Discover Financial (NYSE:DFS) reported earnings for the second fiscal quarter of 2012 on June 19.  A 6% year-over-year increase in revenues was offset by lower reserve releases as the company reported net income of $537 million or $1 per diluted share, down 11% from $600 million or $1.09 per share reported for the second quarter of 2011. Despite a decline in direct banking, the company’s risk management strategy helped its credit card and loans business perform well in a difficult market environment. We discuss below a few key takeaways from Discover’s second quarter earnings report.
Cards Business On The Right Track
An effective marketing strategy and focus on promotional offers and advertising to increase merchant acceptance of Discover’s card products paid off, as card sales volume grew 5% year-on-year to $26.1 billion. Credit card loans followed a similar trend, increasing 4% over the last year to $46.6 billion. Credit card loan delinquency rates hit an all-time low; the delinquency rate for loans over 30 days due was 1.91%, and was below 1% for loans over 90 days due, indicating a strong credit performance. Provision for loan losses increased by $56 million, or 32%, from 2011, to $232 million as charge-offs dropped due to a decline in delinquencies.
The company recently announced its first affinity card in partnership with wetlands and waterfowl conservation group, Ducks Unlimited, (See New Alliance Between Ducks Unlimited And Discover Financial) which is responsible for marketing its branded card services to the group’s 600,000 plus adult members.
We expect Discover’s credit card business, which accounts for over half of our price estimate, to continue to grow through our forecast period, as Discover expands its core business through private-label deals and partnerships.
Diversification Holds The Key
Discover Financial is currently focusing on diversifying its operations. The company’s total loans grew 9% over the last year to $57.1 billion, fueled primarily by the acquisition of Citigroup’s (NYSE:C) $2.5 billion student-loan portfolio in September last year. Private student loans grew to $2.9 billion this quarter, as personal loans increased $703 million from 2011. The company recently started offering a new fixed-rate private student loan product, providing predictability with a set interest rate for the duration of the loan. Although this product has been in the market for less than a month, early signs from school financial aid officers have been encouraging.
Discover has also entered the residential mortgages business with the acquisition of the Home Loan Center business from Tree.com. The company started originating prime, fixed- and variable-rate loans that conform to Freddie Mac (OTC: FMCC) and Fannie Mae (OTC: FNMA) standards for sale in the secondary markets from June 6. We believe that the current market conditions in the U.S. will help Discover’s loan business flourish over the next few years. For more details, refer to our article: Discover Financial Enters The Mortgage Business At Just The Right Time.
We will shortly revise our $26 price estimate for Discover Financial’s stock, which is 20% below the market price.Notes:
- Discover Financial Services Management Discusses Q2 2012 Results – Earnings Call Transcript, Seeking Alpha, 19th June, 2012 [↩]