Discover Earnings Preview: Loan Segment To Grow Backed By Strong U.S. Economy

-3.83%
Downside
120
Market
116
Trefis
DFS: Discover Financial Services logo
DFS
Discover Financial Services

Discover Financial (NYSE:DFS) is scheduled to report earnings for the first quarter of 2015 on Tuesday, April 21. In the previous quarter the company reported a 33% year-over-year decline in net income to $404 million for the quarter, partly due to changes in the structure of the company’s customer rewards program. [1]. However, the company benefited from a modest increase in credit card loans, credit card sales and payment services transaction volume.  The credit card loans division, which accounts for around 80% of the company’s loan portfolio, increased by 6% y-o-y. Overall, the loan portfolio grew over 6% while sales volume increased 5% over the prior year. We expect the company to maintain its loan growth and sales volume momentum.

On the cost side, the last quarter saw an 11% year-over-year increase in expenses, primarily due to higher professional fees, increased investment in web and mobile technology and a one-time elimination of $178 million of credit card rewards forfeiture reserves. In the upcoming earnings, we will look out for whether these one-time expenses have improved the performance of the loan segment.

Our $65 price estimate for Discover Financial implies a slight premium to the current market price.

Relevant Articles
  1. Up 14% YTD, What’s Next For Discover Financial Stock?
  2. Discover Financial Stock Is Undervalued
  3. Discover Financial Stock Is Fairly Priced At The Current Levels
  4. Discover Financial Stock To Edge Past The Revenue Consensus In Q1
  5. Discover Financial Stock Is Attractive At The Current Levels
  6. Discover Financial Stock To Beat The Earnings Consensus In Q4?

See our complete analysis of Discover Financial here

Loan Growth Backed By Strong U.S. Economy

Like American Express (NYSE:AXP), Discover has a closed-loop network, wherein it acts as both the issuer and the acquirer. Discover issues credit cards directly to consumers and allows them to maintain revolving credit on their card balances. The company’s primary revenue source is the interest income generated on these outstanding card balances. Interest income accounts for more than 68% of Discover’s revenues.

Discover was able to maintain a 6% card receivable growth rate through 2014, while maintaining a low charge-off rate of 2.26%. The industry charge off rate was 3.28% in the first two quarters of 2014 and 3.04% in the last two quarters. The market growth rate for revolving consumer credit outstanding was around 3%, which indicates strong credit performance. [2]

Reserves Likely To Grow

In Q4 2014, Discover’s provisions for loan losses increased 29% y-o-y, owing to loan growth and an increase in the charge-off rate. Discover has maintained a good risk profile, with a credit card net charge-off rate lower than the industry rate. However, the charge-off rate increased moderated by 17 basis points in comparison to the previous year. Similarly, its 30-day delinquency rate was 1.73%, a y-0-y increase of 1 basis point. This was still lower than the 2.16% delinquency rate on credit card loans for all commercial banks in the U.S. [3] We expect the company’s reserves to grow moderately as it continues to expand its loan business.

Direct Consumer Banking to Be Driven By Student Loan Growth

Discover’s direct consumer banking products include student loans, personal loans and deposit products. In 2014, the company expanded this division by originating around $2.9 billion in personal loans and over $1.2 billion in student loans. Student loans grew 4.4% (organic growth of 22% that excludes acquired loans), accounting for 12% of Discover’s loan portfolio, while personal loans grew by over 19% over the prior year, accounting for 7% of the company’s portfolio. Discover accounts for 6% of a total of approximately $150 billion of private student loans in the U.S. and can achieve more growth in this area. [4] As student loans have been increasingly rising, we expect Discover’s market share and interest revenue from this division to see a robust growth rate.

View Interactive Institutional Research (Powered by Trefis):

Global Large CapU.S. Mid & Small CapEuropean Large & Mid Cap

More Trefis Research


Notes:
  1. Form 8-K, SEC Filings []
  2. Consumer Credit Outstanding (Levels))

    In the upcoming earnings, the company’s credit performance is likely to continue improving. The credit market is largely dependent on macroeconomic factors and consumer sentiment, as these factors drive borrowing and spending. The U.S. economy has seen a fall in the unemployment rate from 6.6% in January 2014 to 5.5% in Feb 2015, which consequently led to a rise in disposable income. These two factors are likely to spur consumer spending and borrowing, leading to an increase in outstanding credit card balances. ((Bureau of Labor Statistics, U.S. Department of Labor []

  3. Delinquency Rate On Credit Card Loans, All Commercial Banks, Board of Governors of the Federal Reserve System []
  4. America’s Private Student Loan Debt Load Rising, Despite Risks, Costs That Exceed Government Loans, International Business Times []