Credit Cards And Banking Growth Fuel Discover Financial's Growth

| About: Discover Financial (DFS)

Discover Financial (NYSE:DFS) reported a 10% year-on-year growth in revenues for the first quarter of 2013. This growth was helped by the company’s Discover Home Loans business which was launched last June, after acquiring Home Loan Center assets from Discover originated close to $1 billion in direct mortgages for the quarter. We saw organic growth in the credit card division, which reported 5% growth in credit card loans and a 4% increase in card sales volume. Discover also increased its quarterly dividend from $0.14 per share to $0.20 per share.

The Expansion Continues

Through its direct banking segment, Discover offers personal loans, private student loans, home loans, checking and savings accounts, certificates of deposit and money market accounts. The combined loan balance from these lines increased by 10% over the 2012 figure.

Student loans outstanding increased by 6% over the prior year’s figure while the interest yield increased from 6.39% to 6.52%. The company has cut down on late fees and returned check fees for student loans to take a more consumer friendly stance. This approach might help gain market share but can also end up cutting into the company’s profitability.

Personal loans continued to grow, and the outstanding balance was up to $3.4 billion from $3.2 billion at the end of 2012. The figure was up 21% from the Q1 2012 figure. The interest yield on personal loans rose from 12.28% at the end of the first quarter of 2012, to 12.45%.

We expect Discover to maintain growth in its direct banking segment with a steady growth in other interest earning assets. However, this expansion comes at a cost. The operating expenses for the first quarter were up 12% over the prior year. This was primarily due to higher employee and marketing costs associated with the launch of the home loans business last year.

Credit Cards Still Hold Strong

Despite the expansion in the direct banking segment, credit cards are still Discover’s most important product. The company earns more than 80% of its revenues and gross profits from credit cards. Interest income from credit card loans accounts for two thirds of Discover’s revenue while non-interest income from discount and interchange fees accounts for 15%.

Although Discover has maintained low charge-off rates and delinquency rates of 2.36% and 1.77% (for loans over 30 days due) respectively, an increase in promotional rate balances and a decline in higher-priced balances led to yield compression through the first quarter. The interest yield fell from 12.02% observed in the fourth quarter of 2012 to 11.94%. The yield on credit card loans fell through most of 2012, from 12.21% in the first quarter to 12.14% in the third quarter, to 12.02% in the last quarter.

We expect a slight compression in yield in the near term with long term expansion.

Disclosure: No positions.