Discover Financial Services reported net income for the third quarter of 2010 of $261 million, as compared to net income of $577 million for the third quarter of 2009. The results for the prior year included approximately $287 million (after tax) related to the Visa/MasterCard antitrust litigation settlement.
Third Quarter Highlights
Discover card sales volume of $24 billion in the quarter continued to show positive growth trends,
increasing 5% from the prior year.
Net interest margin of 9.16% remained relatively stable as compared to the prior quarter, as the impact
of legislative changes was offset by lower interest charge-offs.
Credit performance continued to improve, with net charge-offs down $102 million from the prior quarter
and a net charge-off rate for the third quarter of 7.18%.
Loans over 30 days delinquent declined $180 million in the quarter, which led to a $187 million release
of loan loss reserves.
Payment Services processed record transaction volume in the quarter of $39 billion and showed
continued strong results with profit before tax up 36% from the prior year.
Deposit balances originated through direct-to-consumer and affinity relationships grew $1.5 billion in
the quarter to $19.1 billion.
“The very positive credit trends that began to manifest themselves earlier this year continued to benefit
our results this quarter,” said David Nelms, chairman and chief executive officer of Discover. “The
ongoing improvement in the outlook for credit performance of our cardmembers has enabled us to
accelerate investments for long-term profitable growth. In addition, Discover card spending continued to
grow nicely this quarter and our third-party credit and debit network businesses achieved record
The discussion that follows compares amounts reported for the third quarter of 2010 to 2009 on an “as-adjusted” basis(1). The table below reconciles the 2009 as-adjusted amounts with the relevant measure on an as reported basis where appropriate, and shows the comparable 2010 U.S. GAAP results.
Direct Banking pretax income of $395 million in the third quarter of 2010 was a $177 million improvement from the third quarter of 2009, as adjusted.
Discover card sales volume grew 5% from the prior year, the fourth consecutive quarter of year-over-year growth, as the average spend from our most loyal customers increased and the company continued to increase merchant acceptance. Credit card loans were $45.2 billion, essentially unchanged from the prior quarter and down $2.9 billion from the prior year, driven by a reduction in promotional rate balances and an increase in the payment rate.
Total loans ended the quarter at $50.1 billion, down 2% compared to the prior year, as the decline in credit card loans was partially offset by an increase in student loans. During the fourth quarter of 2010, the company expects to sell approximately $1.4 billion of certain eligible Federal Family Education Loan Program (“FFELP”) loans to the U.S. Department of Education (“DOE”) as part of the DOE’s loan purchase program.
Net interest margin was 9.16%, a decrease of 79 basis points from the prior year as adjusted and relatively flat to the prior quarter. The decrease from the prior year reflects the increase in lower rate student loan balances, the impact of legislative changes on credit card yield and higher funding costs. This decrease was partially offset by a reduction in promotional rate credit card balances and lower interest charge-offs. Net interest margin was flat to the prior quarter as the impact of legislative changes on credit card yield was offset by a decrease in interest charge-offs.
Loans delinquent over 30 days continued to decline from the fourth quarter of 2009 peak as credit trends continue to improve. The delinquency rate was 4.16%, an improvement of 95 basis points from the prior year, and 36 basis points from the prior quarter. The net charge-off rate decreased to 7.18% for the third quarter of 2010, down 122 basis points from the prior year and 79 basis points from the prior quarter.
Provision for loan losses of $713 million decreased $373 million, or 34%, from the prior year, as adjusted, driven by lower charge-offs and a reduction in the allowance for loan losses. Improvement in the outlook for credit performance over the next twelve months led to a reduction in the loan loss reserve rate, which resulted in a reserve release of $187 million in the third quarter of 2010 versus a reserve build of $7 million in the third quarter of 2009.
Other income decreased $19 million, or 4% from the prior year as adjusted, primarily due to lower late fees and the discontinuance of overlimit fees beginning in February 2010. This decrease was partially offset by a gain related to the liquidation of collateral supporting the company’s previously disclosed Golden Key investment and higher discount and interchange revenue from higher sales volume.
Expenses were up $45 million, or 9%, from the prior year, reflecting increased account acquisition, advertising and promotional marketing spending, partially offset by cost containment initiatives.
Payment Services pretax income of $37 million in the quarter was up $10 million, or 36%, from the prior year. Revenues were up $7 million, reflecting increased volumes from new and existing clients, as well as higher margins from transactions on the PULSE ATM/Debit network. Expenses were down $3 million, as the third quarter of 2009 included a number of significant Diners Club marketing initiatives.
Payment Services dollar volume was a record $39 billion for the third quarter, up 8% from the prior year, driven by higher PULSE and Third-Party Issuer volume. The number of transactions on the PULSE network increased 17%.
Proposed Acquisition of the Student Loan Corporation
On Sept. 17, 2010, Discover announced that it has reached an agreement to acquire The Student Loan Corporation (“SLC”) for $600 million, or $30 per share. Separately and immediately prior to the closing of Discover’s transaction, SLC will sell $28 billion of assets to Sallie Mae and $9 billion of assets to Citibank. Discover will acquire $4.2 billion of private student loans and related assets at an 8.5% discount, along with $3.4 billion of SLC’s existing asset-backed securitization debt funding. The amount to be paid by Discover for the private student loan assets is subject to a post-closing purchase price adjustment between Discover and Citibank, which owns 80% of SLC’s outstanding common stock. Completion of the acquisition, which is expected by Dec. 31, 2010, is subject to certain conditions including, among others, approval by SLC’s stockholders, the closing of SLC’s asset sale transactions with Sallie Mae and Citibank and any regulatory approvals.
Conference Call and Webcast Information
The company will host a conference call to discuss its third quarter results on Monday, Sept. 20, 2010, at 10:00 a.m. Central time. Interested parties can listen to the conference call via a live audio webcast at http://investorrelations.discoverfinancial.com.
Discover Financial Services (DFS 16.10, +0.53, +3.40%) is a direct banking and payment services company with one of the most recognized brands in U.S. financial services. Since its inception in 1986, the company has become one of the largest card issuers in the United States. The company operates the Discover card, America’s cash rewards pioneer, and offers personal and student loans, online savings accounts, certificates of deposit and money market accounts through its Discover Bank subsidiary. Its payment businesses consist of Discover Network, with millions of merchant and cash access locations; PULSE, one of the nation’s leading ATM/debit networks; and Diners Club International, a global payments network with acceptance in more than 185 countries and territories. For more information, visit www.discoverfinancial.com.