Discover Financial, a leading provider of financial services, delivered strong second-quarter results, exceeding analysts’ expectations. The company’s performance was buoyed by significant growth in interest income, driven by a favorable high-interest rate environment. This, coupled with a lower provision for credit losses, expanding loan portfolio, increased PULSE volumes, and margin expansion, contributed to the positive earnings. While higher expenses partially offset these positives, Discover Financial still managed to impress.
The company reported adjusted earnings per share of $6.06 for the second quarter of 2024, comfortably exceeding the Zacks Consensus Estimate of $3.06. This represents a substantial year-over-year increase of 71%. Revenue, net of interest expenses, also climbed 17% year-over-year to $4.5 billion, surpassing the consensus mark by 9.1%.
Discover Financial’s key performance indicators highlighted the strength of its operations. Interest income surged 16% year-over-year to nearly $5 billion, surpassing the model estimate of $4.9 billion. While interest expense increased by 30% to $1.45 billion, it remained below the model estimate of $1.49 billion. Non-interest income, which includes fees and other revenue sources, jumped 45% year-over-year to $1 billion, exceeding the Zacks Consensus Estimate by a significant 41.6%.
Total operating expenses rose 23% year-over-year to $1.7 billion, primarily driven by increases in employee compensation and benefits, professional fees, information processing and communication costs, and other expenses. This figure came in higher than the estimated $1.5 billion. Consequently, operating efficiency, measured as total operating expenses divided by revenues net of interest expenses, declined by 190 basis points to 38.1% in the second quarter. Despite the increased expenses, Discover Financial’s net income still surged 70% year-over-year to $1.5 billion.
The company’s Digital Banking segment demonstrated strong growth, reporting a pretax income of $1.8 billion, a 63% increase year-over-year. This was primarily attributed to a decrease in provision for credit losses, increasing revenue net of interest expenses, partially offset by elevated operating expenses. This result exceeded the consensus estimate by a significant 105.1%. The provision for credit losses declined by 43% year-over-year to $739 million, indicating a strong credit quality environment. Total loans increased by 8% year-over-year to $127.6 billion, driven by growth in personal loans (up 13%), credit card loans (up 7%), and a slight decline in private student loans (down 1%). Net interest income climbed 11% year-over-year to $3.5 billion, surpassing the estimated $3.4 billion, thanks to increased average receivables and a 11 basis point improvement in the net interest margin to 11.17%.
Discover Financial’s Payment Services segment also performed well, recording a pretax income of $277 million, a significant improvement compared to the prior-year quarter’s income of $70 million. This strong performance was attributed to increased PULSE transaction processing revenues and a favorable settlement of existing litigation, exceeding the Zacks Consensus Estimate of $74 million. The Payment Services volume rose 11% year-over-year to $99.3 billion in the second quarter. PULSE dollar volume, driven by improved debit transaction volume, increased by 18% year-over-year. However, Diners Club volume declined by 5% due to lower volumes in India and AribaPay. The Network Partners’ volume decreased by 22% year-over-year.
As of June 30, 2024, Discover Financial exited the second quarter with total assets of $150.9 billion, slightly lower than the $151.5 billion at the end of 2023. The liquidity portfolio, comprising cash and cash equivalents and other investments, excluding cash-in-process, stood at $22.4 billion, a decrease from $23.3 billion at the end of 2023. Borrowings also decreased from $21.3 billion to $19.1 billion, while total liabilities decreased from $136.7 billion to $134.8 billion. Total equity, on the other hand, rose from $14.8 billion to $16.1 billion.
Regarding capital deployment, Discover Financial has currently paused share repurchases due to the pending merger with Capital One Financial Corporation. The company declared a quarterly cash dividend of 70 cents per share, which is expected to remain at this level.
In February 2024, Discover Financial entered into a definitive agreement to merge with Capital One Financial Corporation for $35.3 billion. Integration planning efforts for the merger are on track. Capital One is expected to commit $265 billion in community benefit plan over five years to lending, philanthropy, and investment if the acquisition of Discover is successful. Additionally, Discover Financial has agreed to divest its private student loan portfolio to The Carlyle Group Inc. and KKR & Co. Inc. for up to approximately $10.8 billion.
Discover Financial’s management has provided guidance for 2024, including the impact of the private student loan divestment. The company anticipates low single-digit loan growth for the year. The net interest margin is projected to be in the range of 11.1% to 11.4%. Operating expenses are estimated to rise by mid-single digits from $6 billion in 2023, excluding merger and card misclassification-related costs. The average net charge-off rate is estimated to be between 4.9% and 5.2% for the full year, higher than the 2023 figure of 3.42%.
Analysts have generally revised their estimates for Discover Financial upward in recent weeks, indicating positive sentiment. While the company’s Growth Score is currently average (C), its Momentum Score is performing better with a B. The stock has also been allocated a grade of A on the value side, placing it in the top 20% for this investment strategy. Overall, Discover Financial has an aggregate VGM Score of A, making it an attractive option for investors who are not focused on a specific investment strategy.
Given the upward trend in estimates, the magnitude of revisions, and Discover Financial’s Zacks Rank of #3 (Hold), analysts expect an in-line return from the stock in the next few months.
