Discover’s Earnings Fall as Expenses Rise, Card Yields Shrink

Discover Financial Services reported a 7% drop in quarterly earnings on Tuesday, driven by rising expenses, a growing loss provision and shrinking yields in its flagship credit card business.

The Riverwoods, Ill., company earned $586 million in the first quarter, or $1.28 per share, which was down from $631 million, or $1.31 per share, in the same period a year earlier.

The first quarter drop-off in net income came on the heels of a bigger decline in the fourth quarter of 2014. That 33% fall was attributed to non-recurring events, including the firm’s decision to make it easier for credit card holders to redeem their cash rewards, and a charge related to the company’s mortgage business.

For the quarter that ended March 31, Discover’s decline in earnings was less severe, but it couldn’t be chalked up to one-time charges.

Discover’s operating expenses rose to $873 million, an 11% increase from a year earlier, due to more spending on marketing, larger legal reserves, higher employee compensation, and expenses related to the firm’s anti-money laundering compliance program. Discover has been operating under a regulatory order aimed at improving its defenses against money laundering.

The rise in marketing spending at Discover is part of a broader trend in the credit card business, in which issuers are spending more on advertising in order to grab a share of the loan growth that has finally materialized following the recession.

During the first quarter, Discover boosted its provision for loan losses to $390 million, a 43% increase from a year earlier. That move came as Discover’s net charge-off rate for credit card loans rose by eight basis points to 2.40%. (The firm’s 30-day delinquency rate on credit card loans fell by eight basis point to 1.64%.)

Discover reported that its credit card yield was 12.05%, which was down nine basis points from the previous year.

The earnings report did contain some bright spots. Discover’s loans outstanding totaled $67.6 billion, up 6% from a year earlier. The company’s credit card loans rose by 5.1%, personal loans rose by 17.5%, and private student loans rose by 3.9%.

In a news release, Chief Executive Officer David Nelms characterized the loan growth as “solid.”

Discover’s net interest income rose 4% to $1.63 billion, while its net interest margin fell by 18 basis points to 9.69%.