Buoyed by a litigation settlement, Discover Financial Services posted a profit of $120 million, or 25 cents a share, for the quarter that ended Feb. 28 but continues to shore up its capital to reserve against a predicted surge in credit losses.
The Riverwoods, Ill., card company, which reported results for its fiscal first quarter Thursday, said profits rose 48% from a year earlier, including a $297 million after-tax gain from an antitrust settlement with Visa Inc. and MasterCard Inc. (Discover expects three more payments at the "$472 million" pretax level this year, according to Roy Guthrie, its chief financial officer.) Excluding discontinued operations, including the March 2008 sale of the Goldfish business in the U.K., profit fell 50%.
Discover cut its quarterly dividend by 4 cents, to 2 cents a share, out of what David Nelms, its chief executive, called "an abundance of caution." During a conference call, Nelms told investors that the decision will "provide a capital benefit of about $80 million on an annualized basis." That would be a relatively "modest" savings but it would "help us maintain a strong capital position in the midst of this uncertain environment," he said.
The dividend cut comes a week after Discover received $1.2 billion through the Treasury Department's Capital Purchase Program and received bank holding company status. The company said Thursday that it has added $504 million to its reserves, in excess of its current chargeoffs, partly in anticipation of an increase in chargeoff rates in its current fiscal quarter.
Losses on managed credit card loans rose 100 basis points from the previous quarter and 215 basis points from a year earlier, to 6.48%. That rate was in the "mid-6%" range the company had predicted, but Nelms said during the call that he expected the rate to "exceed 7.5%" in the current quarter as a result of rising unemployment and delinquency rates.
"The thing that caused this cycle to disconnect is the velocity or speed to which you see accounts roll once they go in to default status," he said in response to analyst questions.
In an interview Thursday, Nelms said he expects these defaults to grow more slowly after the current quarter, because "we've already seen the huge jump in unemployment rates. Not so many people expect unemployment to jump up quite as much" in the future.
Quarterly volumes on Discover's Pulse debit network grew almost 11% from a year earlier, to $27.5 million, but credit network volumes from both Discover's own cards and its third-party issuers were down. Diners Club International, which Discover bought in July, added $6.3 million to the network volumes, though that amount was down over 15% from the previous quarter. The company attributed the decline partly to reduced corporate and travel and entertainment spending.
But Nelms said in the interview that this drop-off would not affect Discover's commitment to "heavier" investment spending on integrating Diners Club. "Full speed ahead," he said. "It's a great growth opportunity without taking on additional credit risk."
He said Discover has "more opportunity" to cut expenses, especially on marketing, though he would not give specific projections. (Its quarterly expenses fell 7% from a year earlier.)
Discover's current funding plan assumes that the company will not issue any more asset-backed securities this year, Guthrie said during the call. "We have about $6.5 billion of … [Term Asset-Backed Securities Loan Facility]-qualifying capacity that could be funded using this new program," he said, though the pricing on such securities is currently "50 to 70 basis points higher than we would prefer." But "if the economics of the program become attractive, we could begin issuing under that program," he said.