Discover Financial Services

NYSE:DFS

Earnings Call Analysis

Discover Financial Navigates a Transformative 2023

Discover Financial Services marked 2023 as a transformative year with major transitions and a continued emphasis on strong performance, culture, and customer experience. Recognized as a top employer and marking the year as the third best in earnings per share history, the company reported $2.9 billion in net income and an EPS of $11.26. However, the fourth quarter saw a dip in net income to $388 million from $1 billion the prior year. Despite strong revenue growth of 13% and loan growth of 15%, provision expenses rose by $1 billion due to higher charge-offs and delinquencies. Net interest margin slightly declined year-over-year to 10.98% while total expenses climbed by 19%, reflecting investments in compliance and risk management. For 2024, Discover expects modest loan growth, a net interest margin between 10.5% to 10.8%, and is preparing for four anticipated rate cuts of 25 basis points each.

A Year of Change and Resilience for Discover in 2023

In a transformative year, Discover Financial Services navigated challenges and implemented strategic changes that have fortified its market position for continued long-term growth. The company reported a full-year 2023 net income of $2.9 billion with a solid earnings per share of $11.26, ranking as the third-best EPS performance in the company's history.

Financial Highlights and Strategic Shifts

Discover achieved significant milestones, including surpassing $100 billion in Card receivables and registering a 21% annual increase in deposit growth. The firm has also launched a national cash-back debit account and announced plans to exit the private student lending business. Leadership changes, marked by the appointment of a new CEO, indicate a dedicated focus on Discover's core banking services and a commitment to an improved customer experience, further aligning with the company's recognition as one of the best companies to work for.

Q4 2023: A Detailed Financial Assessment

The fourth quarter saw a mixed financial performance, with net income declining to $388 million from over $1 billion in the previous year's comparable quarter, primarily due to increased provision expenses and growing operating costs. Revenue rose by 13%, slightly counteracted by a modest net interest margin (NIM) compression. Noteworthy increases in receivable growth were observed across card and personal loan segments, while student loans remained unchanged due to an anticipated exit from this market. The quarter's net interest margin was resilient, ending at 10.98%, and expenses reflected the company's investment in compliance and risk management.

Credit Performance and Operational Efficiency

Credit performance exhibited a higher net charge-off rate of 4.11%, which Discover anticipates to be in the range of 4.9% to 5.3% for 2024. These figures are indicative of the company's conservative approach to risk management and a strategic response to the evolving credit environment. Reserve increases reflect the proactive management of potential credit risks, and a stable capital position with a common equity Tier 1 ratio of 11.3% ensures Discover can comfortably navigate through the expected economic conditions.

Forward-Looking Statements for 2024

Looking forward to 2024, Discover has set an expected net interest margin range of 10.5% to 10.8%, acknowledging the possibility of rate cuts that might affect margins. Operating expenses are projected to rise by a mid-single-digit percentage, in part due to approximately $500 million in compliance-related costs. The company is prepared to partake in the upcoming Comprehensive Capital Analysis and Review (CCAR) process, reflecting its prudence in capital management and readiness for the fiscal year ahead.

Earnings Call Transcript 2023-Q4

[Operator]

Good morning. My name is Todd, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter 2023 Discover Financial Services Earnings Conference Call.

[Operator Instructions]

I will now turn the call over to Mr. Eric Wasserstrom, Senior Vice President of Corporate Strategy and Investor Relations. Please go ahead.

[Eric Wasserstrom, executive]

Thank you, and welcome to this morning's call. I'll begin on Slide 2 of our earnings presentation, which you can find in the financial 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 our fourth quarter 2023 earnings press release and presentation.

Our call today will include remarks from our Interim CEO, John Owen; and John Greene, our Chief Financial Officer.

[Operator Instructions]

Now it's my pleasure to turn the call over to John.

[John Owen, executive]

Thank you, Eric, and thanks to our listeners for joining today's call. 2023 was a year of significant change for Discover, and we believe the actions we've taken position the company to continue driving strong long-term performance.

When I stepped into the interim CEO role, I had three priorities. My top priority was to advance our culture of compliance, and we have made meaningful strides in our corporate governance and risk management capabilities. That said, this is a journey that will take time and continued investments over the coming years to further enhance our compliance and risk management capabilities.

My second priority is to continue delivering a great customer experience at every touch point, which we do by providing our customers with award-winning service and products. I'd like to thank our 20,000 employees for delivering a great customer experience to help our customers achieve a brighter financial future. In 2023, we were recognized for the first time as one of Fortune 100 best companies to work for. This award adds for accolade for working parents, women, people with disabilities and members of the LGBTQ+ community, and we're proud to be an inclusive workplace.

My third priority is to sustain our strong financial performance. We reported net income of $2.9 billion for full year 2023 and earnings per share of $11.26. This makes 2023 the third best year for EPS performance in our history. In delivering these results, we achieved several important milestones. We exceeded $100 billion in Card receivables, grew deposits by 21% year-over-year, successfully launched our cash-back debit account on a national scale, and we announced our intent to exit the private student lending business.

On December 11, we announced a new leadership and we're excited to have Michael Rhodes joining us for our incoming Chief Executive Officer. Michael is an experienced leader of the deep background in the financial services industry. He has managed all aspects of our Consumer Banking business with deep experience in the credit card space, payments, online and mobile banking and served as Group Head of Innovation and Technology. His appointment marks the conclusion of a rigorous search process, and we look forward to Michael's arrival. When Michael arrives, I will return to my prior role on Discover's Board of Directors.

In conclusion, I'm proud of the progress we made in 2023. Our integrated digital banking model, resilient financial performance and maturing risk management and compliance capabilities position Discover well for 2024 and beyond.

With that, I'll now turn the call over to John Greene, who will review our fourth quarter 2023 financial results in more detail and provide some perspective on 2024.

[John Greene, executive]

Thank you, John, and good morning, everyone. I'll start with our summary financial results on Slide 4. In the quarter, we reported net income of $388 million, down from just over $1 billion in the prior year quarter. There are three broad trends to call out.

First, we grew revenue 13%, reflecting 15% loan growth, partially offset by modest NIM compression. Second, provision expense grew by $1 billion. Charge-offs increased, but landed at the low end of our expected range. Strong loan growth and higher delinquency drove the increase to our reserve balance. Finally, expenses increased 19% year-over-year, reflecting investments in compliance and risk management, a reserve for customer remediation and higher marketing expense to support our national cashback debit campaign. We'll get into the details of these topics on the following pages.

Turning to Slide 5. Our net interest margin ended the quarter at 10.98%, down 29 basis points from the prior year and up 3 basis points sequentially. The decline from the prior year quarter was driven by higher funding costs and higher interest charge-offs, which were partially offset by higher prime rates and increases in revolving balances. For the full year, net interest margin was 11.07%, up 3 basis points from the prior year. This margin performance reflects the improvement in our funding mix over the past several years and a reduced level of balance transfer and promotional balances as we tightened underwriting.

Receivable growth remained robust. Card increased 13% year-over-year due to contributions from the prior year new account growth and a lower payment rate. The payment rate declined about 110 basis points from the sequential quarter and is now 100 basis points above 2019 levels. Overall, new account growth declined 9% as a result of credit actions. Sales were up 3% compared to the prior year quarter. Personal loans were up 23%, driven by continued strength in originations and lower payment rate versus the prior year. Student loans were flat year-over-year. As we prepare for a potential sale of this portfolio, we will cease accepting applications for new loans on February 1.

Our Deposit business delivered outstanding performance in a challenging year. Average deposits were up 21% year-over-year and 4% sequentially. Our direct-to-consumer balances grew $3 billion in the period and $14 billion in the year.

Looking at other revenue on Slide 6. Noninterest income increased $74 million or 11%. This was primarily driven by an increase in loan fee income, higher transaction processing revenue from our PULSE business and higher net discount and interchange revenue. Our rewards rate was 137 basis points in the period and 140 basis points for the full year 2023, a decrease of 1 basis point on a full year basis. The decline reflects lower cashback match from slowing new account growth and our active management of our 5% categories.

Moving to expenses on Slide 7. Total operating expenses were up $280 million or 19% year-over-year and up 22% from the prior quarter. Looking at our major expense categories, compensation cost increased $73 million or 13% from higher headcount. Marketing expenses increased $59 million or 19%. Professional fees were up driven by continued investment in compliance and risk management capabilities, while other expense reflects a reserve for customer remediation.

Moving to credit performance on Slide 8. Total net charge-offs were 4.11%, 198 basis points higher than the prior year and up 59 basis points from the prior quarter. In card, as anticipated, delinquency formation is slowing as more recent vintages season. We added a slide detailing some of the drivers of our credit performance in the appendix to the earnings presentation.

Turning to the allowance for credit losses on Slide 9. This quarter, we increased our reserves by $618 million, and our reserve rate increased by 17 basis points to just over 7.2%. The increase in reserves was driven by receivable growth and higher near-term loss content from higher delinquencies. Under CECL, reserve levels increase as you approach peak losses. We expect our losses to rise through the midyear and then plateau through the back half with some seasonal variation. In terms of our macroeconomic outlook, our view of unemployment was relatively unchanged, while household net worth projections increased slightly. These changes provided a small benefit to reserves.

Looking at Slide 10. Our common equity Tier 1 for the period was 11.3%. The sequential decline of 30 basis points was driven largely by asset growth. We declared a quarterly cash dividend of $0.70 per share of common stock.

Including on Slide 11 with our perspectives on 2024. These exclude the impact of a potential student loan portfolio sale. We expect end-of-period loan growth to be relatively flat while average loan growth will be up modestly year-over-year. We expect full year net interest margin to be 10.5% to 10.8%. We're currently anticipating four rate cuts of 25 basis points in 2024. This is two more rate cuts than in our forecast in December. Each cut reduces NIM by approximately 5 basis points subject to a deposit beta. We expect total operating expenses to increase by a mid-single-digit percent. This contemplates our expectation for compliance-related costs to be approximately $500 million this year. Total expenses may increase as incremental resources or remediation is required. We expect net charge-offs in the range of 4.9% to 5.3%.

Finally, regarding capital return. We will participate in this year's CCAR's process and believe the results should help inform our view of capital management for 2024. Importantly, our capital management priorities have not changed and remain centered on supporting organic growth and returning capital to shareholders.

To summarize, we continue to generate solid financial results. For 2024, we will continue to advance our compliance and risk management capabilities and existing methods that drive sustainable, long-term value creation.

With that, I'll turn the call back to our operator to open the line for Q&A.

[Operator]

[Operator Instructions]

Our first question will come from Rick Shane with JPMorgan.

[Richard Shane, analyst]

The -- excuse me, I'm not a little under the weather today, so I apologize. The loan growth expectations, is that organic loan growth or is that net of the portfolio sale of the student loans?

[John Greene, executive]

Rick, John Greene here. That is organic loan growth. So all of the guidance excluded the impact of a potential student loan asset sale.

[Operator]

Our next question will come from Moshe Orenbuch with TD Cowen.

[Moshe Orenbuch, analyst]

John, maybe just a follow-up on Rick's question. I mean given the strong growth that you're currently seeing in the Personal Loan business, and the fact that you're still adding accounts, albeit at a lower level in the Credit Card business, you did mention kind of lower balance transfers, but is there something else going on? Can you talk about kind of deconstruct that loan growth expectation for us a little bit?

[John Greene, executive]

Sure. Sure. Thanks, Moshe. So the onus of loan growth sales, new account generation, payment rate trends. And so what we're anticipating for sales given the slowdown through 2023 in terms of sales, although we did have a pretty strong holiday season is that sales will be relatively flat year-over-year. New account generation relative to last year, certainly down, but overall positive new account growth. And payment rate, what we've tried to do here is kind of derisk the forecast. So we assume that 100 basis points of payment rate that's elevated versus 2019 will remain elevated.

So those three components reflect end up coming in and reflecting on our projections. Now loan growth could actually come in higher if payment rate continues to decline. But overall, our basis for guidance, loan growth, net interest margin and charge-offs was to give a range and then also be relatively conservative in terms of the expectations on those ranges.

[Moshe Orenbuch, analyst]

Great. And maybe just as a follow-up on the credit side. I mean, you did talk a month ago and then mentioned again today that you expect kind of losses to peak around the middle of the year. How do we think about the performance after that peak? I mean, you said kind of flattish. What's driving that? Why isn't that something that improves? And how do we think about reserving in that context?

[John Greene, executive]

Sure. Yes. So there's a couple of different components that are driving that. So if you go back in time, we had about two years of unusually low charge-offs and delinquencies, so from the pandemic. And that process of normalization, typically will take about the same amount of time, two years. The vintages, '21 and '22 are seasoning, and that's why we expect it to plateau. The '23 vintage actually was relatively large, but too early to call whether it's going to outperform our expectations, but certainly, a highly profitable vintage from our vantage point today.

So what you're actually just seeing is a period of normalization. My expectation is that charge-offs will plateau and then and beginning in '25, I would expect those to step down. Now you will know from this past year and the prior year, what we've tried to do in terms of the guidance is the conservative in terms of the range. And throughout 2023, we tightened the range and actually came in at the low end. So my hope is that we'll be able to do the same thing in 2024.

[Operator]

Our next question will come from Ryan Nash with Goldman Sachs.

[Ryan Nash, analyst]

John, maybe to dig a little bit deeper on some of the commentary you gave regarding loan growth. Maybe just focusing on the account growth. The market clearly thinks there's a better chance of a soft landing right now. We're seeing peers who are talking about mid- to high single-digit growth. And I'm just curious on the account growth. Is this more just conservative underwriting? Are you trying to make sure that you make more progress on risk governance and compliance before you increase growth? Maybe just a little bit more color on why you're seeing such a slowdown in terms of the account growth relative to the last few years.

[John Greene, executive]

Yes. Thanks, Ryan. So our approach in '23 and then early into '24 was that we took a look at underwriting and performance of, what I'll say, buckets within our underwriting box. And essentially tightened and we've tightened throughout 2023.

What you're seeing here in terms of account growth, at least projections today, is us getting back to 2018 and '19 levels as we continue to watch the '22 and '23 vintage perform. And six months from now, we may end up stepping in a little bit more aggressively. But what we wanted to do certainly was let kind of get further confirmation that the delinquency trends that we have seen in terms of slowing rate of delinquency formation continue to persist and that the charge-offs, the forecasted come in at or better than our expectations. If those two factors are at play, there will be an opportunity to be more aggressive in terms of new account growth.

[Ryan Nash, analyst]

Got it. And maybe as my follow-up, can you maybe help us understand where you stand with the student loan sale? And how would you foresee that impacting the outlook as well as capital return over the next four to six quarters?

[John Greene, executive]

Yes. Thanks, Ryan. So good news. So it is actually progressing to schedule. So as a matter of fact, last evening, we signed a servicing agreement with Nelnet to become the servicer of this portfolio. So that was great news. It was a competitive process. And certainly, Nelnet showed that there's a commitment to continue to dedicate resources and service that portfolio at a high level.

The next step will be to continue the servicing migration activities. We expect those activities will take around 6 months. We're conservatively it may take a month or two longer. And then as we're doing that, our adviser will begin to market the portfolio. So our expectations are that it will sell in the second half. And the implications for the business are as follows: So there's $9.5 billion of receivables. That equates to risk-weighted assets of about $10.8 billion. We expect that, that will be -- the exit of that will be -- have a positive impact on net interest margin by somewhere between 10 and 20 bps on a full year basis. Charge-off rate could tick up mildly, so under 5 bps. And as of 12/31, we had $858 million of reserves. So with a successful exit, those reserves will drop. And the sale price, the market will determine that, but we expect it to go above par.

[Operator]

Your next question will come from Mihir Bhatia with Bank of America.

[Mihir Bhatia, analyst]

We're going to start with loan growth also. And I just want to go back to the building blocks a little bit. I think you essentially said in terms of the building blocks, you're expecting payments rates to be elevated like flat to stay at the elevated level and sales to be flat. You're also adding accounts. So I'm just like trying to understand I guess, what's the [ bad guy ]? Like how does loan growth stay flat given this year, you have 15%. I'm just trying to understand like -- that's something we're missing, I feel like, and I'm just trying to understand that.

[John Greene, executive]

Yes. So let me try to give a little bit of color that hopefully gets folks comfortable with our view of loan growth today. So in 2023, really, really strong loan growth. Much of that was driven both by new account growth, but also a slowing payment rate, that payment rate in our assumptions is holding flat. And as a result, what we expect to see is the 2023 vintage will begin to kind of build in terms of assets, but there's likely going to be some impact from sales. And then also as we cycle through the 2022 vintage, we're not expecting significant new balance builds from that vintage.

Now maybe there will be. But overall, what we've tried to do here is reflect our view of our underwriting box today, not reflect any potential openings of our underwriting box in the later part of 2023. And if we out deliver on loan growth, that will be fantastic. The other element that has come into play here as we pulled back on balance transfers and promotional balances in the second part of 2023. We don't anticipate significantly increasing that level of balance transfer, promotional balances. Now if we do, that will certainly be accretive to loan growth as well. So what you're hearing in the guidance is that our expectation is that there's an opportunity to deliver better. But certainly, we've positioned both the guidance and the business to be conservative at least for the next quarter or 2.

[Mihir Bhatia, analyst]

Got it. And then I wanted to go back to the expenses and the reserve for customer remediation that you mentioned that you took this quarter. Can you just provide some more color on that? Like is that related to the merchant mispricing issue? How much was the reserve this quarter? Where does that leave the reserve overall, I think you had $365 million in 2Q. Just trying to understand how the estimate for the costs related to that issue changed? I think you also mentioned it could be higher -- expenses would be higher in '24. If you need to take more reserves there, like -- where are we with that investigation? Just give us an update on that merchant mispricing issue too?

[John Greene, executive]

Yes. Okay. So let me start with the reserves so -- and the remediation reserve that we put up. So they're unrelated. So the merchant tiering reserve we booked $365 million as a liability, that has moved now about $370 million just as we've had some payments and other flows in through the interchange that we had to correct manually for. So the progress there in terms of discussions with our merchants is positive. We'll -- we don't have enough data points to make a material change to that reserve level yet, but it's progressing, my view, positively through the end of the year and today as we speak.

Now separately, we put up $80 million for a -- as we described it, a customer remediation reserve. Now some context to that is as part of this compliance journey, we've put in a significant number of resources to help us identify and correct issues. And as we prepare the business to continue to move forward to drive organic growth, we're getting much, much better at identifying issues and we identify an issue. What we've done here is if we think there's is appropriate to refund customer payments, we're going to do that. So we identified a particular issue largely within servicing for our student loan business, although there was a general impact in another business line and we continue to look across our business. But the lion's share of that reserve relates to student loans and essentially what we're doing is trying to position the business and that product for a successful exit.

[Operator]

Our question will come from Sanjay Sakhrani with KBW.

[Sanjay Sakhrani, analyst]

Sorry, multi-part question on the same topic and then a follow-up. Can you update us, John, on the progress made with the regulatory agencies, I think that was sort of alluded to in the previous question. But maybe just the firmness around capital return post CCAR? What exactly happens to the CFPB consent order when the loan servicing is transferred? And then just curious, the loan growth expectations, was that any part driven by any regulatory related matters?

[John Owen, executive]

This is John Owen. I'll take part of that, and John Greene will take the capital part. What I would tell you is over the last 18 months or so, we made significant progress improving our risk management and compliance capabilities. We've increased our investments on risk and compliance in 2022 to 2023 up to about a $500 million level. And as John mentioned earlier, we think expense growth, and that will be in the mid-single digits in line with other guidance we've given. We've made improvements in risk and compliance, but we still have quite a bit of work to do.

One thing I'd point out, the FDIC consent order, which we did get and was made public, it does not include the misclassification issue in that scope of work. We're working closely with our regulators on that topic and really don't have anything further to add on that topic at this point in time.

[John Greene, executive]

Okay. Sanjay, I feel like your question is a 5-part question, but what we'll do our best to answer it. So the loan growth aspect that you asked, it is completely unrelated to any regulatory issues. So nothing to connect on that point.

In terms of capital return, our commitment to capital return and capital allocation have not changed. So first, to invest in profitable organic growth; and second, to return excess capital to shareholders. So as we kind of progressed through the fourth quarter, we remained on pause with our buybacks. And given we've got a new CEO coming in, we are contending with a number of different compliance and risk management matters. We got the merchant [indiscernible] reserve. We don't have any feedback from our regulators on that point. We decided that it would be most appropriate to remain conservative in terms of our guidance related to buybacks.

We will go through CCARs, as I said in my prepared remarks, that will form a view of capital under significant stress as it always does. And then we're going to have the exit or hopefully, the exit from the Student Loan business, which will provide free up at least $2 billion worth of capital. So what you're hearing here hopefully is some indications that one, we're committed to returning excess capital to shareholders; two, that there will be excess capital generated and available; and three, we're going to go through a diligent process internally, share it with our Board and then take the Board's direction in terms of buybacks.

[Sanjay Sakhrani, analyst]

The consent order?

[John Greene, executive]

And...

[Sanjay Sakhrani, analyst]

With the loan servicing, like does that move...

[John Greene, executive]

Yes, that was part 5A, I think. Yes. So that remains in effect and our chosen provider, Nelnet is fully aware of the consent order requirements in terms of kind of servicing excellence. And they were chosen because they've got a track record in terms of being able to kind of service a portfolio such as this, and they've dedicated both technology and resources to ensure a seamless transition.

[Sanjay Sakhrani, analyst]

Okay. Then my follow-up, just question is -- sorry, to my 5-part question. Is the reserve rate, Moshe sort of asked about it a little bit, but how should we think about that reserve rate migrating over the course of the year given that the charge-off rate plateaus. Does the reserve rates start coming down? And where does it come down to in a normal environment? I'm just trying to think about how we model that because that's really important.

[John Greene, executive]

Yes, yes. We are hoping that, that question would come out. So the -- let me talk about the reserves for that quarter, and then I'll give some perspective on '24 and what could potentially happen there. So we grew receivables in the quarter, $5.7 billion. Now some of that was transactor balances that are reserved light. But one thing that we've been consistent on in terms of our communication is that as we approach peak losses, reserve levels increase. And what we've said previously is, typically, we hit the highest reserve rate level one to two quarters before peak losses. So that's the path we're on.

Let me provide some details on some assumptions that were used to set the reserve levels this year at year-end. And then I'll give a perspective on what we -- what could happen in 2024. So macro is relatively benign. So unemployment levels, we ended the year at 3.7% what we've assumed is an unemployment level of 4.2%. So a mild increase, household net worth, mild decrease, savings rate, mild increase and GDP to be in 2024 to be about 1.3%. So relatively conservative but not overly optimistic of assumptions.

Now what will come into play in 2024 is obviously the macros, which will continue to be important. The portfolio performance and -- by the way, it is tracking to our expectations with month-over-month delinquency formation declining. The credit quality of the book remains relatively consistent with what we've done historically. So our expectation is that assuming the macros remain consistent and the portfolio performance remains to our expectation that there will be some level of opportunity to reduce the reserve rate in 2024.

Now that's subject to a significant amount of governance, and we're going to we're going to make sure that we comply with our internal processes and generally accepted accounting principles. So they're my caveats. But there's a lot of things that are different today than day one. So the step down will be aligned with those points I just mentioned.

[Operator]

Our next question will come from Bill Carcache with Wolfe Research.

[Bill Carcache, analyst]

John, I wanted to follow up on your credit commentary, given that it is such an important area of focus for investors. So you've been saying all along that you didn't move down the credit spectrum, but the concern for many investors had been that other card issuers also experienced outsized growth as we emerge from COVID and they had also experienced some normalization headwinds, but they were now starting to see delinquency reformation start to roll over. As Discover's DQ rate formations as recently as prior months data showed that your formations remain on and up until the right trajectory. So I guess the question is, does the new disclosure on Slide 14 confirm that your delinquency rate formations are indeed now also starting to roll over? And if so, does that really just reinforce your confidence that we could see peak NCOs hit in 2024, all else equal?

[John Greene, executive]

Yes. And thanks for the question, Bill. So just to give you kind of the benefit of some data here. From September through December this year, so the 30-plus delinquencies have declined month-over-month. So in September, we peaked at an increase month-over-month of 26 bps. What we said in the fourth quarter is we expected that to decline. Our October formation increased 20 bps so relative to decline to the prior month. November 15 bps, December 11 bps. And our expectation is that will continue to decline.

Where it becomes negative, we're not going to get into that because it will be subject to a number of different things, including kind of our origination path and broad macro. To get to the essence of your question, we do have a level of confidence regarding kind of what's happening in the portfolio and the trend. And as we progress in 2024 that will be reflected in hopefully, tightening guidance and then also tightening guidance to the lower end and then also, hopefully, reserve rate changes.

[Bill Carcache, analyst]

That's helpful. And following up on your expense commentary, I believe you said that expenses may need to increase further potentially. Maybe if you could frame the possibility of their being -- what you would view as another step function higher from here? Or how should we think about the risk of further increase in expenses? And how are we -- how should we think about your sustainable long-term efficiency ratio? I think as we look at historically, Discover has been very, very much had lowest efficiency ratio in the industry. To what extent is that still something that we can expect?

[John Greene, executive]

Okay. Yes. Thanks, Bill. So our expectation is that the long-term efficiency ratio will be sub-40%. So there's still a view that, that will happen. The reason we put the, what I'll call is the caveat in the 2024 expense guidance was a number of different institutions when they've been on this compliance and risk management journey have not been able to call what the actual compliance and risk management spend would be. We had that remediation reserve in the fourth quarter. There were some indications that we might have to put something up for that. But we didn't know. There's still some level of unknowns, unknowns. And I wanted to make sure we're clear to the people listening to this call that there is some level of risk to the expense guidance.

Now that said, 5% on our expense base is a significant amount of dollars. We feel like we have nearly a full complement of resources around risk and compliance today, which is good news. Our issues management capabilities significantly improved. Our path to improving overall governance is certainly on the right trajectory. So those factors give me confidence that we're not going to have a huge surprise. But there could be just -- we just don't have enough certainty given where we are on our compliance journey.

Now the rest of the cost base, there's a couple of things to keep in mind here. So right today, we have nearly 3,000 resources dedicated to risk and compliance management. A significant amount of those resources are dedicated to issues related to student loan servicing, which with a successful exit and transfer, it will give us an opportunity to scrutinize the cost base in a different way. So that's certainly on the list of planned activities for the second quarter, third quarter, and then hopefully, we begin some execution in the fourth quarter. So overall, I feel comfortable with the expense guidance that we've provided. And we're going to do our best to make sure that every dollar we spend is wise and that the shareholders get the benefit from that.

[Bill Carcache, analyst]

Very helpful.

[John Greene, executive]

You're welcome, Bill Thanks.

[Operator]

Our next question will come from John Pancari with Evercore ISI.

[John Pancari, analyst]

Good morning. Regarding the new $80 million remediation charge, did all of that remediation relate to the Student Loan business, specifically, and was that in part tied also to the July '22 disclosure around the Student Loan issues that surfaced then? And did any of that $80 million relate to the other business that you point that you mentioned that could have had a tangential impact and what was that business?

[John Greene, executive]

Yes. So the $80 million was related to servicing issues, the lion's share of that, the significant share of that was related to student loans. There was a small amount that we put up related to personal loans upon reviewing that, there may be an opportunity to release that reserve, very small though. The $80 million is not connected to the issues that we discussed in July.

So what I tried to do is provide as much context as I could. So we've dedicated a number of resources to identifying issues to help us on this consumer compliance journey. As with any company, as you dedicated resources, they come up to speed, they are going to get more effective at identifying issues and correcting issues. This is symptomatic of that progress. So we've got folks that are coming through every single bit of our business to make sure we're executing consumer compliance at a high level. An issue was found. Cross-functional team reviewed it, and we made an election that we are going to accrue something at year-end to cover potential remediation payments.

[John Pancari, analyst]

Okay. And just related to that, this -- so this is a newer issue versus what was discussed in July? And is it also newer versus what is in your existing consent order tied to student loans?

[John Greene, executive]

Yes. So what we disclosed in July was a broad program around risk and compliance management activities. This -- the specifics of the particular issues weren't discussed in any details. And what I've shared with you right now is probably as much information as I'm going to share at this point.

So the takeaway should be is that we're progressing on the risk and compliance management activities. We're getting better at identifying issues. When we find an issue, we're going to deal with it. And we found an issue. We've put up a reserve for that issue. And we're going to work through further details on it in order to ensure that consumer compliance is where we want it to be. So with that, I think I'll probably close at this particular item out, if you don't mind.

[John Pancari, analyst]

No, that's fine. And my last thing is a very quick one on the loan growth guidance. You guided to average balances for '24 up modestly. Can you help maybe quantify the up modestly, if you could really help frame it. Thanks.

[John Greene, executive]

Yes. So 5% to 6% on average.

[Operator]

Our next question comes from Don Fandetti with Wells Fargo.

[Donald Fandetti, analyst]

John, it's good to see the delinquency formation showing some progress. Can you talk about later-stage delinquency rates? I mean, they seem like they're still going up on a year-over-year basis. Like how are cure rates? I'm still trying to get my arms around this, like potentially 5% NCO rate, it just seems high for Discover.

[John Greene, executive]

Yes. Yes, the later-stage buckets are kind of modestly improving. So we're seeing improvements across every bucket. The first bucket is really the key one. And then as you get into later and later buckets, the ability to cure just becomes more challenging because of the situation that the consumer is in, but we are seeing kind of mild improvements there. So that also is encouraging.

[Donald Fandetti, analyst]

Okay. And the '23 vintage, can you talk a little bit about what your early read is on that?

[John Greene, executive]

Yes. The net of it is that it's early. So it's performing profitably, and we're going to continue to keep our eye on it.

[Donald Fandetti, analyst]

Does that mean it's not really trending that well relative to your expectations? Or is it kind of in line?

[John Greene, executive]

No, no, I didn't say that. It's just -- it's early. So it's performing generally in line with expectations.

[Operator]

I'll take our next question from Jeff Adelson with Morgan Stanley.

[Jeffrey Adelson, analyst]

John, I just wanted to kind of follow-up on the charge-off guide. I know you've mentioned that you're hopeful this year coming at the low end. But could you maybe just dive into what would take us to the low versus the high end here? And if this delinquency formation slowing continues throughout the year, is that kind of what's embedded in your expectation at getting at the low end here?

[John Greene, executive]

Yes. Thank you. Yes. So our baseline is that it's going to come in at the low end. Now I shared the information in terms of the macros that we use for reserves pretty consistent in terms of what we used for our, what I'll say, the second half view of charge-offs.

So what could make that worse? Certainly, change to the macros, some servicing issues, which highly unlikely or a miss in terms of forecasting. I'm comfortable with our forecasting team. I'm comfortable with our servicing team and we've got a number of programs, and we've dedicated a lot of dollars in terms of analytics, in terms of call frequency and best time to call, and we've worked on our call scripts to ensure they're compliant but also effective in terms of prioritizing payments. So I feel good about that. So the range just reflects a level of kind of broad uncertainty that we're going to tighten.

[Jeffrey Adelson, analyst]

Got it. And just as my follow-up, as we think about the NIM guide this year, I know you mentioned you're embedded in an expectation of four rate cuts. If I think about where NIM exited the year though, it feels like the range of rate cuts using your 5 basis points for every 25, it seems like there's more rate cut that embedded in there. Can you maybe just help us understand the drivers is, there may be a little bit more interest accrual reversal going on? And maybe help us understand what you're assuming in positive betas on the way down? Is it going to be a little bit slower than what we've seen in the last four rate cuts on the way up?

[John Greene, executive]

Yes. So good question. So let me start off with 2023 and then the fourth quarter of 2023. So as a business, my view is great execution in terms of being able to kind of manage net interest margin so year-over-year, we're up. I think we're an outlier, and that's from that standpoint in financial services.

What we saw in the fourth quarter was cost of funding increased as lower rate CDs term out and higher rate CDs would come in. Our OSA rate remains competitive. And the expectation on beta is that it will be in the mid-70s in a declining rate. And I hope that the beta on the declining rate is higher. Also something that's not baked into the elements of the guidance. But certainly, with the exit of student loans or the proposed exit from the Student Loan business, that's going to throw a lot of liquidity back into the business. That will give us an opportunity to be slightly more aggressive in terms of deposit pricing. That -- again, that will be a second half activity.

So the four rate cuts that we put into the baseline assumption, again, two more than what we had forecasted in December. It could be as many as 6, which if it is, that will certainly impact deposit betas and deposit pricing and consequentially net interest margin. So the guide here, I think, is appropriate, perhaps a little conservative. And our baseline expectation is that we're going to deliver to the upper end of the guidance range.

[Operator]

We'll take our next question from Terry Ma with Barclays.

[Terry Ma, analyst]

Maybe I just want to touch on the loan growth guide for '24 a little bit. Aside from the balance transfers and promos, how much control do you actually have on growth going from 15% loan growth to 0% just seems like a hard pivot to me. So maybe can you just talk a little bit more about that?

And then my second question is just what needs to happen before you can actually grow again, and is there a way to think about what that growth rate looks like as we look out towards 2025 and beyond?

[John Greene, executive]

Okay. Thanks, Terry. I think it's important to take a look at the quarterly trends on loan growth versus the total year because each quarter, what you will see is that the amount of loan growth decreased quarter-over-quarter. And that was partly due to payment rate, partly due to underwriting standards and partly due to kind of sales activity slowing as well.

So in 2024, we've guided to loan growth to be flat. Again, payment rate is 100 basis points higher than it was in 2019. That could be a positive if it holds where it ended the year. It's not going to impact loan growth. So I feel like what we've tried to do here is put something on the table that's reasonable that doesn't reflect a level of undue risk taking in a time where consumer behavior is actually changing relatively dynamically if you think back 2.5 years ago coming out of the pandemic to kind of where it is today and also the impact of inflation that hit certainly all consumers, but certainly in terms of our prime revolver consumers, the lower third of those consumers were impacted fairly significantly by inflation. So we do want to kind of watch, as I said previously, watch delinquency formations and our other metrics before we press on the gas on generating high level of new accounts in 2024.

[Terry Ma, analyst]

And is there a way to think about what growth would look like before when you reaccelerate?

[John Greene, executive]

Yes. I would go back to kind of historical growth rates. The companies typically delivered somewhere between 3% and 8% year-over-year growth. And then we feel like our underwriting and credit and the opportunity to lend profitably at a rate higher than that, we will do that. So what -- an important thing for our investors to remember is we seek to generate high returns over the short, mid and long term. And that's essentially what this plan is seeking to deliver.

[Eric Wasserstrom, executive]

So Todd, I think we have time for one more, please.

[Operator]

Thank you, sir. We'll go next to John Hecht with Jefferies.

[John Hecht, analyst]

I know you've answered a lot on credit, so I apologize for one more. But your '18 and '19 charge-off levels were in the low 3% range. And I think we -- we've all kind of said that was a good environment, but a relatively normal environment. You're guiding toward a high -- relatively higher, closer to 5% charge-off rate this year despite low unemployment. I know you kind of called out the 2022 vintage is something to think about there.

But maybe can you talk about the attribution of the difference in charge-off rates between that period and now? I think the kind of -- the reason for the question is just to give us a sort of level of understanding of where we are in the credit cycle and give us comfort that things will stabilize, if not improve from here?

[John Greene, executive]

Yes. happy to, John. So a few points. So we're in a significantly different environment today than we were back in 2018 and '19. So we're coming off of two years of abnormally low losses, so sub-2%. We had an incredibly high payment rate in -- going back two years ago, that is normalized.

What we're seeing is that consumers had significant amount of savings. Those savings levels have been depleted. You had a spending pattern with the consumers across the Board that was reflecting kind of pent-up demand. And as savings rate came down, the consumers needed to adjust their spending patterns. Some did successfully, some did not.

And then you're also seeing inflation, if you go back 1.5 years or 2 years ago, inflation significantly outpacing wage growth. And that put certainly the lower quartile of the consumers in a significant amount of stress and that's across all sectors of the economy. So not specifically to our prime revolver segment. And on top of that, you also had in '21 and '22, two very large vintages. And so you put all those together, what naturally is going to happen is you're going to have charge-offs.

What I'll say is peak before they normalize back to levels that you're accustomed to seeing from Discover. So my sense is that given real wage growth, our consumers will end up in, frankly, a better spot in '24 and '25 than they were in '22 and '23. And our charge-off forecast and reserves reflect a view that the consumers will manage through this and delinquency formation will continue to slow. So anyway, I hope that -- hopefully, this color is helpful.

[John Hecht, analyst]

That's super helpful. And maybe could you give us a sense of the charge-offs by product or maybe like the -- is the mix going to be consistent with historical mix just to give us a sense from a modeling perspective?

[John Greene, executive]

Yes. The only piece of information I'm going to give is in the fourth quarter, we expect student loan charge-offs to be significantly lower because we're exiting.

[Eric Wasserstrom, executive]

All right. Well, I think we're going to conclude the call there. Thank you for joining us. I know there was a few of you still in queue, who we didn't get to, but feel free to reach out to the IR team. We'll be around all day and available to answer additional questions. Thanks for joining us, and have a great day.

[Operator]

And this does conclude today's Discover Financial Services Earnings Conference Call. You may disconnect your line at this time, and have a wonderful day.