Discover beats expectations on loan growth

Discover Financial Services third quarter earnings beat analyst expectations.
Discover Financial Services’ third quarter earnings beat analyst expectations.

By Megan Hart

Discover Financial Services turned in better-than-expected third quarter earnings that reflect the credit card company’s continued growth.

In the latest quarter, Discover’s net income climbed 8.8 percent to $630 million, or $1.37 per diluted share, from $579 million, or $1.20 per share, in the year-ago quarter.

Chairman and CEO David Nelms cited “robust card loan growth, strong revenue growth and near historically low credit performance” as key profit drivers.

Discover’s per share results beat by four cents the $1.33 a share that analysts polled by Bloomberg had anticipated.

Despite the upside profit performance,  Discover shares came under pressure Wednesday: in mid-day trading the stock was down $2.25, or 3.5 percent, at $62.13.

The Riverwoods, Illinois-based company benefited from an increase in its net interest margin, or the amount the company pays for funds compared to the profit it makes from lending that money out. The margin strengthened 14 basis points from last year to 9.79 percent. According to Discover, lower funding costs helped widen the net interest margin, more than offsetting a low-rate promotional offer the company successfully used to draw in new customers.

Discover’s success may be a sign of a stronger economy, as the historically economy-sensitive company reported an increase in new accounts, a growth in average spending activity by active customers and a surge in card re-activations.

Another factor that contributed to the increase in per-share earnings was a repurchase campaign, in which Discover paid $622 million to buy back about 10 million shares, or 2 percent of its common stock during the quarter that just ended.

Discover’s latest quarter’s results were also helped by a lower tax rate, noted William Blair analyst Robert Napoli.

During a conference call with analysts, company officials cautioned that expenses will be higher in 2015.

Discover reported loan loss provisions for the entire company of $354 million, which is up just over 6 percent compared to last year’s third quarter total of $333 million. Credit quality is continuing to strengthen, the company said: Loan loss set asides rose at a lower rate than did net interest income.

“I think what we’re seeing is a little bit more confidence by the consumer,” Nelms said in a conference call.There were signs, however, that some customers struggled to make payments. For credit card loans, the net charge-off rate grew by 11 basis points from last year’s rate to 2.16 percent. For loans that were over 30 days past due, delinquency rates rose by four basis points to 1.71 percent.

In spite of these setbacks, Napoli said the company’s “low charge-off rate, product innovation, loyal customer base and attractive rewards program should allow Discover to continue to gain market share.”

The company also saw an increase in its student loan portfolio, which grew 5 percent in the third quarter. Student loans, which generate the second-most revenue for Discover, have been a focus of Nelms as he’s tried to diversify the company’s revenue stream.

“In terms of student loans,” Nelms said, “I’m very pleased with the growth that we achieved.”

Napoli said Discover’s student loan portfolio could grow by as much as $15 billion over the next four to six years.

In a conference call to discuss earnings, analysts peppered Nelms with questions regarding the company’s plans regarding Apple Inc.’s newly launched Apple Pay application. Discover is one of the only major credit card companies that is not currently participating in the program. Nelms, however, said he anticipates that this will change.

“I would say that we certainly do expect to be participating in Apple Pay,” Nelms said. “We don’t know when that will be, but we’ll be actively working to be included over time.”