--Profit of $1.21 per share beat analysts' estimates
--Credit-card loans increased 4.2% from a year earlier to $48.12
billion
--Legal expenses increased due to settlement with CFPB and
FDIC
(Updated with new details throughout.)
By Andrew R. Johnson
Discover Financial Services' (DFS) shares rose more than 3% in
early trading Thursday after the credit-card lender's fiscal
third-quarter earnings beat analysts' estimates on solid loan
growth and improved credit quality.
The benefits were partially offset by an increase Discover's
loan-loss provision and higher legal expenses tied to the company's
recent $214 million settlement with federal regulators over the
sale of add-on products, which led to a 3.4% decline in profit.
Discover's profit was $627 million, or $1.21 per share, down
from $649 million, or $1.18 per share, a year earlier. Analysts
polled by Thomson Reuters were expecting the company to earn $1.03
per share.
The company's shares were up 3.5% at $38.30 in early
trading.
"Card sales and receivables grew in a challenging environment
while credit quality continued to improve," David Nelms, chairman
and chief executive officer of Discover, said in a statement.
Discover has been one of the best-performing stocks this year as
loan delinquencies have fallen to historic lows and the company has
managed to eek out portfolio growth while most credit-card issuers
are struggling to add new loans. The company's shares are up more
than 54% this year, and it was recently cited as a possible
acquisition target by analysts at Susquehanna Financial Group.
The company's credit card loans increased 4.2% from a year
earlier to $48.12 billion. It also experienced growth in private
student lending and personal loans, which are significantly smaller
portfolios than Discover's main credit-card business but have
become a more important focus for the company as it looks for new
growth opportunities.
In June, Discover also launched a new online
mortgage-origination business, through which it is making home
loans that adhere to Freddie Mac (FMCC) and Fannie Mae (FNMA)
standards and selling them in the secondary market versus holding
them on its balance sheet.
Credit quality continued to improve in the quarter, with its
delinquency rate for credit-card loans decreasing to 1.81% from
2.43% a year earlier and from 1.91% in the previous quarter. Its
net charge-off rate, which measures the percentage of loans deemed
uncollectible, decreased to 2.43% from 3.85% a year earlier and
2.79% in the previous quarter.
Loan quality has continued to improve for the credit-card
industry as borrowers have been cautious about carrying large
balances each month after deleveraging following the financial
crisis. Analysts expect delinquencies and net charge-offs to edge
up again, noting there is little room for further improvement.
That may lead to lenders adding more money to their loss
reserves, reversing a trend in which they have released such money
credit-quality has improved, boosting their earnings.
Discover said it recorded a loan-loss provision of $126 million
in the quarter, up from $100 million a year earlier but down from
$232 million in the previous quarter.
The prospect of increasing loan-loss provisions coupled with
relatively muted consumer-loan demand amid an uncertain global
economy has put pressure on credit-card issuers to seek new revenue
opportunities.
"With credit tailwinds having largely abated, earnings growth
could turn negative unless issuers are able to drive positive
revenue growth ... and/or realize efficiency gains," Bill Carcache,
an analyst with Nomura, wrote in a research note on Sept. 11.
In addition to lending to consumers, Discover also operates a
payments network that competes with Visa Inc. (V), MasterCard Inc.
(MA) and American Express Co. (AXP) to process transactions.
In addition to launching its mortgage business, Discover has
struck partnerships to expand its payments-network business in
foreign countries. Last month it announced a deal with eBay Inc.'s
(EBAY) PayPal subsidiary to expand acceptance of the
online-payments service in to brick-and-mortar merchants who accept
Discover cards next year.
Discover will help process the transactions that PayPal
customers make at its merchants, potentially growing its network
revenue.
One major source of ancillary revenue faces ongoing pressure,
though.
Discover agreed to pay $214 million to settle regulators' claims
that it and its third-party telemarketers used deceptive tactics to
sell add-on products including identity-theft protection and
debt-suspension services to its credit-card customers.
In a joint consent order made public by the Consumer Financial
Protection Bureau and Federal Deposit Insurance Corp. on Monday,
Discover was ordered to refund about $200 million to 3.5 million
customers who bought the products between December 2007 and August
2011. It must also pay $14 million in penalties to the two
agencies, which will split the amount.
The company said its expenses were up $178 million, or 29%, from
the prior year mainly due to a $94 million year-over-year increase
in expenses for legal reserves. That was primarily tied to the CFPB
and FDIC settlement.
A Discover spokesman said this week that the company has stopped
selling the products over the phone but continues to sell them
online to customers.
Revenue from Discover's add-on products was $104 million in the
quarter, down from $108 million a year earlier but up from $101
million in the previous quarter.
--Saabira Chaudhuri contributed to this story.
Write to Andrew R. Johnson at andrew.r.johnson@dowjones.com
Write to Saabira Chaudhuri at saabira.chaudhuri@dowjones.com
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