Despite Falling Earnings, Discover’s Loan Division Continues To Grow

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DFS: Discover Financial Services logo
DFS
Discover Financial Services

Discover Financial Services (NYSE: DFS) announced its first quarter earnings on Tuesday, April 21. Discover reported a 7% year over year decline in net income to $586 million, leading to a 2% decline in earnings per share to $1.28. Even with the earnings decline, EPS still beat the $1.27 consensus estimate. [1] The first quarter earnings decline was driven by increasing expenses and weak performance by the Payment Services division, although the company benefited from a modest increase in credit card loans.

There was a 4% uptick in total revenue, net of interest expense, on a year over year basis, owing to robust growth in the loan segment. While net interest income increased by 4% year over year, the company saw an 11% increase in total expenses that dragged down the top line. Expenses increased in part due to the increased cost of anti-money-laundering and related compliance programs. The FDIC warned the company last year of possible deficiencies in its anti money-laundering program. Discover then stated it would put a new anti-money-laundering compliance program in place.

Our price estimate of $64 for Discover’s stock is over 10% higher than the current market price.

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See Full Analysis For Discover Financial Services Here

Growing Loans Drive Direct Banking

Discover’s Direct Banking business includes credit cards, student loans, personal loans, home loans and deposits. Revenue from this segment saw a 5% year-over-year increase, reflecting growth in loans, though it saw an 11% year over year decline in pretax income to $881 million. This was partly due to a 43% increase in loan provisions as well as a moderate increase in the charge-off rate. [2]

  • Credit Cards: 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, with interest income accounting for more than 68% of Discover’s revenues. Credit card loans, which represent approximately 80% of the company’s loan portfolio, increased by 5% year over year. Meanwhile, Discover’s card sales volume increased by over 3% year over year. The net charge-off rate of 2.4% represents a 14 basis point increase over the previous quarter, and an 8 basis point increase over the first quarter of 2014, but is still below the industry average of 3.04%. Card receivables also increased by over 5% year over year. A low charge-off rate and an increase in the credit card loan portfolio indicates a strong credit performance by the company.  [3]
  • Other Loans: Other loans include private student loans and personal loans. The company reported an increase of 3.9% in private student loans and 17.5% in personal loans. This was aided by 20% organic growth in the student loan portfolio and 18% organic growth in personal loans over the prior year. Discover accounts for 6% of the approximately $150 billion in private student loans in the U.S., and we expect Discover’s market share and interest revenue from this segment to see solid growth going forward. [4]

Loss Of Co-Branded Merchants Continue to Hit Payment Services

The Payment Services segment is comprised of PULSE, Diners Club International, and cards issued by third-party networks. In the first quarter, Payment Services revenue reported a 4% decline in pretax income. Payment Services revenues declined by $5 million compared to the first quarter of the prior year, due to the loss of Sam’s Club and Wal-Mart (NYSE:WMT) as network partners to rival MasterCard.

Payment Services transaction dollar volume was relatively flat compared to the prior year. PULSE’s transaction dollar volume dropped 3% year-over-year, while Diners Club International’s volume dropped by 1%. Diners Club International faced FX headwinds as the dollar continued to strengthen against other major currencies. On an FX adjusted basis, the transaction volume for Diners Club increased by more than 10% year over year, owing to strong market growth in the Asia Pacific region.

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Notes:
  1. Form 8-K, Press Release []
  2. Discover Financial Services (DFS) CEO David Nelmson Q1 2015Results – Earnings Call Transcript, Seeking Alpha []
  3. Charge-Off and Delinquency Rates on Loans and Leases at 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 []