DFS Discover Financial Services

Lower late payments and increased card use helped Discover Financial Services (DFS) post a 36% increase in fiscal first-quarter profit to beat analysts' estimates.

The Riverwoods, Ill., credit-card lender said Wednesday it benefited as its book of loans expanded, thanks in part to its foray into student and personal lending in recent years. Total loans were up 9% from a year earlier to $56.3 billion. Outstanding credit-card loans, which had contracted after the recession, rose 4% year over year to $45.9 billion but were down about 2% from the previous quarter.

"Continued improvements in credit performance, solid organic growth in each of our lending products and strong volume growth across our networks were key drivers of this quarter's earnings," said David Nelms, chairman and chief executive of Discover.

Discover, like American Express Co. (AXP), is both a lender to cardholders and a processor of transactions, which means it earns interest on loan balances and fees each time a card is swiped at a merchant. By comparison, Visa Inc. (V) and MasterCard Inc. (MA) only process transactions and partner with banks, which issue their cards and lend to consumers.

Credit-card companies have been among the top stock performers over the last year as borrowers have been diligent about paying their bills on time, leading to lower delinquencies and bad-debt expenses for lenders.

Discover card sales volume rose 7% from a year earlier to $25.6 billion.

The company posted a quarterly profit of $631 million, or $1.18 per share, up from $465 million, or 84 cents per share, a year earlier. Analysts surveyed by Thomson Reuters predicted earnings of 94 cents a share.

Discover's shares have climbed more than 39% over the last year. They were down 1.2% at $31.25 in after-hours trading.

Discover benefited from the release of funds set aside to cover bad loans, a trend that has helped other credit-card issuers bolster earnings but is expected to slow as lenders pursue growth. Discover said it released $226 million in loan-loss reserves, compared with a release of $271 million a year earlier and a release of $68 million in the previous quarter.

The company expects credit performance to remain strong over the next year, said Mark Graf, chief financial officer of Discover.

"We expect any reserve build going forward to be directly related to growth" in loans, Graf said during a conference call with analysts.

The company's delinquency rate for credit-card loans was 2.22%, down from 3.59% a year earlier and 2.39% in the previous quarter. Its net charge-off rate, or percentage of loans written off as uncollectible, was 3.07%, down from 5.96% a year earlier and 3.24% in the previous quarter.

Discover has been expanding into areas beyond credit-card lending, including private student loans and personal loans, which are unsecured loans that borrowers can use to consolidate other balances and pay for various purchases like home repairs and vacations.

It also has been planning to get into the mortgage-origination business through its pending purchase of assets from Tree.com Inc. (TREE), an online-lending platform. The $55.9 million deal announced last May has dragged out, with the companies announcing last month they pushed back the deadline to close the acquisition.

Discover, the sixth-largest credit-card issuer by spending, is trying to expand its footprint outside the U.S. to take advantage of new markets where card use has yet to hit a saturation point. Wednesday, the company said it struck a deal with Evertec Inc., which operates the ATH bank-network alliance in Puerto Rico that will let participating banks issue Discover debit cards.

The company also recently made deals to have its Discover cards issued in Ecuador through its Diners Club franchise there and to process transactions made over India's RuPay payments network.

Discover faces expenses from an expected enforcement action by the Consumer Financial Protection Bureau, the new agency formed by 2010's Dodd-Frank Act. Discover said in January it expected the CFPB and Federal Deposit Insurance Corp. to file a joint enforcement action against the company stemming from a review of a product it sells to credit-card customers to delay monthly payments when a hardship event occurs.

The cost of the action, which pertains to Discover's marketing of the "payment protection" product, could exceed $100 million, the company said, adding it had changed its practices before the FDIC and CFPB began their review.

Discover's expense line increased 14% to $677 million, which the company attributed to higher reserves for litigation and regulatory matters.

Nelms didn't specifically address the CFPB review during the conference call but said the company is looking to have a "constructive dialogue" with the agency.

"Our understanding is that they want to be factually based," Nelms said. "If that's how things proceed, we think we've got good facts."

-By Andrew R. Johnson, Dow Jones Newswires; 212-416-3214; andrew.r.johnson@dowjones.com

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