Discover Financial Services' (DFS) Pulse debit network posted solid gains in the first quarter, but executives say new regulations banning network exclusivity could prove a hurdle going forward.
The credit card company's pretax income from processing transactions grew to a record $52 million for the fiscal first quarter ended Feb. 29, up 21% from a year prior. The boost resulted from processing more debit transactions on Discover's Pulse network, which signed up 129 new customers in 2011.
Some of those new customers rely on Discover for additional services, boosting the revenue the company earns from small banks that use its debit card network, chief executive David Nelms told American Banker.
"We can provide more fraud models and extra processing services, where a large institution might be able to do that themselves. And some of that has revenue or fees associated with it," Nelms said in an interview Wednesday night.
He added that Discover has yet to see much increased business as the result of a new rule requiring that banks partner with at least two debit card networks. The new rule, slated to go into effect next month, is part of the Durbin Amendment to the Dodd-Frank Act.
"I don't think Durbin had an effect on this quarter's profits or volumes with Pulse to any great extent," Nelms said.
In fact, it may lead to new challenges for Discover. During an investor presentation on Thursday, executives raised concerns about the new pricing plan at rival Visa (NYSE:V).
Visa, stands to lose the most volume under the Durbin rule changes, has rejiggered its pricing plans to prepare for the regulations. The largest payments network has historically had more exclusive routing deals, which are now banned.
"Visa's actions are a concern," Discover's president and chief operating officer Roger Hochschild said during a Thursday morning presentation to investors.
"We'll have to see how that plays out," he said, adding "I'm confident in our ability to compete in a fair and level market."
Visa declined to comment.
While the future growth of its network business is uncertain, Discover's bread-and-butter credit card lending business remains strong.
The company posted a quarterly profit of $631 million, or $1.18 per share, up 36% from $465 million, or 84 cents per share, a year earlier.
"It's a very good quarter," says Sanjay Sakhrani, an analyst with Keefe Bruyette & Woods, pointing in part to the strong credit quality of Discover cardholders.
While analysts wonder "how long these positive and favorable trends can persist … it sounded like [Discover executives] don't see anything changing the course in the short-term," says Sakhrani.
Credit card delinquencies for loans 30 days past due fell to 2.22%, down from 3.59% a year earlier, and the credit card net charge-off rate fell to 3.07%, down from 5.96%.
Discover's Nelms says that the broader economy appears to still be working in the company's favor.
"I think we're seeing modest growth in terms of recovery of sales and we're very pleased that we're one of the few companies that's growing loans," he told American Banker.
"The credit environment remains amazingly benign, and we're not seeing right now anything that would cause that to suddenly increase," he added, pointing to the record-low charge-offs and delinquencies. "That might suggest we're approaching a bottoming, but there's not sign of an increase."
Nelms told analysts in a conference call Wednesday that credit losses could also take longer than expected to tick up to normal.
"Consumers are more cautious and that will show up in lower losses over time," he said. "So, if I had to guess, I would say eventually we're going to see more like 4% to 5% [losses] being kind of a range of normalization. And I think it's going to maybe take longer than we might have expected to get there."
Total loans were up 9% from a year earlier to $56.3 billion. Outstanding credit-card loans, which contracted after the recession, grew 4% year-over-year to $45.9 billion but were down about 2% from the previous quarter.