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updated: 9/27/2012 10:44 AM

Discover 3Q profit slips, but tops Street view

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Associated Press

BOSTON -- Discover Financial Services on Thursday reported a slight earnings decline in its fiscal third quarter, but the result easily beat Wall Street expectations as credit card use increased and more customers paid off their card balances on time.

Those gains helped offset higher expenses, including a legal bill from a settlement with regulators, and shares of Discover rose nearly 4 percent in morning trading.

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The Riverwoods-based company reported net income of $621 million, or $1.21 per share, for the quarter ended Aug. 31, after paying preferred shareholders.

That was down 3 percent from $642 million in last year's third quarter. Discover's per-share earnings in the year-ago period were $1.18, slightly lower than in the latest quarter because the company had a greater number of common shares outstanding last year. Discover repurchased about 10 million shares for $350 million in the latest quarter.

The latest quarter's earnings topped the consensus forecast of analysts surveyed by FactSet, who expected $1.03 per share.

Revenue rose nearly 10 percent to $1.96 billion from $1.79 billion, beating analysts' forecast for $1.9 billion.

Shares of Discover rose $1.35, or about 3.7 percent, to $38.37 in late morning trading. The stock has risen more than 50 percent this year, in part due to improvement in customer payment habits.

Discover, which provides banking services including issuing its namesake credit cards, said total loans grew 9 percent from the year-ago quarter to $59.2 billion. Credit card loans and Discover card sales volume both increased 4 percent.

Nomura Equity Research analyst Bill Carcache said in a note to clients that the card loan growth suggests that Discover continues to gain share in the revolving credit market, which he estimated is growing at a 1 percent annual rate.

Carcache, who has a "buy" rating on the stock, characterized the company's quarterly revenue performance as a "solid" beat compared with expectations. He attributed the performance in part to better-than-expected net interest income, as money earned from loans increased 11 percent compared with a year ago, due to loan growth and lower interest expenses.

Discover Chairman and CEO David Nelms said card sales and customer payments on balances due "grew in a challenging environment while credit quality continued to improve."

The third-quarter increase in total loans came amid a slump in consumer sentiment due to the slow economic recovery and weak hiring. Discover tracks sentiment through a monthly index of spending intentions, and reported its Discover U.S. Spending Monitor fell to its lowest level of the year in August.

Credit card loans over 30 days past due fell to an all-time low, dropping to 1.81 percent of balances on an annualized basis, from 2.43 percent a year ago.

Charge-offs, or loans written off as unpaid, fell $151 million from a year ago, due to declines in delinquencies and bankruptcies.

Discover increased its provision for loan losses by 26 percent to $126 million, as the company set aside more money while making more loans.

Discover also said the yield earned from credit cards declined, due to fewer high rate balances and an increase in promotional rate balances.

Expenses jumped 29 percent to $826 million, primarily because of a $94 million increase for legal reserves due to a regulatory agreement announced last week.

Discover agreed to pay a $14 million fine and refund $200 million directly to certain customers under deal with the Federal Deposit Insurance Corp. and the U.S. Consumer Financial Protection Bureau. The agreement resolved accusations by regulators that Discover pressured credit card customers to buy costly add-on services like payment protection and credit monitoring. Discover previously established a reserve of $115.9 million in anticipation of the settlement.

Expenses, as well as revenue, are both up in part because Discover's operations have grown. The company closed in June on its $45.9 million acquisition of Tree.com Inc.'s mortgage business and began originating residential mortgages. Discover also recently added a fixed-rate private student loan product, and its first major affinity credit card.

In the latest quarter, Discover reported a 13 percent increase in transaction volume at its payment services business, to $50.3 billion. That segment, which competes with Visa and MasterCard, reported a 31 percent increase in pretax income, to $49 million.

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