Discover Financial Services (DFS), upbeat after beating analysts' earnings expectations, delved into its plans Thursday to grow beyond its flagship credit-card business.
The company earned $627 million during the quarter that ended Aug. 31, buoyed by a 30-day credit card delinquency rate that fell to 1.71%, a historically low level.
"Both our delinquency and charge-off rates for credit cards are the lowest they've been in our 26-year history," Discover Chief Executive David Nelms said in an interview. "So we feel very good about that."
The biggest blemish of the quarter for the Riverwoods, Ill.-based firm involved a settlement that requires Discover to repay $200 million to cardholders who bought its credit protection products. Federal regulators alleged that Discover used deceptive marketing tactics to sell the products.
Discover Chief Financial Officer Mark Graf told analysts Thursday that the company does not plan to stop marketing the credit-card add-on products, but it does expect the revenue it collects from them to fall.
Discover has collected $100 million to $110 million from protection products in each of the last five quarters, which is slightly more than 5% of the company's total revenue.
"I think that in the big picture, this is a relatively modest part of our revenues and profits," Nelms said.
To replace the expected loss of revenue, Nelms said the firm will continue to grow its core credit-card business, as well as to push into new areas, including mortgage lending.
The credit-card issuer launched Discover Home Loans in June after buying mortgage origination assets from Tree.com. The firm is looking to cross-sell mortgages to its existing base of credit-card customers and, over time, sees its mortgage origination business playing a bigger part of its consumer banking strategy.
"It's obviously still new to us, but our focus is on providing the best service in the industry," Nelms said. "And one of the things that we try to do is to make it simpler for consumers, to get it done faster and more predictably for consumers, and to have better communication with consumers on the Internet or by phone."
Another area where Discover sees the potential for strong growth — despite the fact that delinquencies and chargeoffs rose in the most recent quarter — is private student lending. Discover's student loan portfolio has grown by more than 50% in the last year, and Nelms said that he expects the business to continue to grow faster than Discover's credit-card operations.
"We see that both the number of enrollments and the average tuitions continue to grow. And some of the states and other people are cutting back on money available for school, so there's certainly a growing need," Nelms said.
"And fundamentally, college education for the vast majority of people is the best investment they can make. So if we can help parents and students pay for that, that is a good growth business, and something that really benefits consumers," he added.
Discover officials also discussed their new partnership with PayPal, which is expected to allow consumers, starting in 2013, to use their PayPal accounts in more than 7 million U.S. retail locations that accept Discover cards. The deal gives Discover access to what PayPal says is an active customer base of 50 million Americans.
In addition, Discover officials described the PayPal alliance Thursday as a move that may eventually allow their firm to grow their business globally. In the United States, they said it will not only generate fee revenue, it will also put pressure on more merchants to sign on to the Discover network.
"So I think that it's really allowing us to leverage and monetize our payments assets," Nelms said.
Analysts and investors responded positively Thursday to Discover's earnings report, in which revenue rose by about 10 percent from the year-earlier period to nearly $2 billion. Earnings per share were $1.21, 18 cents better than the average of analysts' estimates, according to Bloomberg.
"I think they crushed it," said Henry Coffey, an analyst with Sterne Agee of Discover's performance.
Discover's shares were trading at $39.40 late Thursday, up 6.4%.