along with Italy on to our books at this point in time, the answer is yes.

There's a very modest operating drag. I would say it's not material to DFS overall, which is why we specifically have not called it out.

But there will be a modest operating drag associated with that. The line item that showed up in the Diners P&L or the payments P&L that you're specifically referring to is not related to consumer or corporate credit extensions to cardholders.

It's related specifically to the loans we had extended to those franchisees when they began encountering difficulty, to try and get them over the hump, as it were. So that was the thought process behind that and that's what those are related to.

I guess the best way I can help you size it is again, to say that yes, there's a modest run rate drag, but it's not material to DFS overall. There's about $40 million more of these loans outstanding roughly and that's it.

So that's a very modest number as well. And I would anchor you back to that only about 5% of the total Diners volume is sitting in franchises we consider to be troubled today.

So are there a couple of European challenges around Diners? Yes, you bet there are.

It is something that's going to materially drive our run rate earnings profile in a bad direction going forward? No, I don't see that either.

To be clear, Mark, I think the $40 million -- $40 million gross loans, of which we've impaired $15 million.

That's correct. That is correct, thank you for the clarification.

So that's not a huge net.

That's correct. Thank you, David, I appreciate that clarification, yes.

And then I guess the other question I had was within student -- private student lending. We saw delinquency rates went down, but we saw a little bit of an increase in charge-off rates, both excluding PCI and as well as just the reported rate.

Can you talk a little bit about that? And could you give a little bit of commentary on -- there was an article that I saw about you guys giving -- expanding cardholder access to free ATMs.

Maybe if you could just comment a little bit on that and that's it.

I'll cover off on the student loan one, then I'll punt the ATM issue over to David to address. I guess what I'd say is a couple of different things taking place in the private student loan space.

I guess, first of all, we typically tend to see an uptick in losses in the charge-off rate from the second -- from the first quarter into the second. You can see, if you look back last year, that occurred as well.

What you have is an element of as these loans come out of deferral and then come in to a repayment period, you begin to see a lumpiness factor of that. A number of those folks will come back current again at some point in time.

But you also recognize you take the majority of the losses, you take, on a student loan account in the first 2 years after that loan comes out of deferral. So as we have a portfolio that's seasoning, what we've said is that we expect the loss rates to rise up above 1%.

They'll come back down over time. So our expectation is, yes, the charge-off rate spikes.

It's our clear expectation. You'll see that come back down again meaningfully next quarter.

But losses overall, we'll continue above that 1% level until we reach a stabilized level in the organically originated portfolio. And David, I'll kick it to you for the ATMs.

Yes. And you may recall that earlier this year, we launched Discover Cashback Checking.

And with no minimums and cash rewards on debit, bill pay and checks written. And in doing so, one of the features we had is we have access to a full million ATMs around the globe on our network.

But within that, we announced that we were establishing a network of no-fee cash advance or cash access locations. And these are ones that we don't charge an ATM fee anywhere, but these are ones where the ATM operator also doesn't charge any, so there's no fee at all to the consumer.

Allpoint, we've just added, was -- I think Allpoint announced it themselves yesterday, this week. And they -- that one is the largest single network and it's combined now with another network we had already signed.

And so together, we're going to be able to -- we are able to offer our customers access to a larger network nationwide of no-fee ATMs than even the largest single traditional branch bank in the country offers. So I think it's a very -- makes it's a very competitive offering and we will look forward to growing that checking account product in our current customer base this year.

And I look forward to sometime next year, launching it broadly to customers beyond the current Discover cardholder base.

I would like to revisit capital management. I realize, we're at risk of beating a dead horse, but it's an important issue.

Discover continues to have a very high capital ratio. You're accumulating capital at a very good pace, just given that credit is good and it looks like it's going to remain that way for a while.

I guess, understanding you're not going to go back in to see if you can top up the buyback this year. Do you think that as you think about the capital plan for 2014, there's an opportunity to be more aggressive in terms of what the payout rate would look like?

Do you think that the environment is such that, that has a good likelihood? Or do you think that you have to look at other strategic uses of capital in -- specifically around M&A?

what types of properties would you be most interested in looking at that would absorb the excess capital?

Yes. Ken, I would say, I think as we look to the capital plan, yes, we will look to be more aggressive than we were this year, would be our hope and our thought process.

I would say the plan itself, we were more aggressive than we're actually realizing. I think there's 2 things.

Number one, credit has gotten better than we expected it to and lasted -- that trend has continued longer than we expected it to. And number two, our stock prices had a great rise as well, associated with it.

So given that you have to plan payouts in dollars as opposed to payout ratios, there's been some constraining factor there. So we have not been able to achieve what we had filed and hoped to achieve, quite honestly.

Just to be abundantly clear about it. Going forward, it would be our clear expectation that we will learn from our mistakes.

We did better at it this year than we did the year before, but we clearly have room to do even better at it next year, would be my general sense. Then kind of talking about the M&A side of the equation, I guess what I'd do is I'd just kind of reiterate my prior comments.

I think when you start getting too excited about M&A is when you can make a lot of mistakes. Discipline is the keyword around this place when it comes to M&A.

So I would say, if we found the right opportunity, and that right opportunity was priced correctly, we would be as intrigued as we ever were to pursue that opportunity. But it would have to fit strategically, it would have to financially make sense.

What we won't do is stretch to make something make sense just because we have some excess capital.

And if I could just add, Ken, I think if you look at the fact that we actually took 6% of our share count out over the last year and increased our dividend from $0.14 a quarter to $0.20 a quarter, I don't think you see too many companies in financials who have actually had that level of impact with our current capital management. And I mean, I guess, it's a nice problem to have.

And maybe we wish we had done even more, but it's a pretty strong record of capital return.

Yes -- no, that's not meant to be a critique in any way. In fact, I think it’s very much a unique scenario that you have in front of you, just in terms of how things have played out on the credit front.

And these situations obviously have another, there's element here in terms of the decision-making, in terms of what can get approved. And I was trying to get a sense if you thought that the environment was one that you would be able to take up that payout ratio or not.

It's not meant as a critique, I think you've got a huge opportunity. I'm just wondering if the environment is ripe to take advantage of that.

So that's really...

Clearly, the current horizontal review process does not especially favor folks who enter it with excess capital. Let's put it that way and we're going to work diligently to try and increase the returns.

Most of my questions have been asked and answered. But one of the topics that you did talk about, David, that maybe you could revisit a little bit, is this idea of competition.

I mean, you mentioned, actually, that strong balance growth, the industry is kind of maybe getting a little better but still not anywhere near where you guys are at an attractive cost per account and less reliance on balance transfer. I mean, anything else that you can kind of talk to?

Because I mean, you don't -- every single day, you see another kind of cashback card being thrown out there. So what -- how have you been able to achieve that?

I mean, it seems like an even -- I guess, an even better performance given the backdrop.

Well, thank you, we're proud of it. I would say that number one, we focus very hard on being the leader in cash even though there's a lot more people in the space.

And I'd say, the other thing is there's a lot of execution beyond cashback bonus, providing great service because it's a lot easier to grow when you're not losing people out the back end. Having very strong credit environment process to make the right credit decisions on the front end and I think, even the execution of our advertising campaign, our sponsorships of the NHL and college football, all of these things work together.

And I think the thing that we're focused on is not just executing for today, but planting seeds for tomorrow. And so you're seeing us tiptoe a bit into the Affinity market and do some things that we think will help us to continue to be able to gain market share over the long term.

Not standing still, but being an innovator.

And maybe just to follow up quickly. I mean, what would you consider a success over 2 to 3 years, from the Affinity channel?

I mean, how would you kind of think about framing that?

I would not venture on anything on that. We're still in the early days.

I mean, we're in Affinity group #6. And so, I mean, we wouldn't have done it if we didn't think that it couldn't be important over the long term.

I would think more about what it could be over a 5-year term. And I think over a 5-year term, we have some good aspirations for it.

But I think, this year or next year, it's not going to make much difference. Discover it is going to be it.

I have one question on the rewards element. And I know you've given commentary about the sort of 1% or 100 basis points for the full year.

But just trying to understand how much of the volatility in the rewards level is driven by the 5% rewards program that rotates through every quarter. Is that a big chunk of it?

Or do you have just a whole portfolio of rewards programs that cause the number to move around?

It is, in fact, promotional rewards that causes volatility. As you would expect, the underlying programs are quite stable quarter-to-quarter.

And the 5% is our biggest single promotional aspect. We have others related to new accounts.

We have programs with individual merchants and special redemptions, so there's a host of promotional activity designed to try to get people to make Discover their primary card, to use us in categories that they may not be using us in historically. And so that will cause it to fluctuate and as you'd expect, we tend to have more of those promotions around the holiday season, which is one reason you see, generally, a little lighter time in the second quarter and a little bit heavier in the second half this year -- of the year.

And then just one quick one on the home loans. I understand we're in a different mortgage environment.

Can you talk a little bit about the flexibility you have on the expense side on that business in a different rate environment?

Yes. I think, like all kilty [ph] businesses, there's a much greater degree of flexibility in some of those businesses than there is in others.

I would remind you that for us, this is a pretty small business at this point in time and we are building it up for what we want it to be as opposed to having been feeding at the trough and now looking to pare back expenses. So I think we'll be prudent managers.

As it relates to that, we definitely have some flexibility. But I wouldn't think we would be taking actions to the magnitude that some of our competitors have, shall we say.

Just a little bit of a strategy question. The structural changes that we've seen over the last couple of years seem to be driving down loss rates through lower frequency of default, as opposed to severity of default.

Given that trend and what you guys are seeing, do you feel comfortable widening the credit funnel just a little bit? Because it seems that for each borrower who's out there, the probability of default seems to be structurally changed.

Well, certainly, the lower frequency has been the bigger driver, although the average losses also declined over time. And I would say that where we can find pockets of being able to approve people for accounts that we think will produce the right returns and the right loss characteristics over time is a dynamic process, and we're always fine-tuning those models.

But I would say we're also being cautious because we know that losses will not remain this low forever. And -- but yet, we're going to need to live with our credit decisions today for a long, long time.

Especially given the fact that we tend to retain our customers for a long, long time. So we are not just going to reduce our credit standards to try to get the overall losses back up to the level they used to be.

Instead, I think that there will be a new lower level of losses in the industry and in our company and it's a little hard to tell exactly what that is, but it's certainly lower than history.

I apologize if I missed this during your prepared remarks, but could you discuss the decline in the transaction processing revenues? Was that related to the merchant routing competitor actions that you referred to?

And if so, is there a potential for a little bit more of a decline in that as the kind of actions of your competitors kind of shake out?

Well, I think that PULSE has gone through a period of great share gains and growth over the last 6 or 7 years, generally. But I think we are, right at the moment, in a much more challenging time because of some of the rules tying PIN, debit and signature together.

Some of the pricing strategies are fixed and variable, designed to really benefit a 70% market share player. And we are doing our all -- absolute best to maintain volumes and margins.

But we're going to continue to be under assault here for a while. We've got an awful lot of strategies.

I was real pleased that we announced our second signature issuer this quarter. And so -- being the only PIN network that also has a signature strategy and being able to compete in signature, which represents about 2/3 of the total U.S.

debit volume, I think is an important part of that strategy. But focusing on our individual pricing, the partnerships, how can we add value, working with issuers, working with acquirers, working with merchants, we're going to be pulling all those levers, but I do not -- I do expect PULSE's volume to be down year-over-year.

And that's the first time we've been in that position, probably, since we bought the company. But what we're focused on doing is turning things back to a growth opportunity for the longer term.

Okay, that's helpful. And then a second question.

It looks like the protection products revenues stabilized, at least Q-over-Q. Has that bottomed here, or is there still room for a little bit more attrition in that revenue?

I would expect you'll see continued attrition in that revenue. In the first quarter, I think it was a little bit greater than we expected because there were some customer refunds that were issued in addition to the impact from the discontinued sales.

But we've got a big interest [ph] trading book. And since we discontinued sales, the top of the funnel was not being refilled, if you will.

So we would expect that over time, as cancellations occur or as deaths occur, whatever the case might be. That book will begin to attrite until such point in time as we make a decision about reentering the marketplace.

David, I just wanted to follow up in your response to that prior question. With regard to the trends at PULSE and the fixed versus variable fee among your big competitor, would you consider legal or injunctive relief to try and pursue some remedy, relative to their pricing strategy?

And I have a quick follow-up after that.

Well, I'm not -- I would say that we certainly look at all of our options. I think the primary focus is doing everything we possibly can do from a competitor perspective and that's where our -- that's where our primary attention is.

Okay. So just to finish that.

Do you anticipate that the Department of Justice inquiry in this very area will lead to some relief for PULSE?

I couldn't speculate on what the Department of Justice may or may not do.

Okay. And then as a related, but slightly separate question, Mark, the Payment Services expenses on Slide 7 did accelerate this quarter.

I'm sorry if I misheard this, or if you didn't reference it. But it did increase in excess of the decline in the revenue, I was just wondering if there was some more color on that, the $37 million going to $86 million?

Yes, that's going to be the charges related to Diners. The one-time charges that we're taking this quarter that are flowing through that segment of the P&L.

It was around $40 million in operating expenses.

The growth rate in consumer loans seemed to pick up a little bit this quarter. And you also talked about entering the home equity market.

And so I was wondering if you can maybe give a little bit of an update on the consumer loan business and your thoughts. Why did it accelerate this quarter?

And then your thoughts around entering home equity.

Well, I would say that, kind of what I said before, I mean, we're at the high end of the range on card growth that we had expected. And I'd be thrilled if we can maintain it at close to the high end of that range.

I'm not sure that I would, at this point, count on it accelerating beyond the growth track. And the fact that we're the fastest-growing of the major card issuers, if we can hold this kind of level, I'd be really pleased.

With respect to home equity, we do expect to enter that business next quarter. And I wouldn't expect that to be a big contributor to loans this year.

But certainly, it should be a contributor next year.

David, I thought my -- maybe I misspoke. I thought -- now at the consumer loan business, I wasn't -- I didn't mean credit cards.

The acceleration -- sorry...

I'm sorry, personal loans. Personal loans, yes, we have seen great results in that business and certainly, there's still a good number of consumers who want to consolidate and pay down debt, which is the primary focus of that product.

You can see in the credit metrics that it's performing very well for us. And so we did intentionally make some additional investments to grow that business a little bit faster.

And I was pleased with the results this quarter.

And you expect that to continue?

I expect it to continue to be the highest percent year-over-year growth of our loan businesses for some period of time.

Then last question. Could you just remind us -- remind me what the primary differentiators are for the "it" product?

And how unique it is and how sustainable that advantage is?

Well, I'd encourage you to go on our website and apply and experience it yourself. One of the things about Discover it is that there's a whole page of differentiating features.

So that's why I can't just say, "Well, it's these 2 things." There's a whole series of them starting with the great rewards program, including lower fees, higher service and even a cool look for the card and how it's delivered.

And it's a total package of differentiated features and one of the things that we tend to use in our marketing materials is one that shows how each feature compares to a bunch of major competitors. And there's a few that are unique across all competitors, but there's a bunch where only one other competitor has it.

So the fact that we've sort of brought some unique and some the best of everything is how we designed it and why I think the appeal is so great for consumers today.

And Bob, if you go out to our Investor Relations website and pull down the Investor Day deck, the page that David is referencing is contained in that deck.

I just had a cursory question on recoveries. It seems like recoveries are beginning to trend down the last couple of months, but we're still way above historic levels.

I assume as we move further away from the bulk of charge-offs and the crisis that we can expect that to come down a little bit more. And I know you haven't typically sold those charge-off loans.

But can you give us a sense of kind of the magnitude or the duration of the expected normalization of recoveries?

Well, that last point you mentioned is important, that we don't sell our recoveries. And that's one of the reasons the recovery stream has held up better because we didn't sell them and recognize a gain a few years ago like almost all of our competitors did.

But certainly, as we move further and further away from the crisis and the peak of our charge-offs, we will have less and less inventories and those will be older. And so we certainly expect recoveries to diminish over time because charge-offs are so low now, we're simply not adding fresh charge-offs to that inventory, that could lead to recoveries.

Thanks, Larissa. As a reminder, the Investor Relations team will be here this evening if you guys have any additional questions.

I want everybody to have a good evening. Bye.