Discover's Plan to Revamp Rewards Comes with a Cost

Discover Financial Services plans to make it easier for its credit card users to redeem their cash rewards points, the latest salvo in the industry-wide competition to lure customers with more generous perks.

Under Discover's current rules, customers lose their rewards when they become seriously delinquent or close their accounts, Chief Executive Officer David Nelms said in an interview Tuesday. There is also a $50 minimum for redeeming cash rewards, he added.

Riverwoods, Ill.-based Discover expects to eliminate some or all of its restrictions on redemption, though a final decision has not yet been made, according to Nelms. The company said Tuesday that the changes could result in a one-time charge of up to $185 million in the fourth quarter, as well as an ongoing cost of less than 5 basis points per year.

"It could be good for customers at a pretty modest cost to us," Nelms said.

Investors seemed to view the cost as being more significant. Shares in Discover fell by 3.5% in after-hours trading Tuesday after the news broke, despite the company's announcement that its third-quarter net income was 9% higher than it was in the same period last year.

During Tuesday's earnings call, Nelms was quizzed by analysts about the intensity of competition over credit-card rewards offers.

Mark DeVries, an analyst at Barclays Capital, said that he has seen "some offers that just cause you to scratch your head on how the economics work for the issuer."

Nelms downplayed the issue, saying that the competition over rewards offers has been heated for a number of years. "I actually think that there has been more stability in competitive intensity than one might think," he responded.

Also Tuesday, Discover acknowledged that its foray into mortgage lending has not gone according to plan. The company launched Discover Home Loans in June 2012 after acquiring mortgage origination assets from Tree.com.

Discover's third-quarter earnings per share of $1.37 were about a penny lower than they would be without the mortgage business, Nelms told analysts.

In his interview with American Banker, Nelms attributed the struggles to higher regulatory costs and the sharp industry-wide decline in mortgage refinancing.

"We need to generate more revenue to cover fixed costs," Nelms said in the interview.

He noted that Discover currently sells the servicing rights on the mortgages it originates, and he said that retaining those servicing rights might be a way to boost revenue. 

Nelms also fielded questions Tuesday about Apple Pay, the mobile payments initiative that currently works with Visa, MasterCard and American Express cards, but not Discover cards.

"We would like to be added," Nelms said in the interview. "And we just don't know when that will be at this point."

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