Company Reports

Narrow-moat-rated Discover Financial Services reported decent first-quarter results that were affected by additional losses associated with its product compliance issues. Earnings per share fell 69% from last year and 28.6% from last quarter to $1.10, while revenue increased 13% from last year to $4.2 billion. These results translate to a return on equity of 8%, well below the bank’s historical average.

After a period of unusually strong results from high loan growth and low net charge-offs industrywide, Discover will face a more difficult operating environment in 2024. While credit costs had initially normalized from their postpandemic lows slower than we had expected, they increased materially in 2023 and we expect them to rise further in 2024. This will reduce the bank's returns in the near term and likely lead to tighter underwriting and lower loan growth.

Narrow-moat Capital One Financial has agreed to acquire Discover Financial Services in an all-stock deal worth $35 billion. The acquisition is expected to close by late 2024 to early 2025. In general, we are neutral on the deal as we do see strategic value to it, particularly as it relates to Discover’s network. Additionally, we believe Capital One is paying a fair price, with the implied transaction price of $139.86 per share at the time of the announcement being nearly equal to our $141 fair value estimate for Discover. That said, there will be meaningful integration risk and some uncertainty around regulatory approval, as the combined company would be the largest credit card issuer in the U.S. by loan volume. Therefore, we do not expect our fair value estimate to change as a result of the transaction.

Returning to Discover following its fourth-quarter earnings release, we are reducing our fair value estimate for Discover to $141 per share from $150 and lowering our Capital Allocation Rating to Standard from Exemplary. Our new fair value estimate translates to 14.2 times our projected 2024 earnings.

After a period of unusually strong results from high loan growth and low net charge-offs industrywide, Discover will face a more difficult operating environment in 2024. While credit costs had initially normalized from their postpandemic lows slower than we had expected, they increased materially in 2023 and we expect them to rise further in 2024. This will reduce the bank's returns in the near term and likely lead to tighter underwriting and lower loan growth.

Narrow-moat-rated Discover reported weak fourth-quarter results as higher credit costs and operating expenses led to lower earnings. The bank’s revenue increased 13% from last year and 3.7% from last quarter to $4.2 billion. Meanwhile, net income fell 62% from a year ago to $388 million, which translates to a return on equity of 11%. The decline in earnings was primarily due to a $1 billion increase in Discover’s credit provisioning expense, which was due to both higher net charge-offs and a $305 million increase in reserve build. The earnings release was worse than we had anticipated, and as we incorporate these results, we expect to reduce our $150 fair value estimate for Discover by mid to high single digits.

As consumer debt repayment rates in the United States normalize, Discover has enjoyed a period of significant loan growth. On the other hand, while credit costs had initially normalized from historic lows slower than we had expected, they increased materially in 2023 and we expect them to rise further as we head into 2024. That said, we do not expect this to put any pressure on the bank's balance sheet as the firm is in a strong financial position with good reserves. Additionally, Discover's net interest income will benefit from the larger credit card receivable base. The bank ended September 2023 with over $97.3 billion in credit card loans, 16.8% higher than the prior year.

Narrow-moat Discover reported weak third-quarter results as the bank's credit costs rose sharply. Discover's net revenue increased 17% from last year to $4.04 billion. Earnings per share declined 27% year over year to $2.59, which translates to a return on equity of 19%. The drop in profitability was due to higher credit provisioning costs, as the company built $601 million in reserves during the quarter. As we incorporate these results, we do not expect to materially alter our $152 per share fair value estimate. We see the shares as undervalued right now.

As consumer debt repayment rates in the United States normalize, Discover is enjoying a period of significant loan growth. On the other hand, while credit costs had initially normalized slower from historic lows than we had initially expected, they have increased materially in the first of 2023 and we expect them to rise further as we head into 2024. We do not expect this to put any pressure on the bank's balance sheet, though, as the firm is in a strong financial position with good reserves. Additionally, Discover's net interest income will benefit from a larger credit card receivable base now that growth has returned. The bank ended June 2023 with just under than $94 billion in credit card loans, 18.6% higher than the prior year.

Narrow-moat Discover Financial reported solid results in line with our expectations. However, the bank’s generally decent results were overshadowed by news that Discover has been overcharging the merchants who accept its cards by misclassifying card types. The affected amount of revenue is limited, less than 1% of cumulative transaction fees since 2007, and the firm has set aside $365 million for estimated merchant compensation. However, Discover has once again paused share repurchases as it reviews its corporate governance and compliance policies. Discover also announced it has received a proposed consent order from the Federal Deposit Insurance Corporation in connection with customer compliance, which is a separate matter from the card misclassification issue.

Narrow-moat-rated Discover Financial reported solid earnings as strong loan growth and rising interest rates drove net interest income higher, offset by higher credit costs. Net revenue increased 29% from last year to $3.75 billion. However, earnings per share fell 15% from last year to $3.58, which translates to a return on equity of 27%. The decline in earnings was due to a higher provisioning expense, which increased to $1.1 billion from $154 million last year. As we incorporate these results, we are maintaining our $146 per share fair value estimate for Discover and see the shares as undervalued.

Many of the credit card-focused firms under our coverage have developed deep discounts to our fair value estimates as concerns about rising credit costs have been aggravated by recent turmoil in the banking sector following the failure of Silicon Valley Bank. While the market has gone too far in discounting many of these names, the concern is not entirely unwarranted. Rising interest rates, debt levels, and shelter costs have increased financial pressure on consumers as a larger portion of their income becomes tied up in servicing financial obligations, and we expect this pressure to continue to build in the near term.

After more than two years of little to no receivable growth and credit losses well below normal levels, Discover to was able to generate impressive loan growth in 2022. On the other hand, while credit costs have normalized slower than we had initially expected, there are clear signs that investors should expect higher net charge-offs from Discover and other credit card issuers in 2023. We do not expect this to put any pressure on the bank's balance sheet, though, as the firm is in a strong financial position with good reserves. Additionally, Discover's net interest income will benefit from a larger credit card receivable base now that growth has returned. The bank ended December 2022 with more than $91 billion in credit card loans, 21% higher than the prior year.

Narrow-moat-rated Discover Financial reported good fourth-quarter results, though strong interest income growth was offset by higher credit provisioning. Net revenue increased 27% year over year and 7.3% sequentially to $3.73 billion. Earnings per share rose 4% from last year to $3.77, which translates to a return on equity of 28%. As we incorporate these results, we are maintaining our $146 fair value estimate. While we do see the shares as currently undervalued, we note that Discover is materially exposed to uncertain macroeconomic conditions, and its near-term results will be affected by factors outside its control.

After more than two years of little to no receivable growth and credit losses well below normal levels, we are seeing things starting to normalize as consumers are once again borrowing on their cards, which is allowing Discover to generate impressive loan growth. On the other hand, while credit costs have normalized slower than we had initially expected, we are still anticipating high charge-offs for Discover in 2023. We do not expect this to put any pressure on the bank's balance sheet, though, as the firm is in a strong financial position with good reserves. Additionally, Discover's net interest income will benefit from a larger credit card receivable base now that growth has returned. The bank ended September 2022 with $83.6 billion in credit card loans, 19% higher than a year ago.

Narrow-moat-rated Discover Financial reported decent third-quarter results as strong loan growth was offset by higher credit costs. Discover’s net revenue increased 25% year over year and 7.9% sequentially to $3.48 billion. Earnings per share were flat from last year at $3.54, which translates to a return on equity of 29%. As we incorporate these results, we are maintaining our $142 fair value estimate for Discover, and we see the shares as undervalued at current prices.

After more than two years of little to no receivable growth and credit losses well below normal levels, we are seeing signs of normalization as consumers are once again borrowing on their cards. We anticipate credit costs will be higher in 2022 but given how low the firm's delinquency rates are we do not expect a full return to normal credit costs until 2023. We do not expect this to put any pressure on the bank's balance sheet as Discover is in a strong financial position. Additionally, Discover's net interest income will benefit from a larger credit card receivable base as growth has returned, with the bank ending July 2022 with $81 billion in credit card loans, 16.7% higher than a year ago.

Narrow-moat Discover Financial Services reported a very strong second quarter, with resilient credit costs and rising net interest income driving results. Preprovision net revenue decreased 10% year over year as the firm lapped a $729 million gain on equity investments and rose 11.1% quarter over quarter to $3.2 billion. Discover reported earnings per share of $3.96, which translates to a return on equity of 32%. However, these strong results were overshadowed by the announcement that Discover is suspending its partially complete $4.2 billion share-buyback program as it conducts an internal investigation into its student loan servicing practices. Details on the investigation that provoked the suspension are scant, creating considerable uncertainty for Discover.

We went into this year’s Federal Reserve bank stress tests expecting a bit more pressure on stress capital buffers as multiple banks had warned in the preceding quarter that their SCB was likely to increase. This is indeed what played out, as we estimate that roughly seven of the 20 U.S. banks we cover that participated this year are likely to see a higher SCB once the assigned SCBs become official. It appears that JPMorgan, Bank of America, and Citigroup are all likely to see increases to their SCBs of close to 1% each. The biggest increase seems likely to come from M&T Bank, which we expect to increase close to 2.2%, going from 2.5% to roughly 4.7%. Meanwhile, we expect the SCB for 11 of the 20 U.S. banks we cover to remain stable, including for Wells Fargo, which had previously warned that their SCB could go up, so this is a slight positive surprise for the bank in our view. Finally, we think Goldman Sachs could see a slight decrease to its current SCB of 6.2%, potentially declining to 6%, while Discover could see a more material decline, going from 3.6% to 2.5%.

After more than two years of little to no receivable growth and credit losses well below normal levels, we are seeing signs of normalization as consumers are once again borrowing on their cards. We anticipate credit costs will be higher in 2022 but given how low the firm's delinquency rates are we do not expect a full return to normal credit costs until 2023. We do not expect this to put any pressure on the bank's balance sheet as Discover is in a strong financial position. Additionally, Discover's net interest income will benefit from a larger credit card receivable base as growth has returned, with the bank ending April 2022 with $75 billion in credit card loans, 11.9% higher than a year ago.