Discover Financial Services - Q4 2023
January 18, 2024
Transcript
Operator (participant)
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. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question at that time, please press star one on your telephone keypad. If you should need operator assistance, please press star zero. Thank you. 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 (Senior VP of Corporate Strategy and Development and Investor Relations)
Thank you, and welcome to this morning's call. I'll begin on slide two 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. After we conclude our formal comments, there will be time for a question-and-answer session. During the Q&A session, we request that you ask one question followed by one follow-up question. After your follow-up question, please return to the queue. Now it's my pleasure to turn the call over to John.
John Owen (Interim CEO and President)
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 touchpoint, 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 to our 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. 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 the eleventh, 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 with a deep background in the financial services industry. He has managed all aspects of 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 (Business Leader and CFO)
Thank you, John, and good morning, everyone. I'll start with our summary financial results on slide four. 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 five.
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 six, non-interest 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 in 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 points 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 seven. 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 eight. 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 nine. 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 mid-year 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. Concluding 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%-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 %. This contemplates our expectation for compliance-related costs to be approximately $500 million this year. Total expenses may increase if incremental resources or remediation is required. We expect net charge-offs in the range of 4.9%-5.3%.
Finally, regarding capital return, we will participate in this year's CCAR 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 invest in actions 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 (participant)
... At this time, if you would like to ask a question, please press star one on your telephone keypad. If you wish to remove yourself from the queue, you may do so by pressing star two. We remind you to please pick up your handset for optimal sound quality. Again, that's star one to ask a question. Our first question will come from Rick Shane with JPMorgan. Please go ahead.
Rick Shane (Managing Director and Senior Equity Research Analyst)
Good morning, everybody, and thanks for taking my question. Excuse me, I'm 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 (Business Leader and CFO)
Hey, Rick, John, John Greene here. That is organic loan growth. So all of the guidance excluded the impact of a potential student loan asset sale.
Rick Shane (Managing Director and Senior Equity Research Analyst)
Okay, that's it for me. Thank you, guys.
Operator (participant)
Thank you. Our next question will come from Moshe Orenbuch with TD Cowen.
Moshe Orenbuch (Managing Director and Senior Equity Research Analyst)
Great, thanks. John, maybe just to follow up on Rick's question. I mean, given the strong growth that you're currently seeing in the personal loan business and, you know, the fact that you're still adding accounts, albeit at a lower level in the credit card business, you did mention, you know, kind of the lower, you know, balance transfers, but is there something else going on? Can you talk about... you know, kind of deconstruct that loan growth expectation for us a little bit?
John Greene (Business Leader and CFO)
Sure, sure, sure. Thanks, Moshe. So, the components 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, you know, what we've tried to do here is kind of de-risk the forecast. So we assume that 100 basis points of payment rate that's elevated versus 2019 will remain elevated. So those three components, you know, reflect... you know, end up coming in and reflecting on our projections.
Now, you know, loan growth could actually come in higher if payment rate continues to decline. But overall, you know, 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 (Managing Director and Senior Equity Research Analyst)
Great, thanks. And maybe just as a follow-up on the credit side, I mean, you know, you did talk, you know, 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. You know, what's driving that? Why isn't that something that improves, and how do we think about reserving in that context?
John Greene (Business Leader and CFO)
Sure. Yeah, so, so there's a couple different components that are driving that. So if you go back in time, we, we had about two years of, of unusually low, charge-offs and delinquencies, so from the pandemic. And, you know, that process of normalization typically will, will take about the same amount of time, two years. The, the vintages 2021 and 2022 are seasoning, and that's why we expect it to plateau. The 2023 vintage actually was relatively large, but, you know, too early to call whether it's going to outperform our expectations, but certainly, a, a highly profitable vintage from, from our, our vantage point today. So what, what you're actually just seeing is a period of normalization.
You know, my expectation is that, you know, charge-offs will plateau, and then, and beginning in 2025, I, I would expect those to step down. Now, you, you will know from this past year and the prior year, what we've tried to do in, in terms of the guidance is be conservative, in terms of the range. And, and throughout 2023, we tightened, we tightened the range and actually came in at the low end. So, you know, my hope is that we'll be able to do the same thing in, 2024.
Moshe Orenbuch (Managing Director and Senior Equity Research Analyst)
Great. Thanks.
Operator (participant)
Thank you. Our next question will come from Ryan Nash with Goldman Sachs.
Ryan Nash (Managing Director in Equity Research)
Hey, good morning, everyone. 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. Look, the market clearly thinks there's a better chance of a soft landing right now. We're seeing peers who are talking about, you know, 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 (Business Leader and CFO)
Yeah. Thanks, Ryan. So, you know, our approach in 2023 and then early into 2024 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 tightened throughout 2023. You know what you're seeing here in terms of account growth, at least projections today, is us getting back to 2018 and 2019 levels as we continue to watch the 2022 and 2023 vintage perform. And, you know, six months from now, we may end up stepping in a little bit more aggressively.
John Hecht (Managing Director)
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, you know, there will be an opportunity to be more aggressive in terms of new account growth.
Ryan Nash (Managing Director in Equity Research)
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, you know, four to six quarters? Thank you.
John Greene (Business Leader and CFO)
Yeah. Thanks, Ryan. So, you know, good news. So it is actually progressing to schedule. So, 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 six months. You know, conservatively, it may take a month or two longer. And then, as we're doing that, our advisor will begin to market the portfolio.
So, you know, our expectations are that, you know, it will sell in the second half. And, you know, the implications for the business are as follows: so there's $9.5 billion of receivables. You know, that equates to kind of risk-weighted assets of about $10.8 billion. We expect that the exit of that will have a positive impact on net interest margin by somewhere between 10 and 20 basis points on a full year basis. Charge-off rate could tick up mildly, so under 5 basis points. And, as of 12/31, we had $858 million of reserves. So, you know, with a successful exit, you know, those reserves will drop.
You know, the sale price, you know, the market will determine that, but you know, we expect it to go above par.
Ryan Nash (Managing Director in Equity Research)
Thank you for all the color.
Operator (participant)
Thank you. Our next question will come from Mihir Bhatia with Bank of America.
Mihir Bhatia (Director and Senior Equity Research Analyst)
Hi, thank you for taking my question. 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 payment rates to be elevated at, like, flat, to stay at this elevated level, and sales to be flat. You're also adding accounts. So I'm just, like, trying to understand, like, I guess, what's the bad guy? Like, how does, how does loan growth stay flat given this year? You know, you're at 15%. And just trying to understand, like, like, there's some pieces I'm missing, I feel like, and I'm just trying to understand that. Thank you.
John Greene (Business Leader and CFO)
Yes. So let me try to give a little bit of color that hopefully gets folks comfortable with, you know, at least our view of loan growth today. So in 2023, you know, really, really strong loan growth. You know, 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, you know, 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, you know, if we out-deliver on loan growth, that'll be fantastic. The other element that has come into play here is, as we pulled back on balance transfers and promotional balances in the second part of 2023. You know, we don't anticipate significantly increasing that level of balance transfer or promotional balances. Now, if we do, that'll certainly be accretive to loan growth as well. So what you're hearing in the guidance is that, you know, our expectation is that, you know, 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 two.
Mihir Bhatia (Director and Senior Equity Research 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. I'm just trying to understand, has the estimate for the cost related to that issue changed? I think you also mentioned it could be higher, expenses could be higher in 2024 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 (Business Leader and CFO)
Yeah. Okay. So let me start with the reserve. So the remediation reserve that we put up. So they're unrelated. So the merchant tiering reserve, we booked $365 million as a liability. You know, that has moved. It is 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. You know, 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 when we identify an issue, what we've done here is if we think it's 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 tangential impact in another business line, we continue to look across our business. But, you know, the lion's share of that reserve relates to student loans. And, you know, essentially what we're doing is trying to position the business, and that product for a successful exit.
Mihir Bhatia (Director and Senior Equity Research Analyst)
Thank you. That's my questions. I'll go back to you.
Operator (participant)
Thank you. Our next question will come from Sanjay Sakhrani with KBW.
Sanjay Sakhrani (Managing Director and Senior Analyst)
Thanks. Good morning. 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, you know, 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? Thanks.
John Owen (Interim CEO and President)
Yeah, 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've made significant progress improving our risk management and compliance capabilities. You know, 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 in that will be in the mid-single digits, in line with other guidance we've given. We've made improvements in the 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, we did get and was made public, 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 (Business Leader and CFO)
Okay, Sanjay, I feel like your question is a five-part question, but we'll do our-
Sanjay Sakhrani (Managing Director and Senior Analyst)
Sorry
John Greene (Business Leader and CFO)
... We'll do it. 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, you know, our commitment to capital return and capital allocation have not changed. So first, invest in profitable organic growth, and second, to return excess capital to shareholders. So as we kind of progress 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, you know, a number of different compliance and risk management matters. Got the merchant tiering reserve. We don't have any feedback from our regulators on that point.
We decided that it'd be most appropriate to remain conservative in terms of our guidance related to buybacks. We, we will go through CCARs, as I said in my, prepared remarks. You know, that'll form a view of capital under, under significant stress, as, as it always does. And then we're gonna have the exit, or hopefully the exit from the student loan business, which will, you know, provide, you know, free up at least $2 billion worth of capital. So, you know, what, what you're hearing here hopefully is, is, some indications that, one, we're, we're committed to returning excess capital to shareholders. Two, that there will be, excess capital generated and available.
And three, we're gonna go through a diligent process internally, share it with our board, and then take the board's direction in terms of buybacks.
Sanjay Sakhrani (Managing Director and Senior Analyst)
The consent order?
John Greene (Business Leader and CFO)
And, uh-
Sanjay Sakhrani (Managing Director and Senior Analyst)
With the loan servicing, like, does that move?
John Greene (Business Leader and CFO)
Oh, oh, yeah.
Sanjay Sakhrani (Managing Director and Senior Analyst)
Oh, yeah.
John Greene (Business Leader and CFO)
Yeah. Yeah, that was part five A, I think. Yeah. 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, you know, 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 (Managing Director and Senior Analyst)
Okay. Then my follow-up just question is, sorry, to my five-part question: Is the reserve rate, Moshe sort of asked about a little bit, but how should we think about that reserve rate per-
John Greene (Business Leader and CFO)
Yeah
Sanjay Sakhrani (Managing Director and Senior Analyst)
... migrating over the course of the year, given that the charge-off rate plateaus? Does the reserve rate 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 (Business Leader and CFO)
Yeah, yeah. Thanks for that. We were hoping that that question would come out. So let me talk about the reserves for the quarter, and then I'll give some perspective on 2024 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 could happen in 2024. So the macro is relatively benign. So unemployment levels, we ended the year at 3.37. 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, you know, relatively conservative, but not overly optimistic set 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 expectation, with month-over-month delinquency formation declining. The credit quality of the book remains relatively consistent with, you know, what we've done historically. So, you know, 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, you know, that's subject to a significant amount of governance, and we're gonna make sure that we, you know, 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.
You know, this step down will be aligned with, you know, those points I just mentioned.
Sanjay Sakhrani (Managing Director and Senior Analyst)
Okay, great. Thank you very much.
Operator (participant)
Thank you. Our next question will come from Bill Carcache with Wolfe Research. Please go ahead.
Bill Carcache (Research Analyst)
... Thank you. Good morning, and thanks for taking my questions. John, I wanted to follow up on your credit commentary, you know, 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, you know, other card issuers also experienced outsized growth as we emerged from COVID, and they had also experienced some normalization headwinds. But they were now starting to see delinquency rate formation start to roll over as Discover's DQ rate formations as recently as, you know, prior months'. Data showed that, you know, your formations remain on an up and to 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, you know, does that really just reinforce your confidence that we could see peak NCOs hit in 2024, all else equal?
John Greene (Business Leader and CFO)
Yes. And thanks for the question, Bill. So, just to give you kind of the benefit of some data here, you know, from September through December this year, so the 30+ delinquencies have declined month-over-month. So in September, we peaked at an increase month-over-month of 26 basis points. What we said in the fourth quarter is we expected that to decline. October formation increased 20 basis points, so a relative decline to the prior month. November, 15 basis points. December, 11 basis points. And, you know, our expectation is that that will, you know, continue to decline.
That, you know, where it becomes negative, you know, we're not going to get into that because it'll be subject to a number of different things, including kind of our origination path and broad macro. So to get to the essence of your question, you know, we do have a level of confidence regarding kind of what's happening in the portfolio and the trend. And, you know, as we progress in 2024, you know, that'll be reflected in hopefully tightening guidance, and then also tightening guidance to the lower end, and then also hopefully reserve rate changes.
Bill Carcache (Research Analyst)
That's helpful. Thank you. And following up on your expense commentary, I believe you said that expenses may need to increase further, potentially. Maybe if you could frame, you know, the possibility of there being a, you know, what you would view as another step function higher from here? Or, you know, how should we think about the risk of further increase in expenses, and how are we... You know, how should we think about your sustainable long-term efficiency ratio? You know, I think as we look at historically, Discover has been very, very much had, you know, lowest efficiency ratio in the industry. You know, to what extent is that still something that we can expect?
John Greene (Business Leader and CFO)
Okay. Yeah, thanks, Bill. So, you know, our expectation is that the long-term efficiency ratio will be sub 40%. So there's still a view that that will happen. You know, the reason we put the what I'll call is the caveat in the 2024 expense guidance was, you know, 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. You know, we had that remediation reserve in the fourth quarter. You know, there were some indications that we might have to put something up for that. But, you know, we didn't know.
There's still some level of unknowns, unknowns, and, you know, I wanted to make sure we're clear to you know, the people listening to this call, that, that there is some level of risk to, to the expense guidance. Now, that said, you know, 5% on our expense base is a significant amount of dollars. You know, 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 improve. 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, you know, 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, you know, there's a couple 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'll 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, you know, overall, you know, I feel comfortable with the expense guidance that we've provided.
You know, we're gonna, we're gonna do our best to make sure that, you know, every dollar we spend is wise and that the shareholders get the benefit from that.
Bill Carcache (Research Analyst)
Very helpful. Thank you for taking my questions.
John Greene (Business Leader and CFO)
You're welcome, Bill. Thanks.
Operator (participant)
Thank you. Our next question will come from John Pancari with Evercore ISI.
John Pancari (Senior Managing Director and Senior Equity Research 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 2022 disclosure around the student loan issues that surfaced then? And did any of that $80 million relate to the other business that you mentioned that could have had a tangential impact, and what was that business? Thanks.
John Greene (Business Leader and CFO)
Yeah. 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, you know, what I tried to do is provide as much context as I could. So, you know, we've dedicated a number of resources to identifying issues to help us on this consumer compliance journey.
As with any company, as you dedicate 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, you know, we've got folks that are combing through every single bit of our business to make sure we're executing, you know, consumer compliance at a high level. An issue was found, a 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 (Senior Managing Director and Senior Equity Research Analyst)
Okay. And just related to that, 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 (Business Leader and CFO)
Yeah. So, you know, what we disclosed in July was a broad program around risk and compliance management activities. This, you know, the specifics of the particular issues weren't discussed in any details. And, you know, what I've shared with you right now is probably as much information as I'm gonna share at this point. So you know, the takeaway should be is that, you know, we're progressing on the risk and compliance management activities. We're getting better at identifying issues. When we find an issue, we're gonna deal with it.
And, you know, we found an issue, we've put up a reserve for that issue, and, you know, we're gonna work through further details on it in order to ensure that, you know, consumer compliance is where we want it to be. So, with that, I think I'll probably close this particular item out, if you don't mind.
John Pancari (Senior Managing Director and Senior Equity Research Analyst)
No, that's fine. Thank you for that. My last thing was a very quick one on the loan growth guidance. You guided the average balances for 2024 up modestly. Can you help maybe quantify the up modestly?
John Greene (Business Leader and CFO)
Yeah
John Pancari (Senior Managing Director and Senior Equity Research Analyst)
... if you could, if you could maybe help frame it? Thanks.
John Greene (Business Leader and CFO)
Yeah. 5%-6% on average.
John Pancari (Senior Managing Director and Senior Equity Research Analyst)
Okay, great. Thanks, John.
Operator (participant)
Thank you. Our next question comes from Don Fandetti with Wells Fargo.
Donald Fandetti (Managing Director and Senior Equity Research Analyst)
John, you know, 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. Or, like, how are cure rates? I'm, I'm still trying to get my arms around this, like, potentially 5% NCO rate. It just seems high for Discover.
John Greene (Business Leader and CFO)
Yeah. Yeah, the later-stage buckets are kind of modestly improving. So we're seeing improvements across every bucket. You know, 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 (Managing Director and Senior Equity Research Analyst)
Okay. The 2023 vintage, can you talk a little bit about what your early read is on that?
John Greene (Business Leader and CFO)
Yeah. The net of it is, is that it's early. So, you know, it, it's performing, you know, profitably, and, you know, we're gonna continue to keep our eye on it.
Donald Fandetti (Managing Director and Senior Equity Research Analyst)
... So does that mean it's, it's not really trending that well relative to your expectations, or is it kind of in line?
John Greene (Business Leader and CFO)
No, no, I didn't say that. It's just, it's early. So, it's performing generally in line with expectations.
Donald Fandetti (Managing Director and Senior Equity Research Analyst)
Okay, thanks.
Operator (participant)
Thank you. We'll take our next question from Jeff Adelson with Morgan Stanley.
Jeff Adelson (Research Analyst)
Hi, thanks for taking my questions. John, I just wanted to kind of follow up on the charge-off guide. I know you, you've mentioned that, you know, you're hopeful this could come in at the low end, but could you maybe just dive into what would take us to the low versus the high end here? And, you know, 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 (Business Leader and CFO)
Yeah. Thank you. Yeah, so you know, 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 you know, what could make that worse? Certainly, you know, a change to the macros, you know, some servicing issues which highly unlikely, or you know, a miss in terms of forecasting. You know, I'm comfortable with you know, 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, lot of, lot of dollars in terms of analytics, in terms of call frequency and best time to call. And, you know, we've worked on our call scripts to ensure they're compliant, but also effective in terms of prioritizing payments. So, you know, I feel good about that. So, you know, the range just reflects a level of kind of broad uncertainty that we're going to tighten.
Jeff Adelson (Research 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 embedded in there. Can you maybe just help us understand the drivers? Is there may be a little bit more interest rate reversal going on? And you know, maybe help us understand what you're assuming in deposit betas on the way down. Is it going to be a little bit slower than what we've seen the last four rate cuts on the way up?
John Greene (Business Leader and CFO)
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 were up. I think we're an outlier, and that's from that standpoint in financial services. You know, what we saw in the fourth quarter was you know, cost of funding increased as lower rate CDs term out and higher rate CDs would come in. Our OSA rate you know remains competitive. And you know, the expectation on beta is that it'll be in the mid-70s and a declining rate.
You know, I hope that the beta on the declining rate is higher. Also, something that's, you know, not baked into the elements of the guidance, but certainly, you know, 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'll give us an opportunity to be slightly more aggressive in terms of deposit pricing. You know, that again, that'll be a second-half activity. So, you know, the four rate cuts that we put into the baseline assumption, you know, again, two more than what we had forecasted in December.
You know, it could be as many as six, which, if it is, you know, that'll certainly impact deposit betas and deposit pricing and consequentially Net Interest Margin. So you know, the guide here, I think is appropriate, perhaps a little conservative. And our, you know, our baseline expectation is that we're going to deliver to the upper end of the guidance range.
Jeff Adelson (Research Analyst)
Okay. Thank you for taking my questions, John.
Operator (participant)
Thank you. We'll take our next question from Terry Ma with Barclays.
Terry Ma (Senior Equity Research Analyst)
Hey, thanks. Good morning. Maybe just want to touch on the loan growth guide for 2024 a little bit. Aside from the balance transfers and promos, how much control do you actually have on growth? Because 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? 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 toward 2025 and beyond? Thank you.
John Greene (Business Leader and CFO)
... Okay, thanks, Terry. So, you know, 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, you know, we've guided to, you know, 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. You know, it’s not gonna 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, you know, a level of undue risk-taking in a time where, you know, consumer behavior is actually changing, you know, relatively dynamically. If you think back, you know, 2.5 years ago, coming out of the pandemic to kind of where it is today. And also the impact of inflation that hit it certainly all consumers, but certainly, you know, in terms of our prime revolver consumers, you know, 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, you know, a high level of new accounts in 2024.
Terry Ma (Senior Equity Research Analyst)
Thanks. And is there a way to think about what growth would look like before, when you reaccelerate?
John Greene (Business Leader and CFO)
Yeah, I would go back to kind of historical growth rates. Yeah, you know, the company's typically delivered, you know, somewhere between 3% and 8%, year-over-year growth. And then, you know, we feel we feel like our underwriting and credit, and the opportunity to lend profitably at a rate higher than that, we will do that. So you know, an important thing for, you know, our investors to remember is, you know, we seek to generate, you know, high returns over the short, mid, and long term. And, you know, that's essentially what this plan is seeking to deliver.
Todd, I think we have time for one more, please.
Operator (participant)
Thank you, sir. We'll go next to John Hecht with Jefferies.
John Hecht (Managing Director)
Good morning, guys. Thanks for taking my question. And, you know, I know you've answered a lot on credit, so I apologize for one more. But your, you know, your 2018 and 2019 charge-off levels were in the low 3% range, and I think we've all kind of said that was a good environment, but a relatively normal environment. Yeah, you're guiding toward a relatively higher, you know, closer to 5% charge-off rate this year, despite low unemployment. I know you've 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 reason for the question is just to give us some sort of level of understanding of where we are in the credit cycle and give us comfort that, you know, things will, you know, stabilize, if not improve from here.
John Owen (Interim CEO and President)
Yeah. Yeah, happy to, John. So, a few points. So, you know, we're, we're in a significantly different environment today than we were back in 2018 and 2019. So, you know, we're, we're coming off of, two years of abnormally low losses, so sub-2%. We had an incredibly high payment rate in, you know, 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 reflective kind of pent-up demand. And, as savings rate came down, you know, the consumers needed to adjust their, their spending patterns. Some did successfully, some did not.
And then, you're also seeing inflation, if you go back a year and a half to two 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 2021 and 2022, two very large vintages... And so, you know, 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, you know, my sense is that, given real wage growth, our consumers will end up in a frankly better spot in 2024 and 2025 than they were in 2022 and 2023. And, you know, our charge-off forecast and reserves reflect, you know, a view that, you know, the consumers will manage through this, and, you know, delinquency formation will continue to slow. So, anyway, I hope that this color is helpful.
John Hecht (Managing Director)
Yeah, 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 mixes? Just to give us a sense, you know, from a modeling perspective.
John Owen (Interim CEO and President)
Yeah. 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.
John Hecht (Managing Director)
Thank you.
John Greene (Business Leader and CFO)
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, 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 (participant)
This does conclude today's Discover Financial Services Earnings conference call. You may disconnect your line at this time, and have a wonderful day.