Discover's Profit Falls as Regulatory Costs Rise

Discover Financial Services in Riverwoods, Ill., continued its run of quarterly profit declines in the second quarter, due primarily to higher costs for compliance, marketing and customer rewards.

The card company's profit fell 7% from a year earlier, to $599 million. However, earnings per share of $1.33 were a penny higher than the average estimate of analysts polled by Bloomberg.

Discover has now recorded three consecutive quarters of declining year-over-year profit, including drops of 7% and 33% in the first quarter this year and final quarter of 2014, respectively.

The main cause of the second-quarter decline was an 18% increase in expenses, to $927 million. Discover incurred $19 million in costs tied to improving its anti-money-laundering program, fixes that were ordered by the Federal Reserve Board in May.

Those compliance efforts also factored into an 8% rise in employee compensation costs, to $326 million, and a 37% increase in professional fees, to $153 million.

Like other card companies, Discover has begun investing more heavily in marketing, and th0se costs rose 18% on the quarter, to $199 million. In addition, a 17% increase in the cost of customer rewards, to $314 million, offset higher interchange revenue.

Chief Executive David Nelms has tried to diversify beyond the core card business, and in the second quarter those efforts suffered some setbacks. Discover announced in June that it would shut down its mortgage operations, which it bought from Lending Tree in 2012, after failing to generate enough traction with its online-lending model. It took $23 million in pretax charges in the second quarter tied to shutting this business.

And on Wednesday, the company hit a major speed bump in another key auxiliary business, private student loans. The Consumer Financial Protection Bureau announced a settlement with Discover over alleged abusive loan servicing under which the company agreed to refund $16 million to affected customers and pay the agency a $2.5 million fine. A company representative said that provisions set aside in the first quarter would cover the cost of the settlement.

There were areas of growth in the second quarter, too. Average credit card loans grew 4.2%, to $54.9 million, a rate Nelms called “solid” in a company press release Wednesday.

However, the average yield on card loans fell 6 basis points, to 12.04%.

Credit quality improved, with the 30-day delinquency rate on all loans falling 7 basis points, to 1.49%, and the gross principal chargeoff rate 6 basis points, to 2.76%.