Discover’s earnings will be nicked by new card rule

By Becky Yerak
Posted June 24, 2010 at 3:59 p.m.

A new credit card rule that limits late fees will reduce annual earnings of Discover Financial Services by $80 million to $90 million a year, Chief Executive David Nelms said Thursday.

Under new Federal Reserve rules that kick in on Aug. 22, credit card companies can’t charge a late fee of more than $25, or $35 if a consumer has been late on one of their last six payments.

On its flagship Discover More card, late fees are currently $19 on balances up to $250 and $39 on balances of more than $250.

Nelms discussed the impact of the rules change during an earnings conference call on Thursday, but the market wasn’t too worried.

On a day when the overall market stock market was trading down, shares of the Riverwoods-based credit card company closed up 0.5 percent to $14.08 a share.
The positive close for Discover was prompted by a better-than-expected 14 percent jump in second-quarter profits due to lower delinquency rates and smaller set-asides for bad loans.

In the conference call, Discover also noted that it would boost marketing efforts in the second half of the year to their highest levels since the third quarter of 2008.

“Everyone pulled back marketing at the end of ‘08 through now,” Nelms said in an interview later. “We didn’t pull back as far as others but we pulled back, and now we’re feeling confident enough to go back to more normal levels of marketing.”

Discover was recently named “official credit card” of all U.S. Six Flags parks. The core of the program is a 5 percent instant discount incentive for Six Flags park guests and their families when they use a Discover card.

Discover said it also wants to grow its student-loan business.

Card-spending volume climbed 6 percent from a year earlier. The stock through Wednesday’s close was up 45 percent the past year, more than the broader market.

Discover said the growth is coming from customers with high FICO scores.

“We have a large number of customers who are not under water with their house and are now feeling more confident spending money again,” Nelms said. “They’re feeling a little more confident about the economy.”

The company continues to be happy with the performance of its Discover Bank, which does business online and over the phone.

It has one branch in Delaware, and, in response to a question, Nelms said he wouldn’t rule out a “branch light” strategy, such as that used by rivals that include direct banking giant ING. ING has banking cafes in seven cities.
“That’s not a crazy strategy and I wouldn’t rule that out but there’s nothing imminent,” Nelms told the Tribune.

Nearly from the moment in went public in 2007, many were predicting that Discover’s days of independence were limited. A run-up in its stock a few weeks ago was caused by speculation that Discover might be bought.

Nelms declined to comment on Discover’s stock, but said, “I think it’s likely Discover will remain independent because of its unique focus, and direct banking and payments that are working well,” he told the Tribune. “Long-term the question is can we deliver the most value independently, relative to not being independent, and right now the answer is yes; we can deliver the most value by delivering profit margins better than would-be acquirers.”

Credit-card delinquencies, a key gauge of future losses, have slowed in recent months. A continued decline is important because higher delinquencies force issuers to set more capital aside for potential losses; ultimately, companies must write off loans that aren’t repaid. And while credit losses remain at elevated levels, the pace of the increase has been slowing for most card issuers.

And consumers have been reopening their wallets, which could translate to higher fee revenue for card companies like Discover, which also processes card transactions.

For the quarter ended May 31, the credit-card issuer turned bank-holding company reported a profit of $258.1 million, or 33 cents a share, up from $225.8 million, or 43 cents a share, a year earlier. The latest quarter was helped by the release of $277 million of reserves. Analysts polled by Thomson Reuters most recently forecast earnings of 11 cents.
Dow Jones contributed to this story.

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