Discover Financial Services (DFS) reported third-quarter earnings per share of $1.18, dramatically ahead of both the Zacks Consensus Estimate of 91 cents and 47 cents recorded in the year-ago quarter. Net income spiked substantially by over 148.7% year over year to $649 million from $261 million.
Net income allocated to common shareholders also surged to $642 million from $258 million in the year-ago quarter.
The surge in profits was driven by strong sales volume complemented by lower interest expense, reduced provision for loan losses and delinquency rates based on improved credit quality. The profit was also boosted by the escalated income from both direct banking and payment services business, which also drove the book value per share. However, these were partially offset by increased operating and tax expenses.
Total revenue, net of interest expense, increased 4.6% year over year to $1.79 billion, also exceeding the Zacks Consensus Estimate of $1.48 billion. Net interest income increased 7.8% year over year to $1.24 billion. However, total expenses also increased 13.4% year over year to $642 million.
Direct Banking Segment
The Direct Banking segment reported a pre-tax income of $1.0 billion, reflecting a $614 million increase from the year-ago quarter. The pre-tax income in the reported quarter included $24 million from Student Loan Corporation (SLC). Discover card sales volume grew 9% year over year to $26.3 billion, primarily due to increased spending by existing consumers, growth of new customers and increased gas prices.
Total loans improved 8% year over year to $54.1 billion, driven by an increase of 2% in credit card loans, $3.8 billion in private student loans and $732 million in personal loans. This was partly offset by the sale of $1.5 billion federal student loans, in a move to exit the business. The increase in student loans included $3.1 billion from the SLC acquisition in the first quarter of 2011.
Other income reduced 3% year over year to $15 million, primarily due to a decline in late fees income, which offset the increase in net discount and interchange. The reported quarter’s figure includes a $20 million gain related to the liquidation of the Golden Key investment.
The credit card net charge-off rate declined 388 basis points (bps) year over year and 116 bps from the prior quarter to 3.85%. Moreover, the over-30-days delinquency rate was at an all-time low of 2.43%, having improved substantially by 196 bps year over year and 36 bps sequentially, reflecting an overall better credit trend since the fourth quarter of 2009.
Provisions for losses dramatically declined 86% or $613 million year over year to $100 million, reflecting lower charge-offs and a reduction in the allowance for loan losses. The trend also contributed to a reserve release of $359 million in the reported quarter, up from $187 million in the year-ago quarter.
Additionally, expenses in the segment soared 14% year over year based on higher compensation expenses, investments in growth initiatives and expenses related to the SLC.
Payment Services Segment
The Payment Services segment’s pre-tax income grew 3% year over year to $38 million. Revenues were up $3 million, reflecting an increase in transactions and higher margin volume on the PULSE network. However, expenses also increased $2 million, primarily due to investment in infrastructure.
Payment Services dollar volume accelerated 15% from the year-ago quarter to $45 billion, reflecting higher PULSE, Diners Club International and third-party issuer volume. The number of transactions on the PULSE network increased 8% year over year.
Business Update
On September 1, 2011, Discover made a Securities and Exchange Commission filing for the purchase of $2.5 billion worth of private student loans from Citigroup Inc. (C). The purchase price is $2.48 billion, which translates into a discount of 1% on the outstanding balance and accrued interest. The purchase deal is expected to be closed by September-end this year. Discover will use its liquid assets and available cash to fund the purchase.
Share Repurchase Update
Discover repurchased 8.4 million shares in the third quarter of 2011 under the $1 billion share repurchase program authorized in June 2011. The total purchase price for the shares was $198 million.
Dividend Update
On September 14, 2011, Discover declared a quarterly dividend of $0.06 per share on its common stock, payable on October 20, 2011, to stockholders of record as on October 6, 2011. During the first quarter of the year, the company had increased its dividend from $0.02 per share, paid until the fourth quarter, in order to restore its dividend payout to the pre-financial crisis level.
Discover currently caries a Zacks #2 Rank, implying a Buy rating in the short term.
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