In the second quarter of 2024, Discover Financial Services (NYSE: NYSE:DFS) reported a robust performance with a net income of $1.5 billion, marking a 70% increase from the previous year. The earnings were bolstered by revenue growth driven by loan expansion, a higher net interest margin, and an increase in non-interest revenue. The quarter also saw significant strategic developments, including an agreement to sell Discover's private student loan portfolio and a settlement in card misclassification litigation. Additionally, the company is progressing with its pending merger with Capital One, expecting shareholder votes this fall.
Key Takeaways
- Discover Financial's net income rose to $1.5 billion, up 70% year-over-year.
- Revenue growth was supported by loan growth, an increased net interest margin, and non-interest revenue.
- The company agreed to sell its private student loan portfolio to Carlyle and KKR affiliates.
- A settlement was reached to resolve merchant class actions from card misclassification litigation.
- Discover is in the process of merging with Capital One, with integration planning underway.
Company Outlook
- Discover Financial expects loan growth to be down slightly, considering the student loan portfolio sale.
- Net interest margin projections have been increased to a range of 11.1% to 11.4%.
- Operating expenses are anticipated to remain consistent, excluding student loan net charge-offs.
- Net charge-offs are projected to be at the lower end of the 4.9% to 5.2% range.
Bearish Highlights
- Card receivables growth has normalized, with a 7% year-over-year increase.
- Discover card sales decreased by 3% compared to the previous year.
- Consumer spending shows signs of caution, particularly among lower-income households.
Bullish Highlights
- Personal loans grew by 13% from the previous year.
- Non-interest income saw a 45% increase, partly due to a favorable litigation settlement.
- Average consumer deposits rose by 15% year-over-year.
Misses
- Student loans were down 1% year-over-year.
- The payment rate declined by about 130 basis points compared to last year.
Q&A highlights
- There was no question-and-answer session following the earnings call.
Discover Financial Services continues to focus on strategic priorities, including simplifying operations and addressing compliance matters, while moving forward with its merger with Capital One. The company remains committed to generating solid financial results and managing its loan portfolio in response to market conditions.
InvestingPro Insights
Discover Financial Services (NYSE: DFS) has demonstrated a strong performance in the second quarter of 2024, and the InvestingPro platform offers additional insights that may be of interest to investors considering the company's stock.
InvestingPro Data highlights include a Market Cap of $35.87 billion, underlining the company's significant presence in the financial sector. The P/E Ratio stands at 12.68, suggesting that the stock may be reasonably valued compared to earnings. Additionally, the Revenue Growth for the last twelve months as of Q2 2024 shows a modest increase of 2.47%, indicating steady business expansion.
One InvestingPro Tip that aligns with the article's bullish outlook is that Discover Financial Services has experienced a large price uptick over the last six months, with a 48.47% total return. This could be reflective of investor confidence and the company's strong fundamentals. Additionally, the fact that 6 analysts have revised their earnings upwards for the upcoming period can be seen as a positive indicator of the company's future financial performance.
For readers interested in further insights and tips on Discover Financial Services, InvestingPro offers additional metrics and analysis. There are numerous other InvestingPro Tips available at https://www.investing.com/pro/DFS, and by using the coupon code PRONEWS24, users can get up to 10% off a yearly Pro and a yearly or biyearly Pro+ subscription.
Full transcript - Discover Financl (DFS) Q2 2024:
Operator: Good morning. My name is Todd, and I will be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter 2024 Discover Financial Services Earnings Conference Call. All lines have been placed on mute to prevent any background noise. Please note, there will be no question-and-answer period after this morning's prepared remarks. After the call ends, questions should be directed to the Discover Investor Relations team. [Operator Instructions] Thank you. I will now turn the call over to Mr. Eric Wasserstrom, Senior Vice President of Corporate Strategy and Investor Relations. Please go ahead.
Eric Wasserstrom: Thank you, and welcome to this morning's call. I'll begin by referencing Slides 2 and 3 of our earnings presentation, which you can find in the financial section of our Investor Relations website, investorrelations.discover.com. Our discussion today contains certain forward-looking statements that are subject to risks and uncertainties that may cause actual results to differ materially. Please refer to our notices regarding forward-looking statements that appear in the second quarter 2024 earnings press release and presentation as well as the risk factors detailed in our annual report and other filings with the SEC. Our call today will include remarks from our Interim CEO, Michael Shepherd; and John Greene, our Chief Financial Officer. There will be no question-and-answer session following today's remarks. However, the Investor Relations team will be available for any inquiries. It is now my pleasure to turn the call over to Michael.
Michael Shepherd: Thank you, Eric. Good morning, and welcome to our guests who have joined today's call. Discover's second quarter operating performance was very good, and we advanced several strategic priorities. Let me highlight a few of these accomplishments. On July 17, we entered into an agreement to sell our private student loan portfolio to affiliates and limited partners of Carlyle and KKR. Firstmark, a division of Nelnet (NYSE:NNI) will assume responsibility for servicing the portfolio upon sale. This agreement represents an important milestone in our journey to simplify our operations and business mix. The completion of the sale also has financial implications, which John Greene will detail in a few moments. As we continue to resolve past issues and strengthen our risk management and compliance posture, we have entered into a settlement agreement to resolve the merchant class actions associated with the card misclassification litigation, subject to court approval. The decision to settle was based upon our internal reviews, extensive dialogue with key constituencies, including merchants and regulators and our pending merger with Capital One. The settlement agreement would resolve claims by parties affected by the card misclassification, including merchants, acquirers and intermediaries. Our current remediation reserve is sufficient to cover the expenses under the terms of the settlement agreement. Our results also benefited from a litigation settlement in our Payment Services segment, where Discover was the plaintiff. We are happy to have this matter resolved and are satisfied with the favorable financial outcome. Finally, turning to our pending merger with Capital One. Capital One continues to lead the integration planning process, and the teams are working well together on integration planning and regulatory applications. Upcoming merger-related milestones include a virtual public hearing hosted by the Federal Reserve and the OCC, the completion of the written comment period, an in-person public hearing with the Delaware State Bank Commissioner and the filing of the definitive merger proxy. We expect shareholder votes to occur this fall. We are encouraged by how the merger planning and application processes are progressing and continue to believe that the strategic rationale, operating scale and economics of the combined company are compelling. With that, I'll now ask John Greene to review our second quarter 2024 financial results.
John Greene: Thank you, Michael, and good morning, everyone. I'll start with our summary financial results on Slide 5. In the quarter, we reported net income of $1.5 billion, which was up 70% from the prior year quarter. Our fundamental performance in the period was driven by revenue expansion from loan growth, higher net interest margin and non-interest revenue growth. Credit continues to perform in line with expectations, supporting our view that losses are near peak and will plateau during the second half of 2024. There are several unusual items which impacted the quarter. These included a $869 million student loan reserve release, a gain of $26 million from the sale of our Lake Park facility. And largely offsetting one another were the favorable litigation settlement and a charge for expected regulatory penalties related to the card misclassification matter. Excluding unusual items, we would have reported net income of approximately $915 million and EPS of about $3.63 per share. Let's review the details beginning on Slide 6. Our net interest margin ended the quarter at 11.17%, up 11 basis points from the prior year and up 14 basis points sequentially. On a quarter-over-quarter basis, margin expansion was primarily driven by a lower card promotional balance mix. As anticipated, receivable growth continues to normalize from its early 2023 peak. Card receivables increased 7% year-over-year due to a lower payment rate and a smaller contribution from new accounts. The payment rate declined about 130 basis points compared to last year and is now about 90 basis points above 2019 levels. Discover card sales were down 3% compared to the prior year, spending at restaurants, which is a large category for sales volume declined sequentially as a result of being included in the 5% promotion during the first quarter. Accounting for the influence of promotional categories, sales trends are relatively stable. We continue to see a cautious consumer, evidenced by less card member spend with lower income households being most affected. Personal loans were up 13% from the prior year period. In response to market conditions, we prudently tightened underwriting over the past year, which has served to modestly reduced originations. Student loans were down 1% year-over-year. As Michael mentioned, we have entered into an agreement to sell our student loan portfolio. We expect the transaction to be completed in four tranches by the end of 2024. The purchase price has added a premium to the principal balance and is based on a formula that varies depending on the closing timing, interest rates and other factors. In association with this development, student loans are now accounted for as held for sale. The two most notable impacts to the financial statements are that we will no longer maintain a credit reserve for student loans and future student loan net charge-offs will be recognized through operating expense rather than credit losses. Average consumer deposits were up 15% year-over-year and 1% sequentially. Deposit balances are being managed in relation to our liquidity needs, which will benefit from the student loan sale. Our disciplined approach to deposit pricing has led to a modest reduction in average deposit rates in the second quarter, consistent with our practice of leading the industry on pricing in down parts of the cycle. Looking at other revenue on Slide 7. Non-interest income increased $313 million or 45%. Discount and interchange revenue was up $67 million as a result of lower rewards cost. Our rewards rate was 132 basis points in the period, a decrease of 10 basis points versus the prior year quarter. The decline reflects lower cash back match. Other income increased due to unusual items, including the litigation settlement and the facility sale. On an adjusted basis, non-interest revenue grew 14%. Moving to expenses on Slide 8. Total operating expenses were up $325 million or 23% year-over-year. The most significant driver of this increase was a charge for expected regulatory penalties related to the card misclassification issue. It is important to note that actual penalties imposed are subject to further discussions and may be more or less than this amount. Adjusting for this charge, our expenses would have increased by 9% year-over-year. Looking at our major expense categories. Compensation costs increased $70 million or 12%, primarily due to an increase in business technology resources. Professional fees were up $80 million or 37%, driven by higher recovery fees and investments in compliance and risk management. Our expectation for compliance and risk management expenses for the full year remains in the $500 million range with an upside bias. This figure excludes cards misclassification related costs. Moving to credit performance on Slide 9. Total net charge-offs were 4.83%, 161 basis points higher than the prior year and down 9 basis points from the prior quarter. In card, delinquency formation improvement continued. The 30-plus day delinquency rate was down 14 basis points versus the prior quarter. From a vintage perspective, our 2023 card vintage continues to perform in line with our 2022 vintage. As we look into the second half of the year, we expect there could be some variability in monthly card losses from both seasonality and various credit management actions we've taken. This has not changed our broader outlook for losses to generally peak and plateau this year. Turning to the allowance for credit losses on Slide 10. Our credit reserve balances declined $777 million from the prior quarter, reflecting the student loan reserve release, partially offset by a $92 million reserve build primarily to support loan growth. Our reserve rate was just over 7.2%, largely unchanged after adjusting for student loans. Looking at Slide 11. Our common equity Tier 1 for the period was 11.9%, up 100 basis points, bolstered by core earnings generation and the reserve release. We declared a quarterly cash dividend of $0.70 per share of common stock. Concluding on Slide 12. We have revised our 2024 outlook and having included the impacts of the pending student loan sale. We are updating our loan growth expectations to be down low single digits, reflecting the roughly $10 billion asset sale. Absent this, year-over-year loan growth would be consistent with our prior view. We are increasing our net interest margin range to 11.1% to 11.4%. This change was driven by two factors. We now anticipate higher card yields reflecting a lower promotional balance mix and the student loan sale, which increases NIM by about 10 basis points. Our operating expense guidance is unchanged, notwithstanding the inclusion of the student loan net charge-offs in this line item. Our base case for net charge-offs remains at the low end of the 4.9% to 5.2% range. This includes the 10-basis points impact from student loans. And finally, our capital management expectations have not changed. To summarize, we continue to generate solid financial results, remain steadfast in our efforts to resolve compliance matters and look forward to consummating our planned merger. This concludes our remarks. I'll turn the call back over to the operator.
Operator:
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