DFS Discover Financial Services

Discover Financial Services (DFS) reported a fiscal third quarter profit of $260.6 million as improving credit trends allowed the company to free up funds in reserves and cardholders spent more.

The company's bump in profits from lowering its loss reserves reinforces the trend observed earlier this year in companies, including Capital One Financial Corp. (COF) and American Express Co. (AXP), whittling down their reserves amid improving credit trends.

Discover expects losses from souring card accounts to further decline. For the quarter ended Aug. 31, delinquency rates, a key gauge of future losses, also continued to drop.

Investors, optimistic that borrowers falling behind on payments and losses stemming from souring loans are on the mend, pushed up Discover's shares 4.24% to $16.23.

For the third quarter, the Riverwoods, Ill.-based company reported a profit of $260.6 million, or 47 cents a share, down 55% from $577.5 million, or $1.07 a share, a year earlier. The results from a year ago were bolstered by an after-tax gain of $287 million related to an antitrust settlement. Analysts polled by Thomson Reuters forecast earnings of 38 cents a share for the latest quarter.

Unlike most other card companies, which either issue plastic or process the transactions, Discover and bigger rival American Express do both.

Therefore, in addition to the interest Discover earns on its credit-card loans, a chunk of its revenue comes from fees it charges banks and merchants, such as grocery stores or gas stations, to process card payments.

The more times consumers use Discover-branded cards and the more they charge on them, the more the company earns in fees. Discover customers spent $24 billion on their cards, a 5% jump from a year ago.

Discover reported lower delinquencies and charge-offs, or card loans that the company doesn't expect to collect on. Charge-offs for the third quarter totaled 7.18% of Discover's credit-card loans, lower than the 8.05% a year earlier and the 7.97% in the second quarter. The charge-off rate for the third quarter, although elevated, is lower than Discover's 7.5%-8% estimate for this period.

Borrowers at least a month behind on their card payments totaled 4.16%, down from 4.86% a year ago and 4.52% in the prior quarter. The delinquency rate is important for issuers because higher delinquencies force them to put away capital to reserve for potential losses; ultimately, companies must write off loans if customers can't pay up.

Discover's provision for credit losses, at $712.6 million, fell 34% from a year earlier, with the company releasing $187 million from its reserve in the third quarter.

Revenue declined 7% from a year earlier to $1.7 billion as new rules enacted earlier this year took a bite out of income.

Friday, the company agreed to acquire private student-loan operations of Student Loan Corp. (STU) for $600 million and $4.2 billion of the company's assets for 91.5 cents on the dollar. The company has been ramping up its business in personal and private student loans, seeking revenue growth. The acquisition will add 9 cents to earnings per share in 2011.

-By Aparajita Saha-Bubna, Dow Jones Newswires; 617-654-6729; aparajita.saha-bubna@dowjones.com

(Matt Jarzemsky contributed to the article.)

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