Discover Financial cut to Neutral at Citi as student loan probe clouds outlook

Jul. 22, 2022 8:45 AM ETDiscover Financial Services (DFS)By: Liz Kiesche, SA News Editor

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Citi analyst Arren Cyganovich downgraded Discover Financial (NYSE:DFS) to Neutral/High Risk from Buy because of the uncertainty caused by its newly announced internal investigation into student loan servicing practices.

In its Q2 earnings release on Thursday, the company disclosed that an board-appointed independent special committee is investigating student loan servicing practices related to compliance matters. Discover (DFS) has suspended its stock repurchases because of the probe.

During its earnings conference call, management said the investigation was already factored into its 2022 expenses guidance.

"While the company indicated that large penalties/remediation costs aren't expected to impact 2022 expenses, the lack of details surrounding the issue, particularly if regulators are involved, creates too much near-term risk in our view for us to continue recommending the shares," the analyst wrote in a note to clients.

Discover (DFS) shares are declining 1.0% in Friday premarket trading.

In its earnings slides, Discover (DFS) boosted 2022 guidance for loan growth to low teens from its previous view of high single digit growth, while keeping its net interest margin and operating expense guidance unchanged. It now sees full-year average net charge-off rate of 1.9-2.1% vs. its previous range of 2.2%-2.4%.

Cyganovich raised his 2022 EPS estimate to $16.13 from $15.76 due to lower credit costs and trimmed his 2023 EPS estimate to $15.01 from $15.05 and 2024 EPS estimate to $15.86 from $16.32.

Still, the analyst likes Discover's (DFS) fundamentals, but "there could be more headline risk ahead, if the Consumer Financial Protection Bureau is involved in on the student loan servicing practices investigation," he said.

Cyganowich's Neutral rating contrasts with the SA Quant rating of Strong Buy and the average Wall Street rating of Buy.

See why SA contributor Alpha Gen thinks it's a good time to buy on the knee-jerk market reaction

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