Mar 19, 2009
Executives
Craig Streem - Vice President, Investor Relations David W. Nelms - Chairman and Chief Executive Officer Roy A.
Guthrie - Executive Vice President, Chief Financial Officer
Analysts
Sanjay Sakhrani - Keefe, Bruyette & Woods Christopher Brendler - Stifel, Nicolaus & Company, Inc. Donald Fandetti - Citigroup Bill Carcache - Fox-Pitt Cochran Caronia Michael Taiano - Sandler O'Neill & Partners Bruce Harting - Barclays Capital Brian Foran - Goldman Sachs & Company, Inc.
John Stilmar - SunTrust Robinson Humphrey Moshe Orenbuch - Credit Suisse
Operator
Good day ladies and gentlemen, and welcome to the First Quarter 2009 Discover Financial Services Earnings Conference Call. My name is Dan, and I will be your coordinator for today.
At this time all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference.
(Operator Instructions). As a reminder, this conference is being recorded for replay purposes.
I would now like to turn the call over to your host for today's call Mr. Craig Streem, Vice President of Investor Relations.
Please proceed, sir
Craig Streem
Thanks Dan. I want to welcome all of you to this morning's call.
Certainly, as always, we appreciate your joining us, and we appreciate your interest. 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 8-K report and in our Form 10-K for the year ended November 30, '08, which is on filed with the SEC. In the first quarter 2009 earnings release and supplement, which are now posted on our website at discoverfinancial.com and have been furnished to the SEC, we've provided information that compares and reconciles the company's managed basis financial measures with the GAAP financial information.
And we explain why these presentations are useful to management and to investors, and we urge you to review that information in conjunction with today's discussion. Our call this morning will include formal remarks from David Nelms, our Chairman and Chief Executive Officer and Roy Guthrie, our Chief Financial Officer.
And of course, we will leave ample time for questions and answers. And now, it's my pleasure to turn the call over to David.
David W. Nelms
Thanks Craig. I'm going to start this morning's call with some comments on our first quarter results in the challenging economic environment, and then share a brief comment on the dividend we announced this morning.
As you can see from our results this quarter, and the actions we have taken since the end of the quarter, we are focused on maintaining a very strong capital position as we significantly build reserves in light of rising delinquency rates and growth in on-balance sheet loans. First quarter net income from continuing operations was $120 million or $0.25 a share, driven by net interest margin expansion, expense reductions and the second payment in our anti-trust settlement with Visa/MasterCard, offset by significant loan loss provisions.
Roy will take you through our first quarter results in greater detail, but I'd like to highlight a couple of important areas, beginning with credit performance. Our charge-off rate for the quarter came in at 6.5%, consistent with our investor day guidance.
However, unemployment rates and our delinquency rates have risen significantly. And we anticipate at this time that our loan loss rate for the second quarter will exceed 7.5%.
In response to these trends, we added this quarter over $500 million of reserves in excess of charge-offs. Some of this related to previously securitized loans that came back on balance sheet, and Roy will discuss that in greater detail later.
But the majority of the increase was for reserve rate strengthening. In addition to building our loan loss reserve, we recognize that our customers are facing the highest unemployment rates in over 25 years; in fact, since before Discover was launched as a business.
And we are taking actions to help our customers through this difficult period, particularly those customers in hardship situations. In 2008, we worked with over 1 million of our customers by reducing APRs, waiving fees and establishing payment plans to help them get through tough times.
And for the benefit of our entire card customer base, we recently launched a number of tools to help our customers manage their debts and spending more effectively, including Discover's Paydown Planner and the Discover Spend Analyzer. I want to turn now to key performance measures for our card and payments businesses.
Sales volume for Discover Card was down 8% from last year. However, removing the impact of lower gas prices, the decline was closer to 4%, which is comparable to the level of decline we began to see late last year.
I am pleased that the decline seems to have leveled off. And I am hopeful that when we see the first quarter results from our competitors, we will again see less of a decline for Discover than for the others, consistent with Discover's stronger relative performance in the fourth quarter.
In terms of credit card receivables, our managed credit card loan portfolio was up 4% year-over-year as slowing payment rates offset the effects of lower sales volume, fewer new accounts booked and a 17% reduction in balance transfer volumes. Credit card payment rates have fallen significantly, as consumers in general have diminished access to credit and less discretionary income to pay down debt.
The balance of our year-over-year loan portfolio growth came from Discover personal loans, and Discover student loans. Regarding the personal loan product, I want to remind you that we are primarily originating these loans to existing customers, using underwriting criteria that are appropriate and conservative enough for the current environment, including significant use of manual underwriting.
And we're generally positioning these loans for debt consolidation. Concerning student loans, we added a little over $300 million in receivables this quarter, driven by disbursements for the second semester of school.
We are pleased with the prospect for this business as it now stands, especially since we originate into 250 schools and obtaining government guarantees or co-signers on most of these loans. However, we are well aware of the proposed legislative changes in the area of student lending, and we'll be looking very closely at the implications for future originations.
So to summarize concerning loan growth for all our lending businesses, we do expect our owned loan portfolio to grow significantly as maturing asset-backed securitizations are funded on balance sheet. On the other hand, we expect that reduced marketing spend and appropriate risk management practices will reduce the level of managed loan growth from the 7% year-over-year that we reported this quarter, to a lower level later in the year.
And in fact, on a sequential quarter basis, the overall managed portfolio came down a bit this quarter. Now turning to our payments business, we continue to achieve double-digit growth in dollar volume despite what appears to be a global recession.
PULSE, our PIN debit business turned in 11% volume growth, and we believe, we are continuing to take share from our major competitors in this space. The Diners Club volume slowed year-over-year, reflecting the global decline in corporate and T&E spending.
Nevertheless, we are very pleased with profits that the Diners Club acquisition is contributing, and we are making strong progress on integrating our networks and are on track with providing global ATM acceptance. As we have said before, the integration of Diners Club and Discover is a critical initiative, and we will continue to invest to complete the integration and maximize the benefits of global acceptance.
Finally, I'd like to comment briefly on our decision to reduce the quarterly dividend to $0.02 per share which will provide a capital benefit of about $80 million on an annualized basis. The savings is modest compared to our $5.5 billion of tangible common equity, but it will help us maintain a strong capital position in the midst of this uncertain environment.
That includes change in accounting rules and rising loan loss provisions and is consistent with our conservative approach to managing the business. It is also consistent with our desire to be in a position to repay to U.
S. Treasury Capital Purchase Program investment as soon as it is prudent do so.
Now let me turn the call over to Roy for more details on our results.
Roy A. Guthrie
Okay. Thanks David.
I'm going to start with a review of our U.S. Card and Third-Party Payments segments and then going on into our funding liquidity and capital.
And then we'll open it up for questions. Starting with U.S.
Card, this segment earned $167 million pre-tax this quarter, which includes the anti-trust litigation settlement income of $475 million. On an after-tax basis, the litigation payment benefited capital by about $297 million.
David already spoke about sales and receivables goals, so I'm going to go to really the details of margin and the other aspects of the P&L. Net interest margin increased to 9.11%, up 102 basis points from the prior year and 56 basis points from the prior quarter.
Both comparisons here benefited from a significant decrease in our cost of funds and the year-over-year comparison also benefited from the balance transfer fee amortization, that we talked about previously which was worth about 36 basis points. These were offset by a decrease in the yield on our variable rate assets and the impact of higher charge-offs.
So spread income continues to be a bright spot for us, up 86 million sequential quarter and up over 180 million or 19% year-over-year. Other income in the card segment includes this Visa settlement of $475 million as well as an IO asset write-down of about $98 million.
The IO write-down reflects both maturing ABS, as well as excess spread compression associated with higher expected charge-offs. Excluding these impacts on the BTP impact I just mentioned, other income was effectively flat year-over-year.
Turning to credit performance charge-offs came in at 6.48%. 30 day delinquency was 5.25%, a sequential quarter increase of 69 basis points.
We added a total of 504 million in reserves in excess of charge-offs in the quarter, 351 million of that was reserve strengthening attributable to the impact of the deteriorating environment on our credit trends and 153 million principally due to the shift onto the balance sheet of $3 billion in maturing ABS deals. Our reserve rate for the quarter was 6.70%; that represents an increase of 125 basis points from the last quarter.
In terms of expenses beginning last year, we implemented a variety of cost control measures throughout the company with the benefits starting to show in our results during the second half of last year. We expect those operating costs benefits to continue to show during the course of this year.
In the first quarter, our U.S. card segment operating expense was down 10% year-over-year, reflecting principally lower marketing spend and professional fees, and even as we spend I think aggressively in the collections offered in around portfolio control.
Turning to the Payments segment, Third-Party Payments earned 29 million for the quarter with total volume of $35 billion, including $6 billion from Diners Club. The segment had significant growth in revenues driven by higher transaction volume, and the inclusion of franchisees' revenues from the Diners Club International acquisition.
Expenses were higher primarily due again, to the inclusion of Diners Club and investment spending related to integrating our networks, and enhancing the relationships with Diners Club licensees. We're pleased with the record pretax profits in the Payments segment this quarter.
But over the next couple of quarters, we're going to see heavier investment spending related to the integration of Diners Club, and our other networks. And so we don't expect to see this level of pretax contributions from the Payments segment to continue for the foreseeable near-term future.
I'm going to move on to funding, liquidity, and capital, and begin with deposits, which reached $28 billion at the end of the first quarter, representing a 14% year-over-year increase, with the direct-to-consumer and affinity programs once again, growing $1 billion during the quarter to reach $7 billion at quarter's end. And while we continue to emphasize our direct-to-consumer channel, I want to point out that the broker channel remains very effective funding source for us.
The temporary liquidity guarantee program now has accounted for over $200 billion of term funding, since its exception. And I think we believe that this has had the affect of shifting issuer's focus away from this broker channel and thereby reducing competition in that market.
Our maturities for the balance of 2009 totaled about $10.5 billion, including 6.5 billion from our deposit programs, 2 billion more of public term asset-backed deals, and 2 billion in short-term borrowings. So to put that 10.5 billion in context, over the last year using an equivalent nine month forward look, we've had maturities ranging anywhere from 9 billion to 15 billion.
So, we don't view this 10.5 as unusually high. We anticipate we will continue to meet those commitments through ongoing deposit issuance plus the recent $1.2 billion Capital Purchase Program investment.
To the extent that maturities include previously securitized receivables, I want to remind you that we will add loan loss reserves and write-down the IO strip as those receivables come back on balance sheet, similar to what happened here in the first quarter. ABS maturities for the rest of the year represents virtually zero in the second quarter with that $2 billion I mentioned all spread between the third and fourth quarter.
Our contingent liquidity at the end of the quarter included 8.3 billion of cash liquidity, 1.5 billion of conduit capacity, 2.4 billion in our committed credit facility, and 4.5 billion of borrowing capacity at the Fed discount window. And I think importantly now given TALF is an active program, we have about $6.5 billion of TALF qualifying capacity that could potentially be funded using this new program.
Our trust is presently structured with sufficient subordination to issue 5 billion of AAA securities. The first transactions under the TALF program were introduced here today and yesterday.
And we're going to be studying the levels at which these transactions were executed very closely. While our funding plan for the rest of the year assumes no additional ABS issuance, if the economics of the TALF program become attractive, we could begin issuing under that program.
Regarding FAS 140 and FIN 46, the FAS has come out -- FAS became out and indicated they will issue a final pronouncement during the second calendar quarter of the year likely to be effective for fiscal year's beginning after November 15, 2009. Based on expected ABS maturities between now and November 30th of this year, our current assumption is that 20.6 billion of securitized receivables will be restored to the balance sheet upon implementing these new regulations or accounting rules.
And will be required to be reserved against with appropriate level of reserves and the IO strip will be reversed. And that impact along with the impact of reserve additions will be recorded as an after-tax charge to the opening retained earnings of our fiscal year beginning December 1, 2009.
Last month consistent with actions they've taken recently with a number of other credit card, ABS issuers, Standard & Poor's, put certain of our asset-backed bonds on watch for potential downgrade, and we are actively discussing of that with S&P; and you'll hear from us further as we draw conclusions there. As we announced last week, we have issued preferred shares and warrants to U.S.
Treasury for $1.2 billion under the Capital Purchase Program, and have registered as a Bank Holding Company. The incremental capital received under the program will help to support the significant increase in our on balance sheet loans that is resulting from maturing securitizations, and ultimately the transition to on balance sheet accounting for the entire investor interest in the trust.
And I think importantly to echo what David said, it will help us continue to meet our borrowing needs of the creditworthy card members we have in our portfolio. I want to wrap up my formal comments by summarizing our capital position.
At the end of the first quarter, we reported 5.5 billion intangible common equity or $11.51 a share, which was 11.3% of managed receivables and 8.8% of total managed assets. Taking into account the 1.2 billion received under the Capital Purchase Program, on a pro forma basis at February 28, our Tier 1 capital ratio would be 17.1%.
So, in summary, we've taken I think measured steps to further strengthen our balance sheet. We've made the reserve additions that we've discussed.
We've reduced our dividend by $0.04. We are participating in the U.S.
Treasury's Capital Purchase Program, and liquidity levels have been maintained as our deposit channels have proven them self to be effective and adequate. And now in addition to that, we have the potential benefit of TALF.
Operationally, U.S. card provisions have been high, but margin expansion, lower expenses, and Visa proceeds more than offset them.
The Visa settlement will include three additional payments during the course of this year, all expected to be at that $472 million level. In addition, this quarter we recorded record earnings within our Third Party Payment segment.
So, now with that I'd like to turn it back to you, Dan and David and I will take your questions.
Operator
(Operator Instructions) Your first question comes from line of Eg Roshan (ph) from Omega. Please proceed.
Unidentified Analyst
Good morning. Thank you for taking my call.
I've got some basic questions on the IO write downs. You took 98 million of those, I guess, part of as you said was point some of the asset-backed balance sheet, it was relative to higher loss rates.
And I was just wondering, what are the loss rates you are now expecting for the trust? And I guess, over what timeframe are you expecting those losses to be incurred?
Roy Guthrie
Yeah, I think the loss rates that would be resonant in this estimate are consistent with what you heard us sort of outlined in terms of guidance for the second quarter and beyond, so in the mid 7 to 7.5% range. The breakdown of the two component pieces, I'd say rate compression is around 80% of the write-down and the volume attributes associated with the $3 billion in maturities is around 20% of the write-down.
Unidentified Analyst
Okay, excellent. Thank you very much.
Operator
Your next question comes from the line of Sanjay Sakhrani from KBW. Please proceed.
Sanjay Sakhrani - Keefe, Bruyette & Woods
Hi thanks. I think you guys have some pretty good -- a pretty good sense of kind of what's in store for the next six months as far as credit is concerned.
I was wondering if you could give us some color as to what your expectations are, kind of looking out to the third quarter on credit, please?
David Nelms
Well, Sanjay, I think things have actually moved fairly rapidly in terms of unemployment rates. And so that's one reason we're only forecasting one quarter out at this time.
Our base expectation would be that loss has continued to rise through the year, but we would expect a slower quarter-over-quarter increase than what we've been seeing in the last two quarters. But I would say that it's more uncertain than it normally is.
I mean one of the other wild cards is potential legislative changes. If a bankruptcy cramdown law passed and if it was brought, then that would obviously have an impact that we couldn't foresee sitting here today.
Sanjay Sakhrani - Keefe, Bruyette & Woods
Now understood. I mean I think -- I mean I guess what's your sense on that cramdown legislation?
I mean is it -- it seems like the latest talk has been something less onerous on unsecured lenders?
David Nelms
Yeah I think that's fair, but I would say there is a pretty broad range of proposals out there. And so I think we -- I think that the industry has been trying to put facts on the table about what would -- to try to avoid some of the most onerous changes that I think would be detrimental, not only to our credit but to the economy generally and consumers who would be wiping out their credit for seven years, if that's the stuff they had to take to simply renegotiate their mortgage.
And so I think -- I think some of those concerns have been heard, I hope but again, we need to wait and see what actually happens.
Sanjay Sakhrani - Keefe, Bruyette & Woods
Okay, great. And Roy, I had a couple of questions for you, very quick ones.
Just if we look at sequential increase in the margin, could you just break out what the impacts were from the accretion of the balance transfer fees et cetera? And then just kind of give us a sense of kind of what to expect on a go-forward basis.
And then the second question is on TALF. What would be the execution price -- kind of at what level does it makes sense to go the TALF route?
Thanks.
Roy Guthrie
Okay. Sequential quarter, we made the change to re-class the balance transfer fees and during the course of 2008.
And so I think third quarter forward they are resident in the margin. So as you look at the sequential quarter increase here in margin, it doesn't affect -- does not have any impact from the reclass sort of resident within it.
I think the important thing to sort of point out here is that we had a significant amount of interest expense headwind in the fourth quarter associated with that spike in LIBOR which put the spread under a fair amount of pressure. But both the asset side and the liability side helped this sequential quarter look.
In the year-over-year perspective, it's around 35, 36 basis points, because again the first quarter of last year would have had them recorded as fees. So 35 on a year-over-year basis, non-existent in the sequential quarter.
TALF is -- the long awaited TALF is out. And so we're going to see deals and we'll see what the print is on the deals sort of later on today.
We actually heard a credit card deal in the market this morning. And so we don't know what the final terms are going to be there.
But it could be in the high 100s. And I think that when you talk about this in the context of where we would see it advantageous, it would be somewhere south of that.
But I am very pleased to see that somebody could be paying let's say 100 to 75 over with credit card collateral, because that gets us a lot closer to the dipco (ph) where we would find it advantageous. But more than likely it is still 50 to 70 basis points higher than we would prefer.
I think it's important that we demonstrate capacity in this market. And so we may make decisions around simply demonstration of capacity, in terms of deal execution where a slight more expensive piece of debt would be offered than what otherwise could be offered.
But just to put it in perspective, this particular quarter we were issuing at 13 months plus I think on weighted average maturity, with under 3% execution fixed rate funding for the company from these deposit channels. So I'd like to echo what I said earlier about the nature of what's going on in the deposit markets.
We've seen a lot of the large institutions withdraw. We're getting a great execution out the curve at low prices.
And it's with great expectation that we may even see better given what the government has done to try to bring long-term rates down. So I think TALF has to compete with that.
I think assuring that its bear force may drive us into the market to do a deal just to demonstrate capacity. And as we get further into this and study the deals here, we'll keep everybody apprised as they are dealing by (ph).
Sanjay Sakhrani - Keefe, Bruyette & Woods
Okay, thank you.
Operator
Your next question comes from the line of Chris Brendler from Stifel, Nicolaus. Please proceed.
Christopher Brendler - Stifel, Nicolaus & Company, Inc.
Hi, thanks. Just a quick follow-up on the TALF question.
Wouldn't it make sense not only to demonstrate access to securitization market, but also to lock up a little longer term funding? And once when you file -- it doesn't sound too bad to me, when you're talking about LIBOR 50 basis points, you are still all-in less than 2.5%.
So is that not correct? Are there additional costs that you're not thinking about?
Roy Guthrie
Well I think that's right Chris, except that I think you can go out three years under the program. And so you're basically saying do you want to take that interest rate debt?
And I think it's important for all of us to keep in mind that we will get through these troubled times. And we want to make sure that we're cognizant of the fact that there could be significant inflationary pressures that follow this unprecedented period we're in right now of difficult economic conditions.
So I'm clearly cognizant of that. And I think letting things float is something we're willing to do, if we can see advantageous execution.
But nonetheless that is a reasonably significant risk when you're going out three, four and five years, and subjecting a liability to floating.
Christopher Brendler - Stifel, Nicolaus & Company, Inc.
Excellent point. On the relative topic, have you had any initiatives around getting more of your accounts on variable or sort of getting ready for increasing interest rates to take advantage of that?
Where do you stand in terms of your account pricing right now?
David Nelms
Well, I would say we have been rebalancing our portfolio. And I think under the new guidelines that we'll be going in, fixed rate credit card loans will largely be non-existent, because you'd be locking in a fixed rate for an indefinite time period.
And so I would expect that all of our new originations have been variable for sometime. And we've been shifting our accounts predominantly to variable rates to be consistent with the new guidelines.
Christopher Brendler - Stifel, Nicolaus & Company, Inc.
Okay. What percentage of your book is on variable rate now?
And then, another question would be on FAS 140, and the impact on Tier 1 capital. Do you have any sense of the regulators?
I think from a managed perspective, it's not too bad, because you're looking at this nominating (ph), including the off-balance sheet assets for us. I believe for Tier 1, it's a pretty big impact to have those loans sitting back on balance sheet.
Give me a sense on the regulators that how they're going to view that. And is there going to be sort of a window of period where you can get your capital ratios up or for FAS 140, or if it's going to all come in on interest -- and be as onerous as it could be from a Tier 1 perspective?
David Nelms
I'll let in -- Roy answer the second question. But on the first question, I don't have a snapshot for you here today.
But I would say, we will soon be mostly variable rates, credit cards loans at least within our active portfolio. Roy?
Roy Guthrie
Chris, it's a very good question. I think there is really two sort of audiences that we are appealing to regularly to try to get this matter cleared up, and get the uncertainty out of the air.
Clearly the FASB and also the Treasury, as it relates to how reg capital rules are going to be set against the new accounting principles going forward. I think in the absence of clarity on that, and we would expect clarity to follow on reg capital once the accounting pronouncements are out there.
In the absence of clarity, our stress testing includes worst case scenarios or both. The FAS 140 will come on and that no capital relief will be afforded the receivables that are now on the GAAP balance sheet.
And we've stressed that to the extent we're satisfied that we'll maintain well capitalized status even with that event taking place, and in addition to additional stresses within the economic conditions.
Christopher Brendler - Stifel, Nicolaus & Company, Inc.
Okay, thanks guys.
Operator
(Operator Instructions) Your next question comes from the line of Don Fandetti from Citi. Please proceed.
Donald Fandetti - Citigroup
Hi good morning. David.
A question about your comment on spending; it sounds like you think that maybe things would stabilize, correct me if I'm wrong. And I just wanted to get a sense on your outlook if you -- what gives you that confidence and seems like the economy is still pretty weak.
So if you can comment on that, that'd be great.
David Nelms
Yeah, well, I mean -- what I'm seeing is that sales continue to be below a year ago. But I've at least to-date not seen any sign of an acceleration of that trend.
And I think that -- I think what happens from here on through the rest of the year will be a little bit dependent, will be dependent on various actions, how much credit is available in the economy, how much higher does unemployment rates go, et cetera. But I am not forecasting anything, I'm just saying, to-date, it seems to be pretty stable.
Donald Fandetti - Citigroup
Okay. Thank you.
Operator
Your next question comes from the line of Bill Carcache from Fox-Pitt. Please proceed.
Bill Carcache - Fox-Pitt Cochran Caronia
Hi. Can you just share your thoughts on the difference between the incremental reserves that you're booking relating to what -- maturing ABS that are coming back on balance sheet, and they're being funded via deposits versus the I guess kind of inherent reserve that was built-in via the excess spread, and your expected future losses that were baked into that and therefore were kind of built into the retained interest on the balance sheet, and therefore flowed through the securitization and combined item.
Incrementally, the difference between those two if you could just speak to that?
Roy Guthrie
Yeah, Bill, I guess there's often than it's -- both techniques do involve future losses, obviously, the on-balance sheet, clearly with an allowance that's set against it. And it's recorded at what was -- we viewed as net realizable value, so the historical cost adjusted for the reserve.
In the IO valuation, the excess spread calculation is permitted to use not only losses but revenue attributes of the portfolio as well. And in that, it's structurally different than the way GAAP treats on-balance sheet receivables.
So they both have the same forward-looking loss perspective in them. The IO simply has revenue attributes that are permitted by accounting for that to be netted against them.
Bill Carcache - Fox-Pitt Cochran Caronia
Okay, thank you.
Operator
Your next question comes from the line of Mike Taiano from Sandler O'Neill. Please proceed.
Michael Taiano - Sandler O'Neill & Partners
Hi. Thanks for taking the question.
When you guys look at credit across the various geographies in the U.S., are you seeing other states catch up to California, Florida in terms of delinquencies? Or, in other words, is there a narrowing in the credit performance from other states versus those states that have been mostly impacted by home prices?
David Nelms
I would say, yes. I think what we originally saw in places like California or Florida, has been -- has spread to most of the country.
And I think you could just look at unemployment rates by state and have a pretty good feel for how delinquencies by state has spread. And we've already got several states that in total are over 10% unemployment.
But as much as the country -- as on average, the country is on the 8.1%. That's driving losses across the country to be the higher levels that started out in housing but now are being driven by unemployment.
Michael Taiano - Sandler O'Neill & Partners
Okay. So does that -- presumably, does that mean that the benefit you guys have enjoyed over the last year or so -- what timing was exposure to those states should narrow vis-à-vis your competitors?
David Nelms
No I don't -- I wouldn't expect the difference in there all. I mean we still have both the geographic advantage and a portfolio maturity advantage.
I mean there is still better likelihood of continuing payments for the customers who have been on the books for five or ten years than for new customers. And so those two things continue to help us, but given that this has now become a more unemployment driven, we're rising as well as others.
But I think as you look at the numbers there is still a gap that I would expect to be pretty consistent between us and most of our large competitors.
Michael Taiano - Sandler O'Neill & Partners
Okay. And then just a separate question, do you -- given where credit losses are trending right now and the acceleration in unemployment, do you expect to have to trap cash in your trust at some point this year?
And if you could maybe give us some color on what sort of the maximum amount of cash that you would trap before I guess you would get or potentially get to 0% and then have an early amortization event?
Roy Guthrie
Sure Mike. I think there is a couple of important points here.
Wholly we operate through three trusts and the last one, the trust we put in place in 2007, DCENT which issues notes, in the only trust that has cash trapping resident in it. It only represents about 30% of our ABS portfolios, lot of that 22.5 or so billion we've got out it's around 7 billion.
So we're less exposed in that regard, that's number one. The number two trapping begins in the structure of the trust around 4.5% spread and we're 150 basis points higher than that right now based on the run.
So you have to see losses, losses we reported in our trust were just over 7%. So you need to see losses go dramatically higher before that would actually occur.
The maximum amount -- if we trap the maximum amount in this, it would only be -- it would be less than $500 million. So the trapping I think goes up to around 4.5, some maybe 6% something like that.
But it would be less than 500 million. So we think about that from a liquidity perspective.
It is not a significant impact on us, and that's principally because of the trapping mechanisms only are resident in 30% of our outstandings.
Michael Taiano - Sandler O'Neill & Partners
Okay, great. Thanks a lot.
Operator
Your next question comes from the line of Bruce Harting from Barclays Capital. Please proceed.
Bruce Harting - Barclays Capital
Thank you. How much flexibility do you have left on the expense side, Roy, in terms of the outlook for this year?
And then if I may, just any comments on line management open to buy and contingent liability management---some of your competitors have been showings declines in receivables. And I don't know if that's a function of active purging or other things but if you could comment on line management.
And then just a final quick one. You have talked in the past about showing discount revenue as a separate line item, any progress on that.
Thanks.
Roy Guthrie
Okay. I think there -- yeah I think as I said, our expense initiatives really began last year and we began to see some of those manifest themselves in the numbers in the second of this last year.
We've seen it here in this quarter, and we would expect to see more of it come through as we go through the rest of this year and on into 2010. I don't want to size this for you but I do want to emphasize how important it is, the management here to keep that trend going in the right direction.
I don't think you're going to see the bottom fall-out expenses, but on the other hand, I think you're going to see that the direction we have set is going to be consistent.
David Nelms
And Bruce, in terms of your second question, contingent liability is something we try to manage carefully. In total it is down for us by about 15 % year-over-year.
But if you look within it, to look at our active base versus inactive base, our active base is pretty flat. And that suggests that we're continuing to give line increases and those are roughly offsetting line decreases.
So it's pretty stable and that's what our customers are actually able to spend their money on. The primary focus on managing the inactive is purging long time inactive accounts, which we've previously discussed.
And we have felt that one of the responsible things to do is to ensure that there aren't access lines out there that customers could conceivably get themselves into trouble with. And so, we will continue to purge the longer time inactive accounts.
Roy Guthrie
And then to just take this in order, Bruce, the last question. I think where we have giving some consideration to when we consolidate Discover Card Master Trust.
I think one of the benefits of that will be improved transparency around the discounting interchange line, which really only gets crowded when it goes into the excess spread calculation associated with the trust not being consolidated. So, it's more than likely, we would move to those disclosures when that consolidation occurs.
Bruce Harting - Barclays Capital
Thank you.
Operator
Your next question comes from the line of Brian Foran from Goldman Sachs. Please proceed.
Brian Foran - Goldman Sachs & Company, Inc.
Thanks. I know we've asked a lot about the reserves, but I guess just to come back to it, you are building reserves pretty aggressively here and some competitors are much more sanguine.
For example, GE (ph) is giving guidance kind of at the same time for year-end reserves that are at 6.7% where you are now even though they've got delinquencies at 7% right now, and you're at 5. So, I know you can only comment on what you are doing, but what should we look for reserves to peak?
Is it delinquencies peaking, is it early delinquency inflow peaking, or is there some other factor from the outside that we can monitor to try to get a sense of when reserves might peak?
Roy Guthrie
Well, Brian, I think it's I'll say what I've historically said is monitor the delinquency. And I think that's your best; that's the best broad.
30 day plus is the best broad measure of impairment that we have. The thing that has caused, I think this particular cycle to sort of disconnect from that is the velocity at which, or the speed with which you'll see accounts roll once they go into default status.
And so, what you have seen here in the last couple of quarters, we've raised the reserve over 1% each of the last two sequential quarters. And that's been significantly above the rate at which we've seen our 30 day balances pass to rise.
And that's principally to take into account the fact that there is a continued expectation that the velocity that we've seen over the course of this year is going to continue. So, I really can't give you anything as tangible as we might have been able to afford you in a more traditional sort of downturn.
But I still think the peaking of delinquency will also signal the peaking of reserve. So at the triggering of that in that regard it may not be as good as it used to be in terms of the absolute size.
Brian Foran - Goldman Sachs & Company, Inc.
Thanks. And if I could ask one follow-up on TALF, if you participate, is there any concern about political pressure to increase lending volumes?
Roy Guthrie
Well, I think most of the political pressure it appears to me is on the people borrowing from the government to buy our AAA qualifying collateral. And then hopefully, we can get that cleared up in the market, because obviously for us the issue, we need people to buy and be comfortable borrowing from the government.
We are a -- EPP (ph) program, so we're already in the middle of all that. And I'm just hoping that these don't cause this program to be anything, but a robust success on people that may not have been financial institutions that we're in TALF's initial programs.
Brian Foran - Goldman Sachs & Company, Inc.
Thank you.
Operator
Your next question comes from the line of John Stilmar from SunTrust. Please proceed.
John Stilmar - SunTrust Robinson Humphrey
Good morning. Thank you for allowing me to ask my question.
My first one is going to be with Roy. And just with regards to net interest margin.
Clearly at the Investor Day, you talked about margin expansion. And it showed remarkable strength this quarter.
Have we sort of reached a run rate especially given the Fed's actions yesterday, or is there a little bit more opportunity for a little bit -- for some more margin expansion from here. And how would you characterize that?
Roy Guthrie
I am glad you brought that up. I think that might have actually been a part of the previous question that may be I didn't address.
We have seen I think structurally, the major things that -- we've finally got this thing to settle down a little bit here. Obviously, LIBOR all over the place, which put a lot of noise in the interest expense, and number of other things including pressure on the yield associated with charge-offs.
So, I'd like to guide you not to see substantial margin expansion, particularly in the size that you've seen here, sequential quarter going forward. We've got interest expense down at 3%.
I have indicated to you that we're borrowing through that at the margin. So, that has probably some room, some downward sort of opportunities and yield, in terms of the positioning of the portfolio possibly has some upward opportunities.
But I'm not going to ask you to think about this, continuing at the pace, it's continued here this quarter but rather think about it in this range that we've got it out now. Just low 9%, 9.11% here the first quarter is pretty much where I think you should be thinking about for the rest of the year.
John Stilmar - SunTrust Robinson Humphrey
Excellent, thank you. And then with regards to operating expenses, just trying to put a final point on some comments that were made earlier; you've clearly talked about operating expense improvement, but continuing to invest in the network business.
As we net all this out and I look at your operating expenses for the quarter right around 560 million, frankly is that number kind of a run rate or should we be also thinking about that expense number to come down, very modestly or there is opportunities to drive further synergies?
Roy Guthrie
How about option B with a little C? I mean I think 559 is going...
we're going to continue, I think to be able to offset some of the investment criteria that we've got interoperability, we've talked about portfolio control. There are number of things that we are continuing to dedicate bundle of resources too.
But our view is that that number is probably going to move flat to down over the course of this year as you net those things together. And I think that was somewhere and where you're talking about with your second and third deals.
John Stilmar - SunTrust Robinson Humphrey
Perfect. And then, David, just returning again to put a final point on spending composition, and one of the statements made by a fellow bank executive, I believe, on his earnings call, in which he saw spending change from non-discretionary, from what he saw migration from debit-to-credit from non-discretionary types items.
And even though overall spending volumes, certainly, some of you talked to me is stabilized. Are you seeing shift in the mix similar to those kinds of statements?
Are you seeing a shift in the types of purchases that are made and how would you comment given even though your credit and debit networks may not be competing in terms of product, but can you enforce such a changes from the types of information that you see from your customers and transaction volume?
David Nelms
Well, I would say that we continue to see people pull back on their discretionary spending as opposed to their non-discretionary spending. And I would say the -- so things like travel, eating out, some of those kind of things, even some home improvement features, where people can pull back spending, they are pulling back spending, because their incomes are lower right now.
I think on the non-discretionary, and I would include gas purchases in that, where we see as it's more reflective of the price, the spending is down purely, because gas prices are down. And I'm hopeful that that some of that will eventually get reflected in grocery prices and so on.
So you may see dollars come down. But it's -- they're still buying food, they're still buying cash.
In terms of credit to debit, I'm not sure that I would agree that I've seen that kind of shift. And obviously we're the third largest PIN debit network, and 11% PIN debit growth year-over-year is a healthy growth.
So, I'm still seeing maybe debit not grow at the same pace it was, but I'm seeing more growth on the debit than I am on credit. And I am sure that there are some consumers that don't have enough money in their checking account, and they're relying on the credit card.
So there is no doubt that happens. But I think that is somewhat offset by some people, who are just cutting back on credit right now if they can and paying down debt, they can more in savings; so some offsetting factors.
John Stilmar - SunTrust Robinson Humphrey
Great. Thank you very much.
Operator
(Operator Instructions). Your next question comes from line of Moshe Orenbuch from Credit Suisse.
Please proceed.
Moshe Orenbuch - Credit Suisse
Thanks. I was just wondering if you could kind of look forward a little bit possibly towards the end of the economic downturn, what things which you look forward to start rebuilding kind of account acquisition?
What would you need to see before that would happen?
David Nelms
What I would want to see is delinquencies coming down and credit improving fundamentally. And I think that there have been a lot of changes, certainly, credit, but also some of the new laws in terms of how one has to price -- less ability to price for risk.
And so we have to adjust with all those things to make sure that we're returning our business to that 1.5 to 2% after-tax ROA that a credit card company needs to be profitable appropriately over time. And I do think that if you look past this current time, consumers de-leveraging having less debt out there, I do believe longer-term, we may see lower charge-off rates in the credit card business.
And it may have to -- it may shrink a little bit. But I think the business model will adjust to earn adequate profits and it may be with the low or less risk.
Moshe Orenbuch - Credit Suisse
Great. Thanks.
Operator
At this time there are no further questions in queue. I would now like to turn the call back over to Mr.
Craig Streem for closing remarks.
Craig Streem
Thanks Dan and thanks to all of you for your interest and your questions this morning. And of course, feel free to back to me if you need any clarification or any follow-up.
And we wish you all a good day. Bye.
Operator
Thank you for your participation in today's conference. This concludes the presentation.
You may now disconnect. Good day.