Discover Financial Services

NYSE:DFS

Earnings Call Transcript 2020-Q3

[Operator]

Good morning and my name is Maria.And I will be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter 2020 Discover Financial Services Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you. I will now turn the call over to Mr. Craig Streem, Head of Investor Relations. Please go ahead.

[Craig Streem, Head-Investor Relations]

Thank you, Maria. And good morning, everybody. Welcome to today’s call. We will begin this morning on Slide 2 of our earnings presentation, which you can find in the Financials section of our Investor Relations website, investorrelations.discover.com.

Our discussion today contains certain forward-looking statements that are subject to risks and uncertainties that may cause actual results to differ materially. Please refer to our notices regarding forward-looking statements that appear in today's earnings press release and presentation. Our call today will include remarks from our CEO, Roger Hochschild, and John Greene, our Chief Financial Officer.

And after we conclude our formal comments, there will be time for question and answer session. During the Q&A session, please limit yourself to one question, and if you have a follow-up please queue back in so we can accommodate as many participants as possible.

And now as always it’s my pleasure to turn the call over to Roger.

[Roger Hochschild, Director, Chief Executive Officer and President]

Thank you, Craig. And thanks to our listeners for joining today's call. In these uniquely challenging times, I'm pleased with Discover’s results and how well our business model has performed.

In the third quarter, we are in $771 million after tax or $2.45 per share. We clearly benefited from the actions we took in the first half of this year to protect employees, manage credit risk, and control costs while preserving momentum on long-term investments. While significant uncertainty remains as to the extent and timing of a recovery, we were pleased to see the return to year-over-year sales growth in September.

Managing credit remains a top priority. We entered this recession from a strong credit position due to our traditionally conservative approach to underwriting as well as actions taken over the past few years to reduce our contingent liability and tighten credit at the margin. We quickly implemented changes to credit policy at the onset of the pandemic, including tightening criteria for new accounts in line increases and additional income verification.

While we saw very strong credit performance this quarter, we expect to see deterioration in the coming quarters as the prime consumer may be impacted by increasing permanent white collar unemployment. That said, we believe we have taken the appropriate credit actions and don't see the need to make significant changes at this time.

The improvements in sales volume continued during the quarter with a return to growth in the month of September. Sales have improved across all categories with particular strength in online retail, home improvement, and everyday spend categories partially offset by continued weakness in travel and entertainment spending.

Loan growth continues to be affected by the pandemic, with total loans down 4% year-over-year, including card loans down 6% and personal loans down 5%. The drop in spending during the pandemic and our own credit tightening has impacted loan growth. But another driver has been a significantly higher payment rate in our card and personal loan portfolios.

Consumers have had improved household cash flows due to reduced spending and government stimulus and have taken this opportunity to boost savings and make larger payments against their loans. In our student loan business, originations in the peak season were down year-over-year, reflecting the large number of students who chose not to enroll this fall. Even in this challenging environment, our organic student loans were up 7% reflecting innovative features like our multiyear loan and our strong competitive position.

In terms of operating expenses we remain on track to deliver $400 million of cost reductions this year, while continuing to invest in core capabilities, such as advanced analytics to increase efficiency and drive long-term value.

In conclusion, this quarter our business generated high returns as we remained focused on discipline credit management, profitable growth, and an industry leading customer experience supported by our 100% U.S. based customer service. The economic environment remains uncertain but our strong capital and liquidity and the actions we've taken to strengthen the business position allows us to continue to drive long-term value for our shareholders.

I’d now ask John to discuss key aspects of our financial results in more detail.

[John Greene, Chief Financial Officer]

Thank you, Roger. And good morning, everyone. Thanks for joining us. I’ll walk through our results, starting on Slide 4. We earned $2.45 per share driven by solid credit performance of our portfolio and significantly lower operating expenses. While total revenue was down from last year reflecting the slowdown in the economy, sales volume turned positive in September and net interest margin expanded nicely.

Net interest income was down 6%, as the impact of lower market rates was partially offset by lower funding cost. In addition, average receivables were down 3% contributing to the decline in net interest income.

Non-interest income was down 10% driven by lower fee income, reflecting fewer late fee incidences and the impact of lower overall spending on cash advance fees. The decrease in net discount and interchange revenue was driven by sales volume in the quarter. The provision for credit loss is improved by nearly $50 million from the prior year as a result of a decline in net charge-offs in a lower reserve build. Operating expenses were down 9% year-over-year driven by marketing expenses and professional fees.

Turning to loan growth on Slide 5, total loans were down 4% from the prior year driven by a 6% decrease in card receivables. Lower card receivables were driven by three factors, a higher payment rate as customers continue to be mindful of their debt obligations. A decline in promotional balances as a result of credit tightening, which will benefit net interest margin going forward. And third, lower sales volume.

In the quarter sales were down just 1% on a year-over-year basis. Sales returned to growth in September up 4% year-over-year, with improvement in all categories, grocery, retail and home improvement were very strong. The trend continued through the first half of October with sales up 7%. In our other lending products, organic student loans increased 7% from the prior year and personal loans decreased 5%.

Moving to Slide 6, our net interest margin bottomed out in the second quarter and improved 38 basis points to 10.19% in the current quarter, relative to the second quarter NIM increased primarily due to favorable consumer deposit pricing. Since June 30, we have decreased our online savings rate 41 basis points down to [0.60%]. Approximately two-thirds of our consumer deposits are indeterminate maturity accounts, primarily savings, which has provided an immediate benefit from deposit rates decreases. Average consumer deposits were up 22% year-over-year, and up $2.7 billion from the second quarter.

Looking at Slide 7, you can see how our funding mix has changed overtime. We're also providing details on our funding maturities and corresponding rates over the next couple of years.

Given our current excess liquidity position, we expect to issue very little wholesale debt in the near-term. The majority of our new deposits have been in online savings. And we would expect this trend to continue in the current low rate environment. As we move towards our target at 70% to 80% of funding from consumer deposits, we expect to see continued benefits to net interest margin.

Turning to Slide 8, total operating expenses were down $102 million or 9% in the prior year. Marketing and business development expense was down $90 million or 39%. The bulk of the reduction was in brand marketing and card acquisition.

Professional fees decreased $38 million or 20% mainly driven by lower third-party recovering fees related to foreclosure, as well as favorable vendor pricing adjustments. Employee compensation was up $32 million or 7% driven by staffing increases mainly in technology, as well as higher average salaries and benefit costs.

To date, we've realized approximately 90% of the targeted $400 million of expense reductions we discussed over the past two quarters. We are on track to deliver the remaining 10% in the fourth quarter and continue to review the business for efficiency opportunities.

Turning now to Slide 9 showing credit metrics. Credit performance remained very strong in third quarter. Cards net charge-offs dollars actually came down $7 million, while the rate increased 13 basis points

Sequentially, the card net charge-off rate improved 45 basis points. The 30 plus delinquency rate improved 59 basis points from last year and 26 basis points from the prior quarter as credit performance of our card portfolio continued to be stable, demonstrating the strength of our prime revolver customer base.

Our private student loan portfolio had another quarter of strong credit performance with net charge-offs down 1 basis points compared to the prior year. Excluding purchase loans, the 30 plus delinquency rate improved 37 basis points from the prior year and 8 basis points sequentially.

Credit performance in our personal loan portfolio continued to be very strong this quarter, reflecting our disciplined underwriting and the benefit of credit actions implemented over the past several years. Net charge-offs improved 130 basis points and the 30 plus delinquency rate was down 39 basis points from the prior year.

While overall credit performance remained strong through the third quarter, we expect the economic environment to lead to deterioration and consumer credit, with delinquencies slightly increasing in 2021. The timing of the rise in delinquency and subsequent losses could be impacted if there is a second government stimulus program or economic trends shift materially.

Slide 10 shows our allowance for credit losses. In the quarter we added $42 million to the allowance driven by a $354 million increase in organic student loans. Other loan products were generally flat from the prior quarter. With the backdrop of an uncertain by improving macroeconomic environment, we modeled several different scenarios and maintained a conservative view in the quarter.

Our key macro assumptions were an unemployment rate of 11% at the end of 2020 and slowly recovering over the next several years. We also considered the current trends in unemployment and the increasing number of COVID cases.

Moving to Slide 11, our Common Equity Tier 1 ratio increased 50 basis points sequentially, primarily due to the decline in loan balance. In March, we suspended our share buyback program in response to the economic environment at that time and it remained suspended. We have continued to fund our quarterly dividend at $0.44 per share. We are in the process of preparing our second stress test submission and will determine our share repurchase and dividend actions subjected to the final stress capital buffer, regulatory and rating agency expectations and Board approval.

In summary, solid results in the third quarter. The portfolio remained stable with improvements in overall delinquency levels. Reserves are flat except for those pertaining to student loans where the balance and commitment levels increased. Net interest margins improved from the second quarter and is trending positively as a result of our aggressive deposit pricing. And finally, strong execution on our targeted expense reductions.

With that, I'll turn the call back to her operator Maria to open up the lines for Q&A.

[Operator]

Thank you. [Operator Instructions]. Our first question comes from the line of Sanjay Sakhrani of KBW.

[Sanjay Sakhrani, KBW]

Thanks. Good morning and good quarter. Appreciate all the color on reserves and provisions. Roger, clearly there's nothing that we see within the credit metrics. That suggests a weakness outside of the headlines on potential white collar layoffs. Are there any specific signs that you're seeing inside the portfolio that lead you to be concerned? And how significant the change in the environment would there have to be for you guys to have to build reserves again.

[Roger Hochschild, Director, Chief Executive Officer and President]

So I'll let John to cover the part about reserves Sanjay. But in terms of the environment, I think that the jobless claims numbers and we'll see what this week has but seven straight weeks over [800,000] and more and more of that permanent unemployment and white collar is a reason for ongoing concern. But I think as you look at our portfolio, I'm very pleased with the performance across all products. And you can see that from the broadest metric, we just close the 30-day delinquency rate.

[John Greene, Chief Financial Officer]

Yes, and Sanjay, in terms of reserving, we modeled a number of different assumptions and took conservative approach across the board. What we saw was actually, as Roger said, excellent underlying portfolio performance. There is, there is a level of concern in terms of jobless claims and the impact on prime consumers. But today, we don't see anything that -- that's out there that would suggest that reserves are -- I'll say weak or deep strengthening at this point. We did model a second round of stimulus. We don't know if that's going to happen. There's some reason to be optimistic, but no one can tell that on this sorts of things these days. So we'll say, but what we'll look at through the quarter, the fourth quarter, and make a call in terms of what's appropriate from a GAAP standpoint.

[Sanjay Sakhrani, KBW]

Thank you.

[Operator]

Our next question comes from one of Rick Shane of JP Morgan.

[Rick Shane, JP Morgan]

Thanks, guys, and good morning. Look, we're entering, what's historically the most important part of the year in terms of spending in consumer behavior? I'm curious -- two things you're seeing an uptick in spending, which is a good sign. I'm curious how you will approach this from a marketing and rewards perspective, we know you pull back a little bit to this point to manage expenses. But given the consumer seems to be rebounding, will you be a little bit more aggressive on rewards or marketing as we head into the holiday season?

[Roger Hochschild, Director, Chief Executive Officer and President]

Yes, thanks, Rick. In terms of marketing, while we did cut expenses, in line with the economic environment, we have continued to market across all of our products, and have been very excited actually about the quality of new accounts we're bringing in on the card book, as well as some of the costs we're seeing as competitors pulled back more aggressively. Now, I do expect some of that to normalize over time. But again, we're going to continue marketing through the fourth quarter. In terms of the rewards program, so our program is well suited to this environment. Consumers prefer cash over miles. I think a lot of the miles programs I see in the marketplace are struggling to add relevance and redemption options. And in particular, our strong partnerships with PayPal and Amazon, some of the programs we're already putting in market with Amazon will serve us well in the fourth quarter.

[Rick Shane, JP Morgan]

Great. That's very helpful. Thank you guys.

[Operator]

Our next question comes from the line of Don Fandetti of Wells Fargo.

[Don Fandetti, Wells Fargo]

Hi, good morning. So Roger, I mean these are the times where you can potentially step in and gain share and be opportunistic. We saw American Express buy Kabbage, do you have any thoughts on your position of strength? How you could use that maybe on acquisitions or you going to just sort of hold tight given the uncertainty?

[Roger Hochschild, Director, Chief Executive Officer and President]

Yes. I think we are leveraging that position of strength. I believe we're gaining share both in terms of sales and loans and card and had a very strong peak season for student loans. Acquisitions are a little more challenging. And so as we think about how we use capital, the top priority is supporting organic growth. Next comes a mix of dividends and buybacks. Acquisitions tend to be a distant third, our primary interest is in the payment space. But while valuations have come in a bit, especially where cross border type of company, they're still very high. And so a lot of what we're seeing opportunities for either investments, partnerships, so we'll look at it, but I think we're probably more likely to be aggressive on the organic side, subject to our conservative credit policy than making acquisitions.

[Don Fandetti, Wells Fargo]

Okay, just one quick clarification. What percentage of the portfolio is promo right now? Because it sounds like that's going to help on the card yield going forward?

[John Greene, Chief Financial Officer]

Yes, it's come down recently. We've been intentional about that in terms of taking a look at promo balances as well as balance transfers. So…

[Don Fandetti, Wells Fargo]

And so I think -- usually you guys are in the mid teens or somewhere in that range?

[John Greene, Chief Financial Officer]

Yes, it's, right around 15 or so.

[Don Fandetti, Wells Fargo]

Okay. All right. Thanks a lot.

[Operator]

Our next question comes from the line of Bill Carcache of Wolfe Research.

[Bill Carcache, Wolfe Research]

Thank you. Good morning, Roger and John. It's encouraging to see positive operating leverage in this environment. That's consistent with what we've seen over the last decade plus from you guys, but there had been some concern among investors when you guys gave guidance earlier this year pre-COVID that is cover may have lost its expensive discipline and that the reason that you guys had at the time guided to negative operating leverage was due to years of chronic underinvestment? Roger, understanding that there will always be one-off investments that need to be made. But that aside, you speak to your confidence level and being able to continue to generate consistent positive operating leverage as we look to the other side of this?

[Roger Hochschild, Director, Chief Executive Officer and President]

Yes, thanks, Bill. So first, having been here for over 20 years, I have to maybe disagree with the phrase chronic underinvestment, I think our investments have been appropriate. But at the beginning of the year, we saw an opportunity to invest more. And so I would characterize it that way.

Clearly, the year changed dramatically. And hopefully, you've seen very strong expense discipline in terms of the target we put out there and how well we're progressing against that target. It's a little challenging just to look at operating leverage, because that includes well of course day-to-day corporate type expenses that we're always trying to bring down.

But then also marketing investments that drive profitable growth and high returning accounts. And so it's a blend of those two. But again, I think you can expect to see the continued expense discipline that I think has always been a hallmark here to discover our overall lower cost operating model. But we will invest according to the opportunities we see in the marketplace. And I guess I'd point you to the returns we're generating as an example of the effectiveness of that business model even through extremely challenging cycles.

[Bill Carcache, Wolfe Research]

Thank you.

[Operator]

Our next question comes from the line of Ryan Nash of Goldman Sachs.

[Ryan Nash, Goldman Sachs]

Hey, good morning, guys.

[Roger Hochschild, Director, Chief Executive Officer and President]

Good morning.

[John Greene, Chief Financial Officer]

Good morning.

[Ryan Nash, Goldman Sachs]

John, on net interest margin, you saw some really nice expansion. You talked about, the benefits that you're seeing from lower promo activity. Can you maybe just talk about some of the puts and takes from here as the yields are obviously going to be improving? And it seems like the funding tailwinds are sizable over the next couple of quarters. So if we had peaked out in the low to 40s, could we actually, potentially see the margin, somewhere in excess of that over the next few quarters?

[John Greene, Chief Financial Officer]

Yes. So, we were mindful in terms of what we included here in the presentation as well as in terms of the comments. To provide, frankly, an additional insight in terms of what's happening to the funding mix, maturity profile, and the cost of our dead stack and what you can see there is based on the maturity profile, and the cost we're seeing versus online deposits, that there will be an opportunity to expand net interest margin. Now, that subject to a lot of different things, right, obviously, there's one piece, which is the health of the portfolio. And that's been strong. Certainly, the mix of revolvers and transactors will also have an impact and typically impacts the fourth quarter a bit. But, overall, as you look at where we are this quarter, I see some upside from that, from my advantage point today.

[Ryan Nash, Goldman Sachs]

Got it. And maybe if I can ask a follow-up question from a topic that was hidden before. So John, I think in your prepared remarks, you commented that you're looking for additional efficiencies, maybe can you just help us understand and maybe Roger can hop in on this too, of the 90% of the $400 million that you've saved? How much of that was just investments that have been deferred versus actual core efficiencies that you guys have identified and taken out? And, what could this mean for the trajectory of the cost base outside of marketing as we look into 2021? Thanks.

[John Greene, Chief Financial Officer]

Yes. So thanks. So I would characterize it this way is the $400 million of cost savings from the previous guidance. I wouldn't necessarily call that a deferral, what I would say is, we took a look at the economic environment and took $400 million for planned spending. Now, as I said in the March remarks, which you clearly picked up and Ryan was that the bulk of that has been on marketing and brand.

Now as we look through the balance of this year, and some of the actions that we took, we saw benefits across the host of P&L line, expense line specifically. And we're going to use that frankly as a new benchmark in order to really make some determinations on what we need to spend in 2021 to ensure that we continue to grow profitably. I would say that if the economic environment continues to improve, it's natural that we're going to spend more money on customer acquisition in order to drive profitable growth into the future. But the other expense lines, professional fees, information processing other miscellaneous expense, we're going to keep a foot on those to ensure that we're disciplined about how we're spending the dollars.

[Ryan Nash, Goldman Sachs]

Great. Thanks for the color.

[Operator]

Our next question comes from the line of Moshe Orenbuch of Credit Suisse.

[Moshe Orenbuch, Credit Suisse]

Great, thanks. Most of my questions have been asked and answered. But I guess, I sort of I am struck by the fact that the efficiency ratio in the quarter was actually better than it was in 2019. And you're kind of demonstrating, certainly likely to be the best growth and spend volume and one of the better growths if not the best in receivables or smallest decline.

And I guess I'm also struck by stuff we see in the industry, that there's continued more cash back mail from some of your big competitors were that wasn't as bigger focus. And so, kind of maybe, some of this has been discussed already. But I'm sort of struck by that, it seems like you have an opportunity. And, where does -- where can you direct that attention? And, how much do you have in kind of available whether it's spending on rewards or marketing, like, what are the tools? And how are you going to use them over the next few quarters, particularly now, as we're going into the holiday season? Thanks.

[Roger Hochschild, Director, Chief Executive Officer and President]

Yes, thanks Moshe. We're using all the tools we have available, I would point out there's still a good amount of economic uncertainty. And so we are not changing credit policy on the card side, I think we want to see more signs of sustained recovery. But the cash back program is resonating well as I said earlier. And there's always a lot of competition in cash rewards from major issuers.

So I wouldn't necessarily characterize it as more intense than ever, but it is a time where consumers are rethinking which cards they want, do they really need another frequent flyer miles at this point. And then the other part is the only major issue with no fees on any of our card products, but knowing you'll see, message resonates surprisingly well.

But then [indiscernible] we're seeing great strength on the other side of the balance sheet on the deposit side, where we compete the same way, right, good value, but an outstanding customer experience. So we're really excited. Certainly uncertainty as to what the holiday season will bring, as I talked to retailers out there. But I feel good about our ability to continue to gain share.

[Moshe Orenbuch, Credit Suisse]

Thanks very much.

[Operator]

Our next question comes from the line of Kevin Barker of Piper Sandler.

[Kevin Barker, Piper Sandler]

Good morning. I just like to follow up on some of the NIM comments. You're seeing some a little bit more resiliency on the asset yields, in particular, from the personal loans and card rates. Could you talk about, the competitive environment in both those products and your expectations for those yields at least in the next couple of quarters, just given the resiliency that we've seen in the near-term?

[John Greene, Chief Financial Officer]

Yes. So we look at the card yield, that will overall be relatively stable subject to kind of the mix of balance transfers and promos. And as I said earlier we're going to be mindful in terms of those sorts of decisions. If we can do that, do some promos or balance transfers safely in their credit environment we'll do that because it would be high returning by returning customers. But the leverage that we're going to get in future quarters will come out of the funding base.

[Roger Hochschild, Director, Chief Executive Officer and President]

Yes, and Kevin may one thing I'd add to. As we said pricing, given how hard it is to re-price card after the Court Act, we're not reacting to specific competitors in a given quarter. We're taking, working closely with finance a very disciplined through the cycle book and so it's really where our growth is occurring. And that promo mix, it'll drive it as opposed to reacting to competitors.

[Kevin Barker, Piper Sandler]

Yes, that'll make sense. And then regarding the liability side, the order of magnitude in the drop in liability costs over the last couple quarters are obviously very strong. Just given the rate environment, how much more room do you feel like you have to bring deposit costs lower, just given the current rate environment and the outside liquidity on your balance sheet?

[John Greene, Chief Financial Officer]

Yes. So we continue to look at that. And the decision would be subject to two factors, one, the amount of liquidity we have on a balance sheet. And right now we're in a situation we have access to liquidity. And then the second piece of the equation is the competitive landscape. And then third, which is a consideration of the business is certainly the customer relationships and ensuring that our long-term good quality customers aren't feeling like they're impacted in a way that's unfair. Now, with all that said I'm seeing a persistent low rate environment. And with a persistent low rate environment, I do believe that there is some amount of room price downward. But again, it's caveated by all those points that I just mentioned.

[Kevin Barker, Piper Sandler]

Thank you very much.

[Operator]

Our next question comes from the line of Robert Napoli of William Blair.

[Robert Napoli, William Blair]

Thank you and good morning. I just wondered what your built -- what you built into your reserves as far as the trajectory of charge-offs. And I would expect, I mean, I guess you're not really given where delinquencies are, you are not expecting to see charge-offs move up much in the fourth quarter and then more back half weighted to 2021?

[John Greene, Chief Financial Officer]

Yes, so I would start off by saying that, the portfolio performance versus what we thought it potentially could be, when we close the book in March has been extraordinarily strong. And we're really, really pleased by that. In terms of trajectory of both delinquencies and charge-offs, yes, we are seeing certainly a push from ‘20 into ‘21.

And the absolute quantum of that will obviously depend on all the factors that we built into our reserve calculation, GDP, unemployment, new jobless claims, stimulus, or lack thereof. So we will, we're going to monitor the portfolio, but to kind of net it for you and the other folks that are on the call, ‘20 looks super solid ‘21 level of uncertainty and we expect the bubble to push through into -- certainly, beginning maybe in the midpoint of the year into the second half of ‘21.

[Robert Napoli, William Blair]

Thank you. And then follow up with just jobless claims 787,000 this morning a big improvement that ridiculously high that's right. But yes, I mean, direct bank your position Roger is a direct bank. It gives and I think it's the right strategy for the long-term. Are there new products or services or then you're planning to build through that direct bank? And when we have, obviously a lot of these Neo banks that are delivering different products, and maybe to different demographic than discover focuses on but where do you see opportunities to leverage off of your direct bank strategy?

[Roger Hochschild, Director, Chief Executive Officer and President]

So in terms of positioning ourselves as the leading digital bank, I think we're in great shape. And it's leveraging the products we already have. I don't see the need for expanding our products. If you look at the breath from home equity to a broad range of deposit products, including checking our debit accounts or great strength of course on the card side, personal loans. So we have the products, I think the opportunity is building awareness of the products we have and that can drive a lot of growth. So I'm very excited about where we're positioned. I'd say maybe one of the big differences versus the Neo banks is perhaps a different focus around profitability. So we'll see how that plays out over the long-term, but I couldn't be more excited about where we're positioned.

[Robert Napoli, William Blair]

Thank you. Appreciate it.

[Operator]

Our next question comes from the line of Mihir Bhatia of Bank of America.

[Mihir Bhatia, Bank of America]

Good morning. Thank you for taking the question. [indiscernible] did I hear correctly, you said your [indiscernible] model the second round of stimulus in your modeling for credit?

[Roger Hochschild, Director, Chief Executive Officer and President]

Yes. Yes, we did. There's an input in our modeling, reflecting a second round of stimulus.

[Mihir Bhatia, Bank of America]

And then just one quick one on the -- if you can update on the network business, specifically, I was looking at -- it looks like your volumes are growing very nicely in both [pulse] and network performance. But yet, you attribute the revenue decline to both of those businesses. So I'm just wondering, what is happening there or is it just competitive factors is there a mix issue, just hoping to get a little more color on that? Thank you.

[Roger Hochschild, Director, Chief Executive Officer and President]

Yes. Thanks for the question. So it was actually a combination of two things. So there was a bit of a mix, shift to some products with lower fees and rates. There was also some higher incentives that came through based on the mix that we enjoyed in the quarter. I would say that in terms of overall volume it was up 16%, year-over-year at least for pulse. And certainly, we're happy about that, we are continuing to look at the mix and incentives to ensure we're driving appropriate level of profitability for the investments we're making there in the payments business.

[Mihir Bhatia, Bank of America]

Okay. Thank you.

[Operator]

Our next question comes from the line of Betsy Graseck of Morgan Stanley.

[Betsy Graseck, Morgan Stan]

Hi, good morning.

[Roger Hochschild, Director, Chief Executive Officer and President]

Good morning Betsy.

[John Greene, Chief Financial Officer]

Good morning.

[Betsy Graseck, Morgan Stan]

Couple questions, just first off on the outlook for growth. I know typically, it's a function of account growth and balances per account. And obviously, you've had some shrinkage recently, because of the spend levels that we all know about. I'm just wondering if we could dig into the account growth aspect of that equation, just understand how account growth has been going? What COVID has meant to account growth, how you flexed? And do you see any opportunity to accelerate account growth from here as we go into the back half of the year and into ‘21?

[Roger Hochschild, Director, Chief Executive Officer and President]

Yes, so just one thing on the receivables growth, the higher payment rate is a big factor as well. So good news on what it's doing on the deposit side of our business. But that is having a significant impact on loan growth for both card and personal loans. In terms of new accounts, while we don't disclose a number on that, what I would say is that we think we probably sustained to account marketing, more than a lot of competitors as I look at industry metrics. And so we feel good about that, and kept our marketing spend sort of appropriate for the environment and for our somewhat narrowed credit box with the changes we made earlier in the year. So I would not expect dramatic changes until we get more certainty in terms of the pace of recovery, but we continued to market across all of our products.

[Betsy Graseck, Morgan Stan]

Okay. So you've been pleased with your account growth that you've generated over the past couple of quarters? That's what I'm hearing from you, Roger, is that right?

[Roger Hochschild, Director, Chief Executive Officer and President]

Yes. And in particular, I think we pulled out on the last goal, some of the costs per account that we were seeing in different channels as competitors pull back more.

[Betsy Graseck, Morgan Stan]

Right. Okay, and then just separately on credit and the outlook for credit here. One of the questions is around stimulus. And if you don't get it, how much did that impact potential changes in the reserve. And then the other piece is on the mortgage forbearance, I think, I believe a majority of your customers have mortgages, and I'm wondering if you know through credit data checks, how many of those people are benefiting today from the mortgage forbearance and does that feed into your reserve analysis as well? Thanks.

[John Greene, Chief Financial Officer]

Okay. Yes, so let's talk about the credit outlook and then handle the mortgage question on the back end. So in terms of the stimulus that we modeled, and it is one of many inputs, and we'll look at what happens in the fourth quarter and see how the roll rates are progressing in the portfolio through the quarter to get -- I'll say, a bottoms up view of actually, the impact there. So no specific information on that other than to say that underlying roll rates are far more positive than we thought they would be at this time.

And if another round of stimulus doesn't come in, I think that's going to be tough for a number of people that have been impacted by the pandemic. And progressively it will start to impact the prime revolver base. And that's why we're conservative in terms of our reserve outlook here for the third quarter. But overall, again, we're pleased with our positioning.

Now, in terms of the mortgage forbearance that we really don't have any data on that. What we are seeing is our home equity business continues to, it's open for business, we are underwriting standards that have tightened mildly through this and it's positioned pretty well and open for business.

[Betsy Graseck, Morgan Stan]

Okay. Thanks, John. Appreciate the color.

[John Greene, Chief Financial Officer]

You're welcome.

[Operator]

Our next question comes from the line of Meng Jiao of Deutsche Bank.

[Meng Jiao, Deutsche Bank]

Great. Good morning, thanks for taking my call. I wanted to take a look at a capital trend [indiscernible] invest and I know that you guys are in the midst of preparing the second stress of submission. But I was wondering, in terms of timing as to when you would get a better sense of the economy in order to possibly execute the buybacks one more time, is it in the back half of ‘21 into more into ‘22. Just any thoughts on when you guys feel you would have more clarity in terms of the economy in order to reinstate that buyback program? Thank you.

[John Greene, Chief Financial Officer]

Great. Thanks for the question. So we're submitting our second round of stress tests in November. And including there are a number of judgments. I'm not going to get into the details would be premature on that. I would say, as you take a look at the capital trends for the business, they're super solid, our capital levels are higher than our targeted levels. And Roger was specific in terms of our cheering of capital allocation priorities. So there's no change to that. And we're going to work through kind of the details with the Fed, other regulators rating agency and then board. Sorry, I can't be more specific than that at this point.

[Roger Hochschild, Director, Chief Executive Officer and President]

Maria next question?

[Operator]

Our next question comes from the line of Mark DeVries of Barclays.

[Mark DeVries, Barclays]

Yes, thanks. Just wanted to drill down a little bit further on the funding tailwinds. Could you give us a better sense of kind of what mix you're targeting between the DTC and affinity deposits and the broker? Is there a minimum level of broker that you want to maintain? And also kind of what's the funding difference between those two, just to give us a sense of how much your deposit funding on average could compress?

[John Greene, Chief Financial Officer]

We want to keep the broker CD channel open. So we'll continue to attest that the relative change or difference between the direct to consumer and the broker deposits narrowed, narrowed significantly in the early stages of the pandemic, there was a substantial difference and the market took care of that and narrowed the gap. We do enjoyed slightly better pricing, if it's direct relationship versus through a broker so that -- what that will be our focus in terms of overall kind of mix of those, I would expect the broker channel to continue to contract a bit and the direct channels expand.

[Mark DeVries, Barclays]

Okay. And in the, with such low funding on the ABS, why not maintain that or expand that or they are like, liquidity concerns of having assets on income or that you're managing to or is there something else I'm not thinking about?

[John Greene, Chief Financial Officer]

No, the cost there on the ABS, that's reflected is net of the hedge impacts. So fortunately, we hedge those and have a nice benefit coming through over the next couple of years. The actual outside contract rate on those ABS transactions quite a bit higher than that. So that was -- frankly that was the rates we are enjoying, there's just good work on the part of our Treasury team to hedge that. So we'll continue to ensure that the ABS channel is there and present and available to us. But it will certainly come down as maturity profile indicates.

[Mark DeVries, Barclays]

Okay, got it. Thank you.

[Operator]

Our next question comes from the line of Dominick Gabriele of Oppenheimer.

[Dominick Gabriele, Oppenheimer]

Hey, good morning. Thanks so much for taking my question. I just wanted to see if we could kind of square this circle around unemployment and where the unemployment rate is and the kind of liquidity that the consumer has been given up and so this day, and it sounds like we've -- both agree that, delinquencies, probably given this liquidity don't even start rising until the first of the year. And so when you think about your expectation for unemployment at 11 by yearend, and where we are, and the idea of a white collar rush of unemployment, that would be quite the rush of white collar unemployment versus the amount of people that are unemployed now versus a steady state. And so can you just talked about where the -- perhaps the job losses come from, and why it's a large magnitude of white collar versus still unemployed call it blue collar that we saw now, and how that's influencing your outlook for the 11% unemployment rate? Thanks.

[John Greene, Chief Financial Officer]

Yes. Thanks, Dominick. So you touched on a lot there. And I would sum that up by saying there's a level of uncertainty around what actually will happen on unemployment. Now, the 11% does feel at this point, like, I'll call it a robust number. But what we're trying to get a good clarity on it as the service workers who initially were impacted by the pandemic containment activity went to the unemployment ranks, some of those have returned, we certainly have seen some indications across the economy that across the nation and frankly the world that it could be a tough winter here from a COVID standpoint.

So that's going to further impact not only service industry, but the entire economy. And so as we sit here today, we're mindful of that as a risk and continue to kind of maintain the reserves where they are. So we don't expect there to be a rush of white collar unemployment. But what will be clear and we've seen some of this already, is businesses are sizing both their professional staff and the blue collar staff for the business at hand. And there's enough indications today that there could be some contraction and as such the unemployment numbers not exactly an easy number to predict but we feel like as an input to our model, it is appropriate at this point.

[Dominick Gabriele, Oppenheimer]

Great, thank you. And if I could just have one follow-up here. I really appreciate that. And if you look at the other expenses in the expense base. It looks like the acceptance incentives came down as well as fraud even though we're kind of in this more online environment. Could you talk about what you're doing on the fraud side? And how that was -- and did you renegotiate in the global acceptance or is that a function of just volume and mix year-over-year versus the third quarter of ’19 and how your expense base and other expense came down? Thanks so much. I really appreciate it.

[John Greene, Chief Financial Officer]

Yes, so in terms of fraud, it doesn't reflect any, renegotiations with any of our merchant partners. Fraud is one of the areas where we're deploying advanced analytics, and next generation [technical difficulty].

Yes, and then I would just add, in terms of the other expense line, so. So we did see lower global acceptance, expense in the quarter. And that's a function of two things a little better on the economy and liability associated with some of our partners executing on kind of terms associated with previous incentive agreements.

And then, frankly, just a level of uncertainty that's caused us to be cautious on I’ll say signing up new rich incentive deals. Now we're still doing that, where it makes sense. But in terms of timing little bit cautious on that one. But we've seen, actually great effectiveness from our procurement team, driving year-over-year savings on the entire indirect cost base.

And we're still, as we said, in the remark, investing in advanced analytics and some digital capabilities that driving up information processing, but my expectation is that we continue that we are and we will continue to get more efficient and overall information processing and technology spend.

[Dominick Gabriele, Oppenheimer]

Great. Thanks and congrats on the quarter.

[Roger Hochschild, Director, Chief Executive Officer and President]

Thank you.

[Operator]

Our next question comes from the line of Bill Carcache of Wolfe Research .

[Bill Carcache, Wolfe Research]

Thank you. Quick follow up on the credit. There has been a lot of touch [indiscernible] around booming credit headwinds in the TDR portfolio, can you discuss how that [indiscernible]?

[John Greene, Chief Financial Officer]

Yes, So thanks for the question, Bill. So you folks don't have the TDR disclosures but will come out or come out in the Q1 it's published. And what you'll see there is relative to the first quarter TDR volumes will be substantially down. But there's also the impact of the CARES Act with a regulatory exclusion for certain modifications that banks such as ours make.

So we can put those two together and compare where we are in the third quarter versus where we were in the first quarter and called the first quarter of pre-pandemic relatively stable.

So the point there is that there's not an abundance of activities or a massive jump in any sorts of activities there. That's impacting delinquencies. We do these programs to improve the cash flows of the company, and ensure that when there's a temporary issue with a customer, that they can manage through it and return to paying their bills. So from a credit standpoint, TDR standpoint, there's been good execution from our customer service teams.

[Bill Carcache, Wolfe Research]

Thanks John.

[Operator]

And ladies and gentlemen, that was our final question. I'd like to turn the floor back over to Craig Streem for any additional or closing remarks.

[Craig Streem, Head-Investor Relations]

Thank you, Maria. Thanks, everybody, for your interest. Enjoyed the conversation this morning and we are available for any follow-up questions that you may have. Thanks have a good day.

[Roger Hochschild, Director, Chief Executive Officer and President]

Thank you everyone.

[Operator]

Thank you ladies and gentlemen. This does conclude today’s conference call. You may now disconnect.