Why Are American Express’ Revenues 4x Discover’s Despite Both Having Similar Loan Balances?

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American Express (NYSE: AXP) and Discover Financial (NYSE: DFS) are leading credit card companies which operate a closed-loop payment processing network (i.e. they issue cards, and also process payments on their own network). Since the Fed’s rate cut on July 31, Amex and Discover stock have lost 5.5% and 12.5% of their value, respectively, with the U.S.-China trade war expected to result in lower consumption in the U.S.

Trefis compares the various revenues sources as well as operational parameters of American Express vs. Discover Financial in an interactive dashboard. Notably, American Express reported revenues of $40.3 billion in 2018 – roughly four-times the $10.7 billion figure for Discover, even though Discover had a slightly larger loan portfolio of $85.3 billion compared to Amex’s card-only portfolio of $81.9 billion (average for full-year 2018). This article takes a detailed look at their revenue streams to explain this glaring discrepancy.

American Express and Discover Financials Have Identical Revenue Streams, But In Vastly Different Proportions

Net Revenues for American Express and Discover Financials can be broadly classified into two categories:
Net-Interest Income: The interest earned on credit card and other loans (net of expenses) is recorded as net-interest income.
Non-Interest Income: The fees charged for processing transactions on the network are recorded as non-interest income, along-with other commissions.

  • In 2018, American Express and Discover Financial reported $40.3 billion and $10.7 billion of net revenues (before considering credit loss provisions), respectively.
  • Non-interest income and net-interest income had a contribution of 81% and 19% of Amex’s net revenues, respectively.
  • On the other hand, non-interest income and net-interest income had a contribution of 18% and 82% of Discover Financials’ net revenues respectively – almost exactly opposite their respective contribution to American Express’ top line

Their Net Interest Incomes Are Comparable, And In Line With Their Respective Loan Portfolios

  • In 2018 the average credit card loans outstanding for American Express and Discover Financial were comparable at $81.9 billion and $68 billion, respectively.
  • Discover Financial also offers student loans and personal loans, therefore its overall average loan balances were higher than American Express at $85.2 billion in 2018.
  • Owing to its larger loan portfolio, Discover Financials’ net-interest income was higher than American Express in 2018 ($8.8 billion vs $7.7 billion).

But American Express Fares Much Better In Terms Of Non-Interest Income

  • American Express reported $32.7 billion in non-interest income in 2018, as opposed to the substantially lower figure of just $2 billion for Discover.
  • Annual membership charges, delinquency penalty, and currency conversion charges are recognized as net card fees and other commissions by American Express under non-interest income.
  • Loan fee income (fee on loan receivables), protection products revenue (fee charged security services) and transaction processing revenue (charged to financial institutions for utilizing Discover’s pulse network) are the other non-interest revenue sources for Discover Financial.

And This Can Be Attributed Almost Completely To Significantly Higher Discount Revenues

  • Discount revenues contribute nearly 75% of non-interest income for American Express and Discover Financial (cashback bonus rewards are added to discount revenues for calculation), respectively.
  • However, Discover Financial earned just $2.9 billion in discount revenues (including cashback bonus rewards) as compared to American Express’ $24.7 billion. There are 2 reasons for the stark difference:
    • In 2018, network volumes for American Express and Discover Financial were $1.18 trillion and $376 billion, respectively. American Express’ focus on affluent customers, and its sizable portfolio of charge cards (which do not generate any interest revenues) are responsible for higher network volumes for the company
    • American Express also charges much higher discount fees from merchants compared to any of its competitors (Discover, Visa as well as Mastercard). This coupled with higher network volumes translates into elevated discount fees for Amex

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