Discover posts 2Q profit due to gain from lawsuit settlement, triples loan-loss reserves

Discover 2Q profit slips, gain boosts results

CHARLOTTE, N.C. — Discover Financial Services said Thursday it managed to remain profitable during its fiscal second quarter, thanks to a payment from a lawsuit settlement.

Without the gain from the lawsuit settlement, the credit card lender would have had a loss due to rising defaults and delinquencies. Nearly all lenders are seeing more customers stop making their monthly payments as the economy falters and unemployment surges.

In the United States, Discover said its sales volume fell 4 percent compared with a year ago, reflecting lower gas prices and a general decline in consumer spending.

The Riverwoods, Ill.-based company also declared a dividend of 2 cents a share.

Discover said its earnings available to common shareholders slipped to $209.2 million, or 43 cents per share, during the quarter ended May 31, down from $234.1 million, or 48 cents per share, a year earlier.

The company’s results were bolstered by a $473 million payment received as part of a $2.75 billion settlement of an antitrust lawsuit with Visa Inc. and MasterCard Inc. The payment boosted Discover’s profit by $295 million after taxes. The lawsuit claimed MasterCard and Visa harmed Discover’s business by preventing their member banks from issuing credit cards for Discover’s network.

Discover did not provide a per share figure on how much it would have lost without the settlement gain.

Analysts polled by Thomson Reuters, on average, forecast a loss of 30 cents per share for the quarter. Analysts estimates often do not include one-time items.

Discover shares rose 36 cents, or 4 percent, to close at $9.27 Thursday.

“Discover’s recent earnings were quite the murky mix,” said Red Gillen, an analyst with Celent, a Boston-based financial research and consulting firm. “Net profits were up … Delinquencies were down, but charge-offs were up. Third-party payment volume rose … but proprietary network volume dropped.”

And because the company will have no legal-based financial settlements to fall back on in the near future term, “it is likely that this picture will turn a bit darker,” Gillen added.

With default rates skyrocketing, credit-card companies continue to be casualties of an economic crisis that began with the collapse of the U.S. housing and subprime mortgage markets and spread worldwide.

Last month, President Barack Obama signed into law new regulations for the credit card industry that put limits on sudden hikes in interest rates and restrict who can receive a card and how much time people are given to pay their bill.

The legislation will have short and long-term impacts on the industry, CEO David Nelms told analysts on a conference call.

“We believe some aspects of the act may have less of an impact on Discover than on some of our competitors,” he said, adding that Discover does not assess over limit fees intracycle and that the company has been less active in student card marketing than some rivals.

During the quarter, Discover’s provision for loan losses more than tripled to $643.9 million from $211 million in the same quarter the previous year. The company’s charge-off rate, the percentage of debt it does not expect to be repaid, climbed to 7.79 percent from 6.48 percent in the first quarter.

However, Discover’s managed 30-day delinquency rate fell to 5.08 percent from 5.25 percent in the prior quarter, but rose from 3.81 percent a year earlier.

Looking ahead to the third quarter, the company forecast its charge-off rate would rise to between 8.5 and 9 percent.

Earlier this year, Discover became a bank holding company and received $1.2 billion from the federal government under the Troubled Asset Relief Program.

The company joins hundreds of financial-services companies — including rival American Express Co. — that have gotten government capital during the financial crisis. On Wednesday, American Express said it repaid the $3.39 billion it received last fall.

“We certainly look forward to repaying it and being out, but I would say just as we’ve historically been deliberate and conservative on capital and credit, we will continue to do so,” Nelms said in an interview with The Associated Press, adding the money is being used to support the company’s lending efforts. “I don’t expect to pay it back next week … but maybe sooner than we certainly would have expected three months ago.”

Discover said Thursday that $13 million of preferred dividends were accrued in the second quarter related to shares of preferred stock issued in March as part of its participation in the government’s program.

During the most recent quarter, income from Discover’s third-party payments business — which processes ATM and debit transactions — rose sharply to $26.7 million from $16.8 million a year earlier. The boost was due to the addition of Diners Club International, which was acquired from Citigroup Inc. last year.

Discover’s third-party payments business processed $36.7 billion in transactions during the most recent quarter.

Average total loans during the quarter increased to $51.1 billion from $47.5 billion the same quarter last year.

Total deposits rose 18 percent to $29 billion.

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