Sep 25, 2008
Executives
Craig Streem – Vice President Investor Relations David Nelms - Chief Executive Officer Roy A. Guthrie - Chief Financial Officer, Executive Vice President
Analysts
[David Hopstein] Sanjay Sakhrani - Keefe, Bruyette & Woods, Inc. Sero Bettini - Credit Suisse [Shane Daneen] - Pershing Square Capital Bradley Ball - Citi Investment Research Michael Taiano - Sandler O'Neill & Partners, L.P.
Craig Maurer - Calyon Securities (USA) Inc. Moshe Orenbuch - Credit Suisse Securities Michael Cohen – Sinova Capital John T.
Williams - Macquarie Capital Bob Napoli - Piper Jaffray
Operator
Welcome to the third quarter Discover Financial Services earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s conference Craig Streem, Vice President of Investor Relations.
Craig Streem
I want to begin by reminding everyone 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 AK report and in the company’s Form 10-K for the year ended November 30, 2007 which is on file with the SEC.
In the third quarter 2008 earnings release and supplement, which are now posted on our web site at discoverfinancial.com and have been furnished to the SEC, we have provided information that compares and reconciles the company’s managed basis financial measures with the GAAP financial information and we explain why these presentations are useful to management and to investors and we would urge you to review that information in conjunction with today’s discussion. Our call this morning will include formal remarks from David Nelms, our chief executive officer and Roy Guthrie, our chief financial officer and of course we will have plenty of time for a question and answer session.
Now it is my pleasure to turn the call over to David.
David Nelms
I am going to begin with an overview of our third quarter results and then cover a number of topics including credit, receivables growth, our merchant acceptance strategy, and also the performance of our payments business. Roy is going to then give you more details on our results and then we’ll both take your questions.
Very simply this historically tough environment for many financial services companies and consumers, given that environment, our business model has enabled us to turn in another solid quarter with net income from continuing operations at $179 million or $0.37 per share. We achieved this strong performance in the key areas of growth, margin, and expense management offset by higher loss provisions reflecting the current environment.
Touching on some of the highlights, receivables growth came in at 6% and revenue net of interest expense was $1 billion 6, up 14%. Our continued focus on expense control bore fruit again this quarter with non-interest expenses down 2%.
Our payment segment achieved pre-tax income of $29 million, significantly above last years level, in part reflecting the contribution from two months of Diners Club results. Offsetting these very positive factors was the significant increase in our credit loss provision, up over $300 million from last year, which reflects the weak consumer credit environment and growth in our on balance sheet loans.
Turning to the specifics, let me begin with more detail about our credit performance. First and foremost our quarterly credit performance continues to track with our expectations with charge-offs for the quarter at 5.2% and we remain comfortable with our fourth quarter guidance for charge-offs in the mid 5% range.
Our 30-day plus delinquency rate was 3.85%, virtually flat sequentially, while charge-off rates continued to rise. This is different than the traditional pattern because a greater percentage of delinquent accounts are now flowing through the delinquency buckets and into charge-off and also because of an increase in consumer bankruptcy filings.
We believe these trends reflect a contraction in the availability to consumers of alternative forms of credit as well as stress in many consumers household cash flow. We are pleased that our credit performance continues to be among the best in our industry, reflecting our disciplined growth and highly seasoned portfolio, our favorable geographic distribution, and our use of sophisticated analytical tools in our underwriting and line management processes.
We also feel we have an advantage due to our in-house collections staff who serves us and our card members’ very well, particularly I this time of stress. Turning to sales and receivables growth, results came in a bit stronger this quarter as card members took greater advantage of Discover products and programs.
As an example, nearly $4 million customers signed up to earn a 5% cash back bonus on gas purchases this summer using our Discover More card. Offered right in the middle of the midst of the spike in oil prices, this card helped our cardholders get some relief from the pressure at the pump.
Balance transfer volume was up this quarter about 11% year-over-year. We continue to be very selective with our balance transfer efforts with somewhat shorter durations and we also continue to offer existing customers closed end personal loans geared to debt consolidation.
I am also especially pleased with the strength of our direct to consumer deposit business which we expanded by over $1 billion this quarter. Recently consumer demand for Discover Bank deposit products has increased and given the very attractive characteristics of these products we expect to continue to emphasize this source of cost effective funding and strong customer relations.
In terms of our merchant acceptance strategy, in the third quarter we added an average of over 175,000 new merchants per month. We now have agreements in place with 88 merchant acquirers which represent an estimated 98% of the bankcard sales volume in the US and we continue to rapidly implement with these partners.
The last subject I want to cover is the performance of the third party payment segment, which continues to do extremely well and now includes the results of Diners Club International. Total volume for this segment in the third quarter was $35 billion, up 48%.
We had another great quarter with volume of $28 billion up 27% as we continue to benefit from new issuers and increased volume from existing relationships. Our Discover Network third party issuer business is also growing nicely with volume up $1 billion 7, up 15% from last year.
We are seeing good momentum in this business with volume for the last four quarters totaling over $6.3 billion. Diners Club contributed over $5 billion to our volume this quarter.
Now with two months of Diners Club under our belt we are even more excited about our licensee partner relationships and the future benefits of combining our networks and taking advantage of global opportunities. Before I turn the call over to Roy I want to comment briefly on two matters: the various regulatory and legislative proposals and our litigation with Visa and MasterCard.
We have seen the large amount of credit card related legislative and regulatory activity this quarter and we are providing comments and data on these various proposals. We remain hopeful that the fed will put appropriate regulatory measures in place by year-end.
Regarding our anti-trust litigation seeking damages from Visa and MasterCard, the trial is now set for October 14 and we are ready to make our case with the jury. Now let me turn the call over to Roy for his comments.
Roy Guthrie
In my comments this morning I am going to amplify just a few of the things you heard David cover and then give you an update on our funding and liquidity of the business. The U.S.
Card segment earned $245 million pre-tax this quarter as we have seen higher loss provisions offset the strong gains in our net interest income, as you heard David say. Also the reduction we saw in non-interest expense year-over-year.
Interest margin was 8.95% and up 116 basis points year-over-year and roughly 70 basis points of that was pure margin expansion while about 45 basis points was attributable to the inclusion in net interest income of the balance transfer fee amortization, which I mentioned to you last quarter. On a sequential quarter basis the margin adjusted for those fees was essentially flat.
Other income in the card segment was basically flat, but it had an increase due to the lift in sales driving our discount and interchange revenue, but was offset by the loan fee that is now being included up in net interest income. Also in other income there was a $34 million charge for the unfavorable revaluation of our retained interest in securitized assets.
Last years quarter included a $24 million charge, so we’re looking at about a $10 million negative swing from this item in that line year-over-year. Loss provisions were up $336 million from last year reflecting higher charge-offs, but also reflecting reserve additions for our current quarter receivables growth and a further increase in the reserve rate.
This quarter we added $113 million to loss reserves in excess of our charge-offs versus a reserve release of $15 million last year, so that represents a $128 million swing in the year-over-year comparison. As David mentioned we had continued solid growth in the quarter in our non-loan card products, so principally closed end installment loans which are now about $1 billion.
This product is an important compliment to the balance transfer activities in the card business as we respond to our customers needs for debt consolidation with a closed end product. David discussed the volume levels within the components of third party payments, so I’m really not going to expand on that, but I do want to comment briefly on the contribution that Diners has made to the quarter.
As you know we closed the Diners Club acquisition on June 30, so we’ve got two months of the business in our results this quarter. Diners Club contributed about $7 million pre-tax, it’s in the payment segment for the quarter, and this is a lot higher than the guidance that we gave you of that $10 to $15 million per year when we announced the deal and I’m going to talk a little bit about that.
Because we closed the acquisition so recently, we’ve really only just begun to incur the costs that we’re going to need to incur to fully integrate Diners Club with our other networks. Additionally we expect to invest more in marketing to support the licensees around the world, so you should not assume that Diners Club contributions of this segment are going to be at this elevated level ongoing.
Before I go on to discuss funding, I want to comment on the effective tax rate briefly, which was just under 355 this quarter. We had a settlement in one particular state of an outstanding issue that resulted in a one-time tax benefit so this quarter’s tax rate is lower than it otherwise would have been.
Going forward I would guide you back to that 38% level that you’ve seen in the quarters preceding this one. So in terms of funding, the capital markets continue to be under a high degree of stress with credit card asset backed securities marketed continuing to be characterized by fewer players, by wider spreads at issuance and shorter terms.
During the quarter we did a five year fixed rate AAA deal for $750 million and also sold just over $400 million into a partner banks conduit facility. We also established a new $750 million bank conduit facility during the quarter, which brought our total open capacity in partner bank conduits to $1.5 billion.
At this point we’ve got contractual relationships with sponsors of six conduit programs, all very large global financial institutions, all of which have significant experience in the product. We are very comfortable with that line up.
Over the last few months we have seen execution levels in the capital markets pass significantly through the levels at which we can borrow under our deposit programs and therefore you have seen us turn towards our deposit programs to fund the business. As we mentioned in last quarters call we have $2.6 billion in term asset backed security maturities coming up in our next quarter, in the fourth quarter, and that is an unusually high level for us.
To put that in perspective I think we’ll do about 10% of our entire ABS book and pretty much equal to the entire 2009 term maturities of $2.9 billion. So with present market conditions being what they are, we expect that some or all of the fourth quarter maturities of $2.6 billion will be funded by our deposit programs, which has two effects to the income statement: first the assets come back on the balance sheet, so we would have to book reserves against those assets.
Second, to the extent the receivables come back on the balance sheet we would have to write down the remaining IO receivable associated with those maturities. As a result, our fourth quarter could have a far greater level of reserve additions and IO write-downs than what we saw here in these third quarter results.
Another note on the fourth quarter is where LIBOR is positioned. Our third quarter master trust LIBOR resets were around 40 to 50 over fed funds at the 2, 240, to 250 sort of level and presently LIBOR is positioned significantly higher; so this could affect our interest expense and IO valuation in the fourth quarter as well if we see those elevated levels remain.
Total deposits reached over $27 billion at the end of the quarter with about $5 billion of that coming from our direct to consumer program. The direct to consumer deposit funding program is a very important channel for us and we continue to grow it through the direct marketing, which is classical being in the way we’ve been doing it, but as well as through affinity relationships such as our new relationship with AAA.
So in the quarter, direct to consumer deposits grew $1.1 billion and as such this channel is now beginning to make a real contribution to our liquidity and funding. So the growing presence of our direct to consumer capability really compliments the distribution we’ve had for many years through the US wealth management system which represents the other $1.1 billion of deposit growth in the quarter.
In this program we work directly with six major financial institutions as well as indirectly with a larger external selling group representing about 200 broker dealers, all of which distribute insure Discover Bank deposit products. In addition to ramping up the level of deposit issuance in the quarter, we have also been successful in lengthening our certificate of deposit maturities with the average maturity of 27 months at the end of this quarter, up from 22 months last quarter.
Given our strong presence in the deposit markets and the relatively low level of asset-backed maturities we see in 2009, we are well prepared to fund our business through 2009, principally through our deposit platforms. In terms of liquidity, at quarters end we had $1.5 billion of unused conduit capacity; I mentioned that previously and the $2.5 billion revolving credit facility is still in place and in addition we had $5 billion of AAA capacity in our master trust.
We have taken our cash liquidity up $1.2 billion during the quarter to $9.6 billion, in effect pre funding a portion of the fourth quarter ABS maturities I mentioned previously. We finished the quarter with over $5.5 billion in tangible equity and the ratio of tangible equity to net managed receivables came in at 11.2%, down just a bit from the previous quarter due to growth and the fact that a portion of the Diners Club purchase price was recorded in intangible assets.
So our capital position remains stable and strong and we’ll continue to maintain a cautious posture towards capital given the present environment. Last week we declared a $0.06 dividend to our shareholders; that’s consistent with the levels that we’ve paid since becoming public.
And as I said last quarter, we will not be active in our share repurchase program until we feel better about the overall market environment that we’re operating in. In response to your questions that we’ve received, I wanted to comment just briefly on our exposure to other financial institutions.
Our $2.5 billion bank revolver is comprised of 25 global financial institutions, with the largest participant being less than 7%, so that’s very, very well spread. At the end of the third quarter we had a small book of swaps which is expected to continue to shrink as it has over the last year and the net mark-to-market on that position at the end of the third quarter was a $2.5 million receivable, a very small amount there.
Finally, the investment portfolio has no direct exposure to mortgages and is principally invested in prime and government mutual funds and major bank short dated fed funds sold, so a very solid position there as well. To wrap up, given the stresses of the market, I would echo what I think David said and that is that I think we had a solid quarter.
That concludes our formal remarks; I will turn it back over to you, Keith, for the Q&A.
Operator
(Operator Instructions) Your first question comes from [David Hopstein].
[David Hopstein]
Could you give us a sense of how much residual is associated with those securities that are going into repayment in the fourth quarter? Then also could somebody talk about the loan growth in the quarter and sort of how much of that wasn’t solid wasn’t clear and really what’s happened in this quarter that’s made you more comfortable growing the loan portfolio, for you really haven’t grown over the last year until this quarter.
Roy Guthrie
The aggregate, in the statistical supplement we’ve shown you the aggregate asset which is now positioned at $408 million, $408.6 million. The relationship between that asset and the investor’s interest or the outstanding asset backed securities is about 1.4%.
So what I would guide you to, if you use the averages, was simply to take 1.4% of the maturities and that would give you and indication of the IO write down.
[David Hopstein]
And you would write that off completely.
Roy Guthrie
Yes, 1.4% of the maturing ABS.
David Nelms
In terms of growth, I would say first we have continued to grow; we’ve just been very controlled in that over the last year. Over the last several years our growth rate has been any where from 2% to a 5 or 6% each quarter on a year-over-year basis.
This quarter was a bit higher and what I would say though is that the bulk of that growth was from sales, about $1 billion 5, about $700 million was from balance transfers, which were at a little higher level this quarter and the remaining between $3 and $400 million was from personal loans. The sales, I would say, came from two parts: one is some of the promotions I mentioned, our sales growth was a bit higher because of some of the positive things we put in place to help our customers, but I would also say we are starting to see some moderation in payment rate and I think some of that is some of our even high quality consumers are seeing fewer alternatives out there in terms of borrowing on installment loans or other types of lending.
But I would note that the payment rate remains quite high. You are looking back over a peak.
It had risen for five years plus and so it still remains very high compared to two or three, four years ago and so on the balance transfer I do expect the third quarter is likely the highest of the four quarters this year, but the big adjustment we made was in the first half and we continue to have very tight credit criteria. None of it came from any loosening, I can assure you, of credit criteria.
[David Hopstein]
As a follow up, Roy, can you talk more about the role rates and sort of what you’re seeing specifically as you go from bucket to bucket?
Roy Guthrie
Yes, I would he glad to. We first announced this maybe four quarters ago where we saw elevated rule rates start to define the way the loss profile was going to pan out.
I think you heard David say that we’ve seen sequential quarter, in fact for the last three quarters delinquency has been reasonably flat as measured both by 30-day and 90-day past due balances, but none the less, we have seen the loss ratio advance. So role rates are advancing, that’s clear to us and the credit team that we put against portfolio control.
It means that you need to move your collection activities up in the queues, and you need to emphasize a different pattern of things that reflect the lack of liquidity, again echoing one of David’s comments, the lack of liquidity that we see behind the consumer now that was otherwise there that’s creating a little slipperier slope.
[David Hopstein]
But in terms of if you try to relate today’s level of delinquencies and the ultimate charge-offs, do 30% cure today versus 50% before 30-day or?
Roy Guthrie
Yes, I’m not sure I’m prepared to really answer that with specifics because that is something that maybe we could guide you into in terms of our master trust data that would show you some of the statistics that are disclosed within that that would maybe help you solve through that rubric and Craig would be glad to help you with that.
Operator
Your next question comes from Sanjay Sakhrani.
Sanjay Sakhrani - Keefe, Bruyette & Woods, Inc.
I just want to drill down on that sales volume growth. How much of the growth came from kind of existing accounts versus new account additions?
I’m just trying to understand kind of what the core growth would be just from the existing accounts as well as x maybe the promotion that you guys had on the gas purchases?
David Nelms
It primarily came from current customers. We did not have an increase in our new account generation during the quarter and the new accounts we put on continued to have a 734 FICO score during the quarter, but there are a couple things going on.
One is gas prices, especially year-over-year are still elevated and so that drives some extra sales for us and then on top of that the promotion drove some and it’s frankly a little hard to tear apart how much came from which component, but certainly gas prices helped drive some sales increase.
Sanjay Sakhrani - Keefe, Bruyette & Woods, Inc.
So if you had insignificant kind of account growth, was the receivables growth then primarily from slower payment rates?
David Nelms
Well I would say it was a mix of lower payment rates, higher sales, you saw 5% year-over-year sales growth. You saw 11% higher balance transfer and some personal loans, so I would characterize it as fairly balanced and it puts us right in the middle of the 4% to 8% range that we had originally set out, but I would say we were pleased with the growth because of where it came from this quarter.
I think if it got too much higher I might start to have concerns, but it shows a little, I think some competitors, and not just in credit cards but other kinds of lending have pulled back and that is partly what had driven the rise in payment rates over the last five years and now as some of that pulls away it is starting to benefit our growth prospects, even with the very high credit criteria that we have.
Sanjay Sakhrani - Keefe, Bruyette & Woods, Inc.
Roy you mentioned the Diners Club impact and kind of the expectation to invest. Should we assume the investing would have a negative impact on what we’ve seen from earnings in the third party payment segment on a go-forward basis because you may have to catch up a little bit?
Roy Guthrie
I think what we tried to provide to the investors was what we thought the impact would be over an intermediate horizon and that’s the $10 to $15 million. We’re okay with that.
We recorded $7 million in the quarter and that seems a little out of character with $10 to $15 for the year and it’s principally because we have yet to really, I think, engage in both those incentive programs with our regional licensees as well as the interoperability. So you will see that spend begin to season into the third party segments and it will come off of this high in terms of its contribution from Diners going forward and come back into that $10 to $15 per year range.
David Nelms
The one thing that I would add is that we’ve always characterized that as a little lumpy and this quarter we had just really strong contributions from all three pieces, Discover Network, Pulse, and Diners Club.
Sanjay Sakhrani - Keefe, Bruyette & Woods, Inc.
Right I got it and then just maybe, I wanted to kind of get a little bit more color on bringing back, or the impact of bringing back those receivables on balance sheet. Just when we think about reserve adequacy, I mean what’s the number to focus on?
I generally look at kind of reserves to own receivables and kind of the coverage to charge offs. I mean what do you think is the best way to look at that and then if you could just, Roy, just mention that IO write down impact again, just the methodology, I would appreciate it.
Roy Guthrie
Okay well we are reserving it for a little over 4.4% as of the third quarter and you have seen the trend line so we’ve upped our reserve rate 113 basis points over the last four quarters and so I will let the trend speak for itself, but clearly we’ve been advancing that rate and you can draw any conclusion you want as to where it may be at the end of the year. We have reassured you of the guidance of the mid-5% charge-off is where we are going to land.
So, reserves are directionally pointed higher and simply said, that as those asset backs mature, they will be repatriated to our balance sheet and reserves will be posted against them, it’s just that simple. So you take a reserve rate and you multiply it by the $2.6 billion, that’s the math.
The same occurs with the IO strip. We own the residual interest in the off balance sheet securitized assets.
We value that quarter for quarter and that value at the end of the third quarter was $408 million. If you just take a simple measure of that value expressed as a percentage of the aggregate off balance sheet receivable, the investors’ interest, that is 1.4%.
So I am simply taking a difference between owned and managed and dividing that 400 into it 1.4%. So again, on average, if a receivable comes back on the balance sheet you are going to see a 1.4% write-down against those receivables attributable to the discharge of the IO asset.
Sanjay Sakhrani - Keefe, Bruyette & Woods, Inc.
Any update on this FIN 46, FAS 140 rule? I mean I haven’t heard much about it, but I thought they were deferring it, but I wanted to see if you had heard anything.
Roy Guthrie
I think the general indication is that it will be deferred and the expectation now is that that would be effective for year-ends that would begin after November 15, 2009, so that would make it effective for us in the fiscal year 2010. A lot of color has come out, there is plenty of time for us to absorb it.
We are in a comment period right now from what was issued in terms of the exposure draft. We have yet to hear from the regulatory side in terms of the capital formula that will be used with whatever accounting gets determined, so I think it’s not an imminent issue, it’s out there.
It will be debated, I know, in the coming months and I think as we get more clarity we will certainly be very crystal clear with our investors as to what it means to us.
Operator
Your next question comes from Sero Bettini [ph] of Credit Suisse
Sero Bettini - Credit Suisse
I would like to get a better understanding really of what is the aggregate amount on your balance sheet of your exposure to first loss pieces in securitization and in that I include the, let me know if I’m wrong, I include cash collateral accounts, a crude interest receivable aisle strip, other subordinated retained interest which was on the note 6 in your 10-K, so that sort of sums up to about $3 billion as of the end of the year. I wanted to get your thoughts, is that sort of an accurate description of what the first loss pieces is and if so how is that performing except for the IO strip?
Roy Guthrie
Yes I think it is an accurate position and what you will see, through the passage of time, is that you will see the cash collateral account exposure reduced and the retention of subordination rise, but more than in all material respects to offset each other. We have disclosed for you here the first loft position which is the interest only strip receivable and that’s right here on the statistical supplement, so the aggregation of those three continues to be the exposure that we have.
I would point back to the trust disclosures around the excess spread generated by the trust receivables and that is now in excess of 8% on the month on the run rate and 8.39% of the rolling three month average is what a lot of the triggers are built upon, so we have an enormous cushion as it relates to excess spread protecting initially the IO strip and that would be the first thing you might see valuations taken against as well as then the more senior trounces that you mentioned disclosed in our 10-K. So I would guide you and others that want to follow this to the statistical release that we provide every month that talks about the excess spread within the trust.
That would be your best measure.
Sero Bettini - Credit Suisse
Okay, so this aggregate amount which summed up to about $3 billion, because I think I have a good understanding of the details, but we summed up to $3 billion at the end of the year. Where did it come up now as of the second quarter?
Roy Guthrie
It would be essentially flat with where it was at the end of the year and again you would see lower cash collateral accounts and higher retained subordination.
Sero Bettini - Credit Suisse
And the only element where you’ve taken write-off so far is with the IO strip?
Roy Guthrie
That’s correct.
Sero Bettini - Credit Suisse
And the rest have been performing according to expectation and you don’t see any further write off taken against the other element of this aggregate amount?
Roy Guthrie
That’s correct.
Operator
Your next question comes from [Shane Daneen] of Pershing Square Capital.
[Shane Daneen] - Pershing Square Capital
I was just wondering if you could comment a little bit on some of the trends in the broker deposit market and also if you would be willing to say how many of the broker deposits you are currently getting come from Morgan Stanley.
Roy Guthrie
We have seen the broker to market. You heard my comments previously so we’ve been a long-standing participant in it and about half of our deposit growth this quarter came from that channel.
We use a broad group of participants in it and I think I sighted a collection of six major financial institutions as well as an indirect involvement through another agent with a seller group of some 200 regional and small broker dealers. So we have an enormous platform that we access those markets through.
The markets have been, there has been a flight to safety and I think insured certificates are one area where we’ve seen sort of robust demand. We have also seen new participants sort of evolve into the space so it has sort of been balanced by both supply and demand.
So we haven’t necessarily seen, over the course of the last few quarters, any significant change in the way the price points are being set up. Today we are posting at one year around 3-8 and two years around 4.5 and I think that’s consistent with where you see a lot of the market.
In terms of our exposure to Morgan Stanley, we do not necessarily talk about any of our providers individually, but I will say that it is a very well balanced group and you can think about Morgan Stanley in terms of its wealth management system in the context of the wealth management industry and that’s probably a good proxy for our exposure there.
[Shane Daneen] - Pershing Square Capital
Do you have the cash back bonus expense number for the third quarter?
Roy Guthrie
I do, but not in front of me. I will tell you that it is consistently at the high 70s low 80% of 8- basis points of sales and we haven’t seen necessarily any change, so although we don’t necessarily disclose that here it is netted within the discount and other income line.
It will be about 80 basis points of sales.
David Nelms
That will get disclosed in the queue.
Operator
Your next question comes from Brad Ball of Citi.
Bradley Ball - Citi Investment Research
What do you attribute the higher back end role rates to? Are you seeing more delinquents going into loss by states, is that still a key factor or are we seeing more impact from the broader economic slow down, higher unemployment and bankruptcies?
David Nelms
Yes, we are seeing a higher amount from some of the problem states like California and Florida. One of the things that we have noticed is that some customers who traditionally were lower risk customers and had higher levels of mortgages and other kinds of debt are some of the ones who are being affected in some of those problem areas, so part of the issue is that when you get behind and you have a much bigger balance, then it’s harder to get caught back up to current.
A second thing that we believe is happening is that some people who fell behind in the past might have been able to get that current by tapping other kinds of loans, like a home equity loan and today some of these people simply don’t have access to those kinds of instruments and then the third piece is just the cash flow and the impacts both on higher food and gas prices and a little bit higher unemployment and so you simply have people run into the cash flow and credit problems, just like companies. So once they get behind, not as many of them can work with us to get caught back up.
Bradley Ball - Citi Investment Research
Could you remind us what proportion of your new account acquisitions would qualify as sub-prime or FICOs below 660?
David Nelms
When we had disclosed that, we think it’s important to look at the loans, because that’s where you have the risk and we had disclosed that not more than 3.5% of loans that we generate in any one year from new accounts would come from below 660 FICO score customers and given the environment, well we haven’t changed that cap, we’ve actually been pulling back even further than that.
Bradley Ball - Citi Investment Research
Have you seen a higher proportion that have migrated into sub prime, even if they were originated above 660?
David Nelms
Well I would say yes, because any time one goes delinquent on us and other loans, that takes the FICO scores down, so both our FICO score at the margin would migrate up a little bit and I would also say if you could look at the average FICO score for every consumer in the country, it’s actually declining a bit because of what’s going on particularly in some parts of the country. So it’s going to be correlated somewhat with delinquency.
Bradley Ball - Citi Investment Research
That’s very helpful, thank you. Then you brought up, David, your views on the regulatory changes.
I wonder, is there any particular provision of the proposed guidelines, the issuer practices guidelines that is particularly difficult or something that you think is going to have to change your business model to some degree? I guess one question I would have is the BT offers that you did this most recent quarter.
Would you still be able to do those under the new guidelines?
David Nelms
Well I would say the two parts that could cause us to need to change the most, one would be the payment hierarchy and certainly that could change and would change how we think about and execute balance transfer offers and frankly one of the reasons we have moved to shorter durations is because we don’t want to have loans that extend past when we think the new regulations could go in place and we would obviously make adjustments to make sure that it was still done in the profitable way. I would say the second piece is the ability to re-price for consumers that end up taking on more debt and become more risky and today we are able to re-price.
The consumer can reject that re-pricing and pay down the old rate over time, or they can accept the new rate and continue to have charging privileges and some of the proposals would take away that right and we would essentially have to tell consumers they no longer have a choice. We’ll have to close them and have them pay down because we can’t price for the higher credit risks.
So we would essentially have to reduce our charge-off rate to help offset the inability to price for risk.
Bradley Ball - Citi Investment Research
Right and that’s something that the whole industry will have to face, of course.
David Nelms
Certainly.
Operator
Your next question comes from Michael Taiano - Sandler O'Neill.
Michael Taiano - Sandler O'Neill & Partners, L.P.
Could you maybe give us a little bit of color on what you’re doing in terms of percentage of your account that you’re re-pricing and perhaps reducing the credit lines and given that it seems like most of your growth this quarter came from existing accounts, are you seeing any material change in just overall utilization rates at this point?
David Nelms
You know I think the growth was not really enough to move the dial on utilization rates. It’s still very modest compared to the overall credit lines and balances that our customers have.
In terms of pricing, we have not done any upward re-pricings for our customers beyond the normal delinquency triggered re-pricings and that frankly may be contributing a little bit to our growth, because we wouldn’t have attrition, so we’ve tried to keep our prices as low as we can while maintaining a strong net interest margin.
Michael Taiano - Sandler O'Neill & Partners, L.P.
Okay and credit line reductions, any material change there as well?
David Nelms
We continue to take actions to reduce some exposure where appropriate, but I wouldn’t say we’ve done anything wholesale or dramatic, but just fine tuning on an individual basis to make sure that our customers can afford the lines that they have and that they don’t get over extended, which obviously would be in neither our nor the consumers best interest.
Michael Taiano - Sandler O'Neill & Partners, L.P.
Roy Guthrie
2006A and 2006 that would not be correct. We would have the aggregate maturities of our term issuance in the entire fiscal year beginning November out through November of the next year is $2.9 billion.
If you would like I will be glad to sit down with you and help you interpret the filing that you’re referring to. We do have a conduit that is maturing in January that may be what is being featured there and we traditionally renew our conduits well in advance of the maturity, so that would be something that would be tended to long before January arrived.
Michael Taiano - Sandler O'Neill & Partners, L.P.
Just on the deposit side, you mentioned sort of the price points that you’ve gotten on some of the CDs. Is that significantly higher than where they were last quarter and are there any limitations from a regulatory perspective on how fast you can grow deposits?
Roy Guthrie
I think we use them responsibly, so we view that the way in which we have accessed it to be in a very balanced way and obviously the asset model that we have is what really makes a difference, so it’s not really going into some of the troubled asset categories that I think have been stressed in some of the bank failures. But yes, I think we are out the curve.
We do not attempt to be competitive on the short end and we’re getting the majority of our volume at two and one half, three and four year maturities and out there you just don’t see the same noise and crowding that occurs at the six and one year marks. So we are less affected and we’re not seeing necessarily any dramatic movement in terms of the price points out there and we are seeing consumers more and more willing to stretch the duration of their commitment to the certificate out.
While that traditionally was viewed as about 1/3 of the market, it has been a growing presence and we’ve been able to capitalize on that. ] I mentioned earlier one important point I would like to reemphasize here and that is that the deposit base is actually being extended in its aggregate maturities.
Twenty-seven months this quarter up from 22, all that is based on the volume that we did during those three months, so we’re moving the liability liquidity of that particular channel out very significantly and I think that’s a reflection of our ability to get out there and to offer and to do it cost effectively in a place where we don’t see as much contention.
Michael Taiano - Sandler O'Neill & Partners, L.P.
Do you have a percentage of your deposit accounts that are over $100,000 at this point?
Roy Guthrie
It is very, very small. The average balance is in the 30s.
Craig Streem
If I could interrupt for a moment, I would like to ask each of you to try to hold it to one question so we have time for everyone please.
Operator
Your next question comes from Craig Maurer – Calyon.
Craig Maurer - Calyon Securities (USA) Inc
Regarding the balance transfers, I was hoping for a little more clarity on the recent volume. If you use what MasterCard reported last quarter as a proxy for what a large swath of consumer banks are doing you saw a huge mid teens climb in that volume.
So I am just curious, if the large card issuing banks risk based pricing model does not allow them to ride the gain share in that manner, how is your risk based pricing model allowing you to go out and grab that share in that manner?
David Nelms
Well if you are talking about balance transfer volume from last quarter, I mean our VP volume last quarter was down 32% year-over-year and so I would say on an apples-to-apples basis we were down more than others. Part of what’s happened is in the first half of this year, look back over some very high balance transfer volumes from the year before, we’re now looking back over much more modest levels of balance transfer volumes in these last two quarters, so part of it is simply the comparison.
The amount of volumes that we did are still well below, especially what we did a few years back.
Craig Maurer - Calyon Securities (USA) Inc
So in terms of the environment with balance transfers, I am curious what is getting your customers to move over. I mean obviously banks are trying to raise interest rates where they can to protect themselves from a risk-based point of view, so are you targeting customers who have recently seen an increase in their rates or how are you going after those customers?
David Nelms
As I said, most of our growth and focus is on current customers and I would say that the key pitch is cash back bonus, you know over $700 million a year that we’re paying to our customers and the special features that we offer like the gas promotion and we also have won various service quality awards and that is helping our retention of customers and so service, price, value, I think all those things play very well right now and our consumers are responding.
Craig Maurer - Calyon Securities (USA) Inc
So what percentage of these VPs are generating new account relationships versus taking advantage of existing ones?
David Nelms
The vast majority of our balance transfer volume comes from current customers as opposed to new customers.
Craig Maurer - Calyon Securities (USA) Inc
So when you bring in balances for existing customers is that generating increased transaction volume or is it just simply you are now owning a bigger piece of their balance sheet?
David Nelms
The latter, we are primarily consolidating up other existing debt onto our card and we are actually very careful in how we do it, because we don’t want them to use up the whole credit line because we want them to keep charging as well. In terms of emphasis, the big emphasis is on sales volume and activity and balance transfer would take second place to that very important thing.
Operator
Your next question comes from Moshe Orenbuch - Credit Suisse.
Moshe Orenbuch - Credit Suisse Securities
Just very briefly, you talked a little bit about the higher cost of asset bank facilities. How high is it and where would it have to come back to in order to get you more interested in that as a funding source here?
Roy Guthrie
I think we have seen the market move and continue to move in the last two or three months. Given the severe disruptions it’s hard for me to give you an indicative price point; we just simply are not seeing the market volumes.
But I think an indication would be you would see the industry out in the high hundreds in terms of LIBOR spreads for the three to five year term. Our execution on both our conduit programs as well as on the swap basis are terms certificates are significantly less than that.
Significantly enough that I think the economics begin to weigh very heavily in the decisions around how you structure your balance sheet to maximize cash flow and the shareholder interest against some of these other issues associated with reserves and IO release. If it was close I think we would be showing a more of an effort, but it is by a wide margin that we’re incurring lower interest costs by using our deposit program.
Moshe Orenbuch - Credit Suisse Securities
So more than 50 basis points of tightening would be needed?
Roy Guthrie
That’s fair, yes, more than 50.
David Nelms
Although I would say it may be the mix. I mean we could decide to do some even at that elevated price to continue to keep balance, but certainly we would tend to skew more towards deposits as long as things stay decelerated.
Operator
Your next question comes from Michael Cohen of Sinova Capital.
Michael Cohen – Sinova Capital
My question is on the IO in the fourth quarter. If you are amortizing your IO down, why would there necessarily have to be a revision to the retained interest?
Roy Guthrie
I guess the point I was trying to make is that there wouldn’t be any new volume to offset the amortization that naturally occurs otherwise.
Michael Cohen – Sinova Capital
Then shifting gears, when you talk about some of the components as to how you see the margin on a go forward basis, how much on a sequential quarter basis was the margin affected by the amortization of balance transfer fees and how would you see that going forward and what are kind of the factors pushing the margin up or down as you see it?
Roy Guthrie
Well I think I had given you that sort of guideline of 45 basis points, so that is probably a pretty good guide. I think we began that initially this quarter, so I would steer you that way moving forward.
In terms of the pressures, I think you have begun to see after the early parts of this year the cost of funds stabilize and it was sort of flat sequential quarter. So I think we’re sort of in a period now where we’ve got our margin elevated and we would expect for it to stay at our around this range as we move through the coming quarters, absent some of the things that I tried to highlight for you all in my remarks; in particular around the LIBOR reset and our exposure to that.
Michael Cohen – Sinova Capital
Great and what day of the month does that affect you?
Roy Guthrie
Generally it is around mid-month. It varies a little bit, but it’s generally around mid-month.
Operator
Your next question comes from John T Williams of Macquarie Capital.
John T. Williams - Macquarie Capital
You have touched in the past upon the receivables and sort of the real estate markets that are troubled. You called out Florida and California specifically.
To the extent that you can talk about it, what have you been seeing over the last few months in those markets? Is it more of the same?
David Nelms
I would say we have seen generally continuing deterioration and I would also say we’ve seen more spread to additional states and so we do look at an awful lot of information at the customer level and in certainly the amount of equity in consumers have in their mortgage versus what they’ve got in their home, combined with what’s happening to real estate values in each area is contributing significantly to consumer stress. We think we have not seen it peak yet, as far as we can tell and so there is a number of people speculating as to when exactly it will peak and then start turning around the other way, but it’s been deteriorating and you are seeing that in our numbers.
John T. Williams - Macquarie Capital
The other question was, Roy had mentioned the contribution of Diners earlier, I missed the number. Was it $7 million net income that you said?
Roy Guthrie
Yes, pre-tax.
Operator
Your next question comes from Bob Napoli of Piper Jaffray.
Bob Napoli - Piper Jaffray
I have a question on the Pulse business and the competitive environment that you’re seeing out of Pulse. So what effect are you seeing out of MasterCard’s moves in that business and what kind of growth do you think you could maintain over the long-term?
David Nelms
Well as we reported we saw Pulse volume grow 27% year-over-year, so we’re continuing to feel that we’re growing faster than our competitors in that space and we’re committed to continuing to grow it rapidly.
Bob Napoli - Piper Jaffray
There are a number of changes in the market, I just wondered what you are most concerned about that would prevent that growth?
David Nelms
I would say, over a period of time I have seen more challenge from Visa than MasterCard, but we’ll see, obviously their MasterCards’ had recent announcements, but I haven’t seen any particular impact to date.
Bob Napoli - Piper Jaffray
And on the fee businesses with the acquisition of the Diners Club card, is there any other additions that you would like to make through acquisition or products or areas that you would like to get that business involved in?
David Nelms
Over the medium to long-term we certainly would consider additional opportunities. We are very excited on the Pulse acquisition from a few years ago and this recent Diners Club acquisition, but I would say the primary focus is on organic growth and we have a long to do list to integrate and take full advantage of Diners which we’re incredibly excited about and frankly it’s going to be hard for me to find something that has as good of a fit at the kind of price that we got it for.
So we are going to mainly focus on that.
Bob Napoli - Piper Jaffray
Do you have any interest on the pre-paid market?
David Nelms
We do have a number of current activities in pre-paid both as a network and as an issuer, but it is a relatively modest part of our overall business. I think it’s a bigger part of our payments business than of our issuing business itself.
Operator
There are no further questions.
Craig Streem
Thank you all for your interest and any follow-ups please feel free to come back to me and we’ll take care of business for you. Have a good day everyone, thanks.