VALUATION HIGHLIGHTS

1. Direct Banking (Discover Credit Cards, Student Loans & Other, Investment Gains & Other Income) constitutes 93% of the Trefis price estimate for Discover's stock.

WHAT HAS CHANGED?

1. Latest Earnings

In Q4 2023, Discover Financial reported revenues of $4.2 billion, which was 13% more than the year-ago period. This could be attributed to a 13% y-o-y increase in Net Interest Income and an 11% rise in noninterest revenues.

The company's top line saw some recovery after 2021, due to improvement in the interest rates and higher consumer spending levels. Notably, the revenues were around $13.34 billion in FY2022 and $15.86 billion in FY2023.

POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

Below we look at the key drivers that present an upside or downside to our price estimate for Discover Financial.

• Average Credit Card Loans Outstanding Discover's average credit card loans outstanding increased from $69 billion in 2021 to $79 billion in 2022. We expect the average credit card loans to grow at an annual rate of 4% and reach ~$100 billion by the end of the Trefis forecast period. However, there would be a 4% upside to our price estimate if loans outstanding reach $115 billion by the end of our forecast period.
• Provision for Losses as % of Average Credit Card Loans Provision for losses is an expense item that represents an estimate of losses on the outstanding loan balance. It is estimated by management, given the composition of its credit portfolios, the probability of default, the economic environment, and the allowance for credit losses already established. This figure declined from 7.60% in 2021 to 7.42% in 2022.

BUSINESS SUMMARY

Discover Financial Services is a leading credit card issuer in the United States and an electronic payment services company. In March 2009, it became a bank holding company under the Bank Holding Company Act of 1956 and a financial holding company under the Gramm-Leach-Bliley Act in connection with its participation in the U.S. Treasury's Capital Purchase Program (CPP).

The firm offers credit cards, personal and student loans, and deposit products. It operates the Discover Network - a credit card payments network, the PULSE Network (PULSE) - its ATM, debit, and electronic funds transfer network - and Diners Club International (Diners Club) - its global payments network.

SOURCES OF VALUE

Strong position in student loan market

Discover is the third-largest student lender in the U.S., behind Sallie Mae and Wells Fargo.

Strong position in credit card market

Discover currently has the # 4 position in the U.S. payment-card network after Visa, MasterCard, and American Express. We expect the company to maintain this strong position throughout our forecast period.

KEY TRENDS

Below are some trends that could have a significant impact on Discover and the credit card industry in general:

1. Greater use of credit and debit cards
   • Americans spent more using cards than with either cash or checks. Even outside the U.S., cards are increasingly used for making payments.
2. Growth in Online Shopping
   • Cards are a preferred mode of payment for online shopping. Online retail sales in the U.S. have been growing at a staggering rate over the past decade. The card transaction volumes have moved from predominantly travel sales (air tickets, car rentals, and hotel reservations) to non-travel and entertainment (T&E) areas such as personal and home care products, electronics, books, and clothing. Rising online sales are expected to benefit card transaction volumes.
3. Credit CARD Act
   • The U.S. government in February 2010 passed into legislation the Credit Card Accountability, Responsibility and Disclosure (CARD) Act, which enforces more disclosure about interest rates, caps on service fees within the first year, well-defined grace periods and also makes it difficult for people under the age of 21 to obtain cards. This could put downward pressure on the total number of cards outstanding.
4. Growth In Mobile Payments
   • Mobile phone payments are rapidly gaining popularity, coinciding with the surge in smartphone sales. As most mobile payments are linked to credit or debit cards, this should drive volumes.