Discover's rewards push pays off — at a steep cost

Discover leaned heavily on rewards to drive new card acquisitions and sales growth in the fourth quarter, but suffered a double whammy of rising reward costs and higher charge-offs, causing it to miss analyst earnings expectations.

In a crowded credit card market awash with lucrative awards, Discover has increasingly used the “It Card” platform as its flagship offering. The program originally launched in 2013 for travelers and new cardholders, and proved highly attractive to consumers. Leveraging this success, Discover launched the Small Business It Card program last September in a desperate battle with American Express, Chase and others to rise above. While new cards and sales are growing, it’s coming at a higher rewards costs, with no end in sight.

“Our rewards rate for the fourth quarter was 128 basis points, up five basis points year over year. This increase is due to both portfolio mix, which continues to shift toward the Discover It product with its slightly higher average rewards rate, as well as our decision to feature warehouse clubs in the 5 percent [rewards] category in the fourth quarter,” R. Mark Graf, Discover's chief financial officer, said in Thursday's earnings call.

There have been recent reports of some card issuers seeking to scale back rewards due to their high costs. These include the new Citi Rewards+ Mastercard which has leaner rewards focused on everyday essentials; and the recent failure of the American Express Plenti program. Meanwhile, other issuers have continued to raise the stakes in the card rewards game. Just recently American Express and Chase increased their rewards for the new Marriott Bonvoy card rebranding.

Discover reported that its net discount and interchange revenue fell by 2 percent in the fourth quarter, to $277 million, compared with $283 million a year earlier. Rewards costs grew to $475 million, up by 9 percent from $434 million for same quarter in 2017. Meanwhile, discount and interchange revenues for the same comparison period grew by only 5 percent, to $752 million.

Charge-offs for credit cards grew to 3.23 percent in the fourth quarter, up 20 basis points from the same quarter in 2017. Personal loan charge-offs jumped to 4.49 percent in the fourth quarter, up 40 basis points from the third quarter and up 87 basis points from the fourth quarter of 2017.

Overall revenue for the quarter rose 7 percent year over year, to $2.8 billion.

In providing guidance for 2019 finances, Discover said it would continue to lean on its rewards platform for growth, which inevitably will drive up costs.

“With respect to rewards, we expect the rate to come in between 132 and 134 basis points for 2019, a modest increase largely resulting from the ongoing shift in product mix,” Graf said.