Discover's treating downturn as a matter of when, not if

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Income from late fees climbed last quarter at Discover Financial Services, as did loan delinquencies and charge-offs in the company’s flagship credit card business. Still, the firm said that consumers generally remain positioned to meet their financial obligations.

“The U.S. consumer is holding up well,” Discover CEO Roger Hochschild said Tuesday during the firm’s quarterly earnings call. “But we remain disciplined and conservative in credit because it feels late-cycle, and certainly is by any historic measure.”

Various measures of credit performance at Riverwoods, Ill.-based Discover worsened during the third quarter, as compared to the same period in 2018.

Loans that were at least 30 days delinquent made up 2.5% of the company’s credit card portfolio, up from 2.32% a year earlier. Discover charged off $784 million in card loans, a 16% increase. Income from late fees totaled $120 million, which was up 17%. The provision for loan losses rose 8% to $799 million.

Analysts at Compass Point Research & Trading wrote in August that Discover’s loss rate in credit cards would be higher if not for the company’s stepped-up efforts to modify loans to troubled borrowers. Discover has said that $2.68 billion of its credit card loans were modified as of June 30, which was roughly $1 billion higher than the same period a year earlier.

Hochschild said in an interview Tuesday that the majority of the company’s modified credit card loans are performing well. He also told analysts that the weaker credit trends are being driven more by recent growth in the company’s loan portfolio than by the performance of its more seasoned loans.

Discover reported 7% growth in credit card loans during the third quarter, continuing a recent pattern in which the company has been growing its card business faster than many competitors. Newer credit card loans tend to have higher losses than older ones.

Discover has been signaling its expectation that its credit metrics would worsen in 2019, so the third-quarter numbers were not a surprise to investors. In fact, the $110.8 billion-asset company is tracking toward the lower end of its full-year guidance on the percentage of loans that get charged off, said Chief Financial Officer John Greene.

Hochschild expressed confidence that Discover is well positioned to respond quickly if it sees signs of an economic downturn. The consumer lender would tighten its criteria for card applicants who have near-prime credit scores, and also take steps to manage the credit lines available to existing customers, he said.

Discover has also been investing more in its efforts to recover money from consumers whose accounts get charged off. The company’s professional fees rose by 14% in the third quarter, which it attributed primarily to higher commissions paid to vendors that make recoveries.

“We have a very strong, stable management team that has operated through multiple cycles,” Hochschild told American Banker. “And consumer lending is a cyclical business.”

For the third quarter, Discover reported net income of $770 million, up 7% from the same period a year earlier.

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Credit quality Credit cards Earnings Consumer lending Discover Financial Services
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