Discover Financial Services
) reported third-quarter 2012 earnings per share of $1.21, beating
both the Zacks Consensus Estimate of $1.03 and the year-ago quarter
earnings of $1.18. However, net income declined 3.4% year over year
to $627 million from $649 million. Net income allocated to common
shareholders also declined to $621 million from $642 million in the
The decline in net income was due to lower loan loss reserve
releases and higher legal expenses, which offset revenue growth and
reduced charge-off rates.
Total revenue, net of interest expense, increased 9.8% year over
year to $1.96 billion. Net interest income also improved 11% year
over year to $1.37 billion. However, total other expenses jumped
29% year over year to $826 million.
Direct Banking Segment
The Direct Banking segment reported pre-tax income of $963
million, reflecting a 5% decrease from the year-ago quarter.
Discover card sales volume grew 4% year over year to $27.2
Total loans improved 9% year over year to $59.2 billion, boosted
by an increase of $1.9 billion in credit card loans, $2.9 billion
in private student loans (including purchase of a $2.4 billion loan
portfolio in the fourth quarter of 2011) and $675 million in
Other income increased 5% year over year, primarily due to
higher interchange revenue and additional revenues from the newly
launched Discover Home Loans.
Expenses in the segment surged 29% year over year on higher
legal reserves related to the recent settlement agreement with the
Federal Deposit Insurance Corporation (FDIC) and Consumer Financial
Protection Bureau (CFPB), along with increased marketing expenses,
expenditure on the Home Loan Center acquisition and higher
The credit card net charge-off rate declined 142 basis points
(bps) year over year to 2.43%. Moreover, the over-30-days
delinquency rate was at an all-time low of 1.81%, having witnessed
a substantial 62 bps decrease year over year, reflecting an overall
better credit trend since the fourth quarter of 2009.
Besides, the provisions for losses surged 26% or $26 million
year over year to $126 million, reflecting lower reserve release,
which was partly offset by lower charge-offs. Reserve release was
$182 million in the reported quarter, as opposed to $359 million in
the year-ago quarter.
Payment Services Segment
The Payment Services segment's pre-tax income grew 31% year over
year to $49 million. Revenues were up $17 million, reflecting an
increase in point-of-sale transactions on the PULSE network, which
carry a higher margin.
Expenses increased $6 million from the year-ago level.
Payment Services dollar volume accelerated 13% from the year-ago
quarter to $50.3 billion, reflecting higher PULSE and third-party
Share Repurchase Update
During the reported quarter, Discover repurchased 10 million
shares for $350 million under its $2 billion share repurchase
Discover has been generating exceptional card sales volume over
the past few quarters, owing to improved consumer spending and
credit quality trends. Moreover, operating performance of the
Payment Services segment was impressive, which contributed to the
Besides, the company has a strong inorganic growth policy in
place, which apart from boosting earnings also fosters portfolio
diversification. The Home Loan Center acquisition from
) has added a residential mortgage component to Discover's
direct-to-consumer banking business, thereby enabling it to launch
its subsidiary - Discover Home Loans. This has also amplified the
revenues of the Direct Banking segment.
However, the expenses of Discover have been on the rise due to
higher compensation and benefit expenses, infrastructure
development and growth initiatives. Moreover, the company is facing
substantial litigation expenses and has been strengthening its
reserves for the same. Reserve strengthening related to the recent
settlement agreement with FDIC and CFPB has led to almost 15%
year-over-year growth in expenses.
Nevertheless, the remarkable improvement in credit quality makes
us optimistic about Discover's future earnings. Additionally, the
company's extensive network, sound capital position and cost
containment initiatives are expected to accentuate growth over the
Discover competes with other card companies like
). Currently, the company caries a Zacks #2 Rank, implying a Buy
rating in the short term.
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