Discover Profit Falls 11% as Loan Loss Provisions Climb

Discover Financial Services (DFS), the credit-card issuer that has expanded into mortgages and student lending, said fiscal second-quarter profit fell 11 percent as provisions for loan losses increased and expenses climbed.

Net income in the period ended May 31 dropped to $537 million, or $1 a share, from $600 million, or $1.09, a year earlier, the Riverwoods, Illinois-based company said today in a statement. That matched the average estimate of 22 analysts surveyed by Bloomberg.

Discover, led by Chief Executive Officer David Nelms, 51, has stepped up stock repurchases and is acquiring businesses to expand beyond the firm’s core credit-card operations. The company started offering mortgages this month after buying the assets of Home Loan Center Inc. for $55.9 million and last year became the third-biggest private student lender in the U.S. with the purchase of a portfolio from Citigroup Inc.

“The U.S. consumer has delivered and is now back in a less cautious mode around purchases and spending,” Chief Financial Officer Mark Graf said in a telephone interview. There will be a “continued modest recovery in the health of the U.S. consumer.”

Revenue climbed 6.4 percent to $1.85 billion compared with the same period in 2011, the company said. Provisions for future losses on bad loans rose 32 percent to $232 million. Discover released $110 million from the reserves, compared with a $401 million release last year.

Expenses Jump

Write-offs of credit-card loans deemed uncollectible fell to 2.65 percent in May from 4.82 percent a year earlier, regulatory filings show. Loans at least 30 days overdue, a gauge of future losses, fell to 1.93 percent from 2.88 percent.

Expenses jumped 18 percent to $749 million, including a $71 million increase in legal costs, according to the firm. The “bulk” of the gain is tied to a regulatory probe into Discover’s marketing of fee-based products, including payment protection, Graf said.

The Consumer Financial Protection Bureau and the Federal Deposit Insurance Corp. plan to take a joint enforcement action as a result of the probe, which could hurt net income, Discover said in January. The matter is not yet resolved, Graf said.

Student Loans

Purchases made with Discover cards in the second quarter increased 5 percent to $26.1 billion from a year earlier, the company said. Net interest income climbed $122 million, or 10 percent, to $1.32 billion.

Credit-card loans rose 3.6 percent to $46.6 billion. Moshe Orenbuch, a Credit Suisse Group AG analyst, had predicted $46.8 billion. Other consumer loans rose 38 percent to $10.5 billion, the firm said, matching Orenbuch’s estimate. This portfolio included Discover’s student loans, which jumped to $7.5 billion at the end of May compared with about $4.6 billion a year previously, according to Graf.

Regulators are scrutinizing the marketing and interest rates of private student loans as college costs spiral, which Discover is watching “very closely,” Graf said. The firm charges interest rates of between 6.79 percent and 9.99 percent on fixed-rate student loans, he said.

Top Performer

“I feel very good about the way we tackle and approach that business,” said Graf, who declined to say how much profit Discover makes from student loans. “We feel very strongly that the student loan business is a very good business.”

Discover gained 2.41 percent, or 79 cents, to $33.62 at 1:01 p.m. in New York. The firm’s shares climbed 42 percent in the past year through yesterday, the top performance in the 81- company (S5FINL) Standard & Poor’s 500 Financials Index.

“DFS remains our favorite name among card issuers,” Jason Arnold, a Royal Bank of Canada analyst, wrote in a June 14 note to clients, referring to Discover’s ticker symbol. “We still see no reason to expect credit trends to change course meaningfully anytime soon.

To contact the reporter on this story: Donal Griffin in New York at dgriffin10@bloomberg.net

To contact the editor responsible for this story: Rick Green at rgreen18@bloomberg.net

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