Discover 3Q profit more than doubles, card use up

AP News
Posted: Sep 22, 2011 5:22 PM
Discover 3Q profit more than doubles, card use up

Discover Card users used their plastic more often during the summer, with higher gas prices adding to increased pursuit of the card's cash-back rewards.

The increased use, combined with better payment habits, helped Discover Financial Services fiscal third-quarter profit more than double.

The Riverwoods, Ill.-based credit card company's results solidly beat Wall Street expectations, which buoyed its stock while the broader markets plunged as fears mounted over the health of the global economy.

Discover shares fell 9 cents, to close at $25.25.

The company reported net income attributable to common shareholders soared to $642 million, or $1.18 per share, for the three months ended Aug. 31. That was up from $258 million, or 47 cents per share, in the year-ago quarter.

Revenue rose 5 percent to $1.79 billion from $1.71 billion last year.

Analysts, on average, were expecting profit of 96 cents per share, on revenue of $1.77 billion, according to a survey by FactSet.

Higher gas prices helped push sales volume on Discover cards up 9 percent to $26.3 billion for the quarter. The average price per gallon during the June to August period was $3.648 per gallon, up from $2.729 the prior year, according to auto club AAA, Wright Express and Oil Price Information Service.

CEO David Nelms said gas purchases make up about 10 percent of sales, and the higher prices contributed about 2 percent of year-over-year growth. While he suspects that some customers have substituted spending on gas for other purchases, Nelms said the company has had difficulty measuring any shift. "The trick is, you don't know what people otherwise would have spent," he said in an interview.

There was a slowdown in spending in late August, when Hurricane Irene hit the East Coast, but Nelms said early results from September showed spending recovering.

Nelms also said customers are keeping their accounts open longer. "We are seeing attrition rates that are the lowest we have seen in over 10 years in our card member base," he said during a conference call to discuss the results. "We are doing a pretty good job of hanging onto our customers."

One reason for the reduced customer loss is less competition. That can be attributed in part to a law that took effect at the beginning of 2010 that restricts how quickly and how frequently card companies can raise rates. The rules make it "harder for competitors to come in and steal customers," the CEO said during the interview.

Discover does not reveal the number of cards its customers have outstanding, but said new customers also contributed to the quarter's growth. Heavier marketing, sponsorship and the appeal of its cash back rewards program are also attracting new customers, Nelms said. An increased number of merchants that accept Discover cards _ up 7 percent from last year _ also helped boost spending.

Nelms said that as more stores accept Discover, sales improve even at stores that were already part of the network, because customers are more used to pulling that card out of their wallet. The number of customers using their Discover cards at least 15 times per month has increased as the number of locations it is accepted has grown, he said. "Small merchants, some of whom didn't take the cards in the past, are increasingly taking the card, and our customers can use us for everything. That helps our sales."

The higher usage was spelled out in figures that showed the volume of purchases its networks processed, including Discover, Diners Club International and its Pulse debit card network, rose 13 percent to $71.89 billion. Revenue from transaction processing rose 10 percent to $44 billion.

The balances customers carried on cards rose 2 percent, the first such increase since the spring of 2009. Yet the company says it also sees more customers paying their balances off each month.

Discover also sharply cut its provision for loan losses, or the money it sets aside to cover unpaid balances, to $100 million, from $713 million last year.

It was able to do so because late payments fell to an all-time low, dropping to 2.43 percent of balances on an annualized basis. That's down from 4.39 percent in the third quarter of 2010, and less than half the all-time high delinquency rate of 5.6 percent in the fourth quarter of 2009.

The rate of defaults, or charge-offs, also dropped by half, to $440 million, or 3.85 percent of balances, from $875 million, or 7.73 percent of balances, a year ago.

Nelms attributed the improvements to the fact that those customers who didn't default during the height of the recession are increasingly reducing their debt.

As a result of the improved payment behavior, Discover released $365 million from its reserves set aside to cover bad loans.

The reserve release helped drive earnings higher, but Sterne, Agee analyst Henry Coffey said investors should focus on the increased spending and higher balances customers are carrying. "That's what drives the business forward," he said, adding that Discover turned in "an amazing quarter."

Discover also got a boost from increased interest payments related to its growing student loan business. It added $3.1 billion in student loans through acquisition during the period. That was partially offset by the sale of $1.5 billion in federal student loans, a part of the business that Discover is exiting.

Discover last year bought The Student Loan Corp. from Citigroup Inc., and has targeted the private student loan market as a growth area.