Though the Discover card division was a rare bright spot in Morgan Stanley Dean Witter & Co.'s first-quarter earnings report last week, company executives said they are girding for leaner times ahead.
The good news was that the Discover Financial Services unit booked a 6% rise, year over year, in merchant and cardholder fees and a 4% increase in transaction volumes. Managed loans grew to $49 billion, 5% more than in the previous quarter and 18% higher than a year earlier.
But Robert G. Scott, president of Morgan Stanley Dean Witter, said Discover is bracing for a rocky future. A 14% payroll increase during the quarter was largely an effort to shore up the collections department. Mr. Scott said that as the U.S. economy falters Discover will look to other markets - particularly in Europe and Asia - to sell its products.
Discover said it spent on technology infrastructure so that it can more accurately assess customer creditworthiness and then reduce credit lines to customers who seem to be falling into financial trouble. The company will also try to identify its more creditworthy customers.
"A major part of our strategy here is to increase credit availability to cardholders with good credits," Mr. Scott said. He called the issuer's top customers an "underutilized resource."
Discover's first-quarter income was up $2 million from the year earlier, to $142 million, but down 3% from the previous quarter's $147 million, before adjustments for accounting changes. Mr. Scott said the economic downturn slowed transactions in the latter part of the most recent quarter and prompted a 22-basis-point rise in chargeoffs, to 4.79% of loans outstanding.
In another warning sign, the proportion of Discover's loans that are 30 days delinquent rose 42 basis points, to 6.34%. "The increase in the delinquency rate is something we are very focused on," Mr. Scott said. "It could well portend some further weaknesses in the chargeoff rate, but right now it is hard to say."
Discover was plagued by high chargeoff rates several years ago, and Mr. Scott said the company has learned its lesson. "I think we can say that we have significantly more sophisticated tools this cycle for managing credit quality," he said. "We are aggressively managing delinquencies at a much earlier stage in the process."
One category in Discover's budget that will not be cut, Mr. Scott said, is marketing, which at $315 million was down slightly from the previous quarter but up 13% from a year earlier. He called the quarterly drop a normal pattern and said the company will continue to invest in, among other things, television commercials and offbeat marketing experiments.
"We would consider tweaking marketing spend, in particular the amount of direct mail and other acquisition expenses," Mr. Scott said. "But they will be relatively small changes."
An analysis of Morgan Stanley's results by A.G. Edwards & Sons praised the company's approach with Discover. "Credit quality in its credit card portfolio is weakening, which the company is aggressively addressing through beefed-up collection and administration," the report said. Ultimately, this could lead to "higher provisioning levels, with the possibility of making up some on the yield side of the equation as a result of higher average balances."
