Following the release of
Discover Financial Services
) second quarter 2012 earnings last week, Fitch Ratings reaffirmed
the long and short-term Issuer Default Rating (IDR) of the company
and its subsidiary - Discover Bank at "BBB" and "F2", respectively,
with a stable outlook on both.
The affirmation of the ratings came on the back of Discover's
well-established card franchise, high liquidity, substantial
capital balance and high-quality assets. However, non-diversified
revenue sources, limited flexibility in borrowing capacity and a
highly regulated environment prevented a rating upgrade.
Besides, Discover has been witnessing record low charge-offs,
while the losses on its credit card portfolio in the first half of
the year have been substantially lower than the average loss rate
of the five industry leaders during the first quarter of this year.
However, Fitch expects the loss rate to rise in the later part of
2012, although credit metrics are still expected to outshine the
last year levels.
Discover's outstanding credit trends, higher processing volumes,
improving consumer spending and expanding portfolio have driven its
earnings in 2011 and so far in 2012. However, high operating
expenses emerged as a spoiler.
Further, Discover has strong capitalization with a Tier 1 common
ratio of 14% in the second quarter of 2012, which is more than both
the company's long-term target as well as the capitalization of
peers. Nevertheless, Fitch expects the ratio to come down to the
long-term target of 9.5% with time.
Overall, stable earnings, modest portfolio expansion,
high-quality assets, substantial liquidity and strong
capitalization support the stable outlook on the ratings. Going
ahead, Fitch can upgrade the ratings on increased diversity in
revenue sources, stronger competitive position and credit
performance in the non-card loans, higher flexibility in funding
sources and increased clarity in regulations.
On the other hand, lower earnings, driven by a decline in credit
performance or market share, reduced liquidity, substantial
deterioration in capitalization, adverse legislative or regulatory
changes and reduced competitive strength can also lead to lower
Within the industry, recently, Standard & Poor's Rating
Services (S&P) raised the long-term issuer credit rating (ICR)
of the operating subsidiaries of
American Express Co.
), a rival of Discover, to "A-" from "BBB+". Additionally, the
rating agency affirmed the ICR of the holding company at "BBB+/A-2"
and the short-term ICR of its operating subsidiaries at "A-2".
The outlook for all ratings remains stable.
We maintain a long-term 'Outperform' recommendation on the
shares of Discover. Currently, the company caries a Zacks #2 Rank,
implying a short-term 'Buy' rating.
AMER EXPRESS CO (AXP): Free Stock Analysis
DISCOVER FIN SV (DFS): Free Stock Analysis
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