Business Description
Discover Financial Services (DFS) operates as a digital banking and payment services company, managing its business activities in two main segments: Digital Banking and Payment Services. The company offers Discover-branded credit cards, personal loans, home loans, and deposit products, generating substantial revenue from interest income on these loan products . Additionally, DFS provides payment transaction processing and settlement services through the PULSE network, Diners Club, and the Network Partners business on the Discover Global Network . The company's primary revenues consist of interest income earned on loan receivables and fees from customers, financial institutions, merchants, and issuers .
- Digital Banking - Offers Discover-branded credit cards, personal loans, home loans, and deposit products, generating revenue primarily from interest income on loan products and fees related to discount and interchange, protection products, and loan fee income.
- Credit Cards - Provides Discover-branded credit card products contributing significantly to revenue through interest income and fees.
- Personal Loans - Offers personal loan products with revenue generated from interest income.
- Home Loans - Provides home loan products, contributing to interest income.
- Deposit Products - Includes consumer deposit products that fund business activities.
- Payment Services - Encompasses the PULSE network, Diners Club, and the Network Partners business, providing payment transaction processing and settlement services on the Discover Global Network.
- PULSE Network - Generates transaction processing revenue.
- Diners Club - Provides royalty and licensee revenue.
- Network Partners - Offers additional payment services on the Discover Global Network.
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Q3 2024 Summary
What went well
- Strong financial performance in Q3 2024, with net income of $965 million, up 41% from the prior year, driven by revenue growth and net interest margin expansion.
- Credit performance in line with expectations with net charge-offs plateauing, and net charge-offs in card declining 27 basis points sequentially, outperforming seasonality.
- Progress on strategic initiatives, including the sale of the private student loan portfolio (recognizing a $70 million gain in the quarter) and preparations for the merger with Capital One advancing well.
What went wrong
- Discover card sales were down 3% compared to the prior year, indicating a decline in customer spending or market share .
- Operating expenses increased by $238 million or 16% year-over-year, which could pressure profitability if revenue growth doesn't keep pace .
- Loan growth expectations have been revised down to low to mid-single digits, suggesting slower growth prospects .
Key Metrics
Revenue by Segment - in Millions of USD | FY 2013 | Q1 2014 | Q2 2014 | Q3 2014 | Q4 2014 | FY 2014 | Q1 2015 | Q2 2015 | Q3 2015 | Q4 2015 | FY 2015 | Q1 2016 | Q2 2016 | Q3 2016 | Q4 2016 | FY 2016 | Q1 2017 | Q2 2017 | Q3 2017 | Q4 2017 | FY 2017 | Q1 2018 | Q2 2018 | Q3 2018 | Q4 2018 | FY 2018 | Q1 2019 | Q2 2019 | Q3 2019 | Q4 2019 | FY 2019 | Q1 2020 | Q2 2020 | Q3 2020 | Q4 2020 | FY 2020 | Q1 2021 | Q2 2021 | Q3 2021 | Q4 2021 | FY 2021 | Q1 2022 | Q2 2022 | Q3 2022 | Q4 2022 | FY 2022 | Q1 2023 | Q2 2023 | Q3 2023 | Q4 2023 | FY 2023 | Q1 2024 | Q2 2024 | Q3 2024 |
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Digital Banking | 4,610 | 4,876 | - | - | 20,156 | 5,539 | 5,662 | 5,781 | ||||||||||||||||||||||||||||||||||||||||||||||
- Interest Income | 4,077 | 4,290 | 4,610 | 4,868 | 17,845 | 4,948 | 4,971 | 5,112 | ||||||||||||||||||||||||||||||||||||||||||||||
-- Credit Card Loans | 3,321 | 3,466 | 3,726 | 3,925 | 14,438 | 3,938 | 3,959 | 4,092 | ||||||||||||||||||||||||||||||||||||||||||||||
-- Private Student Loans | 252 | 255 | - | - | 1,033 | 264 | 256 | 244 | ||||||||||||||||||||||||||||||||||||||||||||||
-- PCI Student Loans | - | - | - | - | - | - | - | - | ||||||||||||||||||||||||||||||||||||||||||||||
-- Personal Loans | 248 | 278 | - | - | 1,156 | 333 | 347 | 360 | ||||||||||||||||||||||||||||||||||||||||||||||
-- Other Loans | 64 | 73 | 653 | -464 | 326 | 115 | 126 | 138 | ||||||||||||||||||||||||||||||||||||||||||||||
-- Other Interest Income | 192 | 218 | 231 | 251 | 892 | 298 | 283 | 278 | ||||||||||||||||||||||||||||||||||||||||||||||
- Other Income | 88 | 115 | 130 | 117 | 450 | 132 | 323 | 129 | ||||||||||||||||||||||||||||||||||||||||||||||
-- Discount & Interchange | 321 | - | 377 | - | 1,447 | 371 | 437 | - | ||||||||||||||||||||||||||||||||||||||||||||||
-- Protection Products | 43 | - | 42 | - | 172 | 42 | 42 | - | ||||||||||||||||||||||||||||||||||||||||||||||
-- Loan Fee Income | - | - | 194 | - | 763 | 200 | 205 | - | ||||||||||||||||||||||||||||||||||||||||||||||
-- Transaction Processing | 67 | - | 82 | - | 303 | 87 | 91 | - | ||||||||||||||||||||||||||||||||||||||||||||||
-- Losses on Equity Invest. | - | - | 6 | - | (9) | - | - | - | ||||||||||||||||||||||||||||||||||||||||||||||
-- Other Income | 42 | - | 21 | - | 85 | 23 | 239 | - | ||||||||||||||||||||||||||||||||||||||||||||||
Payment Services | 88 | 115 | 130 | 117 | 450 | 132 | 323 | 129 | ||||||||||||||||||||||||||||||||||||||||||||||
Total Revenue | 4,698 | 4,991 | 5,332 | 5,585 | 20,606 | 5,671 | 5,985 | 5,910 | ||||||||||||||||||||||||||||||||||||||||||||||
KPIs - Metric / Quarter | FY 2013 | Q1 2014 | Q2 2014 | Q3 2014 | Q4 2014 | FY 2014 | Q1 2015 | Q2 2015 | Q3 2015 | Q4 2015 | FY 2015 | Q1 2016 | Q2 2016 | Q3 2016 | Q4 2016 | FY 2016 | Q1 2017 | Q2 2017 | Q3 2017 | Q4 2017 | FY 2017 | Q1 2018 | Q2 2018 | Q3 2018 | Q4 2018 | FY 2018 | Q1 2019 | Q2 2019 | Q3 2019 | Q4 2019 | FY 2019 | Q1 2020 | Q2 2020 | Q3 2020 | Q4 2020 | FY 2020 | Q1 2021 | Q2 2021 | Q3 2021 | Q4 2021 | FY 2021 | Q1 2022 | Q2 2022 | Q3 2022 | Q4 2022 | FY 2022 | Q1 2023 | Q2 2023 | Q3 2023 | Q4 2023 | FY 2023 | Q1 2024 | Q2 2024 | Q3 2024 |
**Network Transaction Volume ($ million)** | 136,933 | 146,412 | 148,996 | 156,817 | - | 152,100 | 154,632 | 155,700 | ||||||||||||||||||||||||||||||||||||||||||||||
**Transactions Processed on Networks (million)** | 2,475 | 2,701 | 2,975 | 3,282 | - | 3,195 | 3,349 | 3,375 | ||||||||||||||||||||||||||||||||||||||||||||||
**Credit Card Volume ($ million)** | 54,100 | 55,229 | 55,000 | 57,145 | - | 53,239 | 56,441 | 56,593 | ||||||||||||||||||||||||||||||||||||||||||||||
**DiscoverSeries 3-Month Rolling Avg Excess Spread (%)** | 14.45 | 14.45 | 14.42 | 14.75 | - | 14.14 | 14.07 | - | ||||||||||||||||||||||||||||||||||||||||||||||
**Aggregate Sales Transaction Volume ($ million)** | 60,833 | 65,850 | 65,490 | - | - | 61,332 | 61,886 | 155,657 | ||||||||||||||||||||||||||||||||||||||||||||||
**Direct-to-Consumer Deposits ($ billion)** | 75.3 | 77.3 | 81.2 | 84.0 | - | 87.3 | 87.3 | 90.309 | ||||||||||||||||||||||||||||||||||||||||||||||
**Brokered Deposits ($ billion)** | 20.4 | 21.7 | 22.8 | 24.9 | - | 23.1 | 21.1 | 20.2 | ||||||||||||||||||||||||||||||||||||||||||||||
**SCB Requirement (%)** | 2.5 | 2.5 | 2.5 | 2.5 | - | 2.5 | 2.5 | 2.5 |
Executive Team
Questions to Ask Management
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With the updated loan growth expectations now projected to decline low to mid-single digits, what specific strategies are you implementing to counteract the higher than anticipated payment rates and slightly lower card sales impacting growth?
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Given the SEC's disagreement with your accounting approach on the card misclassification matter, can you elaborate on the potential implications for future financial reporting and how you plan to address the SEC's concerns?
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Total operating expenses increased by 16% year-over-year, driven in part by professional fees up 15% due to higher recovery fees and merger and integration costs; how do you plan to manage these rising expenses, especially considering the pending merger with Capital One?
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Despite recognizing a gain from the sale of the private student loan portfolio, student loans were down 19% year-over-year; how will the continued sale of this portfolio impact your profitability and focus on a more streamlined business model moving forward?
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With net charge-offs in total loans at 4.86%, up 134 basis points from the prior year, and an increase in 30-plus day delinquency formation, what measures are you taking to mitigate credit risk, especially as consumer spending stabilizes and households face inflationary pressures?
Past Guidance
Q3 2024 Earnings Call
- Issued Period: Q3 2024
- Guided Period: FY 2024
- Guidance:
- Loan Growth Expectations: Down low to mid-single digits; excluding student loan sale, low single digits .
- Net Interest Margin: 11.2% to 11.4% .
- Operating Expense Guidance: Unchanged .
- Net Charge-Offs: 4.9% to 5% .
- Capital Management Expectations: Unchanged .
Q2 2024 Earnings Call
- Issued Period: Q2 2024
- Guided Period: FY 2024
- Guidance:
- Loan Growth Expectations: Down low single digits; without student loan sale, consistent with prior view .
- Net Interest Margin: 11.1% to 11.4% .
- Operating Expense Guidance: Unchanged .
- Net Charge-Offs: Low end of 4.9% to 5.2% range .
- Capital Management Expectations: Unchanged .
Q1 2024 Earnings Call
- Issued Period: Q1 2024
- Guided Period: FY 2024
- Guidance:
- Loan Growth: Up low single digits .
- Net Interest Margin: 10.7% to 11% .
- Operating Expenses: Increase by mid-single digits .
- Net Charge-Offs: 4.9% to 5.2% .
- Compliance and Risk Management Expenses: Approximately $500 million .
- Sales Growth: Flat to slightly negative .
- Payment Rates: About 70 basis points above 2019 levels .
- Student Loan Portfolio Sale: Expected by late Q3 or Q4 .
Q4 2023 Earnings Call
- Issued Period: Q4 2023
- Guided Period: FY 2024
- Guidance:
- Loan Growth: End-of-period flat; average up modestly .
- Net Interest Margin: 10.5% to 10.8% .
- Operating Expenses: Increase by mid-single digits .
- Net Charge-Offs: 4.9% to 5.3% .
- Capital Management: Focus on organic growth and returning capital .
- Efficiency Ratio: Long-term sub-40% .
Competitors
Competitors mentioned in the company's latest 10K filing.
- Visa: Enjoys greater merchant acceptance and broader global brand recognition than Discover. Has entered into long-term arrangements with financial institutions that may discourage them from issuing cards on the Discover Network or PULSE network .
- MasterCard: Similar to Visa, has greater merchant acceptance and global brand recognition. Also has long-term arrangements with financial institutions that may limit Discover's business opportunities .
- American Express: A strong competitor with international acceptance, high transaction fees, and an upscale brand image. Competes in the same market segments as Diners Club internationally .
Latest news
Recent developments and announcements about DFS.
Financial Reporting
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Impact on Financials: The restated financial statements are expected to show an increase in assets by $190 million, an increase in liabilities by $783 million, and a decrease in retained earnings by $593 million as of December 31, 2023. Pre-tax income for 2023 and 2022 will be reduced by $190 million and $77 million, respectively .
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Reason for Restatement: The restatement is necessary to correct the revenue recognition related to the card product misclassification, which was initially recorded as a $365 million liability. This amount has been revised to approximately $1,047 million following discussions with the SEC .
Earnings Report
Discover Financial Services (DFS) has released updated financial results for the quarter ended September 30, 2024. Net Income for this quarter was $870 million, and the Net Income Allocated to Common Stockholders was $834 million. The Basic and Diluted EPS were both $3.32. The Revenue Net of Interest Expense was $4,453 million, and the Total Operating Expense was $1,788 million. The Operating Efficiency was reported at 40.1%, and the Return on Equity (ROE) was 21%. Additionally, the company faced a $90 million charge due to probable penalties related to card product misclassification, which impacted the financial results for this quarter .
Financial Restatements
Discover Financial Services Financial Restatement
Discover Financial Services (DFS) has announced a decision to restate certain prior period financial statements. This decision follows a notice from the New York Stock Exchange (NYSE) regarding the company's non-compliance due to a delay in filing its Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2024 .
Details of the Restatement
The restatement involves adjustments to the company's financial statements for the fiscal years ended December 31, 2023, and 2022, as well as for the interim periods in 2023 and 2024. The restatement is primarily due to the misclassification of certain credit card accounts, which led to an incorrect revenue recognition .
Potential Effects on the Company
The restatement could affect investor confidence and the company's stock price due to the perceived instability in financial reporting. However, the company is taking steps to address these issues, including revising its internal controls over financial reporting .
The restatement also impacts the ongoing merger with Capital One, as the financial statements need to be accurate for the merger process to proceed smoothly .
Conclusion
Discover Financial Services is actively working to file the restated financial statements and address the issues raised by the NYSE and SEC. The company aims to complete these filings by the end of the year, although the exact timing is uncertain .
Investors are advised to monitor the situation closely as the company works through these financial adjustments and the implications for its merger with Capital One.
Financial Actions
Dividend Policy
Discover Financial Services (DFS) and Capital One Financial Corporation Announce Merger Agreement
On February 19, 2024, Discover Financial Services (DFS) entered into an Agreement and Plan of Merger with Capital One Financial Corporation and Vega Merger Sub, Inc. The merger agreement outlines that Vega Merger Sub will merge with and into Discover, with Discover continuing as the surviving corporation. Immediately following this merger, Discover will merge with and into Capital One, with Capital One continuing as the surviving corporation. Additionally, Discover Bank will merge with and into Capital One, National Association, Capital One's wholly-owned national bank subsidiary .
Dividend Policy Coordination
As part of the merger agreement, Discover and Capital One have agreed to coordinate the declaration of any dividends in respect of their common stocks to ensure that holders of Discover Common Stock do not receive two dividends or fail to receive one dividend in any quarter with respect to their shares of Discover Common Stock and any shares of Capital One Common Stock received in exchange .
Dividend Rates
The agreement specifies that Discover may continue to pay regular quarterly cash dividends at a rate not exceeding $0.700 per share of Discover Common Stock .
Conversion of Equity Awards
At the effective time of the merger, each outstanding Discover restricted stock unit award will be converted into a corresponding award with respect to Capital One Common Stock, adjusted based on the exchange ratio. Each outstanding Discover performance stock unit award will be converted into a cash-based award, with the number of shares determined based on performance and the exchange ratio .
Effective Dates and Conditions
The merger is subject to various conditions, including regulatory approvals and the approval of the stockholders of both Discover and Capital One. The effective time of the merger will be determined upon the fulfillment of these conditions .