Morningstar | Discover's Growth Continues; Signals Intention to Slow Personal Loan Growth
Narrow-moat Discover Financial Services is tracking modestly ahead of our full-year expectations. In the second quarter, Discover saw net interest income increase 10% from the previous year. Net interest income is also up 10% for the first six months of the year. However, Discover’s efficiency ratio was mostly unchanged from the previous year, which mostly offset the rise in interest income. Given this, we’ll be maintaining our full-year earnings per share estimate of $7.63. For the period, the company still generated loan growth of 9% from the previous year. We suspect this is pressuring net charge-offs, which saw a year-over-year increase of 40 basis points to 3.11%. Discover saw EPS increase 36% to $1.91 from the previous year. However, almost all of this growth was attributable to a lower tax rate. Pretax income increased only 1%. For now, we’ll maintain our fair value estimate at $77 per share, which translates into a price/book value of 2.4 as of June 30.On a sequential basis, Discover increased loans 2.5% from the previous year. During the call, management signaled its intention to slow growth in order to maintain returns. This decision strikes us as reasonable, as we agree that the space is getting competitive and it’s likely we are closer to the end of this credit cycle than we are to the beginning. We find it interesting that management mentioned Goldman Sachs' entry into personal loans as possibly providing some competition in the space and the company’s commentary around personal lending being the easiest product to enter. Also, should Discover decide to slow growth in credit cards, in addition to personal loans, we’d likely see some deceleration in credit provisions, which was the company's biggest hindrance to earnings growth. For the quarter, credit provisions were $742 million, a 16% increase from last year’s second quarter.
One of this quarter’s biggest detractors from performance came in the form of higher rewards cost. Rewards cost grew 19% from last year’s second quarter and increased 17.6% on a sequential basis. It would appear to us that competition for rewards-focused credit cards remains high but not any worse than before.
Discover Financial Services is a bank holding, as well as a financial holding company. The company manages its business activities in two segments: Direct Banking, which includes consumer banking and lending products, specifically Discover-branded credit cards issued to individuals on the Discover Network and other consumer banking products and services, including student loans, personal loans, home equity loans, and deposit products; and Payment Services, which includes the PULSE network, Diners Club International and its Network Partners business, which provides payment transaction processing and settlement services on the Discover Network.
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