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Discover Financial Services (NYSE:DFS)
Q3 2019 Earnings Call
Oct 22, 2019, 6:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon. My name is Erica, and I will be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter 2019 Discover Financial Services Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]

I will now turn the call over to Mr. Craig Streem, Head of Investor Relations. Please go ahead.

Craig A. Streem -- Head of Investor Relations

Thank you very much, Erica, and welcome everyone to this afternoon's call. I'll begin on Slide 2 of our earnings presentation, which you can find in the Financials section of our Investor Relations website, investorrelations.discover.com.

Our discussion today contains certain forward-looking statements that are subject to risks and uncertainties that may cause actual results to differ materially. Please refer to our notices regarding forward-looking statements that appear in today's earnings press release and presentation. Our call today will include formal remarks from our CEO, Roger Hochschild, covering third quarter highlights. And then, it's my pleasure to welcome John Greene , our new Chief Financial Officer, who will take you through the rest of the earnings presentation. After John completes his comments, there will be time for a question-and-answer session. During the Q&A session, please limit yourself to one question and one follow-up, so we can accommodate as many participants as possible.

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

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

Thanks, Craig, and thanks to our listeners for joining today's call. As you can readily see from our results, we continue to deliver very sound fundamental performance this quarter leading to net income of $770 million after tax or $2.36 per share with a robust return on equity of 26%. We achieved our key objectives for loan growth, net interest margin and credit performance, setting us up to finish the year on a very solid footing. At the same time, the strength and profitability of our business allow us to make ongoing investments, which should further enhance our competitive position in each of our products and enable us to achieve continued strong results.

Looking at the key drivers, total loans were up 6% and credit performance remains strong across all of our products, reflecting our discipline in underwriting new accounts in line management as well as the clear benefits of our continued investments in servicing and collection capabilities. Card receivables grew 7% this quarter, reflecting a healthy mix of volume from both new and existing customers, and origination activity skewed more to higher yielding merchandise balances versus promotional balances. This demonstrates the positive degree of customer engagement, while providing a favorable contribution to the overall net interest margin.

Turning to our student loan business, growth remained strong this quarter and originations were in line with our expectations through the peak season . We're seeing an improvement in conversions, driven by increasing awareness of the Discover brand and the student loan market and better customer experience at the front end. We're excited about our competitive position in private student lending, and we remain confident in our ability to grow loans and gain market share despite competitive pressure.

In personal loans, growth was in line with our expectations as we remain disciplined on originating loans that meet our return objectives. Credit performance continues to stabilize, reflecting the positive outcome from recent credit tightening and implementation of enhanced risk mitigation strategies. Overall, underlying credit trends continue to be favorable across our lending products with credit performance driven more by growth in receivables as compared to normalization of the back book.

The US consumer and the overall economy continue to look good with unemployment at a 50-year low and consumer sentiment at a high level as we enter the holiday season. This was also another quarter of strong growth in consumer deposits, which passed the $50 billion mark and are now over half of our total funding. We've been able to maintain deposit pricing in the middle of the pack and have been pleased with our ability to continue to attract cost effective funding in a falling rate environment. We recently introduced our no fee commitment across our deposit products. And while it's still early, we believe this has resonated with customers and is contributing to our deposit growth .

Pre-tax income for our Payment Services segment increased 16%, primarily driven by strong volume growth from our PULSE business. The PULSE team continues to expand business with existing issuers and win new relationships through creative debit solutions that deliver meaningful value for partners. Additionally, we continue to make progress against our strategy to enhance global acceptance by investing in partnerships with local acquirers and adding network to network partners. This quarter, we added to acquirer partners in France [Indecipherable] as we continue to focus on acceptance in Western Europe.

In addition, we're expanding acceptance in Africa with our partnership with Verve, a Nigeria-based payments network that will provide acceptance in a number of African countries for Discover and our net-to-net partners such as RuPay and BC Card.

To summarize the quarter, our performance once again demonstrates the strength of the Discover business model, our commitment to providing an industry-leading experience to our customers and our disciplined approach to profitable growth in Credit Management continue to provide strong returns and long-term value to our shareholders. The economic environment remains favorable and we do not see that changing in the near-term. That said, it is likely that we are in the later stages of the economic cycle, and we are continuing to manage origination, servicing and operational effectiveness with that very much in mind .

Before I wrap up my section of our formal remarks, I want to acknowledge Mark Graf's retirement from Discover. Mark has been a valued colleague and leaders since he joined the company in 2011 and will remain at Discover as an Executive Advisor until his retirement in early 2020. We wish Mark and his family the very best for the future.

And now, I want to take a moment to formally introduce our new CFO, John Green. John brings significant experience in financial services, including over eight years at HSBC where he held the role of CFO of their largest business unit, Retail Banking and Wealth Management, and he also brings over 12 years of experience at GE. John held public company CFO roles at Willis Group Holdings, where he was instrumental in the turnaround of the company and subsequent merger with Towers Watson. And most recently, John was CFO at the Biogen spin off Bioverativ. John is joining Discover at an important time and brings very relevant capabilities and experience. I'm very excited about the impact I expect John to have here at Discover, and I'm sure you'll enjoy working with him.

I'll now ask John to discuss our financial results in more detail.

John Greene -- Chief Financial Officer

Thank you, Roger. Before I begin, I wanted to say that I'm very excited to be part of the Discover team. My first month confirmed my initial view that I was enjoying a great organization. I'm looking forward to an exciting future with Discover, as well as the opportunity to work with all of you.

Now under the business at hand. I'll begin by addressing our summary financial results on Slide 4. Looking at the key elements of the income statement, revenue growth of 6% this quarter was driven by loan growth of 6%, consistent with our expectation and a very solid 8% growth in net interest income .The 8% increase in provision for loan losses was mainly driven by the seasoning of newer vintages and to a lesser extent by the continued supply driven normalization in the consumer credit industry .

Operating expenses were up 9% year-over-year due to higher compensation expense and investments in support of growth and new capabilities.The effective tax rate for the quarter was 22.5%, reflecting a $12 million benefit from the favorable resolution of a certain tax matters. Net income and EPS were up 7% and 15% respectively.

Turning to Slide 5. Loans increased 6% over the prior year, led by 7% growth in credit card receivables. Standard merchandise balances continue to be the primary driver of card receivable growth while the contribution from promotional balances was minimal reflecting our decision to reduce the level of growth from promotional activities over the past several quarters. Roughly 60% of the increase in loan balance was from new accounts and about 40% from existing.

Turning to student loans. Total loan balances were up 4% from the prior year. The organic piece of our student loan portfolio increased 9% year-over-year, reflecting our strong competitive position. Personal loan growth was in line with our expectations increasing 1% from the prior year, reflecting the previously mentioned slowdown in originations as we work through the development and testing of new underwriting models

Moving to payments volume, to the right on Slide 5, you can see that proprietary volume was up 6% year-over-year. In Payment Services, PULSE volume increased 5% over the prior year, driven by incremental volume from existing issuers, new issuers and the PULSE network and growth in our pinless products such as PULSE PAY Express and PULSE E-commerce. AribaPay drove the 30% increase in network partners volume, while Diners Club volume was flat to the prior year.

Moving to revenue on Slide 6, net interest income of $2.4 billion was up 8% from the prior year, driven by three factors: first, higher loan balances; second, the higher revolve rate this quarter; and third, somewhat lower promotional balances in this year's quarter. Total non-interest income was $498 million in the quarter, down $3 million or 1% from last year's quarter. The principal drivers of the decline were lower net discount and interchange revenue, partially offset by higher loan fee income.

Drilling down a bit, net discounts and interchange revenue was $255 million in the quarter, down 9% as revenue from higher sales volume was more than offset by higher rewards cost. This was primarily due to adding PayPal to the 5% rewards category. Sales volume was up 4% from the prior year or 5% when normalizing for processing days .Offsetting the decrease in net discount and interchange revenue was an increase of $17 million or 17% in loan fee income. The increase was principally due to an increase in late fee occurrences as well as an adjustment in late fee pricing tiers .

As shown on Slide 7, our net interest margin was 10.43%, up 15 basis points year-over-year and down 4 basis points sequentially. Relative to the third quarter of last year, the increase in NIM was due to a favorable promotional balance mix and higher revolve rate. These were partially offset by higher brokered and direct-to-consumer deposit costs and by higher interest charge-offs. Compared to the second quarter, NIM decreased principally due to the roll off of lower coupon brokered and direct-to-consumer deposits along with the impact of prime rate decreases in July and September.

Partially offsetting this was a favorable funding mix, a higher revolve rate and lower interest charge-offs. Total loan yield increased 31 basis points from a year ago to 12.7% driven by increases in yields for all of our principal loan products, 29 basis points in card, 35 basis points in private student loans and 51 basis points in personal loans.

Card yield benefited from the impact of the 2018 prime rate increases, favorability in the revolve rate and a lower level of promotional balances which were partially offset by higher interest charge-offs and the impact of recent prime rate decreases. The year-over-year increase in student loan yield was primarily driven by higher short-term interest rates as about 60% of the portfolio is floating rate. The increase in personal loan yield was also driven by the impact of prime rate increases in the prior year as well as positive pricing actions. We expect to see a degree of yield compression from recent cuts in the Fed funds rate, which won't entirely be offset by lower funding costs. We have taken action by steadily reducing our asset sensitivity and consider our interest rate risk position to be essentially neutral at this point.

Looking ahead, we expect to maintain this interest rate risk position for the foreseeable future. Our outlook anticipates one more 25 basis point rate reduction in 2019. On the liability side of the balance sheet, average consumer deposits grew 19% from last year and now make up 53% of total funding. Consumer deposit rates decreased 4 basis points from the prior quarter and are 28 basis points above the prior year. Importantly, we've been able to achieve strong deposit growth while maintaining a disciplined pricing strategy.

Since the Fed began raising rates in 2015, we realized a 51% cumulative deposit price beta for online savings. Of course, the Fed has recently cut its target rate by 50 basis points, and we've responded by lowering our deposit rates with a realized beta of 50% on our savings accounts over the last few months. We will continue to manage deposit cost prudently, taking into account competitors' behavior .

Turning to Slide 8. Total operating expenses rose $92 million from the prior year. Employee compensation increased $31 million driven by staff additions and technology and other areas to support business growth as well as higher average salaries and benefits. Increased investments in new account acquisitions across our deposits, student lending and card products drove marketing cost up 6% from the prior year. The 8% increase in information processing reflects our continued investment in infrastructure and analytic capabilities. Professional fees were $23 million higher with a little over half of that due to increased collection costs related to higher recoveries in the quarter.

Now I'll discuss our credit results on slide 9. Total net charge-offs were up 8 basis points from the prior year. The increase continues to be primarily driven by the seasoning of loan growth and supply driven credit normalization.

Credit card net charge-offs were 18 basis points higher year-over-year and down 17 basis points from the prior quarter. The credit card, 30 plus delinquency rate, was up 18 basis points year-over-year and up 16 basis points sequentially. Credit performance in the card business continues to be very solid, reflecting our disciplined approach to credit management in both new and existing accounts.

Private student loan credit performance also remained strong with net charge-offs down 37 basis points year-over-year and 2 basis points sequentially, aided by efficiency gains and collections, including enhanced communication and outreach to cosigners. Personal loan net charge-offs decreased 10 basis points from the prior year and 34 basis points sequentially. The significant improvement from the prior quarter reflects a degree of seasonality in originations and charge-offs. The 30-plus delinquency rate was down 8 basis points year-over-year and flat to the prior quarter as credit performance continues to stabilize.

Looking at capital on Slide 10. Just a brief comment here, common equity Tier 1 ratio remains sequentially flat at 11.4%. Our capital payout ratio for the last 12 months, including buybacks, was 79%.

Now summarizing our results for the quarter o n Slide 11. We generated 6% total loan growth and a 26% return on equity. Our consumer deposit business saw strong growth of 19% and now composes over half our total funding with respect to credit. While our charge-off rates have increased as loan growth seasons and credit conditions normalize, performance reflects positive trends across our lending products and remains consistent with our expectations and return targets. We continue to execute on our capital plan with loan growth and capital returns helping to bring our capital ratios closer to targeted levels.

Finally, we remain on track for a strong finish to 2019 achieving all aspects of our financial and operational guidance. In conclusion, this was a great quarter with solid execution by the team. Now, before I go to Q&A I wanted to say again how excited I am to be part of the Discover team.

I look forward to helping the business continue its history of strong execution as we grow this great franchise. With that, I'll turn the call back to the operator Erica to open the lines for Q&A.

Questions and Answers:

Operator

[Operator Instructions] We'll take our first question from Mark DeVries with Barclays.

Mark DeVries -- Barclays -- Analyst

Yeah. Thank you. Roger, I was hoping you could comment on significant to today's announcement around click to pay and what you think it could mean for the business.

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

So, in terms of the announcement on SRC, we are very excited as a member of the EMVCo to be part of that. I think it's really fundamentally going to be great for consumers. It reflects the industry moving forward to significantly enhance the online check-out experience. I think it will be a great step forward. So we're very excited to be part of it.

Mark DeVries -- Barclays -- Analyst

Okay. In terms of just what it can mean now in terms of volumes or defending market share, anything else you could share on that?

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

I think it's probably too early to talk about share shift. But to the extent that we're working with other networks on a seamless integrated customer experience, we think that will help our card holders and be good for our business.

Mark DeVries -- Barclays -- Analyst

Okay, fair enough. Thank you.

Operator

We will take our next question from Betsy Graseck with Morgan Stanley.

Betsy Graseck -- Morgan Stanley -- Analyst

Hi. Good afternoon.

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

Hey, Betsy

Betsy Graseck -- Morgan Stanley -- Analyst

Two questions related -- Roger, just wanted to understand, you had a really strong quarter on the revenue side, and the expense ratio came in nicely as well. So it looks like there was a little bit of investment spend going on in the quarter. How should we think about that? Is there a kind of expense ratio you're looking to run between or was this just a quarter where you had an opportunity to invest a little bit more and so you upped the investment spend this quarter or should we expect this level of investment spend to continue from here?

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

It's -- we don't necessarily target an efficiency ratio to the point you're making our investment spend as we see opportunities to drive loan growth consistent with our conservative approach to credit. We will do so, and we think more in terms of overall returns. Our efficiency ratio is one of the best within financial services, but in terms of overall expense levels, those can vary based on the marketing investment.

Betsy Graseck -- Morgan Stanley -- Analyst

And then, as we think about the NII in the NIM, I think, John, you were mentioning that you are largely neutral, and you've got one more rate cuts baked into your outlook, but we should expect NIM comes down a little bit. So I'm just trying to square that and maybe give a little bit of more understanding as to what you're expecting over the next couple of quarters from a NIM perspective?

John Greene -- Chief Financial Officer

Certainly. Happy to take that. So, we ended the third quarter year-to-date results with a NIM rate at 10.45%. And then, as we look at the fourth quarter, there's really three things that are going to impact it. So, certainly the rate cuts that occurred throughout 2019 will be fully baked in. And then, we'll have our funding rate, which actually ticked up mildly.

And then, of course in the fourth quarter, there is transactor and revolver mix shifts that ultimately will impact the rate. So I know the company gave some guidance at 10.3% and then was subsequently revised upward by 5 to 9 basis points. I would expect based on what we're seeing here, looking at the fourth quarter to come in probably at the higher end of that and probably 1 or 2 basis points higher than 10.39%, so probably 10.4%-ish.

Betsy Graseck -- Morgan Stanley -- Analyst

Got it. Okay, thank you.

Operator

We'll take our next question from Don Fandetti with Wells Fargo.

Don Fandetti -- Wells Fargo -- Analsyt

Yes, Roger. So, it looks like the card businesses are hitting on a lot of cylinders, credits, pretty stable, competition is stable. Demand is decent from the consumer. I guess I wanted to just get your thoughts on whether or not you see any risk to that in the near-term. Obviously we're focusing on the macro. But for example, is your sense the delinquency rate year-over-year, it's going to continue to be in the sort of zip code, and if you're seeing any type of movement within segments of higher end prime?

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

Yeah. So we spend a lot of time looking for turns in the economy. Looking at our portfolio, kind of every way we can kind of whether it's geographically, we look at the different vintage buckets, etc. And as I said on the call, the US consumer is holding up well.

I think part of it is reflected in terms of the 50-year low and unemployment, but we remain disciplined and conservative and credit because it feels late cycle and certainly is by any historic measure. But in terms of what you see in consumer behavior and the numbers we reported, the consumer is holding up very well.

Don Fandetti -- Wells Fargo -- Analsyt

And then, I guess, if you look around at the other networks, there's a lot of talk about B2B. We're seeing a lot of bolt-on acquisitions for the payment companies. Where are you in terms of your thought process on B2B? I know you have a small business card that's pretty modest. And then, do you think you need to make any bolt-on acquisitions at this point, are you in good shape?

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

So in terms of B2B, we're always looking at opportunities. But I think we tend to think about it in terms of the mix of acquisitions, but also partnerships. So, we see a lot of B2B volume coming through our partnership with SAP and Ariba. We announced a new B2B based partnership this quarter. So, it's an area we're focused on, margins tend to be a little thinner on the B2B side compared to B2C payments, but it's an area that we've focused on for quite a while in the payments part of our business.

Don Fandetti -- Wells Fargo -- Analsyt

Thank you.

Operator

We'll take our next question from Sanjay Sakhrani with KBW.

Sanjay Sakhrani -- KBW -- Analyst

Thanks. I guess I got a question on the private student loan credit quality and the nice improvement in the reserve rate there. Obviously we've seen some pretty significant improvement in the charge-off rate and the associated coverage with the reserve came down quite a bit. Is it just a reflection of the delinquency rate trajectory and you expect that to continue and sort of what's driving that improvement .

John Greene -- Chief Financial Officer

Sanjay, this is John. I'll take that. So, we're really pleased with the performance there. And first of all, the book is really solid, about 90% of the portfolio has cosigners. And in the first quarter of this year, the collection team began a outreach to cosigners when there was the early stage delinquency. And that's actually made a pretty substantial difference and collection effectiveness and overall delinquency levels .

Sanjay Sakhrani -- KBW -- Analyst

Okay. I guess, question for Roger, sort of similar to what Don was asking. I guess the ROEs have been really, really strong. And I'm wondering if you're surprised at how strong they are, given where we are in the cycle. It seems like with such high returns, you'd have more competition, but there hasn't been a whole lot. So I'm just curious how to reconcile, is it something you guys are doing differently that's generating these returns or is it just at the competitive intensity is weaker because we're late into the cycle

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

Yeah. I probably would challenge the view that there isn't much competition in the card space. If you look at the players who are in it and the investments they make, I think part of it is, it is a very challenging business, so we tend not to see too many new entrants, but it is very competitive, and I think there is a difference between the marginal return the competitors look to as they think about how to grow their book and the total return. But I think the credit card business has been one of the highest returning consumer asset classes for my 25 years in the business. I think it reflects just sort of some of the challenges and operating it well, and we have a very disciplined model here at Discover .

Sanjay Sakhrani -- KBW -- Analyst

Okay. I wanted to welcome and congratulate, John, on his new position. And just one quick clarification. The NIM guidance that you provided, was that a fourth quarter guide or was that for the full year?

John Greene -- Chief Financial Officer

that was fourth quarter. So when we come out with year-end results. In January, we will provide updated guidance for 2020 .

Sanjay Sakhrani -- KBW -- Analyst

All right. Thank you.

Operator

We'll take our next question from Eric Wasserstrom with UBS

Eric Wasserstrom -- UBS -- Analyst

.Thanks very much. If you just circle back on the credit discussion for a moment, yeah, certainly the NCO trends, it seem very contained and the delinquency trends also seem to be very contained in terms of the rate of change. On the other hand, the delayed fees are creeping up. That's often a Harbinger of a future credit deterioration. You guys have talked a little bit about what you're doing on March. So I'm just trying to put the whole picture together. Is the characterization that it's stable but with, with a slow slope toward deterioration or how should I think about it?

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

Yeah, I think -- I would probably highlight more of the stable side. Part of what's driving up late fees is just overall growth in the portfolio. And certainly that's going to drive more delinquent accounts. But as you look at the overall delinquency rates and the trajectory those have been on, I think those reflect strong performance and a continued stable economic environment.

Eric Wasserstrom -- UBS -- Analyst

Thank you for that. And if I may just follow-up just quickly on NIM as well, without pushing you to provide point guidance which is not my intent, but I think in the past what you've indicated is, every incremental 25 basis point reduction is 1 to 2 points of annualized NIM reduction. And so, as we just think through, whether it's our own economist or the blue-chip consensus in terms of the 2020 expectation, is that still a good framework to consider on the basis of the fourth quarter endpoint?

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

Eric, it is. 1 to 2 basis points for every 25 basis points downward.

Eric Wasserstrom -- UBS -- Analyst

Okay. Thanks very much.

Operator

We will take our next question from Ryan Nash with Goldman Sachs.

Ryan Nash -- Goldman Sachs -- Analyst

Hey. Good afternoon, guys. And John, congrats on joining Discover.

John Greene -- Chief Financial Officer

Thank you.

Ryan Nash -- Goldman Sachs -- Analyst

Roger, maybe I'll start with a similar question that some of the others have asked. So you've been tightening credit for two years, yet you're still growing above the market. So, one, do you think this could continue, and two, what do you think that you're doing different from the market now that's allowing you to continue to take share?

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

Hey, I feel good about the credit decisions we've made. And there are a mix of what we do for new accounts but also for the portfolio. A lot of it has to do with differentiation. And so, we focused a lot on innovation. So if you think about going back to the FICO score on statements, the ability to freeze your card, Cashback Match continues to perform well for us.

And then, also focusing on a superior customer experience, we've won the JD Power award for five of the last six years. We have the best mobile app in the business. So really that relentless focus on every part of the customer experience and then wrapping that with the Discover brand, which obviously having our own proprietary network, helps us in terms of building that brand and providing differentiation. So, yeah, I think the whole business model is focused on driving high quality loan growth.

Ryan Nash -- Goldman Sachs -- Analyst

Got it. Maybe one for John last quarter and the quarter before the company had outlined upfront impact regarding CECL, I was just wondering if you can maybe talk a little bit about the day two impact, how to think about the impact for a company that's experiencing nice growth, yet still seeing supply driven normalization in a very uncertain macro backdrop? Thanks.

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

Yeah. Thank you. Good question. So, let me -- let start by saying that we're looking -- we're looking at CECL impact pretty extensively. We have now three quarters of simulations. We expect the overall reserve rate to be somewhere between 55 and 65, and two most recent quarters it's trending toward the north end of that. We'll continue to monitor that and it will be impacted by the composition of the portfolio and certainly macro factors. So none of that is probably new to the folks on the call.

In terms of the volatility, it is -- it does drive a level of volatility, and we are -- frankly I'm holding off and giving a quantification on the volatility until we bat down [Phonetic] the estimates and clearly have a a view of what the portfolio will look like, and also the macroeconomic. So, it will be more volatile and will provide disclosures. They provide a clear view on an apples-to-apple basis of non-GAAP disclosures that will align to 2019 GAAP so that there's comparability .

Ryan Nash -- Goldman Sachs -- Analyst

Got it. Thank you for taking my questions.

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

You're welcome .

Operator

We'll take our next question from David Scharf with JMP Securities.

David Scharf -- JMP Securities -- Analyst

Yeah. Thanks for taking my questions and welcome aboard, John.

John Greene -- Chief Financial Officer

Thank you.

David Scharf -- JMP Securities -- Analyst

Thank you. Maybe a couple more questions on the credit side, maybe more hypothetical. We're -- listen, we're obviously closing in on four years of everybody wondering whether we're in the eighth or ninth inning of the cycle, and the data has suggested otherwise. But I'm wondering -- two things, just hypothetically whether this occurred in one quarter or six quarters from now, if you had any indicators whether internally based on delinquency trends or even macro indicators suggesting we're heading toward, let's say, a 5.5% to 6% unemployment environment, which is consistent with two recessions ago kind of going to ignore the Great Recession. Trying to get a sense, and I realize there are so many variables and inputs.

But generally speaking, from a strategic standpoint, should we be thinking about Discover as a business that is still targeting some level of loan growth in the midst of that kind of environment sort of flat or year-over-year decline? I realize it's very hypothetical, just trying to get a sense for how to think about at this stage of maturity, how the business operates in that type of macro backdrop?

John Greene -- Chief Financial Officer

Yeah. I can't really sort of comment on exactly how much we grow at what unemployment level. I would say though that as we look at the new accounts we book and the models that John and the finance team do, we use through the cycle loss rate as opposed to where we are at any given point in time .

And we spent a lot of time analyzing accounts that we booked through the last downturn, the vast majority of our new accounts, we would have booked in December of 2007. So even going into that -- even if we had known what was coming, the vast majority of accounts [Indecipherable]. There are certain segments that are sort of more in the near-prime side that are more volatile. And so, those tend to be where you cut back you cut back on the number of line increases you do and there are other actions on the portfolio. But again -- most -- again, the vast majority of those new accounts, we use through the cycle loss rate and book in a much more challenging credit environment than what we have now.

David Scharf -- JMP Securities -- Analyst

Got it. No, that's helpful. And maybe just a follow-up along those lines. Once again, this is hypothetical, but maybe it's something you can quantify for us if the loan book in aggregate starting today. I mean, the back book today were to be flat to over the next 12 months. Is there any sense you could give us in basis points of how much upward pressure on loss rates just the pure seasoning would exert if we no longer had any contributing denominator effect ?

John Greene -- Chief Financial Officer

That's something we really couldn't put together . I mean, we don't run scenarios of our loan book flat, because we're going to keep trying to grow it, but I really can't answer that.

David Scharf -- JMP Securities -- Analyst

Got it. Fair enough. Thanks very much.

Operator

We'll take our next question from Rick Shane with JPMorgan.

Rick Shane -- JPMorgan -- Analyst

Hey, guys. Thanks for taking my question. Look, the uptake on the rewards program the PayPal was very strong during the quarter. I'm curious if you can help us understand tactically what the intent of that program is the a demographic drive for millennials or is there something else we should be thinking about?

John Greene -- Chief Financial Officer

Sure. So, a lot of our programs do in fact target millennials. PayPal is a great business partner, both on our issuing side, but as well as on the payment side and with some merchants like PayPal, you do get a bit of a lock-in because once people change their to full card, there tends to be a tale of sales. So we're always looking for how to use our rewards dollars to cost effectively drive growth and provide value for our customers.

I think it's one of the advantages we have from the structure of our rewards program. And so that was an investment we made and we're excited about what we're seeing in terms of cardholder pickup of that.

Rick Shane -- JPMorgan -- Analyst

Got it. That makes a lot of sense. Thank you for answering the question .

Operator

We'll take our next question from Bill Carcache with Nomura Instinet.

Bill Carcache -- Nomura Instinet -- Analyst

Thank you. Good afternoon. I had a couple of follow up questions, first a follow-up on RIC's PayPal 5% category question. Can you give any kind of early indication of the stickiness of those customers post promo and just trying to get a sense for the willingness of those customers to keep Discover as a primary card after the promotion ends versus how much gaming behavior you're seeing .

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

I will comment specifically. I would say, we've had a lot of experience running our 5% promo and no kind of -- by each different category what type of tail we spend and that goes into the targeting. So I'll go back to saying we're very excited about how it's performed and we think we're getting good value for our investments.

Bill Carcache -- Nomura Instinet -- Analyst

Okay. Thanks, Roger. And then, another follow-up on Ryan's question about the day two [Phonetic] impact of CECL. At a high level, is it reasonable to expect that the building of reserves on future growth under CECL would also increased by the 55% to 65% that you guys have guided to versus what it would have been under the incurred loss model.

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

Yeah, so a great question. So, no. To be specific on that. So, the portfolio when we're putting up the 55% to 65% increase for day one reflects a maturity of the portfolio that already has some incurred losses reflected in it.

So when you put up new loan account, what happens is, you have to book the lifetime losses and therefore the impact is actually greater than the day one impact of 55% to 65% that we've talked about.

Bill Carcache -- Nomura Instinet -- Analyst

Okay. So it's like as a starting 55% to 65% day one impacted the day two impact on the incremental building would actually be larger than that.

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

It would for new loan account and then obviously the macro factors would come into play there. The type of assets we're putting on the books, so are they credit card or personal loans will impact. So there is a lot of factors. And as I said, I'm going to hold off on giving a specific number until we get it sorted out. We've got more work to do as an organization, but we're progressing well on it and in the first quarter, we'll share that .

Bill Carcache -- Nomura Instinet -- Analyst

Got it. Thanks, John. Welcome to the team and look forward to working with you.

John Greene -- Chief Financial Officer

Thank you much.

Operator

We'll take our next question from Bob Napoli with William Blair.

Bob Napoli -- William Blair -- Analyst

Thank you. And I'll also welcome you, John, and look forward to working with you as well. The first question is just on the direct deposits. The growth of direct deposits has been so strong, and it is by far your lowest cost of funds. And I just -- if you could have any thoughts around what percentage of your funding over the long-term could be through direct deposits, because that's a nice tailwind obviously to your business to your margins?

John Greene -- Chief Financial Officer

Yeah. So, it is. So what we do is, we concentrate on the overall funding stack, and obviously it's really important to make sure we have the right level liquidity and other funding sources in place.

But with that said, as we mentioned on the prepared comments, 53% of the funding stack was from deposits. We'd like to grow that. I think the previous guidance the business has given was in the medium term somewhere around 60% and we'll look at that as a path forward, and we may adjust upward if conditions warrant.

Bob Napoli -- William Blair -- Analyst

Thank you. And follow-up call on Roger. On the competitive front, I mean, you do have, one, you have an apple card and just your thoughts around. And then, we've had some mega mergers in the payment space, and they're looking for revenue synergies and one area that one company feels like is low hanging fruit is would be related to the PULSE business. And so, I just wanted to -- if you could comment on the Apple and then the mega mergers and the ability to be able to continue to grow your payments business.

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

Yeah. In terms of the Apple Card, we're yet to see that have a noticeable impact on our volume. So we're watching it carefully. But again no noticable impact in terms of the mega mergers on the payment side, A, we compete against Visa and Mastercard that we're used to competing against very large companies and payments. A lot of it is sort of a broader ecosystem where there are in fact partnership opportunities with some of those companies as well. So, I appreciate it's too early to understand it, the full impact on. But our goal is to be able to compete globally against anyone in the payments industry.

David Scharf -- JMP Securities -- Analyst

Great. Thank you. Appreciate it.

Operator

We'll take our next question from Chris Donat with Sandler O'Neill.

Chris Donat -- Sandler O'Neill. -- Analyst

Good afternoon. Thanks for taking my questions. I had one on the professional fees and the increase in them. And does that represent some sort of change and how you're doing collections like are using rather than first party or in-house collections are using more third-party collections or is it just something else going on there?

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

Chris, thanks for the question. No, what actually you see there is, it's a pretty substantial increase in overall recovery, third quarter '19 versus third quarter '18 are up about 32%. So that drives obviously a bit of the, I'll call it, commission for the third-party collectors .

Chris Donat -- Sandler O'Neill. -- Analyst

Okay, got it. And then, just one more on CECL as you talk about the volatilities, you get more experience with the sort of the parallel run of CECL, does that affect how you might be thinking about capital in 2020 and beyond of maybe needing to have a little more pressure and recognizing that there is a phase-in from a regulatory perspective for seasonal or is that too soon to tell.

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

Yeah. So, there will be capital impact, right? The phase-in is 20% over four-year period. It doesn't change the underlying cash flows of the business. So we're going to continue to try to optimize the capital base and we're progressing excluding toward the target level of 10.5%. So, we'll present a capital plan to the Board and to the regulators and see what that looks like in 2020.

Chris Donat -- Sandler O'Neill. -- Analyst

Okay. Thanks very much.

Operator

We will take our next question from John Hecht with Jefferies.

John Hecht -- Jefferies -- Analyst

Thanks very much. Welcome. John. Most of my questions were asked. I was maybe going to dive a little bit into the consumer behavior. So for new customers that you're attracting at this point are they more -- are they reacting more to zero balance transfers or what are the promotional factors are having heavy reactions at this point.

John Greene -- Chief Financial Officer

We always try and bring in cardholders that are not just balance transfer active but use their card as well. And so, the Cashback Match continues to perform very well for us, but that probably is the other thing that's impacting new customers. But again, we focus on customer experience. We focus on the line of [Indecipherable] every component is important. But I'd probably highlight that Cashback Match, sort of the biggest thing we have for new cardholders .

John Hecht -- Jefferies -- Analyst

Okay. And you mentioned the lines, the -- any changes to utilization rates or are those behavior has been pretty consistent as well?

John Greene -- Chief Financial Officer

. We have, and I'll go back, we have not picked up signs of distress in our portfolio as we look

John Hecht -- Jefferies -- Analyst

So, utilization rate is just stable as expected?

John Greene -- Chief Financial Officer

Yeah.

John Hecht -- Jefferies -- Analyst

Okay. Thanks very much.

Operator

We'll take our next question from Ming Zhao [Phonetic] with Deutsche Bank.

Ming Zhao -- Deutsche Bank -- Analyst

Hi. Good afternoon, guys. Quick question on, I guess, loan growth. Just from simple back of the envelope math. I mean, loan growth need to, I guess, accelerate a bit in 4Q to reach that low end of that 6% to 8% prior guidance range. So I'm wondering if you guys could provide any color on and do you still expect that to be true or -- and where are you seeing the most strength there? Thanks.

John Greene -- Chief Financial Officer

I won't comment on the guidance. I would say, if you look at the quarter, we feel very good about our card loan growth. We feel good about how student loans perform in the peak season. And we had talked about really a lower growth rate for personal loans in terms of expectations for this year as we tested our new credit models for some segments that have not performed as well as we wanted. We're excited about how those who are doing as well. So, again, we feel good about our ability to achieve loan growth. It will of course depend on the holiday season. But so far, consumers seem to be in a pretty good space.

Ming Zhao -- Deutsche Bank -- Analyst

Got you. Great. And then, my second question is just on overall international acceptance. So, thank you.

Mid-quarter, you mentioned that international acceptance of somewhere in something and I know in your prepared remarks, you mentioned focusing more on Africa as well as Western Europe. I'd like to get any sort of updated thoughts you had there in terms of innings and how you see Discover progressing internationally going forward.

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

The seventh inning is quite long. And we may go to extra innings. So maybe that's not the best way to phrase it, it will be a continued investment. And I think Africa just gives you an example of the breadth of our investments. We're also working with network partners everywhere from Eastern Europe to Asia to South America . Our particular focus has been on Western Europe and working with acquirers there. So you heard us announce a number of partnerships. So we will continue to build out our global acceptance footprint .

Ming Zhao -- Deutsche Bank -- Analyst

Great. Thanks for taking my questions.

Operator

We'll take our next question from Brian Foran with Autonomous.

Brian Foran -- Autonomous Research -- Analyst

Hi. Good evening.

Craig A. Streem -- Head of Investor Relations

Hey, Brian.

Brian Foran -- Autonomous Research -- Analyst

Maybe just on the deposit betas. The 50% so far was interesting, and I think most of the traditional banks are struggling to get 15%, 20% beta so far. Do you -- is your feeling that that's a timing issue, i.e., it's easier for you and peers to lower the online deposit rates and reprice most of the existing book quickly or are you more encouraged that maybe the betas could just be higher on online deposits throughout if that easing cycle?

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

Yeah. I mean, I think if you compare to a lot of the more traditional branch-based banks, they tend to have a lower beta. A lot of it has to do with their product mix. And so having more in checking or in savings accounts and are paying in the sort of in the single-digit basis points, they pay through operating expenses as opposed to rates. So I think there is a natural symmetry between the betas you experienced on the way up and what you have on the way down. And so, a lot of those banks captured the rate increases on the way up and didn't move their rates much at all. But that unfortunately doesn't give you much room to adjust when rates are coming back down .

Brian Foran -- Autonomous Research -- Analyst

Got it. And then, two small things on the -- one on the loan fees when you referenced the changes that drove it to 120 versus kind of around 105 before, does it all else equal stay around 120 or does it go back to 105 as we think about putting something in the model going forward?

John Greene -- Chief Financial Officer

So that's a function of the late payments and also the pricing tiers that we put in place. So, I would expect a little -- certainly a tick up based on history, but some of it will be tied obviously to late payments and that you'll be able to see the trends there.

Brian Foran -- Autonomous Research -- Analyst

And then, I hate to ask for a clarification of the clarification of the NIM guidance, but I managed to get myself stripped up. When you were kind of saying a basis point or two above the 10.39% high end, that was for the full year we should think about then [Indecipherable]?

John Greene -- Chief Financial Officer

Yes. Yeah, thanks for that clarification question. Yes, it would be for the full year.

Brian Foran -- Autonomous Research -- Analyst

Okay. So 4Q 10.3% plus or minus is kind of the implied output of that?

John Greene -- Chief Financial Officer

Yeah, you got to solve the math and...

Brian Foran -- Autonomous Research -- Analyst

I wouldn't put a lot of trust in that, so figure it I'd ask [Phonetic]. I appreciate it. Thank you.

John Greene -- Chief Financial Officer

You're welcome.

Operator

We'll take our next question from Jason Kupferberg with Bank of America.

Mehar -- Bank of America -- Analyst

Hi. This is Mehar [Phonetic] on for Jason. Thanks for taking my questions. And firstly, congratulations John on joining the team up. The first question, I think, if I could go back where we started, I guess, back to the quick to pay, unified payment button. And I was just curious,, will you be putting any promotional efforts around getting your cardholders to enroll their Discover Card to make them default on that button?

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

I think, we're in the early stages of implementation. Clearly, we try and make sure that our cardholders are using Discover. And I think this is where there may be an advantage for us in terms of our integrated network and card issuer model. We can enable it probably more seamlessly than someone who uses a third-party issuer. As an example, we were the first ones to be able to provision Apple Pay from within our app. So we will look for opportunities where we can make the experience more seamless for Discover cardholders.

Mehar -- Bank of America -- Analyst

Got it. Thanks for that. And then, just around -- I just had a question around credit and your net charge off guidance. I think you mentioned 3.2% to 3.4% for the year, and I was just, just doing the rough math here looking at how you performed year-to-date. Is there a potential for it to come in a little better than that or are you sticking with -- or at least the very low end of that just because I mean, it sounds like you're pretty favorable on credit and looking at year-to-date performance and Q3 performance that need to be pretty meaningful quarter-over-quarter degradation to get with the higher end of that certainly ?

John Greene -- Chief Financial Officer

Yes. So, thanks for that. So, yeah, the guidance was 3.2% to 3.4% and we're certainly performing at the lower end of that. At this point. I'll probably just pause there and say that the lower end of the guidance, and if we choose to put something else in your model it will be comfortable with it.

Mehar -- Bank of America -- Analyst

Yeah, thank you.

Operator

We will take our final question from Jon Arfstrom with RBC Capital Markets.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Thanks. Good afternoon.

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

Good afternoon.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Hey. Just a quick one on deposit growth. Curious if you had to put your finger on what's driving it. Would you say that new deposit account growth is tracking with overall deposit account growth? Are you seeing something like higher average balances on existing accounts or is it both. If that makes sense?

John Greene -- Chief Financial Officer

Yeah, no, it's both. So we're attracting new customers, but we're also seeing some of our existing customers build their balances, whether it's adding another CD or just putting more money into the savings accounts. So it's a mix of both from new as well as existing customers.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Okay. All right. Thank you.

Operator

And there are no further questions at this time. Mr. Streem, your closing comments please.

Craig A. Streem -- Head of Investor Relations

Thanks, Erica, and thank you all for your attention, for your questions, and you know where to find us for any follow-up. Thanks. Have a good evening.

Operator

[Operator Closing Remarks]

Duration: 58 minutes

Call participants:

Craig A. Streem -- Head of Investor Relations

Roger Crosby Hochschild -- Chief Executive Officer, President & Director

John Greene -- Chief Financial Officer

Mark DeVries -- Barclays -- Analyst

Betsy Graseck -- Morgan Stanley -- Analyst

Don Fandetti -- Wells Fargo -- Analsyt

Sanjay Sakhrani -- KBW -- Analyst

Eric Wasserstrom -- UBS -- Analyst

Ryan Nash -- Goldman Sachs -- Analyst

David Scharf -- JMP Securities -- Analyst

Rick Shane -- JPMorgan -- Analyst

Bill Carcache -- Nomura Instinet -- Analyst

Bob Napoli -- William Blair -- Analyst

Chris Donat -- Sandler O'Neill. -- Analyst

John Hecht -- Jefferies -- Analyst

Ming Zhao -- Deutsche Bank -- Analyst

Brian Foran -- Autonomous Research -- Analyst

Mehar -- Bank of America -- Analyst

Jon Arfstrom -- RBC Capital Markets -- Analyst

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