Dec 17, 2009
Executives
Craig Streem – VP, IR David Nelms – Chairman and CEO Roy Guthrie – EVP and CFO
Analysts
Andrew Wessel – JP Morgan Mike Taiano – Sandler O’Neill Sanjay Sakhrani – KBW Bill Carcache – Macquarie David Hochstim – Buckingham Research Group Chris Brendler – Stifel, Nicolaus Moshe Orenbuch – Credit Suisse Bruce Harding – Barclays Rick Shane – Jefferies Craig Maurer – CLSA Scott Valentin – FBR Henry Coffey – Sterne, Agee Brad Ball– Ladenburg FSG John Stilmar – SunTrust
Operator
Welcome to the fourth quarter 2009 Discover Financial Services earnings conference call. (Operator Instructions) I would now like to turn the conference over to your host for today, Mr.
Craig Streem, Vice President of Investor Relations. Please proceed.
Craig Streem
Thank you. Good morning everyone and we all want to welcome you to this morning’s call and we appreciate your joining us today as always.
I want to begin of course by reminding everyone that the discussion today contains certain forward-looking statements about the company’s future financial performance and business prospects, which are of course 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-Q for the quarters ended February 28, 2009; May 31, 2009; August 31, 2009 and in our Form 10-K for the year ended November 30, 2008, all of which are on file with the SEC.
In the fourth quarter 2009 earnings release and supplement, which are now posted on our website and have also been furnished to the SEC, we have provided information that compares and reconciles the company’s managed basis financial measures with GAAP financial information and we explained why these presentations are useful to management and to investors. Of course 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, ample time for Q&A following the formal remarks. Now it’s my pleasure to turn the call over to David.
David Nelms
Thanks Craig. In my comments this morning I would like to take a few moments to review the highlights of the year, focusing on three main themes; our credit quality, the actions we have taken to strengthen the Discover franchise and finally capital management.
We accomplished a great deal this year in each of these areas which I will discuss more in a moment and we are going into 2010 having improved our competitive positioning in direct banking and in global payments. Let’s first take a look at our full-year 2009 results.
We earned $1.3 billion or $2.42 per share and we were profitable for the year even excluding the Visa settlement which we think is a terrific result in the face of the highest level of unemployment rates and credit losses the credit card industry has ever experienced. The economic environment has taken a heavy toll this year but we believe we will report the lowest full-year charge off rate of our major competitors.
Our fourth quarter managed net charge off rate came in at 8.43% just under our guidance and only four basis points above the third quarter. In dollar terms this is the first time since 2007 that we have achieved a sequential decline in charge-off dollars which is certainly encouraging.
Unfortunately, we have not yet seen sustained improvement in the US economy plus our fourth quarter delinquencies were somewhat higher which leads us to conclude we may be approaching but likely have not yet reached a peak loan loss rate. For the first quarter of 2010 we expect our total managed net charge off rate will be in a range of 8.4% to 8.9%.
In addition to carefully managing credit performance we are focused on enhancing the Discover franchise and strengthening the foundation for future growth. A key contributor to building our franchise has been the steady increase in the number of US merchants accepting the Discover Card with the number of active merchants at the end of November up by more than 6% from last year.
In addition we launched new advertising that focuses on how our customers value Discover’s Cash Back Bonus program. The stories depicted in our ads resonate well with our customers and emphasize Discover’s core brand strength.
Perhaps the clearest indicator of the success of these initiatives has been our strong relative performance in credit card sales volume which suggests we are continuing to take market share. In terms of year-over-year sales volume for Discover Card, we began to see some positive comparisons in the fourth quarter with sales volume down less than 1% year-over-year.
Normalizing for day count October was the first month this year where sales volume did not decline and November was the first month of sales growth in over a year and we are pleased the positive trends we saw in November have continued so far in December. In fact, starting in mid-October and continuing through the most recent week our year-over-year sales by week have been positive which is a nice trend relative to what we had seen earlier in the year.
Another area of significant emphasis for us has been our other direct to consumer banking businesses where we have achieved outstanding growth in deposits as well as in student and personal lending. Our deposit book exceeded $12.5 billion at the end of the quarter, more than double the level of one year ago and we are continuing to invest in this business.
The next major theme of 2009 was capital management. We built our capital base during the year through retained earnings, by issuing over 500 million of common equity in July and last month we issued $700 million of long-term sub-debt at the bank.
As a result, our capital ratios are strong even taking into account the impact of FAS 166 and 167 on our December 1 balance sheet. Roy will walk you through those numbers later on but I also would like to take a minute to address TARP repayment, an issue that has increasingly been in the news recently.
During the past few weeks, several large financial institutions have either repaid TARP or announced their intentions to do so. As we have said before, we will work in a deliberate manner to determine the right time for us to pay back TARP funds.
Given our stabilizing credit trends and the significant capital enhancements we have now completed, we are feeling much more confident that TARP repayment will be sooner rather than later and we will continue to discuss this with you over the coming months. Now let me share with you some of our priorities for 2010.
First, in card issuing we have already made a number of changes as a result of the Card Act but a number of things will not change such as our commitment to cash rewards, superior customer service and the addition of new product features that help customers better manage credit and responsibly use their Discover Credit card accounts. In direct banking, we will continue to have strong growth in direct to consumer deposits and disciplined growth in student loans and personal loans as we leverage our low cost direct infrastructure, brand, credit management and marketing capabilities.
In payments our first priority is to continue with rapid implementation of our domestic acceptance strategy and leverage growing acceptance with the many merchants who now accept Discover through the numerous acquiring partnerships we have built in recent years. We are also working on increasing global volume across the Discover, Pulse and Diners Club networks by leveraging our flexibility, network partnerships and emerging payments opportunities.
For example, in the fourth quarter we began to see a significant increase in the amount of inbound JCV volume running over the Discover network. We also signed multi-year incentive agreements with a number of our top Diners Club franchisees to drive increasing volume on the Diners Club network globally.
We also expect to take advantage of more partnership opportunities to grow volume and market share around the world. Expense control will remain a high priority for us in 2010 as we implement additional efficiencies while continuing to invest in marketing to take advantage of opportunities presented by the recovery in the economy.
To wrap up my comments, I am very pleased with how we have managed the company through this cycle particularly with our industry-leading credit performance, share gains and sales volume and receivables and very strong capital ratios. Looking ahead I believe our competitive position is even stronger with tremendous opportunities to achieve further share gains in global payments and direct banking ranging from card issuing to student lending to direct deposits.
Now I will turn the call over to Roy to go over the numbers in detail.
Roy Guthrie
Thanks David. First focusing on the company overall, we reported net income of $371 million or $0.63 per share, down from $0.92 last year.
The current quarter includes the final payment from the settlement of the litigation with Visa/MasterCard in the amount of $285 million after tax or the equivalent of $0.51 per share while last year’s quarter had the initial payment which amounted to $535 million after tax or the equivalent of $1.10 per share. Turning to our segments, the US card earned $575 million pre-tax this quarter and again that included $472 million from the antitrust litigation revenue.
Net interest margin for the segment which includes cards, student loans and personal loans was 9.37%, down 53 basis points from the third quarter which was the high water mark for margin thus far. This decline reflects a number of factors including about 15 basis points related to having a higher proportion of student and personal loans which have lower yields than credit cards, 14 basis points from a combination of running higher liquidity pool along with a higher cost of funds reflecting our recent debt transactions.
In terms of the yield on the card portfolio itself we reported a decline of 24 basis points sequentially largely attributable to the absence of the fall repricing as we began to implement changes required by the Card Act. Looking back at the third quarter as you will recall we dramatically reduced our BT activity which was a factor in the spike in yield we reported in that quarter.
In the fourth quarter we restored a degree of balance transfer activity as we started to feel better about the environment and saw opportunities to grow. Even with that we ended the year with only about 11% of the portfolio on a promotional rate versus about 20% a year ago.
Looking ahead in yield in the US card segment we expect to see continuing downward pressure on yield as the Card Act is fully implemented and its effects are accumulated throughout the year. However, we have taken a series of management actions that will serve to offset these impacts many of which have been introduced over the course of 2009 and will also accumulate over time.
These include higher new account pricing associated with our pricing for risk at origination, lower promotional rate balances and higher fees on BT offers. Also we would expect lower charge offs on finance charge income as the cycle turns.
So we would estimate credit card yield for the year to finish in a range of something like 25-50 basis points lower than where we landed here in the fourth quarter. Another potential benefit that is not in these numbers relates to the asset sensitive positioning of our balance sheet meaning that as benchmark interest rates rise we would expect to see margin expansion.
David already discussed trends in the card sales volume so I am going to turn now to receivables. Overall, managed loans were virtually unchanged from the prior year and from the third quarter levels as growth in our non-card loan product offset modest reductions in the card portfolio.
The latter basically reflected much lower balance transfer volume as well as sales declines over the course of the year. As I said a moment ago the mix shift between card and non-card loans contributed to the sequential quarter decline in margin but also will contribute to positive trends in credit losses because the student and personal loan portfolios are likely to have lower run rate losses than the traditional card business.
Turning back to the income for the US Card segment, other income includes $472 million of settlement payment from Visa as well as the negative IO mark of $38 million in the quarter. I want to remind you as a result of implementing the new accounting under FAS 166 and 167 this is the last quarter in which we will report an IO strip revaluation and I will give you some more color on that in a few moments.
In my comments on delinquency and charge offs I am going to focus on the card portfolio, again excluding student and personal loans since card trans account for the vast majority of our delinquency. The managed 30 day delinquency rate for the credit card loans was 5.6%, up 29 basis points sequentially.
Delinquency trends tend to be seasonally higher in our fourth quarter than in our third and the movement this quarter is consistent with that pattern. As you saw in the November trust data we reported this week, delinquency remains a bit elevated in the later stage buckets but overall we are very pleased with the current trends.
Looking at the card portfolio loan charge offs increased just 18 basis points sequentially to 8.81%, a significant improvement from the rate of change we have been seeing as both bankruptcy filing and recoveries came in better here than we expected. As David said we are anticipating higher charge off levels in the first part of 2010 and until we see sustained improvement in fundamental economic indicators we are not prepared to suggest that losses have peaked so recognizing this uncertainty along with recent trends in delinquency we have increased our reserve rate this quarter to 7.87% excluding guaranteed student loans.
During the quarter loss provisions were $74 million less than charge offs. Our ABS offerings and trust support actions in the quarter exceeded maturities and generated reserve releases that more than offset the provision expense related to the higher reserve rate I just cited.
Turning to operating expenses, US card came in at $542 million, down 3% year-over-year. Expenses this quarter included a $9 million charge related to a facility closure while the fourth quarter of last year had a one-time reduction in pension expense of $39 million so backing out these items expenses would have otherwise decreased by 12% year-over-year.
As we ramp up for the holiday season our fourth quarter tends to be a higher level of spend for business and this year our spending included increased marketing as we launched a new ad campaign and continue to make investments related to increasing global acceptance. In 2010 our plan is to continue to invest in marketing and other initiatives to grow the franchise.
We believe we can fund these through efficiencies. Our target expense to receivables ratio should be around 4% through 2010 and that is consistent with the low level you have seen us maintain through the course of this year.
Moving to our payments segment, our third-party payments business earned $24 million for the quarter with total network volumes down 2% to $33 billion. [Whole] dollar volumes were down 1% from last year due to the loss of volume from a large financial institution.
Pulse’s primary revenue driver is transactions processed which were up 5% year-over-year. In terms of funding in the quarter we did $1.3 billion of a TALF ABS, sold $700 million of sub-debt out of the bank and issued a small amount of broker deposits but the big story in the quarter was the continued, steady growth in our direct to consumer deposits which were up $2.4 billion to finish the year at $12.6 billion.
Total deposit issuance in the quarter was $4.7 billion with a weighted average maturity of 32 months. Our total maturities from all sources in 2010 will be about $19 billion with about $12.5 billion of that in the first half of the year.
For that reason we finished the quarter with an elevated level of cash liquidity exceeding $14 billion. The last thing I want to cover is our implementation of FAS 166 and 167.
Over the last couple of quarters we have discussed this with you at length so you should be aware of our approach towards implementing this new accounting. We will adopt the new rules on a historical cost basis which means we will reconsolidated $21.1 billion of assets which is net of $2.1 billion of incremental loss reserves and we will also add approximately $22.3 billion of liabilities to our balance sheet.
The reconsolidation nets out to a $1.3 billion after-tax charge against the opening equity for 2010. So from a balance sheet perspective reserves are now put up against the overall portfolio and amount to about $3.9 billion.
Our pro forma regulatory capital ratio under the new accounting for year-end are approximately 13% tier one and 16% total capital, both very strong. In closing, the balance sheet is in great shape even after implementing FAS 166 and 167 which is a great way to start the New Year and like David I am pleased with how we have managed the company through this cycle and how we are positioned for 2010.
With that I will turn it back over for Q&A.
Operator
(Operator Instructions) The first question comes from the line of Andrew Wessel – JP Morgan.
Andrew Wessel – JP Morgan
Starting off, broader picture in terms of asset growth next year, obviously with cards kind of an unknown can you give any sort of outlook for your thoughts in growing student and personal loans next year in terms of either a percentage or a hard number?
David Nelms
I would say what you saw over the last two quarters would be fairly consistent with what we would expect over the next year with some continuing modest declines in card receivables being roughly offset by continuing growth particularly in the student business.
Andrew Wessel – JP Morgan
So kind of flattish assets year-over-year then?
David Nelms
Fairly flat. Yes.
Andrew Wessel – JP Morgan
In terms of student loans rates, I think in the margin we have seen some of the higher credit quality private student loans we have seen prime plus a point going down to prime plus two or three points depending on the actual loan itself and the borrower. Is that something in the range of what you have been printing or is that not anywhere close?
David Nelms
We can follow-up more specifically. I think we have some information on our website that shows typical pricing.
As Roy pointed out, obviously student loans have much lower pricing than credit cards and would be expected to have much lower loan losses over a long period of time as well.
Andrew Wessel – JP Morgan
In terms of the yield on cards, just so I got that right, when you were saying 25-50 basis points lower yield in 2010 that was just for the card yield, correct?
Roy Guthrie
That is right. Speaking specifically to I think we should focus on the card yield because the mix attributes are a little confusing.
I was focusing strictly on the card yield.
Operator
The next question comes from the line of Mike Taiano – Sandler O’Neill.
Mike Taiano – Sandler O’Neill
Just to clarify again on the guidance for yield is that the net yield or the gross yield that you are talking about with the 25-50 basis points decline?
Roy Guthrie
It is the same thing we actually disclosed in the statistical supplement which would be net of charge offs. So it is the net on that basis.
Not net of interest expense obviously but net of gross less charge offs.
Mike Taiano – Sandler O’Neill
That is over the full year or just the fourth quarter the 25-50 basis point decline?
Roy Guthrie
We would estimate that is where it would land over the year that is the impact. So we finish on the run something in that neighborhood.
Mike Taiano – Sandler O’Neill
In terms of the implementation of the Card Act where would you say you stand in terms of the effect of that? Is it 50%?
75%? Maybe give us some context there.
David Nelms
I would say that if you just take the guidance that Roy laid out it is maybe 1/3 in the numbers if you saw what happened this quarter versus what we have between now and the end of next year. Obviously these numbers are net.
Essentially what will happen is the higher rate delinquency pricing will tend to amortize down over the quarters and meanwhile it is partially, but not completely, offset by an amortization down of promo rates and the very low interest rates and effectively risk based pricing is being unwound with pricing being pushed more towards the middle for a broad group of people.
Mike Taiano – Sandler O’Neill
You are holding a significant amount of liquidity with $14 billion in cash. Can you give us some context as to where you see sort of the liquidity balance?
Obviously that has been a drag on your margin. Is it somewhere closer to $10 billion?
Can you give us some idea what we should expect 2010 average cash balances to be?
Roy Guthrie
It is going to obviously reflect I would say liquidity and market conditions as well as the profile of requirements which are obviously a combination of growth and maturities. I cited the $19 billion of maturities.
$12.5 billion of it is sort of concentrated in the front part of the year. I think what we have done here is basically pre-fund a good portion of that.
You should see I think during the first half of the year that liquidity kind of restore itself down to the $8-9 billion level you saw us maintaining sort of coming into the quarter. It sort of releases itself reasonably quickly given that is the profile of the way the maturities lay out next year.
Operator
The next question comes from the line of Sanjay Sakhrani – KBW.
Sanjay Sakhrani – KBW
I had a quick question Roy on the margin again. I am sorry to dwell on this but I just want to make sure I understood it.
The net interest margin which would be gross interest yield, less interest expense, you expect that to be down 20-50 basis points net of all the offsetting impact you are trying to implement?
Roy Guthrie
That is right.
Sanjay Sakhrani – KBW
So that 9.37% you think about be closer to 9% next year?
Roy Guthrie
That has the mix attributes in it and it has the cost of funds in it. So really what I am addressing is the credit card managed interest yield of 12.75 on the statistical supplement on the credit card segment page we bifurcate the aggregate yield and give you the top line.
Focusing on that 12.75 which is presented on the third page of the statistical supplement and the impact on it, there are other things that are influencing obviously cost of funds. We just mentioned liquidity which will come and pass during the course of the first half.
We talked about asset sensitivity in the portfolio. I think importantly I am trying to eliminate the mix aspect of it.
So I think your model should really focus maybe on credit cards and non-credit cards so you can isolate this thing we are trying to give you guidance on.
Sanjay Sakhrani – KBW
Would there be an abatement in interest expense because you have a smaller liquidity portfolio and you would be funding some of the maturities you have? Wouldn’t that benefit the net interest margin?
Roy Guthrie
Yes. There is negative carry on that cash given that the cash is positioned very short-term and very high grade.
You can see the characterization of our cash in our Q as well as our K which will cover it in a lot of detail. So that negative carry manifests itself in the interest expense line and comes and goes as that portfolio grows and shrinks.
Sanjay Sakhrani – KBW
On the default pricing you implemented, is that basically that you have to give 60 days’ notice before or I am sorry the consumer has to be 60 days delinquent before you can reprice them or is it just you have to give 45 days’ notice to reprice?
David Nelms
I would say both and then some additional actions we have taken. The first part of the card act already went into place so there was a 60 day time where no default pricing took place.
Then that will totally be eliminated after February. Additionally, this year we have not been taking some of the actions we historically might have to look at other factors that indicate high risk to take people to a higher rate and instead have been focused on moving people to the middle to eliminate risk based pricing.
I think people have tended to focus on February and there is a lot that goes in February as well but the effects have been accumulating even this quarter.
Sanjay Sakhrani – KBW
So the assumption the ability to reprice with 45 days notice was still an option right now?
David Nelms
Well, 45 days but you really are talking 60 days from a practical standpoint. I would say generally what the focus is to have the price be adequate up front to reflect all future risk and to go back to the way it used to be frankly.
You can, even after February, price new balances with notice and so on. I frankly am not sure that will be a very big aspect because it requires two cycles past due and a lot of those people won’t have charging privileges frankly.
Sanjay Sakhrani – KBW
On the marketing expense, how should we think about this quarter’s elevated levels of expense? Should we use that run rate as a proxy for next year on a quarterly basis or will that ease somewhat next year?
Roy Guthrie
I think seasonally we do see the fourth quarter being sort of a higher level than you normally would see over the course of the year. So I wouldn’t necessarily guide you to that.
I would just come back to the broad guidance across all the expense categories of around 4% plus or minus on the overall assets. I think it is going to be contingent on a lot of things that happen and they way things unfold next year and is probably pre-mature to say how we are going to spend it.
We did I think articulate a couple of things I would like to reinforce here. That is during the course of next year we do have strong plans to continue to grow and invest in the deposits platform we have had great success with this year; inter-operability initiatives we have underway both domestically with the acceptance as well as international Diners.
So those are things that are going to be incredibly important. Some of those go through the marketing line and they are going to be introduced over the course of time as well as the card side.
So it is a dynamic world. I would bring you back to this more global guidance which we think is better suited for looking at the full year 2010.
Operator
The next question comes from the line of Bill Carcache – Macquarie Research.
Bill Carcache – Macquarie
Can you comment on the legislation that made it through the House last week and the impact that you think the creation of the CMPA could have on your business beyond the changes that are already taking place under the Card Act?
David Nelms
I think it is early days right now. There are a lot of very disparate proposals.
It is my hope I think it is really important to get these things right. We are certainly supportive of consumer protections but I think it is still important that things need to be fully thought out and we avoid some of the unintended consequences that could happen so it is my hope that we will end up with something that is good for consumers.
Bill Carcache – Macquarie
Was there any impact to you from the phasing in of regulatory capital requirements on adoption of 166 and 167? Or does the phase in not matter in that you had to consolidate the off balance sheet for regulatory capital purposes anyway after providing support for the trust?
Roy Guthrie
The way I read it so far is the latter.
Bill Carcache – Macquarie
So that would be the case for all of those that provided support the decision on regulatory capital shouldn’t really have an impact?
Roy Guthrie
I think that is right.
Bill Carcache – Macquarie
Next quarter can you give us a sense of whether you plan to show the impact of 166 and 167 prospectively only so that basically prior period numbers aren’t comparable or are you going to adjust the prior period numbers so we have can have some comparable numbers on a year-over-year basis?
David Nelms
Good question. Certainly we intend to help you guys out with this.
I think what we will do is the K will come out obviously in the January timeframe. We intend to sort of gather everybody in New York sometime in March so between somewhere in that sort of timeframe we will try to get into your hands a restatement through an 8-K or through portions of the K itself so you can reset on a historical basis similar to the way we will be accounting for next year.
Operator
The next question comes from the line of David Hochstim – Buckingham Research Group.
David Hochstim – Buckingham Research Group
The $3.9 billion you have in reserves now, how should we think about that relative to expected charge off’s over the next few quarters? I was wondering if you could relate that to your comment you don’t think charge offs have peaked yet even though we have been seeing declines in early stage delinquencies that you have clearly reserved for charge-off’s for some period?
Roy Guthrie
I think the best way I can speak to that is that the next quarter the best benchmark you have that we have provided is our 90 day balances past due. Subject to dynamic things like roll rates, bankruptcies and recoveries.
So you can see that was elevated in the quarter and I think that is consistent with the guidance around charge offs we have provided. Clearly though reserve rates are anticipatory.
So we have already anticipated the guidance that David gave you and the reserve rate we posted for the fourth quarter. You will see the reserve rate probably more closely align itself with delinquency so when delinquency near peaks during the course of this cycle, and I will try and leave it generic like that, you will also see the reserve behavior be sort of the first thing to be affected.
Because if you think about reserves, we are measuring impairment on one-day and greater past due. Charging off at 180 days past due and bankruptcy at 60 days after notification you are going to see the provision expense manifest itself far quicker than the charge off rate in lower provisions.
So that is where you will see it first and it should be somewhat aligned around where we see the cresting and peaking of delinquency, whenever that may be during the course of next year or this cycle.
David Hochstim – Buckingham Research Group
That 3.9 is that a 12 month look?
Roy Guthrie
3.9 is the aggregate amount of reserves in the portfolio that is there to basically create a hedge against known losses. So known losses in our world manifest themselves as anything that is one day or more past due.
David Hochstim – Buckingham Research Group
The change in the Pulse volume which you attributed to a loss of a big customer, does that also explain the change from Q3 to Q4? Is that the same big customer?
David Nelms
That is right. One of the nice things about the Pulse business is it is spread across 4,500 financial institutions and we don’t have the concentration we think some other networks might have.
Nonetheless, I was pleased that our transaction volume year-over-year was still up 5% even net of that loss. But I would expect that to have an impact as it did this quarter but also the next three quarters where we have replaced the business but do not have the growth rate we have been putting up in the last two years.
David Hochstim – Buckingham Research Group
Can you give us any update on what is happening with your discussions with Morgan Stanley about the litigation payment? Are you any closer to getting that resolved?
David Nelms
We are continuing the process and it is not done yet.
David Hochstim – Buckingham Research Group
On TARP are you suggesting in the next quarter or two you will be paying back the government or in the next few months?
David Nelms
I don’t want to get pinned down to an exact time. I think we are going through a very deliberate process but I laid out for you a number of signs that would suggest optimism it would be sooner rather than later.
I would say the early part of this year we may have a further update for you.
Roy Guthrie
I said the reserve was against known losses. I think a better word would be expected losses.
Obviously we are using historical measures to gauge where one day and over, 30 days and over and 60 days and would expect it to roll so let’s amend that to say expected losses.
Operator
The next question comes from the line of Chris Brendler – Stifel, Nicolaus.
Chris Brendler – Stifel, Nicolaus
I missed a little bit of the call this morning so I apologize if this is a little redundant but can you talk at all about how you felt about spending trends in the quarter? Did you see any real signs of improvement in the consumer spending as far as you could tell?
Where there any significant moves throughout the quarter? Was November better than October?
I know you have easier comparisons versus a year ago but just some color commentary if you could on spending trends.
David Nelms
I did cover some of that. Yes, partly because we have reached the year-over-year when the reset happened for consumer spending broadly and partly because of our growing acceptance and marketing we are seeing some positive trends.
I mentioned earlier we turned positive in November and in fact we have seen positive year-over-year sales in Discover Card every week since mid-October all the way up through the first two weeks of December. So not high growth but it is great to see positive numbers.
Chris Brendler – Stifel, Nicolaus
Competitively, I believe last time we spoke you felt like you were making some progress on the competitive front under the new regulations you felt good about some of the products you were testing. It seems to be we have seen a little bit of a pickup in competition.
Your competitors are feeling a little more comfortable with the macro environment and the new rules. Do you see any of that?
What is the outlook for teaser rates and your usage of teaser rates in 2010?
David Nelms
My sense is that both we and some competitors are starting to feel a little more comfortable marketing again and doing a little more balance transfer, a little more new account marketing. I think that teaser rates and balance transfers are not going to go away under Card Act but will be substantially different.
With the changes in payment hierarchy and some of the things that have been put in, what I expect and what we have done is gone to shorter durations, more selective offers, balance transfer fees that help between the actual rate and the balance transfer fee to get an adequate return and on net we still expect our percentage of teaser rates if you will to amortize down over the next year as a result of those actions. We are still going to be active where we think it adds to our profitability to make offers available to our customers.
Chris Brendler – Stifel, Nicolaus
On credit quality on the delinquency trends this quarter they were actually quite impressive on the credit card business. It is obviously a pretty difficult macro situation still and I haven’t seen improvement in the job market but your delinquency trends for this time of year looked relatively benign.
Would you share that view? Were they actually better than you had expected internally during the quarter and if so why are you still building reserves?
David Nelms
Delinquencies while we were pleased, they still were up sequentially and that goes into the reserve break. The thing where we saw an improvement was the dollars of losses and that is the first sequential improvement we have seen in that number since 2007.
If we look at the delinquencies and the continuing high levels of unemployment and what I would characterize is we appear to be approaching a peak but you really can’t declare a peak until you are coming down the other side.
Operator
The next question comes from the line of Moshe Orenbuch – Credit Suisse.
Moshe Orenbuch – Credit Suisse
Apologies for going back to the net interest margin or actually more accurately net interest income, can you talk a little bit in dollars I guess that $[90] million sequentially was that increase negative carry on liquidity? Was it the Card Act?
To the extent it was the Card Act how much more should we think about [audio fades] in the next quarter?
David Nelms
In the margin line?
Moshe Orenbuch – Credit Suisse
Right, net interest income in dollars.
Roy Guthrie
No influence there necessarily from the investment portfolio. So I think the thing we talked about were principally around the impacts inside the Card Act.
I am really principally focused on the yield down there at 12.75. Nominally, dollars obviously would be influenced by the underlying balances and I think we have given you a little bit of counsel on where we want those balances to go.
As you heard David say maybe 1/3 of the way through the impact and by the end of the year that 25-50 basis point offset on that particular line is where we think we will land.
Moshe Orenbuch – Credit Suisse
On a follow-up, you talked a little bit about deposits and liquidity. Is there any way to kind of jump start that with acquisitions or anything we should be thinking about on the deposit side?
David Nelms
Certainly we were pleased organically we grew $2.4 billion this quarter. We did announce one inorganic acquisition of about $1.3 billion of deposits we would expect to close during the first quarter on top of whatever organic growth we have during the quarter.
So that will be the first time we have done that.
Operator
The next question comes from the line of Bruce Harding – Barclays.
Bruce Harding – Barclays
Did you cover already, I didn’t get the increase in total assets and managed assets? Given you have one of the stronger capital positions in the banking industry right now can you remind us what on your comments on acquisitions how you might deploy that either organically or through acquisitions in 2010?
Roy Guthrie
Maybe Dave and I can split that one. The reconsolidation we have to give you a lot more color on this and again I have to refer you back to the K and also the third quarter Q did a pretty good job of outlining some of the component pieces.
As of today we know it will be $21.1 billion of assets reconsolidated. That is net of $2.1 billion of incremental loss reserves which brings the aggregate loss reserves on the pro forma post 166/167 balance sheet to $3.9 billion.
There is $22.3 billion of liabilities and then the net of those assets and liabilities will be reported as a charge, a $1.3 billion charge to our opening equity. I did cite the ratio of 13% tier one, 16% total capital.
I would echo what you said [very strong ratios].
David Nelms
In terms of acquisitions, we are focused primarily on organic growth. We have certainly been pleased with how the Pulse acquisition of a number of years ago and the acquisition of Diners Club just over a year ago.
We have, as I mentioned, done this small deposits purchase. So we have shown that where something is very strategic, has high synergies and makes sense we have a record of moving forward, integrating and realizing the benefit.
I would say inorganic would not likely be our primary focus for 2010.
Operator
The next question comes from the line of Rick Shane – Jefferies.
Rick Shane – Jefferies
In terms of TARP repayment you have given some visibility in terms of timeline. Would you anticipate, given your capital ratios, having to issue additional equity or do you think you can do it given your current liquidity and capital position?
David Nelms
I feel like we have checked the boxes and one of the things you might look at is the fact that if you take the 500 million common and add the 700 million we just did which is tier two capital, it happens to be roughly the same number as the TARP. So we have replaced it with that.
We have also had positive earnings for the year. I think for us we will look at more all the factors.
As you recall, we were not one of those first 19 that went in 2008 and in fact we just entered in March of this year and so I think we are on a little more deliberate path and we don’t want to be rushed into something. We think it is sooner rather than later.
Operator
The next question comes from the line of Craig Maurer – CLSA.
Craig Maurer – CLSA
My question is more of a long-term strategic one regarding the value of the network. When we look at revenue and earnings the contribution is not too great.
You basically are the closest thing we have to the mono-line credit card company harkening back to the days of MBNA. You have about 1/3 the volume of American Express which is the number three player.
I am just wondering why the card portfolio itself wouldn’t be better off on a Visa/MasterCard network with the same rewards program co-branding and you would essentially double your acceptance and exposure overnight. I was just hoping you could give me a little color there on the long-term value of the network.
David Nelms
First off, I think we are making great progress on the network and earning $100 million and having margins in excess of 40% across the networks I think is respectable and we certainly want to continue growing that faster than cards. I would also say that we are capitalizing on the brand benefits we get from having Discover at point of sale.
As you see our success in deposits, in personal loans and student loans and having broader direct banking services to consumers I think that I would be hard pressed to give up the brand benefits and the upside potential of what we can do with our own brand as opposed to some of our competitors who are pushing someone else’s brand. One of the things that caught my attention a little is I noticed Chase for instance isn’t even including Visa/MasterCard in a lot of their advertising I am seeing.
We are fortunate to have our own brand and we take advantage of that. We are focused on realizing the full advantage of our payments business, our brand, our unique differentiated position and ultimately we think we can put a lot more points on the board by pursuing that differentiated strategy versus others who as you point out are just another Visa/MasterCard issuer.
Craig Maurer – CLSA
You said there will be a $1.3 billion charge to equity from the FAS changes, correct?
Roy Guthrie
Right to the opening balance sheet. Not the P&L but an opening balance sheet adjustment.
Craig Maurer – CLSA
So the tangible book value as of the opening balance sheet should look more like $10 per share?
Roy Guthrie
That is right. A little over $10.
Operator
The next question comes from the line of Scott Valentin – FBR.
Scott Valentin – FBR
With regards to the Card Act is there anything in your business model that would make you maybe more exposed to some of the new criteria in the Card Act than your peers?
David Nelms
No, I would say the opposite partly because our focus is on prime credit cards. I think some of the fee impacts and so on I would expect us to have less of a relative impact on us.
The other thing is I think a lot more of the focus going forward is going to be on things other than promo APRs or low starter APRs. Our sweet spot is cash-back bonus and being differentiated.
I think you are seeing us already taking advantage of that and growing market share by focusing on things other than just low up-front APR.
Scott Valentin – FBR
With regards to market share, I know it came up earlier it appears you are driving more mail and those are going up. How have you seen your market share shift in terms of acceptance by consumers in the cash-back rewards segment and are you seeing competitors come back and drop more mail in the cash-back segment?
David Nelms
No, not so far. I would say our share of mail volume is dramatically higher this year than it has been in the last several years.
If you specifically look at our cash rewards mail that has moved even more. I have seen pretty significant pull backs on a number of other people’s reward programs so a number of people switched to points versus cash.
They have diluted their earnings and so you have seen us go in the opposite direction with the new ad campaign pushing cash-back bonus. We are doing multiple promotions this holiday season with 5% promotions and up to 20% funded by various retailer partners.
So it has probably been a number of years since we have always been or consistently been the largest marketer but I think the difference between us and the next biggest has grown significantly this year.
Operator
The next question comes from the line of Henry Coffey – Sterne, Agee.
Henry Coffey – Sterne, Agee
I am a little shocked at the market reaction to your news. It seems your capital is in strong order.
You have lower losses. I was wondering if you could give us a little color on the growth of the student loan portfolio?
Roy Guthrie
About 2/3 or at least 70% of student loans are government guaranteed. The other 30% or so was private student loans.
The vast majority of that we have parents as cosigners. We have been very careful to go to some of the top schools in the country.
There are about 600 schools that are originating student loans through us. One of the things that is likely to happen next year is the government part of the student loans there are some programs we could choose to basically offload the government portion of those loans back to the government once we get to a certain scale so you may see that grow and then come back off of our balance sheet at some point during the year.
Henry Coffey – Sterne, Agee
Has that mix changed much over the last couple of quarters?
Roy Guthrie
No it hasn’t. We have been quite consistent.
The larger numbers come from the government part of the student loans but the primary place we think we can earn money, if you will, is on the private side. So far you have kind of needed to do both because a lot of schools or a lot of students get both the government piece and private piece so you need to kind of offer the full shopping which is what we have done.
I am very pleased with how we have been received and our rankings by student, by schools has been very, very strong.
Operator
The next question comes from the line of Brad Ball – Ladenburg FSG.
Brad Ball – Ladenburg FSG
Could you talk a little more about your DTC deposit strategy? What kind of pricing are you offering?
Who are the customers? Do you have any kind of penetration within your card base?
Also, the acquisition you are going to be closing next quarter do you foresee other opportunities to buy deposits like that? My understanding is those aren’t necessarily brick and mortar deposits.
They may be DTC deposits themselves. What kind of attrition rates are you expecting on that deal?
David Nelms
I would encourage you to pop on our website and you can see the exact deposit rate. Right now we are a bit under 2% in the one-year and then a bit higher out five years at just over 3% for CDs which is fairly competitive with other direct banks.
Certainly a lot of our strategy is by not having the brick and mortar costs we are able to offer the consumers a higher rate but still a very competitive to us cost of funds. That is a big reason that direct internet deposits have been growing at I think like a 30% compound rate the last several years while brick and mortar deposits have been in the low single digits.
Even a lot of the brick and mortar banks are increasingly gathering deposits from their customers from the Internet as opposed to people walking in a branch. So our strategy has been to use the brand to cross-sell our base.
It is something nearly half of our business I would say is probably cross-sell to our current customer base although that is dropping as we increasingly become known as a place to get deposits. We have introduced a number of retirement accounts this year.
We have introduced some new savings accounts this year. We have upgraded our website and went to 24 hour customer service.
So our objective is to be the best direct bank in the country and the direct to consumer deposit business is both a funding source and a business for us. You are right, the acquisition I mentioned of $1.3 billion I would expect some level of attrition.
It is our first one so we don’t know exactly how much attrition we will get. It is a direct business.
The other thing I would add is we are also doing some nice things in the Affinity space. For example, AAA is offering up our deposits to their customers at their locations and with their customers around the country and we hope and expect to have additional affinities through which we are originating and getting new customers.
Operator
The next question comes from the line of John Stilmar – SunTrust.
John Stilmar – SunTrust
In terms of your guidance in the first quarter are you expecting to see that improvement in later stage roll rates? It seems like your loss guidance may be a little bit lower than what we might think organically if we are just looking at later stage roll rates in the trust or is that really a function of the mix shift of what we have outside of the trust like student loans or new solicitations positively impacting credit at least from a denominator?
Can you help guide me to what your expectations are even though it is up, it is not up as much as I would have expected given the trust.
David Nelms
I think I would tell you I think the trust delinquencies are probably amongst the highest quality information the trust affords you. I think the role you are seeing there are probably informative as it relates to guidance.
We have also sort of indicated as I mentioned in my prepared remarks we have seen somewhat of a pull back in the rate of growth of bankruptcies and we are actually feeling better about the recovery streams that we are able to achieve. So there are a number of trends you may not see evolving inside the way the trust is behaving which is giving you probably good insight into contractual movements.
I think they reconcile in my mind but we are seeing maybe a broader set of influences than you are strictly by looking at the trust.
John Stilmar – SunTrust
If I was to put a finer point on the response rates, can you talk about response rates to your solicitation and one of two things; the first is obviously pricing has become a little bit more competitive today. Can you talk about the need to go with the zero % teaser rate marketing to achieve a certain response rate or are the response rates on non-promotional balance offers themselves staying as resilient as opportunities for growth?
Can you help identify for me the difference between response rates you are seeing on current mailings versus the pricing choices you have made and where we are relative to where we were?
David Nelms
I can’t be too specific but I would say generally we have seen some of the best response rates this year than we have had in many years. A lot of that is just frankly less mail going out and I would say in terms of promo rates I would look closely at duration.
I think probably the bigger change that is coming mainly from the Card Act is a lot more six-month durations and not the 18 months durations you saw before. Obviously there is a very, very dramatic difference in the zero percent six month versus a zero percent for 18 months.
The other thing I would point you to is the fees. Even in acquisition mail you are starting to see more and more balance transfer fees.
Just speaking for Discover we continue to test and control every day and try to determine what is the best all-in cost taking into account fees, interest rates, response rates, marketing costs, etc. and then we adjust accordingly.
Operator
The next question comes from the line of Bruce Harding – Barclays.
Bruce Harding – Barclays
You said if rates increase that would be helpful to the margin. Is that across the yield curve or just short rates?
Then can you remind us what percent of your customers now are floating and just maybe go through the high level moving parts of what would happen if the bigger parts of the assets and liabilities structure if we had a 100 basis point rise in [rates]?
Roy Guthrie
It is maybe to a certain extent long/short but the principle dimension here is we have floated the assets and I think we sort of articulated there one of the key things the Card Act did was cause the industry to move to floating to protect itself in the case of inflation and your ability to reprice the asset appropriately. So we have floated the assets and to a large extent we have moved to try to fix the liabilities.
So as the assets would float off of short movement changes in benchmark rates would then reprice the assets and there would be a dimension of the liabilities which are fixed which provide that margin expansion that I referenced in my prepared remarks. We have really not provided a lot of insight into how big that is.
We do show you short and long. You know the asset backed markets are principally floating and the deposits principally fixed so you can do some analytics to sort of get some measure of that.
By and large I think it is best to say it is an asset sensitive bias that the portfolio maintains now. So as we saw benchmark rates rise the yield cover the assets provide would exceed the higher liability costs on their own.
Bruce Harding – Barclays
What is the percentage of customers who are floating now? Is it virtually the whole customer base?
Roy Guthrie
Contractually yes it is virtually the entire customer base but there are behavioral patterns that manifest themselves as fixed. So a transactor that floats by contract is not really a floating asset.
So I think we think about it more holistically not just by contractual means but also on a behavioral basis.
Operator
At this time I would like to turn the call back over to Craig Streem for any closing remarks. Please proceed.
Craig Streem
Thank you. Thanks to all of you for your interest and your attention this morning.
I would encourage you to get back to us with any follow-up questions and we will do the best we can to take care of that. We will talk to you all soon.
Thank you.
Operator
Ladies and gentlemen that concludes today’s conference. Thank you for your participation.
You may now disconnect. Have a great day.