Discover Financial Services (DFS) Q1 2021 Earnings Call Transcript

Discover Financial Services (NYSE: DFS) Q1 2021 earnings call dated Apr. 22, 2021

Corporate Participants:

Eric Wasserstrom — Head of Investor Relations

Roger C. Hochschild — Director, Chief Executive Officer and President

John T. Greene — Executive Vice President, Chief Financial Officer

Analysts:

Sanjay Sakhrani — Keefe Bruyette & Woods Inc. — Analyst

Ryan Nash — Goldman Sachs — Analyst

John Pancari — Evercore ISI — Analyst

Bill Carcache — Wolfe Research — Analyst

Betsy Graseck — Morgan Stanley — Analyst

Mark DeVries — Barclays — Analyst

Donald Fandetti — Wells Fargo Securities — Analyst

Richard Shane — J.P. Morgan — Analyst

Mihir Bhatia — Bank of America — Analyst

John Hecht — Jefferies LLC — Analyst

Meng Jiao — Deutsche Bank — Analyst

Moshe Orenbuch — Credit Suisse — Analyst

Kevin Barker — Piper Sandler — Analyst

Dominick Gabriele — Oppenheimer & Co. — Analyst

Presentation:

Operator

Good morning. My name is Maria, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the First Quarter 2021 Discover Financial Services Earnings Conference Call. [Operator Instructions] Thank you.

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

Eric Wasserstrom — Head of Investor Relations

Thank you, Maria, and good morning, everyone. Welcome to this morning’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 will include remarks from our CEO, Roger Hochschild; 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, please limit yourself to one question, and if you have a follow-up question, please get back into queue, so we can accommodate as many participants as possible.

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

Roger C. Hochschild — Director, Chief Executive Officer and President

Thanks, Eric, and thanks to our listeners for joining today’s call. Last April, if you told me that a year into the pandemic we’d be reporting excellent credit performance, positive sales trends, and solid earnings growth, I wouldn’t have believed it. While the pandemic is far from over and there may be twists and turns ahead, as a nation, we have made tremendous progress toward addressing the health crisis and reopening the economy. This quarter, we earned $1.6 billion after-tax or $5.04 per share. I’m very pleased with these results, which reflect our robust business model, strong execution, including a disciplined approach to managing credit, improving economic trends and the impact of federal support for US consumers.

Since the end of 2020, our view on economic conditions has improved. The rapid pace of the recovery has lessened our concern of job losses spreading to the white collar workforce and there is also been substantial support for the US consumer through stimulus in January and in March. Our current expectation is that credit losses in 2021 will be flat to down year-over-year. This improved economic view, combined with lower loan balances and continued strong credit performance, were the primary drivers of $879 million reserve release in the quarter.

As discussed in previous quarters, the strong credit performance was accompanied by elevated payment rates that continue to put pressure on loan balances, which were down 7% year-over-year. Payment rates were over 350 basis points higher than last year and at their highest level since the year 2000. While the impact from stimulus payments should abate over the next few months, we expect payment rates will remain elevated for the rest of the year as household use savings to meet debt obligations and continue to benefit from payment relief programs, such as federal student loan and mortgage payment forbearance.

Despite this pressure, we still expect modest loan growth this year supported by several factors. First, there has been a significant increase in sales volume, up 11% from a year ago and up 15% from the first quarter of 2019. Improving trends in categories like retail and restaurants are positive signs for future growth. Additionally, based on our credit performance in our current outlook for macro conditions, we have begun to migrate our credit standards back to pre-pandemic levels. This is particularly true in card, where our value proposition centered on best-in-class customer service, valuable rewards and no fees continues to resonate strongly among consumers. We’re also expanding credit standards and personal loans, but not quite back to 2019 norms.

To offset the higher payment rate, as well as leverage these credit actions, we intend to increase our marketing spending through the rest of this year. Outside of marketing, we expect that expenses will be relatively flat year-over-year as we remain committed to expense management. We’re reinvesting some of the benefits from our strong credit performance and efficiency gains into technology and analytics to further improve our account acquisition targeting, fraud detection and collections capabilities. The rapid pace of the economic recovery and strong credit performance may provide additional opportunities to lean further into growth. We intend to take advantage of these opportunities and may make additional marketing and non-marketing investments that will create long-term value.

On the payment side, we had continued strong performance in our PULSE business, with volumes up 23%, driven by stimulus payments in the first quarter and higher average spend per transaction. We also continue to expand our global acceptance through network partnerships, and this quarter, we signed new partners in Jordan and Malaysia.

Our digital banking model generates high returns and we remain committed to returning capital to our shareholders. This quarter, we restarted our share repurchase program with $119 million in buybacks, in line with the regulatory restrictions still in place. Looking at our strong credit performance and robust earnings, we see an opportunity to revisit our capital return to shareholders in the second half of the year.

As I look towards the future, I’m excited about Discover’s prospects. Our products continue to bring value to our customers. We remain flexible as we support our employees and their families through the pandemic. And we are well positioned to continue driving long-term value for our shareholders.

Before I turn it over to John, one last thing, you may not know it, but our CLO, Wanji Walcott, sits in on these calls and is a great part of the team. Today is her birthday. So I want to wish Wanji a very Happy Birthday.

With that, I’ll now ask John to discuss key aspects of our financial results in more detail.

John T. Greene — Executive Vice President, Chief Financial Officer

Thank you, Roger. Happy Birthday, Wanji, and good morning, everyone. I’ll begin by addressing our summary financial results on Slide 4. As Roger indicated, the results this period reflects many of the same dynamics we’ve seen over the past few quarters. The influence of stimulus resulted in elevated payment rates, which pressured loan growth. It also contributed to the strong asset quality and our significant reserve release in the quarter.

Revenue, net of interest expense, decreased 3% from the prior year, mainly from lower net interest income. This was driven by a 7% decline in average receivables and lower market rates, partially offset by a reduction in funding costs as we continued to manage deposit pricing and optimize our funding mix.

Non-interest income was 5% lower, primarily due to a $35 million net gain from the sale of an equity investment in the prior year. Consistent with our excellent credit quality, lower loan fee income reflects a decline in late fees, while net discount and interchange revenue was up 12% from the prior year, reflecting the increased sales volume.

The provision for credit losses was $2 billion lower than the prior year, mainly due to an $879 million reserve release in the current quarter, compared to a $1.1 billion reserve build in the prior year. Our improved economic outlook, lower loan balances and strong credit drove the release. Additionally, net charge-offs decreased 30% or $232 million in the prior year.

Operating expenses decreased 7% year-over-year as we remain disciplined on expense management. Other than compensation, all other expenses were down from the prior year, led by marketing, which decreased 33% year-over-year. Looking ahead, we intend to accelerate marketing investments over the remainder of the year. We’ll go into details on our spending outlook in a few moments.

Moving to loan growth on Slide 5. Total loans were down 7% from the prior year, driven by a 9% decrease in card receivables. The reduction in card receivables was driven by two primary factors. First, the payment rate remains elevated, driven by the latest round of stimulus and improved household cash flows. Second, promotional balances have continued to decline, reflecting the actions we took at the onset of the pandemic to tighten credit. As a result, these balances were approximately 300 basis points lower than the prior year. Although we expect new account growth will cause promotional balances to begin to stabilize. As the economy reopens further, we believe consumer spending and prudent expansion of our credit box should drive profitable loan growth going forward.

Looking at our other lending products. Organic student loans increased 5% from the prior year and originations returned to pre-pandemic levels. We continue to gain market share through mini peak season. Personal loans were down 9%, primarily due to the actions we took early in the pandemic to minimize credit loss. As we previously mentioned, we see opportunity to expand credit a bit given the strong performance of this portfolio.

Moving to Slide 6. The net interest margin was 10.75%, up 54 basis points from the prior year and 12 basis points sequentially. Compared to the prior quarter, the improvement in net interest margin was driven by lower deposit pricing as we cut our online savings rates from 50 basis points to 40 basis points during the quarter. We also continue to benefit from the maturity of higher rate CDs and a favorable shift in funding mix. Our funding from consumer deposits is now at 65%.

Future deposit pricing actions will be dependent upon our funding needs and competitor pricing. Average consumer deposits were up 14% year-over-year and flat to the prior quarter. Consumer CDs were down 7% from the prior quarter, while savings and money market increased 4%. Loan yield was flat to the prior year. Seasonal revolve rate favorability and a lower mix of promotional rate balances were offset by the impact of reduced pricing on personal loans.

Looking at Slide 7. Total non-interest income was $465 million, down $25 million, or 5% year-over-year, driven by the one-time gain in the prior year that I previously mentioned. Excluding this, non-interest income was up 2%. Net discount and interchange revenue increased 12% as revenue from higher sales volume was partially offset by higher rewards cost. The decrease in loan fee income was driven by lower late fees, which move in line with delinquency trends.

Looking at Slide 8. Total operating expenses are down $78 million, or 7% from the prior year. Marketing and business development decreased $77 million, or 33% year-over-year. The reduction reflects actions we implemented in March of last year to align marketing spend with tightened credit criteria. However, we accelerated our marketing spend late in the first quarter and plan to continue this through the year. These investments will drive new account acquisition and loan growth.

The year-over-year decrease in other expenses was mainly driven by lower fraud volume to an — due to enhanced analytics around disputed transactions and decreased fraud in deposits. This improvement demonstrates a small part of the benefit we expect from the investments we’ve made in the analytics over the past few years.

Partially offsetting the favorability was a $39 million increase in employment compensation, that was driven by two factors: $22 million from a higher bonus accrual in the current year. The remaining increase was driven by higher average salaries, reflecting the talent build in our technology and analytics team.

Moving to Slide 9. We had another strong quarter of very strong credit performance. The total charge-offs were 2.5%, down 79 basis points year-over-year and up 10 basis points sequentially. The card net charge-off rate was 2.8%, 85 basis points lower than the prior year with the net charge-offs dollars down $209 million, or 31%. Sequentially, the card net charge-off rate increased 17 basis points and net charge-off dollars were up $11 million. The increase in card net charge-offs from the prior quarter was driven by accounts that had been in Skip-a-Pay and did not cure. The program ended six months ago, and at this time, most of the accounts that were in Skip-a-Pay have returned to making payments. Looking forward, we expect minimal impacts to charge-offs from this population.

The card 30-plus delinquency rate was 1.85%, down 77 basis points from the prior year and 22 basis points lower sequentially. With the influence of the Skip-a-Pay group now largely complete, we think that delinquencies are the most clear indicator of our loss trajectory over the short-term.

Credit remained strong in private student loans. Net charge-offs were down 15 basis points year-over-year and 18 basis points compared to the prior quarter. The 30-plus delinquency rate improved 55 basis points from the prior year and 19 basis points sequentially. In personal loans, net charge-offs were down 79 basis points year-over-year with a 30-plus delinquency rate down 47 basis points from the prior year and 24 basis points from the prior quarter.

The positive impact of additional stimulus, combined with an improved economic outlook, have shifted our expectation on the timing of losses. We had previously expected losses would increase in the second half of this year and remain elevated into 2022. That is no longer the case. Based on our current delinquency trends, we believe losses are likely to be flat to down this year with the possibility of some increase in 2022. That said, a material shift in the economic environment could offer the timing and magnitude of losses.

Moving to the allowance for credit losses on Slide 10. This quarter, we released $879 million from the allowance. This reflected several factors, including favorable changes to our macro assumptions, a moderate decrease in our loan balance, the continued decline in delinquencies, and lower losses. Relative to our view in January, the economic outlook has continued to improve. As we’ve done in prior quarters, we’ve modeled several different scenarios and took a conservative but more optimistic view. Our assumptions on unemployment for a year-end 2021 rate of 6%, with a return to full employment in late 2023, we assume GDP growth of about 4.6%.

Our reserve assumptions did not contemplate any additional stimulus directed to consumers, but did anticipate broader economic benefits from infrastructure spending beginning in the second half of this year. The modest increase to reserves in our student loan portfolio was driven by loan growth coming out of the mini peak season.

Looking at Slide 11. Our common equity Tier 1 ratio increased 180 basis points sequentially to 14.9%, well above our internal target of 10.5%. We have continued to fund our quarterly dividend at $0.44 per share and repurchased $119 million of common stock during the quarter. Our Board of Directors previously authorized up to $1.1 billion of repurchases. We will likely accelerate our share repurchases in the second quarter and we see the potential for capital returns to increase in the second half of the year.

As I mentioned earlier, we continue to optimize our funding mix and consumer deposits now make up 65% of total funding. Our goal remains to have 70% to 80% of our funding from deposits, which we feel is achievable. Though, we expect some quarter-to-quarter variability in this figure.

Moving to Slide 12. Our perspectives on 2021 have evolved from last quarter. We continue to anticipate modest positive loan growth for the year. We are investing in new account acquisition and have already seen strong sales growth through the first quarter. High payment rates will continue to pressure loan growth near-term but should become less of a headwind over the course of the year.

Versus the first quarter level, we expect our NIM to remain in a relatively narrow range over the rest of the year. While we’ll continue to benefit from improved funding cost and mix, we may experience modest yield pressure over the next few quarters from variability in the revolve rate.

Our commitment to expense management has not changed. But as Roger mentioned, we believe there is an opportunity to drive long-term growth through increased marketing and further investments in data and analytics. Excluding marketing, expenses should be near flat from the prior year.

Credit performance has remained stronger than originally anticipated, and we now expect credit losses to be flat to down compared to 2020.

Lastly, we remain committed to returning capital to shareholders through dividend and buybacks. Given the level of reserve release and the strength of our fundamental performance, we plan to revisit our capital plan — capital return levels for the second half of this year.

In summary, we’re pleased with our first quarter results. Our sales trend, credit expansion and marketing investments positioned us well for growth going forward. We released $879 million of reserves. NIM continue to improve, driven by lower funding costs, and expenses were down, but we’ll invest in marketing and analytics that will drive revenue, as well as operating and credit cost improvements over the longer-term. As the economy reopens, I’m positive regarding the opportunities for growth. We have a strong value proposition that resonates with consumers and our digital banking model positions us well for strong returns going forward.

With that, I’ll turn the call back to our operator, Maria, to open the lines for Q&A.

Questions and Answers:

Operator

Thank you. [Operator Instructions] We’ll take our first question from Sanjay Sakhrani of KBW.

Sanjay Sakhrani — Keefe Bruyette & Woods Inc. — Analyst

Thanks. Good morning. I got a question on loan growth and marketing. Roger, you talked about moving standards to pre-pandemic levels. Maybe you could just talk about the opportunities for growth relative to 2019? And how we should think about the marketing budget in relation to that? And then maybe you could just also tie in your confidence level on the loan growth given the stimulus? I mean, it seems like you guys have kept it flat in terms of the loan growth expectations. So, maybe just elaborate on that? Thanks.

Roger C. Hochschild — Director, Chief Executive Officer and President

Sure. Thanks for the question, Sanjay. Maybe starting then with the stimulus. Clearly, one of the biggest differences versus 2019 is the payment rate, and that’s partly driven by the cash payments to consumers, the savings rate, but also the relief they get, be it on their federal student loans or other payments they have to make. And so, that’s a real headwind against loan growth. And as I mentioned on the call, it’s actually at the highest level since the year 2000.

In terms of marketing, we feel very good about the cost per accounts, about the projected returns we’ll get on those, have widened our credit box back to the pre-pandemic. Although, as you recall, we had been tightening for a couple of years and I would say, continue to remain conservative in our overall credit approach. So, I really think it’s that headwind from payment rate that has kept us from being even more enthusiastic about loan growth.

Sanjay Sakhrani — Keefe Bruyette & Woods Inc. — Analyst

And when we think about the marketing amount relative to 2019, is there any context you could provide for that? Sorry for the follow-up.

Roger C. Hochschild — Director, Chief Executive Officer and President

Yeah. I think part of it and John indicated this, I think we’re probably more comfortable giving you some view around where we expect total expenses to be. But also it will depend on what we see in the back half of the year. And so, to the extent we see opportunities to deploy more capital against organic growth, we’ve been clear that’s our top priority. And so, that’s why we will — we’re continuously revisiting where and how much we should allocate to marketing.

Sanjay Sakhrani — Keefe Bruyette & Woods Inc. — Analyst

Thank you.

Operator

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

Ryan Nash — Goldman Sachs — Analyst

Hey. Good morning, guys.

Roger C. Hochschild — Director, Chief Executive Officer and President

Good morning.

Ryan Nash — Goldman Sachs — Analyst

So, Roger, John, on capital, post this quarter’s performance, you’re at 15% CET1. You talked about reevaluating in the second half of the year. I guess, given the outlook for credit potential for further reserve releases, I think it’s fair to say, you guys are going to be building in — capital in the near term. So, how should we think about the timeframe of getting back to that 10.5% CET1 level and how does that — how does CECL day one factor into that? And, I guess, Roger as a follow-up to that, just given all the capital sit around, does it at all change the way you think about acquisitions? And if so, what would be the priorities? Thanks.

John T. Greene — Executive Vice President, Chief Financial Officer

Okay. Hey, Ryan, thanks for the question. I’ll start it and then I’ll turn it over to Roger for the second piece of the question. So, really, really strong performance and the economy has strengthened beyond our expectations, as we said in our prepared remarks. So, we came into the year somewhat optimistic but also cautious given the amount of uncertainty. What we’re seeing is, kind of a broad-based improvement in the economy. Our credit fundamentals have been extremely strong. As a result, we made a decision to — an appropriate decision to release about $900 million of reserve. Taking the — obviously, CET1 ratio well above our internal target of 10.5%.

We’re looking to come back to that 10.5% point, we’re not going to do it overnight. We know the CECL transition is somewhere between 200 basis points and 250 basis points on CET1, but that still leaves ample room for actions in terms of dividends, buybacks and targeted M&A when and if appropriate. So, specifics around timing, getting back to the 10.5%, I would broadly say, medium-term, but we are certainly committed to that target, and we’ll do a number of efforts, including revisiting our buyback levels in the second half of this year to get there.

And the follow-up might be, what do we expect the buyback levels to be incrementalize to? We’re not going to give specifics, but I will give a little bit of history. If you go back to ’17 and ’18, our level of buybacks was about $2 billion. I’m not saying history is going to repeat. It will be subject to — it’s a bunch of conversations with our team internally and then, obviously, Board approval. But we’ll continue to evaluate.

So, Roger, do you want to…

Roger C. Hochschild — Director, Chief Executive Officer and President

Yeah. And on the M&A front, we try and be disciplined. And so, I would say, we’d not let extra money burn a hole in our pocket. For those of us — for those of you who’ve been with us for a longer, you’ll recall, we had significant excess capital post the financial crisis. We’re limited by the payout ratios and the CCAR process. But as said, we will return it over time and stay discipline. So, as we think about M&A opportunities on the banking side, not much out there that fits with our digital model. You’re seeing acquisitions that our branch mergers, cost takeout, which doesn’t fit. And then on the payment side, while valuations have come in, they are still really high. And so, we lean a bit more towards partnerships, potentially smaller minority investments. So, again, I think you can expect no change to our disciplined approach around returning capital to our shareholders.

Ryan Nash — Goldman Sachs — Analyst

Got it. And if I could squeeze in one other. So, on the slightly higher expenses, John, can you maybe just help us what is the base for that? Is it GAAP or adjusted?

And then, second, Roger, there is numerous mentions of accelerating investments in data, analytics and account growth. Can you maybe just give us a sense for what you would need to see for those — for you to bring those investments on in terms of whether it’s in the macro account acquisition or what would you expect to drive that? Thanks.

John T. Greene — Executive Vice President, Chief Financial Officer

Great. Real quick, first part of your question, the expense growth relative to GAAP last year.

Roger C. Hochschild — Director, Chief Executive Officer and President

And then on the investment side, a lot of those are on capabilities, especially in the data and analytic area, that just enhance all parts of our operations, whether it’s the credit underwriting, the marketing targeting, personalization, collections, etc. And so, they are — given the return profile, part of it is just bandwidth and talent, I would say, are more gating factors, but we’re really excited about the benefits.

And then in terms of putting more dollars to work on the marketing side, it will vary. Competitive activity has a bit of an impact on that. But we will — just look at on the new account side, what we’re seeing across different channels and carefully at those marginal opportunities and the returns they generate.

Ryan Nash — Goldman Sachs — Analyst

Thanks for all the color.

Operator

Our next question comes from the line of John Pancari of Evercore ISI.

John Pancari — Evercore ISI — Analyst

Good morning.

Roger C. Hochschild — Director, Chief Executive Officer and President

Good morning.

John Pancari — Evercore ISI — Analyst

Given your commentary on expenses and your plan to invest selectively there on the marketing side, can you perhaps maybe help us think about the efficiency trend longer-term? I know you came in around 38.7% in terms of the ratio this quarter. Did you think about what is the reasonable long-term expectation as we look out? Thanks.

John T. Greene — Executive Vice President, Chief Financial Officer

Yes. Happy to cover that. So, as we went through the pandemic, we really scrutinized the expense base. And there has been a long history of expense discipline in this Company. And through the pandemic, we found certain opportunities. So, as we think about the balance of this year, the next year and going forward, we’re going to continue to focus on controlling corporate cost, so that we can invest savings back into overall growth levers. And we’ve done that. We’re going to continue to do that. As we think about the efficiency ratio, we’ll come in this year somewhere around where we finished last year, I think, assuming revenue comes in with the modest growth we talked about in loans. And going forward, I would expect somewhere in the upper-30s would be a reasonable spot. That will indicate that we’re driving efficiencies and still investing in the business.

Eric Wasserstrom — Head of Investor Relations

Any follow-up, John?

Operator

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

Bill Carcache — Wolfe Research — Analyst

Hey, Roger, and John. There is a lot of debate taking place around what’s going to happen with rates whether we get more steepening at the long end and when we’ll get lift off at the short end. Is Discover’s ability to get to a mid-20% ROTCE at all impacted by what happens with rates? Maybe another way to ask it is, can you talk about your confidence level and being able to get to, say, mid-25%-type ROTCE even if the SERP remains in place?

John T. Greene — Executive Vice President, Chief Financial Officer

Yeah. Thanks, Bill. So, specific to rates, so if rates begin to increase, there is indications that a number of different things are happening in the economy. So, you would expect inflation to be increasing, a very, very low level of unemployment, probably near full employment for the economy and a robustness that might rival kind of the pre-pandemic levels on a sustained basis. And so, you have to believe that there is a lot of different things that are going to happen and that the Fed also will take some actions to control inflation. Now, we have seen this over a number years now that the Fed and overall interest rate environment has been on a sustained basis very, very low. As we look forward to 2021 and 2022, my expectation is, rates will remain low and we’ll enjoy the benefits of the economy, they’re just continuing to grow. Beyond that it gets different, that it’s more difficult to call.

In terms of total return levels, it will depend on a number of factors, rate is just one of those, credit obviously be an important item. But certainly longer-term, we think that we’re in a position to drive high returns for our shareholders. Consistent with what we’ve done historically. And our hope is, when we come back to that 10.5% target, that will further enhance overall returns.

Bill Carcache — Wolfe Research — Analyst

Got it. Thank you. As a follow-up, can you discuss the opportunity in the student lending space among customers who may not have been thinking about refinancing their student debt to lower rate when their loans went to forbearance? But as loans start to exit forbearance, is there going to be an opportunity for you guys to see an acceleration there?

Roger C. Hochschild — Director, Chief Executive Officer and President

Yeah. So we don’t really participate in the student loan refi market. The pricing doesn’t really meet our return hurdles. To the extent there is more activity, it can marginally impact the payment rate for student loans. But we feel really good about where we’re positioned. And I think last year was very challenging, there’s a lot of kids either deferred for a year or had reduced expenses because they didn’t have meals or housing, etc. So, again, yeah, we feel good about what this peak season should bring and our ability to continue gaining share.

Bill Carcache — Wolfe Research — Analyst

Thank you for taking my questions.

John T. Greene — Executive Vice President, Chief Financial Officer

Thanks, Bill.

Operator

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

Betsy Graseck — Morgan Stanley — Analyst

Hi. Good morning.

Roger C. Hochschild — Director, Chief Executive Officer and President

Good morning.

John T. Greene — Executive Vice President, Chief Financial Officer

Good morning.

Betsy Graseck — Morgan Stanley — Analyst

Couple of questions. One, you were talking earlier about widening standards, in particular in card. And I just wanted to get a sense as to what you’re expecting that will drive? Is that both an increase in accounts, as well as higher lines extended to your existing accounts? And then, could you give us some color on how you expect to pull in the new clients, given the fact that the consumer is in a fantastic spot? Are you pulling from other folks or do you feel like this is generating new demand from maybe a younger cohort that’s not been borrowing yet? Some color on that could be helpful.

Roger C. Hochschild — Director, Chief Executive Officer and President

Sure. So in terms of the credit expansion, it’s probably more heavily impacting new accounts, but also encompasses sort of our line increase and other criteria on the portfolio side as well. In terms of where we expect? I would say, in all times we give cards to consumers who are in good shape. But we do have particularly strong appeal to millennials and students, our secured card is performing well in the marketplace. But then also the traditional prime revolver segment that Discover has always targeted. It’s a very competitive business. It always has been. So, it’s about differentiation. And there, a superior customer experience, a great rewards program, focus on value, those traditional things are what allow us to continue gaining share and booking new accounts.

Betsy Graseck — Morgan Stanley — Analyst

It’s interesting because your value prop, very clear, especially versus other card lenders with no fee, etc. How do you think you’re positioned against the fintechs who also have a light or low or no fee proposition?

Roger C. Hochschild — Director, Chief Executive Officer and President

So, there aren’t that many of the fintechs that are active yet in the card space. By and large they do loans of different types. And so, we’ve yet to see a significant, I would say, fintech player in the card space. And most of our competition tends to be the traditional leaders in the marketplace.

Betsy Graseck — Morgan Stanley — Analyst

Okay. And if I could squeeze one in for, John. You mentioned in answer to the prior question or two ago around the total expense outlook that you’re thinking about for the full-year 2021. And I think you mentioned that you’re expecting 2021 to come in similar to the end of ’20 and then from there as we look to ’22 and beyond, migrate back towards like the high-30s. Could you just give us some color as to the end of ’20 expense ratio that you’re thinking about? Because there’s a couple of different ways you could place based on one-timers? Is that a run rate that’s north of 40% on the efficiency side, maybe you can help us understand your sizing there?

John T. Greene — Executive Vice President, Chief Financial Officer

Yeah. So, we used a GAAP basis on that. And so, the one-timers that were included in an underlying number that actually we didn’t publish but we called out the underlying numbers. It was about $200 million. So, the operating efficiency is going to be dependent upon what we see in terms of loan growth, payment rate and new account generation, which, as Roger said, and I’ll echo the comments, we’re very positive about how we’re positioned to drive growth in — especially in the second half of the year as the payment rate abates a bit. So, what you can expect here and I’m trying to provide as much details as I can, is that, outside of the marketing investments we talked about, some select investments in data and analytics we’re looking to keep all other costs flat. And we’re going to manage that envelope as we see opportunities, but we’ll be able to use that as a jumping off point to drive further improvements and efficiencies in ’22 and beyond.

Betsy Graseck — Morgan Stanley — Analyst

Okay. And so, the $200 million is what we should ex out to get to operating that’s on the expense side?

John T. Greene — Executive Vice President, Chief Financial Officer

Subject to growth and what we see as opportunities. Yeah. So there is no absolutes, but — and as time goes on we’ll have more clarity on the opportunities.

Betsy Graseck — Morgan Stanley — Analyst

And then if I look pre-pandemic, right?

Eric Wasserstrom — Head of Investor Relations

So, Betsy, we do want to do — Betsy, we do have some other questions to get to.

Betsy Graseck — Morgan Stanley — Analyst

All right.

Eric Wasserstrom — Head of Investor Relations

So, we’ll follow-up later. Thanks.

Betsy Graseck — Morgan Stanley — Analyst

Fine.

Operator

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

Mark DeVries — Barclays — Analyst

Thanks. I was hoping you could give us some color on where we should expect the reserve ratio to migrate to. Is it appropriate to think about it going back to kind of the CECL day one level? And if so, at what pace could we get there?

John T. Greene — Executive Vice President, Chief Financial Officer

Yeah. Thank you. So, yeah, we took a meaningful chunk out of the reserve levels this quarter. Honestly, the credit outlook and our model has indicated that there is a range of different outcomes we could have made on that. And what we tried to do was take a chunk out of the reserves that made sense, given level of absolute uncertainty in the economy. As we look forward, the absolute reserve level or reserve rate will depend on what we see in the macros, how the portfolio is performing and what we do in terms of account growth, loan balance. But overall, as we think about where the provision levels could be, I would use the day one CECL rate as a decent proxy, and subject to how the portfolio is performing, it could migrate up or down from there.

What we did last year in the first quarter and the second quarter was react to an incredibly dynamic and changing macro environment. And we prudently put up an incremental $2 billion. So, the portfolio performs over time. We could get back to that CECL day one and perhaps a little bit lower with excellent portfolio management. Now, timing, I’m not going to be specific on.

Mark DeVries — Barclays — Analyst

Okay. That’s helpful. Thank you.

Operator

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

Donald Fandetti — Wells Fargo Securities — Analyst

Hi. Good morning. Roger, as we went through the pandemic, obviously, there’s more e-commerce spend. And is there anything that you’ve learned in terms of like how you would position the Company differently? It seems like big tech and technology are continuing to gain more touch points with customers. Is there anything strategically that you want to lean into or you’ve learned?

Roger C. Hochschild — Director, Chief Executive Officer and President

Great question. I think it really accelerated a lot of trends that existing prior to pandemic, right? So, consumers were already migrating more and more of their shopping online, but that moved even quicker. Their customer interactions were moving more towards digital. That accelerated even further. So, I think it had us recommitted to the path we were on and looking to accelerate some of the functionality. Certainly, there were some specific things around the tap-and-go cards, a lot of small dollar transactions migrating from cash to debit that benefited our PULSE volumes. But I would say, in general, not so much new trends. But three-, four-, five-year accelerations of trends that were already there and that we have been positioning the Company to take advantage of.

Donald Fandetti — Wells Fargo Securities — Analyst

Got it. And on the potential investments or partnerships, would those be accretive or could they potentially be more technology investments?

Roger C. Hochschild — Director, Chief Executive Officer and President

Where we traditionally made them on the payment side is with partners that either add capabilities or to cement a relationship that will drive volume over our network. On the technology side, we found plenty of great partners/vendors out there that you don’t need — people don’t need money in the current environment. And so, that’s why we tend not to do investments in pure technology companies that aren’t payments related.

Donald Fandetti — Wells Fargo Securities — Analyst

Thank you.

Operator

Our next question comes from the line of Rick Shane of J.P. Morgan.

Richard Shane — J.P. Morgan — Analyst

As you look forward to loan growth, how much opportunity is there to category-specific rebound that’s more indexed to borrow like travel, for example?

Roger C. Hochschild — Director, Chief Executive Officer and President

Great question. I think that will be constructive. Some of the categories that were strongest through the downturn, though, had a pretty good revolve rates. If you think about home improvement that was really doing well. So, a lot of it I think will be in the restaurant and travel segment. But I wouldn’t necessarily expect a huge boost to revolve rate just given, again, some of the categories that were strong in the downturn.

Richard Shane — J.P. Morgan — Analyst

Got it. Okay. Thank you very much.

Operator

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

Mihir Bhatia — Bank of America — Analyst

Good morning and thank you for taking my question. Just really quickly, I wanted to ask about competitive intensity. First, are you seeing any impact on cost of acquisition as customers have come back? I know that had trended very well last year, and that’s an area you’d be making investments in.

And then maybe I’ll just ask my — the related question I had on that. Last year, Discover’s no annual fee, no cashback card was just really well suited for the backdrop. As we reopen and maybe travel rewards become more relevant for consumers, are you seeing any impact on your usage, any early indicators from consumers who had may be moved your card to top of wallet last year and what you’re seeing? So just, I guess, competitive intensity, more broadly? Thank you.

Roger C. Hochschild — Director, Chief Executive Officer and President

Yeah. So, I’ll start with the second one. We are not seeing an impact. And we think the lesson learned in the pandemic of the utility of cash rewards, hopefully will last. And we feel very good about even the new or redemption offers we’ve added. So the ability to redeem at point-of-sale, with PayPal, with Amazon, we just announced the ability to redeem for carbon offsets, which we think will be popular with millennials. So, no real change to that.

In terms of competitive intensity, we talked about, I would say, just extraordinarily attractive cost per account last year as there was a significant pullback. I think we’re now moving towards more normalized levels of competition. And my guess is, we’ll see that increase. But our job is to grow the business in face of the competition that’s there. And so, while I missed the CPA’s from last year, we feel good about the returns we’ll generate from our marketing even in a more intense environment.

Mihir Bhatia — Bank of America — Analyst

Understood. Thank you.

Operator

Our next question comes from the line of John Hecht of Jefferies.

John Hecht — Jefferies LLC — Analyst

Good morning, guys. Thanks very much for taking my question. The first question and, Roger, you addressed some of this. With respect to the loan growth, maybe you talked about it being a mix of line utilization and new customers. I’m wondering, is there one bigger contribution to that relative to the others. And what’s the cadence? Is this more of a second half factor or is this going to be balanced over the course of the year?

Roger C. Hochschild — Director, Chief Executive Officer and President

Yeah. So, on the cadence side, I do expect marketing expenses to ramp up over the course of the year. Yeah. They weren’t overly large Q1. But, again, with the wider credit box we’ll get more leverage for the marketing spend. So, we’d expect a ramp. But we’ll look at that continuously and make adjustments as we see fit.

In terms of the impact of the credit changes, it’s probably more heavily weighted towards the new account side versus portfolio, but we always look for a blend of those two as we think about growth.

John Hecht — Jefferies LLC — Analyst

Okay. And then…

John T. Greene — Executive Vice President, Chief Financial Officer

Go ahead, John. Please go ahead.

John Hecht — Jefferies LLC — Analyst

John, I guess, more of a kind of constant question is, we’re a year into CECL now and obviously it’s had a pretty big impact and how things have turned out from a GAAP perspective. How do you stack the major decision making factors with respect to your ALL [Phonetic] now? Is it the Moody’s model? Is it unemployment? Is it just your internal opinion of your performance trends? How have things changed with respect to the way you look at that ALL level?

John T. Greene — Executive Vice President, Chief Financial Officer

Yeah. Good question. So, certainly, evolving. So, we use Moody’s and also two other providers. So, the broad macros are very important. The portfolio performance itself is also obviously key input and we have a team of technical modelers that have run various scenarios, regression sort of scenarios to help make a determination on what overall life of loan losses could be, which is a key input. There is probably 12 to 15 different variables that go into that model that help through the projection. And then the other [Technical Issues]. And what you have on the balance sheet as of the measurement date in order to set reserve. So, I would say, all of those factors are important.

And then, finally, one other one is the recovery rate which actually also does go into the models. So, four important factors, and we’ve taken a measured approach to ensure that our balance sheet is appropriately stated and we’re on the conservative end of the judgment costs.

John Hecht — Jefferies LLC — Analyst

Appreciate the context. Thank you.

Operator

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

Meng Jiao — Deutsche Bank — Analyst

Hi. Good morning. Thanks for taking my call or questions. So, it looks like monthly sales for travel, restaurants and retail seems to have pretty much materially accelerated from February into March and in particular for restaurants. Have you guys seen that carrying over into April as well?

John T. Greene — Executive Vice President, Chief Financial Officer

Yeah. We have actually — incredibly the sales performance, the first three weeks of April versus ’19, overall, we’re up about 17%. And it’s three weeks into the month, so things can change. And then versus last year, which was certainly dented significantly by the pandemic. We’re up 68% on sales. So, really strong there. And then the mix between revolvers and transactors, obviously, transactors are up higher than revolvers but revolvers are up almost near double digits versus prior year. So, all good.

Meng Jiao — Deutsche Bank — Analyst

Great. Thank you.

Operator

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

Moshe Orenbuch — Credit Suisse — Analyst

Great. Thanks. Most of my questions actually have been already asked and answered, but maybe if you could just follow up on two quick points. One is, the payment rate — the stubbornly high payment rates and how that will likely decline? I mean, is there — I guess, maybe the question is, how much of that is a function of the actual stimulus dollars versus some of the ongoing impacts that you highlighted, whether it’s enhanced unemployment benefits or student loan, interest forbearance, in terms of thinking about the pace of that decline?

And then just very quickly, you talked about the CECL day one. Just conceptually, do you think that the life of loan has a higher or lower likelihood on January 1, 2022 of the near-term recession hit on January 1, 2020?

Roger C. Hochschild — Director, Chief Executive Officer and President

So, I’ll cover the first part. I’ll let John forecast recessions. In terms of the elevated payment rate, it is a mix, but you are seeing a lot of it come from the governmental support. And so, we do expect it to come down over the course of the year, but remain elevated compared to historic levels. And this is because households have a lot of savings withdrawn [Phonetic] and there is just a lot of other forms of support. So it’s not — it is a headwind against loan growth. It’s really been driven by external factors. Sorry, I would say, we’re not overly alarmed about it. And again, we would expect it to start drifting downwards as we get further past that really extraordinary levels of government stimulus.

And I’ll pass it to John for the questions on recessions.

John T. Greene — Executive Vice President, Chief Financial Officer

Great. So, yeah, I think what you’re getting at is what will be our macro assumptions at the end of this year forecasting out to 2022. So, today, obviously, there is no perfect answer or perfect insight. I will say this, the pent-up demand for consumers I believe is fairly pronounced and we’ll continue to drive spending activity through this year and well into next year. So that to me indicates that the macros should be positive through 2022, beyond 2022, it’s really difficult to call at this point.

Moshe Orenbuch — Credit Suisse — Analyst

Okay. Thank you.

John T. Greene — Executive Vice President, Chief Financial Officer

You’re welcome. Thanks. Thanks for the questions.

Operator

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

Kevin Barker — Piper Sandler — Analyst

Good morning. Could you give us a little bit more detail on some of the investment spend you’re making on data, analytics and driving account growth? And then also, is there any way to quantify how much incremental spend you are putting into that and returns that are being generated from that, whether it’s additional growth or other trends that we can identify to quantify the growth that were in investment returns that you’re getting?

John T. Greene — Executive Vice President, Chief Financial Officer

Yeah. Great. So, I’ll hit the second part of the question first. So, in terms of returns, we have a rigorous process where we take a look at incremental investments to ensure that they deliver strong cash on cash returns. And in terms of ROEs or return threshold, I won’t be specific, but very, very strong double digits on those, with — in line with what you can expect from the Company on a normalized basis in terms of return on capital.

In terms of what we’re investing in data, analytics on — specifically on, I’m looking at attrition from the portfolio, we feel like there is an opportunity to reduce attrition levels through some early identification of customers who may not be maximizing the usage of the card. We have data, analytics projects going on in collections. I mentioned in our prepared remarks, in fraud and fraud analytics. So, there’s — frankly, there is almost a insatiable demand for these sorts of programs and what we are, we’re being very, very selective in terms of making sure that we prioritize the highest returning ones in the current year.

Kevin Barker — Piper Sandler — Analyst

Okay. Thank you.

John T. Greene — Executive Vice President, Chief Financial Officer

You’re welcome.

Eric Wasserstrom — Head of Investor Relations

Emily, why don’t we make this our last question, please?

Operator

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

Dominick Gabriele — Oppenheimer & Co. — Analyst

Hey, thank you so much for taking my question. I just wanted to go back to the expenses and sorry, I don’t mean to beat a dead horse here. If you look at the GAAP operating expenses in the fourth quarter of 2020 they were almost about $1.3 billion. Are we expecting a quarter that could be that high or just because there was — it seemed to be a little — or I got a little confused on one of the comments there. So is that reasonable to think that one of the quarters could be near that $1.3 billion level?

John T. Greene — Executive Vice President, Chief Financial Officer

Yeah. So, I’m certainly not in the business of forecasting quarterly. I will tell you this from an expense standpoint. The marketing expense for the balance of the year, we expect will continue to grow into the kind of that envelope we talked about earlier. The quarter-over-quarter comparisons are, frankly, relatively challenging given what happened in 2020 in terms of our focused approach to look at every single dollar that potentially is going out of the door on an expense item. So, I would just focus on the broad numbers and the quarterly break-outs. I’ll leave it to you to figure out what makes the most sense. We here — we’re looking at 2021 and 2022 and don’t specifically try to manage to any particular quarterly number.

Dominick Gabriele — Oppenheimer & Co. — Analyst

Makes sense. And then, I guess, if you kind of look at what happened this quarter with the kind of benefits that you guys have — with having not only a lending business, but one that also gains interchange that really helped to offset some of those slowdown in loans, I guess. Do you expect that the — we could see that Discover proprietary network being much higher as far as the growth basis going forward year-over-year versus your loan growth in 2021 do you expect that divergence to be there for at least a few quarters? Thanks so much guys. Really appreciate it.

Roger C. Hochschild — Director, Chief Executive Officer and President

Sure. So, our total network spend is benefiting from growth in some of our third-party payments areas. If you include the debit side, PULSE is growing very strongly. And so, that’s helpful. But we also believe that having a proprietary network is an important differentiator and gives us a whole series of capabilities that helps us grow our banking business. So, again, total volume will depend somewhat on some of the partners and we are a little skewed towards debit for the third parties, but we’re going to work for continued robust volume growth.

Dominick Gabriele — Oppenheimer & Co. — Analyst

Great. Thanks so much.

Eric Wasserstrom — Head of Investor Relations

All right. Well –. Sorry, Maria. But thank you very much. If you have any follow-up questions, feel free to reach out to Jon [Phonetic], Emily and I. And thank you for joining us.

Roger C. Hochschild — Director, Chief Executive Officer and President

Thank you, folks.

Operator

[Operator Closing Remarks]