Discover Posts Record Net as Card Use Rises, Defaults Ease

Discover Financial Services (DFS), the credit-card issuer and payments network that outperformed three bigger rivals in the past year, posted a record second-quarter profit as consumers spent more and defaulted less.

Net income for the three months ended May 31 more than doubled to $600 million, or $1.09 a diluted share, from $258 million, or 33 cents, in the same period a year earlier, the Riverwoods, Illinois-based company said today in a statement. The average estimate of 19 analysts surveyed by Bloomberg was for adjusted earnings per share of 75 cents. Results were aided by a $401 million release from loss reserves.

Chief Executive Officer David Nelms is boosting dividends and buying back stock as Discover benefits from fewer soured loans and expands beyond card-lending. Losses on uncollectible card loans narrowed to 4.82 percent in May from 8.82 percent a year earlier, Discover said in regulatory filings.

“It certainly is a story of improving quality, that’s been the main theme of the last few quarters,” said Michael Taiano, a Sanford C. Bernstein & Co. analyst, who recommends that investors “hold” Discover shares. “The revenue side is really where the questions exist. That’s really where Discover needs to demonstrate an ability to grow.”

Stock Price

Interest income rose 1 percent to $1.57 billion from a year earlier, and credit-card loans fell 1 percent to $45 billion, even as purchases made with Discover cards increased 9 percent to $25 billion, the firm said.

“We’re still waiting for improving consumer confidence and retail and job growth to drive a more normal growth trend in the industry,” said Christopher Brendler, an analyst with Baltimore-based Stifel Nicolaus & Co. who has a “hold” rating on Discover shares. “Once we get into a stronger job market when consumer confidence picks up, people will be more willing to front load their spending.”

Discover rose 17 cents to $23.76 as of 11:17 a.m. in New York composite trading, the only firm in the 82-company Standard & Poor’s Financials Index showing a gain today. The stock had risen 27 percent this year through yesterday, compared with advances of 21 percent for Purchase, New York-based MasterCard Inc. (MA) and 16 percent for New York-based American Express Co. (AXP) San Francisco-based Visa Inc. (V), the world’s biggest bank-card network, has risen 6.1 percent.

The $401 million release from reserves to cover bad loans compared with $277 million in the same quarter last year, as overdue loans dropped to a 25-year low, Discover said.

“Sustained improvements in credit performance have driven substantial releases of credit-loss reserves, a portion of which has been reinvested for growth,” Nelms said in the statement.

Broader Reach

Nelms, 50, has been increasing the firm’s student-loan portfolio and broadening its payment-processing network to compete worldwide with Visa, MasterCard and AmEx.

In January, Discover acquired Citigroup Inc.’s Student Loan Corp. in a $600 million deal that made it the third-biggest U.S. provider of private student loans. The purchase helped to boost the firm’s overall loan portfolio by 5 percent to $52.5 billion.

The company said in February that it will buy about $1.1 billion of deposits from Allstate Corp. (ALL), and last month announced it would buy Tree.com Inc.’s home-lending business for $55.9 million.

Discover tripled its quarterly dividend to 6 cents a share in March and said last week that it may repurchase $1 billion of stock through June 2013.

To contact the reporters on this story: Donal Griffin in New York at Dgriffin10@bloomberg.net;

To contact the editor responsible for this story: David Scheer at dscheer@bloomberg.net.

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