Discover Financial Services (NYSE: NYSE:DFS) reported its first quarter 2024 earnings, revealing a net income of $308 million, a decrease of 68% from the previous year. This decline was primarily due to a significant increase in the reserve for remediation related to a card misclassification issue.
The core financial performance remained robust, with notable loan growth and a resilient net interest margin contributing to revenue expansion. The company is navigating through a period of change, including an ongoing merger with Capital One, while maintaining a focus on risk management and compliance.
Key Takeaways
- Discover Financial Services reported a net income of $308 million for Q1 2024, down by 68% year-over-year.
- The decrease was mainly due to a $799 million increase in the reserve for card misclassification issue remediation.
- Excluding the reserve increase, net income would have been approximately $915 million.
- Loan growth and a strong net interest margin drove revenue expansion.
- Credit performance was consistent with expectations, with losses expected to peak in mid to late 2024.
- The company is in the process of merging with Capital One, with interim CEO Michael Shepherd at the helm.
Company Outlook
- Loan growth expectations have increased to up low single digits.
- Net interest margin forecast adjusted to 10.7% to 11%.
- Core operating expenses are expected to rise by mid-single digits, excluding costs related to card misclassification and merger expenses.
- Net charge-off range tightened to 4.9% to 5.2%, with the base case at the lower end.
- Share repurchases suspended and dividend increases halted due to the merger agreement.
Bearish Highlights
- The substantial increase in the reserve for card misclassification issue impacted earnings negatively.
- Discover card sales decreased by 1% year-over-year, with lower spending noted particularly among lower-income households.
Bullish Highlights
- Double-digit revenue expansion from loan growth was a positive indicator.
- The company observed strong consumer deposit growth and a healthy increase in noninterest income.
- The PULSE network showed a 21% increase in debit volume.
Misses
- Net income fell significantly due to the remediation reserve increase.
- Card sales experienced a slight downturn.
Q&A Highlights
- No Q&A session was conducted in this earnings call. Further inquiries are to be directed to Discover's Investor Relations team.
Despite facing challenges, Discover Financial Services demonstrated a capacity for solid operating performance and growth in the first quarter of 2024. The company remains committed to navigating through compliance issues and progressing towards a strategic merger, aiming to create long-term value for shareholders and customers alike. With the interim CEO's experience and the company's strategic focus, Discover is positioned to manage the current challenges while looking forward to the opportunities that the merger may bring.
InvestingPro Insights
Discover Financial Services (NYSE: DFS) has shown resilience in its operating performance despite a notable decline in net income for Q1 2024. The company's strategic actions and market performance offer valuable insights into its future prospects.
InvestingPro Data metrics indicate a robust Price to Earnings (P/E) Ratio of 11.01, which is favorable when compared to the adjusted P/E ratio for the last twelve months as of Q1 2024, standing at 13.54. This suggests that the stock may be undervalued based on its earnings. The company's revenue growth for Q1 2024 was impressive at 29.39%, signaling strong quarterly performance. Additionally, the 3 Month Price Total Return of 28.4% and the 6 Month Price Total Return of 48.94% reflect a significant appreciation in share value over recent months.
Two key InvestingPro Tips provide further context to the company's financial health and shareholder value. Firstly, management's aggressive share buybacks demonstrate confidence in the company's valuation and future performance. Secondly, Discover Financial Services has not only maintained but also raised its dividend for 13 consecutive years, showcasing its commitment to returning value to shareholders.
For those interested in a deeper dive into Discover Financial Services' financials and future outlook, InvestingPro offers additional tips that could be pivotal in making informed investment decisions. With the use of the coupon code PRONEWS24, investors can get an additional 10% off a yearly or biyearly Pro and Pro+ subscription, unlocking access to a wealth of expert analysis and tips. Currently, InvestingPro lists several more tips that could be crucial for a comprehensive understanding of Discover's position and prospects in the financial sector.
In summary, Discover Financial Services' recent earnings report, coupled with InvestingPro's real-time data and tips, paints a picture of a company that is managing its current challenges while laying the groundwork for future growth and continued shareholder returns.
Full transcript - Discover Financl (DFS) Q1 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 First Quarter 2024 Discover Financial Services Earnings Conference Call. [Operator Instructions] 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] 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 our first 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's now my pleasure to turn the call over to Michael.
Michael Shepherd: Thank you, Eric, and good morning, everyone. Thank you all for joining today's call. I'd like to begin the call with a few words of introduction. I joined Discover's Board in August of 2023 after a career in the public and private sectors, more than 30 years of which were in the financial services industry. Among other roles, I served as Senior Deputy Controller of the Currency earlier in my career. Most relevant to my current position, I was Chairman and CEO of BancWest Corporation and Bank of the West. As Chairman of Bank of the West, I helped oversee its acquisition and integration into the Bank of Montreal in 2023. I hope my experience will help me serve our shareholders customers and employees as an effective leader during this important period. John Greene will discuss the results of the first quarter in greater detail, but let me highlight a few aspects of our financial performance. Discover's operating performance remained solid with increased revenues in the period, driven by good loan growth, largely reflecting payment rate normalization and a resilient net interest margin. We are seeing receivables expansion while remaining prudent in our underwriting and disciplined in customer acquisition. Credit continues to perform in line with our expectations and delinquency formation has stabilized as we had anticipated. Importantly, we continue to strengthen our risk management and compliance programs where we are investing in meaningful resources. In the first quarter, following continuing internal reviews, and after extensive discussions with several constituencies, including merchants and regulators, Discover decided to significantly increase our liability for the card misclassification issue. We believe that taking this action will advance the resolution of these issues. There's been a lot of change at Discover over the last few months and I thought it might be helpful to emphasize our framework for decision-making. Our goals are to maximize shareholder value by executing on our risk management and compliance priorities, sustaining our commitment to outstanding customer service and seeing that the company remains well positioned to drive long-term value creation. As the interim CEO of Discover, I'm committed to these objectives, which will improve our company and allow us to make the strongest contribution to the combined Capital One. The Capital One team is leading the integration planning process and we look forward to partnering with our colleagues in support of our shared objectives. The process has achieved the first important milestone, the submission of the merger applications to the Federal Reserve and the OCC. We continue to believe that the strategic rationale, operating scale and economics of the combined company are compelling. The merger will advance the company's shared mission to help our customers meet their financial goals support our commitments to our communities and make the combined company a well-positioned bank and a competitive payments network of the future. Finally, I'd like to thank Michael Rhodes for his leadership through an important phase. His new position allows him to fulfill his career goal of leading a public company and my colleagues and I wish him well. With that, I'll now ask John Greene to review our first 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 $308 million, which was down 68% from the prior year quarter. Impacting our operating results was a $799 million increase to our reserve for remediation related to the card misclassification issue. The decision to increase the reserve was based upon, among other factors, the company's experience to date with remediation efforts, regulatory dialogue and our pending merger with Capital One. As Michael indicated, we believe this action is aligned with our compliance and risk management objectives and will significantly help advance the resolution of this issue. Our core financial performance remains strong. Key highlights for the quarter include double-digit revenue expansion from loan growth, a resilient net interest margin strong consumer deposit growth and credit performance consistent with our view that losses will peak and plateau in mid to late 2024. Excluding the card misclassification remediation reserve increase, we would have reported net income of approximately $915 million, EPS of about $3.50 per share and an efficiency ratio under 36%. These figures indicate a strong start to 2024. Let us review the details beginning on Slide 6. Our net interest margin ended the quarter at 11.03%, down 31 basis points from the prior year and up 5 basis points sequentially. On a quarter-over-quarter basis, expanding loan yields from a lower card promotional balance mix and payment rate moderation were partially offset by higher net funding costs. Receivable growth is slowing from its peak in the first quarter of 2023, but continues to be strong. Card receivables increased 11% year-over-year due to a lower payment rate and contribution from prior year new account growth. The payment rate declined about 20 basis points from the sequential quarter and is now about 70 basis points above 2019 levels. Discover card sales were down 1% compared to the prior year quarter. Sales slowed across categories with the largest decline occurring in the everyday category, which includes supermarkets, gas and wholesale clubs. While we continue to add new accounts, in general, we are seeing card members spend less, particularly among lower-income households which are most impacted by the cumulative effects of inflation. Based on trends in the period, we expect sales to be flat to slightly negative this year. Personal loans were up 21%, driven by continued strength in originations and lower payment rates versus the prior year. We are seeing strong uptake on our offering as higher interest rates in card can make debt consolidation more appealing for Summit consumers. Approximately 50% of our first quarter originations and personal loans were utilized for debt consolidation with disbursements primarily made directly to creditors. Student loans were flat year-over-year. As previously announced, we stopped accepting applications for new student loans on February 1. We formally launched the sales process in mid-March and several thousand potential buyers have provided an initial indication of interest. We continue to anticipate strong demand and still target a closing date late in the third quarter or fourth quarter. Average deposits were up 18% year-over-year and 4% sequentially. Our direct-to-consumer balances grew $3 billion in the period. We have started to decrease pricing on our deposit products ahead of any potential moves in reference rates. This is consistent with our practice of leading the industry on pricing in the down part of the cycle and this action contributed to our strong NIM performance in the quarter. Looking at other revenue on Slide 7. Noninterest income increased $113 million or 19%. This was primarily driven by higher net discount and interchange revenue, an increase in loan fee income and higher transaction processing revenue from our PULSE business. PULSE continued to grow at a healthy clip as debit volume increased by $13.8 billion or 21% year-over-year. Our rewards rate was 139 basis points in the period, a decrease of 2 basis points versus the prior year quarter. The decline reflects lower cash back match from slowing new account growth and the active management of our 5% categories. Prior to reviewing expenses, I would like to briefly comment on the CFPB late fee proposal. We continue to closely monitor the legal process around the proposal. If the rule were to be implemented, on an annualized basis, we estimate a pretax reduction of around $600 million or approximately 4% of revenues. Moving to expenses on Slide 8. Total operating expenses were up $926 million or 67% year-over-year. As mentioned, the predominant driver of this growth was the increase to our remediation reserve. Absent this, our expenses would have increased 9% year-over-year. Looking at our major expense categories. Compensation costs increased $46 million or 7% due to an increase in business technology resources and severance related to organizational changes including the wind down of our student loan business. Professional fees were up $60 million or 26%, driven by continued investments in compliance and risk management initiatives higher recovery fees and merger-related expenses. Information processing increased due to technology investments. Our expectation for compliance and risk management expenses for the year excluding remediation-related costs, remains in the $500 million range with an upside bias. Moving to credit performance on Slide 9. Total net charge-offs were 4.92%, 220 basis points higher than the prior year and up 81 basis points from the prior quarter. In Card, as we anticipated, delinquency formation is improving as more recent vintages season. The 30-plus day delinquency rate was down 4 basis points versus the prior quarter. From a vintage perspective, our 2023 card vintage is performing relatively in line with our 2022 vintage. Both vintages remain profitable and above our return thresholds. This performance has been contemplated in our full year net charge-off guidance. We executed some incremental tightening during the first quarter, which will influence our new account growth for the year. Personal loan net charge-offs were 4.02%, 208 basis points higher than the prior year and up 63 basis points from the prior quarter. We expect losses in this product to trend higher in the near term before plateauing beginning late this year or into 2025. Turning to the allowance for credit losses on Slide 10. Our credit reserve balances declined $25 million from the prior quarter, and our reserve rate increased by 9 basis points to 7.32%. The reserve rate increase was primarily driven by the reduction of seasonal transactor balances in the quarter. Given our expectation for total company losses to peak and plateau in mid- to late 2024 and we believe the credit reserve rate is likely at or near peak levels, assuming a stable macroeconomic environment and no significant unexpected changes in portfolio performance. Looking at Slide 11. Our common equity Tier 1 for the period was 10.9%, down 40 basis points sequentially. The impacts from the increase in expenses in the CECL phase-in were offset by lower receivables and core earnings generation. We declared a quarterly cash dividend of $0.70 per share of common stock. Concluding on Slide 12. We have made the following updates to our 2024 outlook. We are increasing our loan growth expectations to up low single digits. This primarily reflects our expectation of further decline in the payment rates, offsetting our view of flat to slightly negative sales growth this year and a modest contribution from new accounts. We are increasing our net interest margin range to 10.7% to 11%. This change was driven by 2 factors: first, the forward curve now reflects an expectation of 2 rate cuts this year versus our prior forecast of 4 cuts. And second, we have been proactive in lowering our deposit rates. Our cumulative deposit beta is now about 70%, and we think there will be further opportunities to manage our deposit costs over the course of this year. We still expect our core operating expenses to be up mid-single digits, excluding card misclassification related costs and merger expenses. Our core operating expense trends are in line with our expectations and we believe the actions we took in the first quarter have substantially de-risked the probability of further increases to the remediation reserve. We are tightening our net charge-off range to 4.9% to 5.2%, based largely on current delinquency trends. Our base case remains at the lower end of the range. Finally, given the merger agreement, we have suspended share repurchases through closing and agreed not to increase the dividend. To summarize, we continue to generate solid results and our financial performance underscores our steady stewardship of the organization as we move towards resolving compliance items and consummating our planned merger. This concludes our remarks. I'll turn the call back over to our operator.
Operator: Thank you. This concludes today's call. The Discover Investor Relations team will be available for questions. Thank you for joining. You may now disconnect.
End of Q&A:
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