Discover Financial Grapples With Drop-Offs in Volume

  Four months into 2005, Discover appeared headed to the orphanage. Morgan Stanley, Discover's parent company, announced in April last year that it was spinning off Discover Financial Services, the Riverwoods, Ill.-based issuer of Discover.
  Chairman and CEO Philip J. Purcell proposed the spin-off to mollify investors. The investors, including many former Morgan Stanley executives, blamed Discover in part for Morgan Stanley's poor financial performance. Purcell had launched Discover in 1986, when he was CEO of Dean Witter, so it was a bitter moment when he told analysts, "It's time for Discover to be on its own."
  Purcell's plans to ditch Discover did not save his job. He was replaced by archrival John J. Mack. Mack and Morgan Stanley's board reversed Purcell's decision, deciding it was in the company's best interest to keep Discover.
  Discover remained in the family, but last year's performance borders on treading water and losing ground.
  At the end of 2005, Discover reported managed card loans of $46.9 billion, down 2.9% from $48.3 billion in 2004. Cardholder accounts also were down 1.5%, to 45.5 million from 46.2 million accounts in 2004. Discover says the drop in managed loans was caused by historically high cardholder payment rates. Card sales volume, however, was up 8.2% last year, to $86 billion from $79.5 billion in 2004.
  Discover reported a 2005 pretax net income of $921 million, a 24.5% drop from 2004's $1.22 billion. Net credit income for 2005 was $515 million, up a dramatic 80.7% from $285 million in 2004. Revenues in 2005 were $3.45 billion, 2.3% lower than the previous year's $3.53 billion.
  The lower revenue in 2005 resulted from lower servicing and securitization income, among other things, the company says.
  Discover's 2005 provision for consumer losses was $878 million compared with $926 million in 2004. The issuer expects a lower level of bankruptcy filings in 2006, but Discover says it will be challenged by a slow growth rate in the U.S. credit card industry, rising short-term interest rates and an increase in cardholder minimum payments.
  Discover reported merchant, card member and other fees of $1.32 billion in 2005, virtually the same as in 2004. These fees include interchange, transaction-processing, late, over-the-limit and balance-transfer fees.
  The issuer purchased Pulse, a PIN-debit electronic funds network, in January 2005. Pulse links cardholders to more than 4,200 financial institutions, nearly 250,000 ATMs and approximately 3.4 million point-of-sale terminals. Pulse's 2005 transaction volume, its first year with Discover, was $1.56 billion.
  Discover also operates the Discover Network, a proprietary credit card network in the U.S. GE Money issues two consumer credit cards, Wal-Mart Discover and Sam's Club Discover, on the network. The Discover network reported 2005 transaction volume of $1.301 billion, up 6.1% from $1.226 billion in 2004.
  Despite the numbers, Roy Guthrie, Discover chief financial officer, says he was pleased with Discover's performance. "We were great at managing individuals with low FICO scores and booking people with high FICO scores," he says. "This doesn't always translate into higher balance growth, but we have seen lower delinquencies, lower credit losses, higher spend and improved credit quality across the spectrum."
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