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updated: 9/27/2012 5:11 PM

Discover shares soar as profit beats estimates

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Bloomberg News

Discover Financial Services gained the most in more than a year after the credit-card lender posted a fiscal third-quarter profit that beat analysts' estimates on fewer soured loans.

Discover rose 7.3 percent to close at $39.71 in New York, the highest since being spun-off by Morgan Stanley in June 2007 and the most since Aug. 11, 2011. The shares have advanced 65 percent this year, the second-best performance in the 81-company Standard & Poor's 500 Financials Index.

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Net income in the quarter ended Aug. 31 fell 3.4 percent to $627 million, or $1.21 a share, from $649 million, or $1.18, a year earlier, the Riverwoods, Illinois-based company said in a statement. The average estimate of 22 analysts in a Bloomberg survey was $1.03 a share.

"It was a great quarter," said Henry Coffey, an analyst with Sterne, Agee & Leach Inc. in New York, who has a buy rating on Discover shares. "Across the board you had favorable trends in every class of loans except student loans."

Discover last month after announced a transaction- processing deal with EBay Inc.'s PayPal unit that will drive more business to the lender's network. Chief Executive Officer David Nelms has repurchased shares as write-offs and delinquencies improved.

"We've been predicting the bottom for the last few quarters and we've been wrong," Nelms, 51, said in a telephone interview. "But mathematically it just can't get much better than it is now."

Defaults and late-payment rates at Discover are the second- lowest among the six biggest U.S. card lenders, after American Express Co. Loans deemed uncollectible fell to 2.19 percent in August from 3.6 percent a year earlier, regulatory filings show. Loans at least 30 days overdue, a signal of future defaults, dropped to 1.79 percent from 2.49 percent.

'Historic Lows'

Discover wrote off $308 million in soured loans for the quarter, a 33 percent decline from the same period last year. Delinquent loans have reached "historic lows," the firm said. Losses on credit-card loans will probably climb beginning early next year, Fitch Ratings said today in a statement.

Purchases made with Discover cards increased 4 percent to $27.2 billion from a year earlier, the lender said. Net interest income climbed 11 percent to $133 million and credit-card loans rose 4 percent to $48.1 billion.

Net interest margin, the difference between what a firm pays in deposits and charges for loans, increased to 9.44 percent from 9.26 percent a year earlier. The measurement is "the key metric and the most important income-statement driver," Donald Fandetti, an analyst with Citigroup Inc., said in an interview.

Margins will probably remain above 9 percent this year, Nelms said. This "elevated" level is tied to loan losses and a lower cost of borrowing, he said.

Discover agreed to give $200 million in refunds to customers and pay $14 million to resolve U.S. regulatory claims concerning the marketing of credit-protection products sold by phone, the firm said last week. Legal costs increased $94 million compared with a year earlier due to expenses associated with the U.S. probe.

The deal with the Federal Deposit Insurance Corp. and Consumer Financial Protection Bureau is the second this year over credit-card add-on products designed to help customers manage debts in case of a job loss or other catastrophic event. In July, the agencies reached a similar settlement with Capital One Financial Corp.

Discover is on a "glide path" to selling fewer of these products, Nelms said.

"We're going to be putting more resources elsewhere," Nelms said. "But we've also said that we're continuing to offer these products to the people that feel like what we offer is of a high value."

The processing agreement with San Jose, California-based EBay will allow PayPal customers, who use the service almost exclusively online, to shop at more than 7 million U.S. merchant locations that accept Discover. That could boost Discover's annual earnings by 6 cents a share to as much as 23 cents, Citigroup's Fandetti said.

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