Discover Financial: Quite Solid Results, All Things Considered

I have a long Discover Financial (DFS) position married against a short Capital One (COF) position; but in this day and age such hedging strategies are moot points. Every stock in a sector goes up (or more rarely nowadays, down) as based on HFT algorithms. Differentiating between companies within a sector is moot as all go in the same direction. Our term for this has been "monolithic trading". We're slowly adjusting to this reality even though we've been pointing it out for over 2 years.

Discover reported earnings today, and considering the economic situation, it's pretty solid, with such low costs of capital nowadays thanks to your friendly Fed. While it's a pain to savers in the country, it is great for the financial corporations of America and really, catering to them is what it is all about. As long as too many Americans don't join the "Debtors Revolution" and are happy to pay 23-30%+ interest rather than their old 5-12%, while the companies can borrow from the Fed at nearly zero, the business model could be the best on Earth. Even with 10, 15, 20% default rates.

Excluding the one time gain from anti-trust settlements with Visa (V) and Mastercard (MA), Discover posted a whopping 52 cents in profit versus -12 cents that analysts estimated. Thank you Ben Bernanke. This came despite a 7% drop in sales volume, showing how incredibly positive the Fed has made the world for financial firms with such a low cost of borrowing. I am surprised the stock is not up much much more; if they can repeat 50 cents in the coming quarters, that's a $2.00 annual EPS rate, slap even a 12 PE ratio on that and you have a $24 stock.

Considering the offering they recently did (which added more shares and diluted earnings) the results are even more impressive. [Jul 7, 2009: Discover Financial to Offer $500M in Stock] Their default rate is also much better than some of our top oligarchs such as Citigroup (C) and JPMorgan (JPM). These results definitely make me more bullish on this name, and has to make one reconsider shorting any credit card company, as the Fed has fixed the playing field in their favor - big time.

Full report here.

Summary

• Discover Financial Services said Thursday it more than tripled its profits during the fiscal third quarter, helped by a payment from a lawsuit settlement. Even without the gain from the lawsuit settlement, the credit card lender would have been profitable, despite rising defaults and delinquencies and falling card sales volume.
• Discover said its earnings available to common shareholders surged to $559.4 million, or $1.07 per share, during the three months ended Aug. 31. That's up from $180.1 million, or 37 cents per share, a year earlier. The company's results were bolstered by an estimated $287 million after taxes related to a settlement of an antitrust lawsuit with Visa Inc. and MasterCard Inc.
• Analysts polled by Thomson Reuters, on average, forecast a loss of 11 cents per share for the quarter. Analyst estimates often do not include one-time items. Discover expected a profit of 52 cents per share, excluding items.
• During the quarter, Discover's provision for loan losses increased 4.4 percent to $380.1 million from $364.8 million a year ago. (provisions still seem low to me considering the economic landscape)
• During the most recent quarter, Discover card sales volume fell to $23 billion, down 7 percent from last year.
• Income from Discover's third-party payments business -- which processes ATM and debit transactions -- fell to $27.1 million from $28.5 million a year earlier.
• Discover's charge-off rate -- loans it does not expect to be repaid -- climbed to 8.39 percent in the third quarter from 7.79 percent in the second quarter but was well below rates at its bigger rivals.

[Jul 2, 2009: Beginning Discover Financial Stake]

Long Discover Financial, Short Capital One in fund; no personal position

Comments

[maz]

To make sense of the loan loss provisions when comparing to the 8.39% net charge-off rate you need to use the loan loss provisions on total managed loans as the charge-off rate is calculated on that basis

$381m is the loan loss provision for owned loans for the quarter. Including managed loans the figure is $924.4m for the quarter.

For the last twelve months owned loan provisions are around $2.6 to $2.7 billion so the lower figure for this month might indicate conservative reserving in prior quarters. Managed basis loan loss provisions are around $4.5 billion over the last 12 months

That figures to be about right. Managed loans are $51 billion and relatively unchanged throughout the period. $4.5b/$51b works out to around 8.82% - a tad higher than the 8.39% charge-off rate. Of course the two are not entirely comparable because of timing but it's a reasonable indicator that the company is adequately reserved if they are expecting charge-offs to rise to 8.5 to 9.0% in the next quarter.

The press release said the quarter's loan loss provisions were UP $873 from last year and down $154 million from the previous. Provisions for the quarter alone were $924 million and the balance sheet had

2009 Sep 21 07:33 PM