While waiting for the Capital One merger approval, the nation’s fourth-largest credit card company experienced a record-breaking quarter.
The fourth largest payment processor in the United States, Find Financial Services, (NYSE:DFS), had a record-breaking second quarter with profits up 70% from last year.
The stock of Discover soared after the release of earnings on Wednesday, after the market closed. The stock of Discover rose 4% to $147 on Thursday.
The credit card processor and issuer smashed earnings estimates by bringing in $4.5 Billion in revenue for the quarter. This represents a 17% increase year-over-year. This exceeded median revenue expectations of $4.2 billion.
Discover’s net income was also higher than expected, with earnings of $1.5 billion or $6.06 a share, up 70% on the same quarter last year. Wall Street analysts expected earnings per share of $3.07.
Discover Financial’s performance is a result of a number of factors.
Discover’s success is due to two factors
Discover’s success is due to two factors
Discover’s record-breaking quarter comes as it awaits approvals for a merger with Capital One (NYSE COF), which had proposed to acquire Discover in the beginning of this year. The deal is currently undergoing various regulatory approvals and would close in 2024 or 2025 if approved.
This is not a foregone conclusion. The merger would create an integrated credit card and banking giant by combining Discover, fourth largest payment processor with Capital One, largest bank and credit card issuer. The proposed transaction is sure to face intense regulatory scrutiny.
Discover is continuing to execute as all aspects of its business performed well in Q2. Discover’s strong results were due to two main reasons.
1. Loans increase by 8%
Discover is different than Visa (NYSE-V) and Mastercard NYSE-MA in that it operates a closed business model. This means it is both the card issuer and the lender. It earns net interest from credit card loans, unlike the two big players.
It also differs in that it does not have the same type of deposit franchises as a typical consumer bank. Therefore, its interest expenses are lower.
Credit card rates are high in this period of high interest rates. This generates a lot of net interest income. Net interest income increased by 11% year-over-year to $3.5 billion in the third quarter. This was helped by a 8% increase in the loan balances, which reached $128 billion.
Credit card loans rose 6% to $100 billion in the third quarter. The average yield of its credit card loans increased from $15.14% to 15.99% in the same quarter last year.
The volume of transactions on the payment network increased by 11% to $99.3 billion. This helped boost non-interest fees income by more than 40%, to $1 billion.
2. Provisions for Credit Losses Drop
Discover’s high earnings were also due to its low provision for credit losses. Lenders must set aside a certain amount to account for bad loans resulting from defaults or non-payments. The higher the provisions are for credit losses, the worse off the economy and the labor market is. Higher provisions can often drag down earnings.
In the second quarter of 2018, the provision for credit losses was $739 million. This is a far cry from the $1.3 billion that was set aside in the Q2 of 2023 or the $1.5 billion that was set aside in the first quarter of 2018.
It is important to note that the provisions were lower because Discover announced this past week that it would be selling its portfolio of $10.1 billion in student loans to the Carlyle Group & KKR. This led to an $869 million release of reserves from provisions for student loans credit losses that were not needed. It also led to a smaller reserve build. Both of these factors helped earnings.
Should I buy Discover stock?
Should I buy Discover stock?
The second quarter report was full of good news, but the earnings were boosted by the sale of the student loan portfolio and the resulting lower provision for credit losses.
Credit quality is generally a bit concerning, even after allowing for provisions. The overall net charge off rate – the percentage of debt that won’t be recovered – rose 161 basis point to 4.83%. The good news is, it’s improving. The net-charge rate has fallen 9 basis points since the first quarter 2024.
Also, the 30-plus-day delinquency for credit card loans is 3.69%. This is 83 basis point higher than Q2 of 2023 but 14 basis point higher than Q1 of 2024.
Discover stock is up by 29% YTD including Thursday’s gains. It is also relatively inexpensive with a P/E of 12. Normaly, I would say that it is a good investment, but given the uncertainty surrounding the merger and its already strong return, it is worth being cautious about how much time it has left to run before the deal, if one happens.
This site is intended for entertainment only and does NOT offer financial advice.
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