Earnings call transcript: Discover Financial Services Q1 2025 beats estimates amid merger anticipation

Discover Financial Services reported a strong start to 2025, surpassing Wall Street expectations with its first-quarter earnings. The company saw a significant increase in net income and net interest margin, while also preparing for its impending merger with Capital One. The market responded positively, with Discover’s stock rising in after-hours trading. According to InvestingPro data, the company is currently trading at an attractive P/E ratio of 10.06, suggesting potential undervaluation relative to its growth prospects.

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Key Takeaways

• Discover’s EPS of $4.25 exceeded the forecast of $3.35.
• Revenue reached $4.25 billion, slightly above the expected $4.23 billion.
• Net income surged by 30% year-over-year to $1.1 billion.
• The merger with Capital One is set to close on May 18, 2025.
• Discover’s stock rose 3.69% in after-hours trading.

Company Performance

Discover Financial Services demonstrated robust performance in Q1 2025, with a notable increase in net income and an expanding net interest margin. The company’s strategic focus on direct-to-consumer deposit growth and conservative underwriting has paid off, as evidenced by the $2 billion increase in deposit balances and a reduction in average deposit rates. Despite a slight decline in card receivables, overall loan growth remained positive.

Financial Highlights

• Revenue: $4.25 billion, slightly above forecasts.
• Earnings per share: $4.25, exceeding the $3.35 forecast.
• Net income: $1.1 billion, up 30% from the previous year.
• Net interest margin: 12.18%, an increase of 115 basis points year-over-year.
• Operating expenses: Increased by 1% year-over-year.

Earnings vs. Forecast

Discover’s actual EPS of $4.25 significantly outpaced the forecast of $3.35, marking a substantial earnings surprise of approximately 26.9%. The revenue also slightly exceeded expectations, coming in at $4.25 billion compared to the anticipated $4.23 billion. This performance indicates strong operational efficiency and effective cost management.

Market Reaction

Following the earnings announcement, Discover’s stock experienced a 3.69% increase in after-hours trading, closing at $179.43. The stock’s upward movement reflects investor confidence in the company’s financial health and strategic direction, especially in light of the upcoming merger with Capital One. The stock is currently trading closer to its 52-week high of $205.76, indicating positive market sentiment.

Outlook & Guidance

While Discover did not provide specific guidance for 2025 due to the pending merger, the company remains optimistic about its future prospects. The merger with Capital One is expected to enhance competition and innovation within the payment networks sector. Discover’s Common Equity Tier One ratio stands at a robust 14.7%, underscoring its strong capital position. InvestingPro’s Financial Health Score rates Discover as "GREAT" with an overall score of 3.17 out of 4, particularly excelling in profitability metrics.

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Executive Commentary

Interim CEO Michael Shepherd expressed enthusiasm about the merger, stating, "We look forward to completing the merger and believe the combination of our two great companies will increase competition in payment networks." CFO John Green highlighted the company’s strong performance, noting, "Our fundamental performance in the first quarter was strong, underscored by our robust net interest margin, strong credit performance and healthy capital and liquidity levels."

Risks and Challenges

• Integration Risks: The upcoming merger with Capital One poses integration challenges that could impact operational efficiency.
• Competitive Pressure: Increased competition in the payment networks sector may affect Discover’s market share.
• Economic Uncertainty: Macroeconomic factors, such as interest rate changes and consumer spending patterns, could impact future performance.
• Regulatory Risks: Potential regulatory changes could affect the company’s operations and profitability.
• Credit Risk: Although credit performance improved, any adverse changes in customer credit behavior could pose a risk.

Note

This article provides a comprehensive overview of Discover Financial Services’ Q1 2025 earnings, highlighting key financial metrics, market reactions, and strategic outlook.

Full transcript - Discover Financial Services (DFS) Q1 2025:

Operator: Please stand by. Your program is about to begin. If you need audio assistance during today’s program, Good morning. My name is Margo, and I will be your operator today. At this time, I would like to welcome everyone to the First Quarter twenty twenty five Discover Financial Services Earnings Conference Call.

All lines have been placed on mute to prevent any background noise. Thank

Erin, Investor Relations, Discover Financial Services: you, operator. I’ll begin by referencing Slide two of our earnings presentation, which you can find in the Financials 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 twenty twenty five 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 and President, Michael Shepherd and John Green, our Chief Financial Officer.

There will be no question and answer session following today’s remarks. It is now my pleasure to turn the call over to Michael.

Michael Shepherd, Interim CEO and President, Discover Financial Services: Thank you, Erin. Good morning, and welcome to today’s call. I’d like to begin by providing a few brief comments about the merger with Capital One. Of course, we’re very pleased to report that the Federal Reserve Board and the Office of the Comptroller of the Currency approved our merger with Capital One. These decisions follow the approval of the transaction by the Delaware State Bank Commissioner in December of last year and by our shareholders in February of this year with over 99% of the ballots cast voting in favor of the merger.

The transaction is expected to close on 05/18/2025 subject to the satisfaction of the customary closing conditions. We look forward to completing the merger and believe the combination of our two great companies will increase competition in payment networks, offer a wider range of products to our customers, increase the resources devoted to innovation and security, as well as bring meaningful benefits to our communities and shareholders. Shifting focus to our recently reported quarterly results, Discover’s financial performance remained strong in the first quarter. Earnings per share increased by 31% compared to last year, driven by a healthy net interest margin and good credit performance. Discover customer behavior was stable, evidenced by spend, payment and credit trends.

The card thirty plus day delinquency rate decreased by 18 basis points compared to last quarter and the card net charge off rate improved year over year. Consequently, our acquisition and underwriting strategies did not change materially during In light of increasing macroeconomic uncertainty, we are closely monitoring economic developments and consumer health. With that, I’ll now ask John Green to review our first quarter financial results.

John Green, Chief Financial Officer, Discover Financial Services: Thank you, Michael. I’ll start with our summary financial results on Slide four. In the first quarter, we reported net income of $1,100,000,000 which was up 30% from the prior year. Provision expense declined by $253,000,000 reflecting a reduction in our credit reserve balance and lower net charge offs. Net interest income increased by $71,000,000 from continued net interest margin expansion.

Let’s review the details beginning with revenue on Slide five. Our net interest margin ended the quarter at 12.18%, up 115 basis points from the prior year and up 22 basis points sequentially. Over the past year, margin expansion has been driven by the student loan sale, a lower card promotional balance mix and a reduction in consumer deposit pricing. Quarter over quarter, the main driver was lower deposit cost. Card receivables were relatively stable, down 05% year over year from modestly lower sales.

The payment rate increased 10 basis points from last year and was sequentially flat. Discover card sales were down 2% compared to the prior year. The decline in card sales was from past credit tightening actions. Personal loan balances were flat. Although demand remains robust, our conservative underwriting posture and increased competition has slowed the pace of new originations.

Total loans after adjusting for the student loan sale increased 1% from last year. Average consumer deposits were up 6% year over year and 1% sequentially. We grew direct to consumer deposit balances by $2,000,000,000 in the quarter while reducing average deposit rates by 22 basis points. Direct to consumer deposits now account for 74% of total funding. Looking at other revenue on Slide six.

Non interest income increased $20,000,000 or 3% driven by an increase in net discount and interchange revenue. The rewards rate was 140 basis points in the period, an increase of one basis point driven by higher spend in the 5% category, which was largely offset by lower cash back match. Sequentially, the rewards rate was up five basis points from changes in the promotional category. Moving to expenses on Slide seven. Total operating expenses were up $19,000,000 or 1% year over year.

Looking at our major expense categories, compensation costs increased $64,000,000 or 10% primarily due to higher wages and benefits and proactive employee retention actions. Information processing increased $17,000,000 or 10% as a result of technology investments related to software and increased systems usage. And other expenses decreased $59,000,000 from a $45,000,000 reduction in anticipated civil penalties and a $20,000,000 decline in legal fees. Moving to credit performance on Slide eight. Total net charge offs were 4.99%, seven basis points higher than the prior year and up 35 basis points from the prior quarter.

Excluding the impact of the student loan sale, the net charge off rate would have been down 24 basis points year over year. In card, net charge offs increased 44 basis points from the prior quarter, primarily driven by normal seasonal trends. The thirty plus day delinquency rate continued to improve, declining in the quarter after plateauing in the second half of twenty twenty four. Personal loan net charge offs and delinquencies were stable compared to last quarter. Delinquency formation, vintage performance and portfolio trends remained positive.

Turning to the allowance for credit losses on Slide nine. Our credit reserve balance decreased $215,000,000 from the prior quarter. The reserve rate was relatively unchanged at 6.91%, up four basis points. Looking at Slide 10. Our common equity Tier one ratio for the period was 14.7%, up 60 basis points compared to the prior quarter, driven by core earnings generation, partially offset by the impact of the final CECL phase in, which reduced capital by approximately 43 basis points.

We declared a quarterly cash dividend of $0.70 per share of common stock because the planned closing of the merger with Capital One is May 18, we expect that holders of the Discover’s common stock will not receive any Discover dividend, but will instead receive any dividend declared on shares of Capital One common stock if they are holders of record of Capital One stock as of the applicable record date. As it relates to 2025 trends, we have elected not to provide an update due to our upcoming merger. In summary, our fundamental performance in the first quarter was strong, underscored by our robust net interest margin, strong credit performance and healthy capital and liquidity levels. Given the recent merger approval and anticipated closing date, this is likely Discover Financial Services’ final earnings call. I want to take this opportunity to thank the covering analysts and our shareholders for your support over the years and for your support of our merger with Capital One.

We wish you all the best. With that, I’ll turn the call back over to the operator.

Operator: Today’s call has ended. Thank you for joining. You may now disconnect.

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