DFS Discover Financial Services

Yesterday, major credit card companies American Express Co. (AXP) (AmEx) and Discover Financial Services (DFS) reported a drop in defaults and delinquency rates for November 2011, implying a favorable credit quality.

Delinquency rates…

Accordingly, the delinquency rate, indicating the future rate of default, for AmEx, 30 days, was recorded at 1.5% of balances, at par with that reported in October and September this year. However, this came in lower than 2.2% of balances recorded in November last year. The delinquency rate for Discover also dipped to 2.43% of balances from 2.48% in October and 4.15% in November 2010.

Nevertheless, the results were also favorable for Discover and AmEx as compared to their worst months of October 2009 and February 2009, when delinquency rate struck 5.72% and 5.3%, respectively.

NCO rates…

Card companies usually write off the loans that are 180 days past due, assuming those as uncollectible. Such credit card defaults or net charge-off (NCO) rate also witnessed a decline for Discover last month. On an annualized basis, the company wrote off $46.7 million or 3.04% of balances, which reduced from 3.26% in October this year and 6.72% in November last year.

However, NCO rose slightly for AmEx over October this year. On an annualized basis, last month, the company wrote off $51.4 million or 2.4% of balances, up from 2.3% in October this year. Nevertheless, NCO came in favorable from 4.4% recorded in November last year.

While the worst NCO recorded for Discover was in February this year, when the metric hit 9.11%, the nastiest month for AmEx was April 2009 when NCO rate was 10.4%. Experiencing the worst of the financial crisis a couple of years back, customers have now become more alert about making timely payments.

Declining default rates largely stemmed from defaulting card holders’ inability to get cards with large credit limits. Also, various regulatory reforms undertaken by the Federal Reserve, such as capping the fees charged by banks and restricting the pace at which they can raise their interest rates, are also enabling the card owners to lower their balances.

However, going ahead, the next couple of months are likely to see some reverse trend given the seasonal issues. Mostly during holiday shopping season credit card companies receive late payments, whereby customers make up for these lapses later in the year.

Our Take

Favorable delinquencies and NCOs have also helped Discover through 2011. Yesterday, the company reported its fourth-quarter 2011 earnings of 95 cents per share, modestly ahead of the Zacks Consensus Estimate of 91 cents but way higher than 64 cents recorded in the year-ago quarter. Net income spiked 46.4% year over year to $508 million from $347 million.

Moreover, improved credit quality has also enhanced Discover’s liquidity, which is also reflected by its efficient capital deployment through share repurchases and dividend payouts. Yesterday, the company even announced about a 67% hike in its quarterly dividend to 10 cents per share. This also marks the second dividend hike for this year, since its dividend hike from 2 cents to 6 cents per share in the first quarter of 2011. 

On the other hand, AmEx has also been driving its fundamental growth through improved credit quality. Alongside, AmEx has been upgrading its digital payment platform through strategic alliances, which will not only expand the company’s card membership base but also help it penetrate the unexplored market and tap the upcoming opportunities in the field of eCommerce.

Overall, these efforts are not only helping AmEx improve its delinquency rates and reducing loan losses but are also crucial for maintaining its competitive strength against arch rivals, such as MasterCard Inc. (MA), Visa Inc. (V) and Discover, in the card industry.

Meanwhile, the Zacks Rank for AmEx and Discover currently stands at #3, implying a short-term Hold and long term Neutral stance. Furthermore, MasterCard and Visa carry a Zacks Rank #2, which translates into a short-term Buy and long-term Neutral recommendation.

 
AMER EXPRESS CO (AXP): Free Stock Analysis Report
 
DISCOVER FIN SV (DFS): Free Stock Analysis Report
 
MASTERCARD INC (MA): Free Stock Analysis Report
 
VISA INC-A (V): Free Stock Analysis Report
 
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