New York — David Nelms may never escape his underdog status. But he's gotten adept at using it to his advantage.

The longtime chief executive of Discover Financial Services, the credit card company mixing the blue-collar heritage of Sears with the blue blood of Morgan Stanley, has spent the last two years in a relatively enviable position. Losses on soured credit card loans have subsided after the financial crisis, while Discover's profits, loan portfolio and share price are all growing.

Regulatory challenges are looming anew, including a federal probe into Discover's marketing of credit card payment protection plans. But the company has so far successfully warded off the worst of the laws crimping its bigger rivals — including much of last year's debit-card swipe fee smackdown. Smaller in debit than Visa Inc. and MasterCard Inc., Discover had less to lose from the much-loathed Durbin amendment capping debit interchange fees.

Discover might always be "a second-tier card," as one banking consultant dismisses it.

But Nelms, a tall, soft-spoken 50-year-old with a penchant for wearing orange ties (to match the company's logo), is skilled at emphasizing the positive.

"People always focus on, 'Well, you're not as good as MasterCard and Visa.' But there's no one besides us that is almost as good as MasterCard and Visa," he said in an interview with American Banker.

That statement is vintage Nelms in its earnest, Midwestern optimism — as is the careful asterisk he hastens to add to his boast. American Express Co., widely considered the first runner-up to Visa and MasterCard, "doesn't have anything in debit," unlike Discover's Pulse debit network, he says.

An engineer by training who is regularly praised by colleagues as "very analytical," Nelms' first job out of business school was at Bain & Co., where his office was around the corner from that of now-presidential candidate Mitt Romney. He then honed his credit card knowledge at giant specialist lender MBNA Corp. before leaving in 1998 for Discover. Named CEO in 2004, he guided the credit card unit founded at Sears through its spinoff from Morgan Stanley in 2007.

Now it is sponsoring football games and hockey leagues. Sitting in a downtown Manhattan hotel in mid-January, Nelms was fresh from a trip to Miami to watch the second straight Discover Orange Bowl. (The color is somewhat of an obsession for the suburban Chicago company, which in 2010 signed a four-year sponsorship deal for the game. This year, "the disappointment was poor Clemson — they were the orange team and they got killed," Nelms says, half-joking.)

A father of three sons in their 20s, Nelms spoke to American Banker as he was preparing to go on vacation with his wife to Kenya and Tanzania. The safari will be about "taking pictures, not shooting animals," he says. "I had some frequent flier miles that were about to expire on British Air, and … the kids are gone."

Many of the company's investors say he has earned a vacation. Nelms has expanded Discover beyond its orange-flecked credit cards into other types of banking, including online deposits, mortgages and student loans, and the lucrative business, dominated by Visa and MasterCard, of processing card transactions for banks.

"He's done a solid job. … People are starting to see this as more than just a pure-play credit card company, and it's got a growing network," says Alan Villalon, a senior analyst at Nuveen Investments, which owns Discover shares.

The Discover network is "a growth vehicle for a challenged industry right now, and it's going to take some share away from other guys," he says.

Of course, while the network is growing, whether it is "almost as good as Visa and MasterCard" depends on whom you talk to. Discover processed $280 billion in volume on its network in 2011, compared to $5.6 trillion at Visa alone in its last reported 12-month period.

The company has only signed up about 30 banks to issue cards on its credit card network since 2004, when an antitrust court victory allowed Discover and American Express to start fully competing with Visa and MasterCard. (Nelms adds that the company has some 4500 banks directly using Pulse, which it bought in 2005 — though banks generally use Pulse as a secondary, back-of-the-card network alongside a Visa or MasterCard signature debit network.)

Discover claims to have largely closed "the acceptance gap," but Nelms admits that some cardholders can still run into problems using its cards, especially in big cities with lots of small businesses.

"In a place like New York or L.A., it's the single-outlet merchants that may not take Discover or American Express," he says. "You go out to the suburbs and it's all about Target and Chili's, and you tend to get much more of the chains," which generally accept all types of credit and debit cards.

And international acceptance is still a problem, despite Discover's efforts to refurbish and integrate the once-storied Diners Club International network it bought from Citigroup Inc. in 2008. Almost four years later, customers still cannot widely use their Discover cards in many popular tourist destinations, including France, England, Spain, Germany or Argentina.

"In some places in the world our acceptance is very robust. In other places we have a lot of work to do," Nelms says.

Discover chief operating officer Roger Hochschild acknowledges in a separate interview that Diners "sometimes gets overlooked when people look at Discover."

And some industry members are more impatient with the company's network business, and particularly with its lack of visible progress with the Diners purchase.

"They're the network I've been waiting for for years. There's so much opportunity, and I haven't seen it" yet, says payments consultant Philip Philliou, a former executive at MasterCard and American Express Co., who has long described himself as "an enormous fan" of Discover and its potential.

He expresses frustration with Discover's still-lagging international acceptance, and adds, "They just get by."

But the handful of bankers who issue credit cards on the Discover network say they are happy with the results.

"Discover has built up quite a bit of brand equity around cash-back [rewards], and we're seeing a specific set of the market that's attracted to that," says Stephen Eulie, who runs the credit card division at First National Bank of Omaha, which started issuing cards on the Discover network in March 2011.

"We've booked quite a few accounts and we're not hearing any complaints about acceptance issues at all, either domestically or overseas," he says. "We're happy — they've got a great brand, a good network, good acceptance … and they're good people to work with, too."

When asked if he is happy with the growth in Discover's network business, Nelms says, "We've come a long way" since the 2004 antitrust victory. But a few minutes later, he acknowledges that the network's growth is still small potatoes compared to the rest of the company, and says, "I wouldn't expect some dramatic thing" in terms of immediate expansion.

The company's network division brought in $166 million in pre-tax profit in 2011, compared to $3.3 billion from the banking and card lending division.

While profitable, Discover's dependence on lending leaves it vulnerable to increasing regulatory scrutiny, especially from the newly-empowered Consumer Financial Protection Bureau. The company is bracing for a joint enforcement action from the bureau and the Federal Deposit Insurance Corporation over the marketing of its credit card payment protection products.

The insurance-like plans brought in $241 million in revenue for Discover in the fiscal year ended on Nov. 30, 2011. That is a relatively small slice of Discover's $7.1 billion in overall revenue for the year — but beyond costing the company future profits, the government's probe could also damage the customer-friendly reputation of Discover, which is generally better-regarded than some of the larger credit card lenders.

Nelms, interviewed before Discover disclosed the government probe on Jan. 26, expressed some vague worries about the CFPB's authority — and the industry's inability to control what it will do.

The CFPB is "just kind of a blank slate and an unknown. They've said they're not going to rely on previous ways of doing things that regulators have used for years and years … so we just don't know," he says. "As long as we're doing the right thing for customers, that shouldn't be a problem. [But with] second-guessing and interpretation, you don't always agree on what is good for customers."

Asked for comment on the government probe, a Discover spokeswoman said via email, "We are working through the process with regulators and remain focused on providing our customers with the products they value and service they expect from Discover."

Other challenges are ahead for Nelms, including figuring out just what Discover is going to do to make its mark in the burgeoning mobile payments market, after its onetime-exclusive Isis partner opened up to work with other networks.

For now, Nelms says he is content with Discover's Zip contactless card, and looking to pick up more traditional credit card customers with the company's longtime focus on offering cash-back rewards. Competitors including JPMorgan Chase & Co. and Capital One Financial Corp. have been increasingly trying to compete for customers on that cash-back turf, which Nelms says Discover is committed to defending "aggressively."

"This is our Coca-Cola formula, this is our business. Other people get hot and cold in it," he says.

And he is hardly sitting around and waiting for Discover's network to take off. If and when that happens, Discover will be a broader "direct banking and payments" company, as Nelms puts it, which is expanding as other banks and financial companies slim down and shed entire lines of business.

The onetime credit card company has snapped up a student lending business from Citigroup and is in the process of buying a mortgage origination unit from Tree.com. Nelms said in the fall that Discover is also planning to launch an online checking account at the end of 2012.

"The original launch of Discover was [as part of] the Sears Financial Services network, and credit card was supposed to be a part of a whole bunch of things. It's ironic — that was the right strategy for now. It was before its time," he says.

And as some of Discover's bigger credit card rivals continue struggling with the after-effects of the financial crisis, Nelms has no regrets about making what, years ago, might have seemed to be a bad career decision.

"I remember when I came from MBNA to Discover they were like, 'Oh you're making this huge mistake, they're going to sell you in two years'," he says. MBNA was itself snapped up by Bank of America Corp. in 2006 — and now pieces of it are being sold off, as B of A struggles with capital issues and tries to slim down.

"I don't laugh too hard," Nelms says, "because I feel bad about what I helped to build that is no more."

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