Morgan Stanley said fiscal second-quarter earnings at its Discover Financial Services Inc. dropped 19% from a year earlier, and the investment banking firm sent new signals that it might reconsider its spinoff plan for the unit.
David H. Sidwell, Morgan Stanley’s chief financial officer and an executive vice president, sounded uncertain about the spinoff plan, announced in April.
“We have to be mindful of the [market] environment,” Mr. Sidwell said on a conference call Wednesday. “It is definitely weaker than when we talked about it in April.”
Richard X. Bove, an analyst at Punk Ziegel & Co., said Mr. Sidwell sounded like “he was backpedaling like crazy” on the plan. “It sounded like he was moving very definitely in the direction of ‘We won’t do this thing.’ ”
On the call, Mr. Sidwell said Morgan Stanley wants “to make sure we understand all the synergies and dis-synergies” of a Discover spinoff.
Funding costs for the card business are high on the list of considerations, but there are other things to consider, he said.
“We continue to be very focused on analyzing the merits of a Discover spinoff, and apart from mechanical aspects of the spinoff, we are spending a significant amount of time on key areas — first, ensuring the transaction enhances overall shareholder value, and second, on working closely with the ratings agencies to make sure Discover will be well-positioned as a stand-alone company,” Mr. Sidwell said.
“We believe with its current allocated capital base of $4.3 billion, and retained earnings prior to spinoff, it will be appropriately capitalized at $4.5 to $4.7 billion,” he said.
In language that made it clear the spinoff was no done deal, he said, “We will keep you updated as a definitive decision is made.”
Mr. Bove said Discover’s lackluster earnings during the quarter, which ended May 31, could make investors less interested in a spinoff.
Discover’s earnings fell 19% from a year earlier, to $242 million, in spite of a deal announced early this year in which Wal-Mart Stores Inc. is using the Riverwoods, Ill., issuer’s network to process its credit cards.
Mr. Bove called the overall results “much worse than expected.”
In a note to clients Wednesday, Glenn Schorr, a UBS Warburg analyst, called it a “tough quarter” all around for Morgan Stanley.
Mr. Sidwell identified higher marketing costs as one of the factors that held down Discover’s earnings during the quarter, and he said it will continue to incur marketing costs for other such potential deals in the coming quarters.
Noninterest expenses rose because of an increase in marketing costs, compensation, and Pulse operating expenses. Discover acquired Pulse during the first quarter.
Discover’s managed loans were unchanged from a year earlier but fell 2% from the fiscal first quarter, to $46.8 billion. Net interest income fell $108 million from a year earlier. Managed merchant, cardholder, and other fees rose 4%, to $486 million. Transaction volume rose 4%, to $25.4 billion; Discover said record sales were somewhat offset by lower balance transfers.
Analysts lauded the issuer’s falling loss rate. The chargeoff rate dropped 154 basis points from a year earlier, to 4.94%, its lowest level in four years. The over-30-day delinquency rate fell 98 basis points, to 3.9%, the lowest rate since 1988, when the Discover Card was just a few years old.
But the lowered losses, and a lower provision for loan losses, were offset by lower net interest income and lower revenue associated with mortgage loan sales.
