Discover Financial (DFS) Q3 Earnings Lag on High Operating Costs

Discover Financial Services DFS reported third-quarter 2022 adjusted earnings of $3.54 per share, which fell short of the Zacks Consensus Estimate by 3.3%. The bottom line was flat year over year.

DFS’s revenues — net of interest expenses — climbed 25% year over year to $3.5 billion in the quarter under review. Also, the top line outpaced the consensus mark by 3.6%.

The quarterly results were hampered by elevated operating costs at the Digital Banking segment. Nevertheless, solid loan growth, improved net interest margin and well-performance of credit metrics partly offset the downside. Strong contribution from the Payment Services segment also drove the upside.

Discover Financial Services Price, Consensus and EPS Surprise

Discover Financial Services Price, Consensus and EPS Surprise

Discover Financial Services price-consensus-eps-surprise-chart | Discover Financial Services Quote

Operational Update

Operating efficiency (total operating expense divided by revenues, net of interest expense) declined 300 basis points (bps) year over year to 39.9% in the quarter under review.

Total operating expenses of $1.4 billion escalated 17% year over year, mainly due to increased marketing and business development expenses, professional fees, and employee compensation and benefits. Our estimate for the metric suggests a 15.2% rise from the year-ago quarter’s reported figure.

Interest expenses surged 91% year over year to $514 million in the third quarter, while our estimate for the metric stands at $353.5 million.

Discover Financial’s net income of $1 billion dropped 8% year over year. Our estimate for the metric stands at $1.1 billion.

Segmental Performance

Digital Banking Segment

The segment’s pretax income of $1.3 billion plunged 17% year over year in the third quarter. The decrease was due to rise in provision for credit losses and higher operating expenses, partly offset by improved revenues, net of interest expense. Our estimate for the metric stands at $1.4 billion.

The provision for credit losses of $773 million increased to more than four-fold year over year.

Total loans increased 17% year over year in the quarter under review, while our estimate for the metric indicates an increase of 12.6% from the prior-year quarter’s reported figure. While credit card loans advanced 19% year over year, total private student loans rose 2% year over year. Personal loans climbed 11% year over year.

Net interest income of $2.8 billion grew 18% year over year, courtesy of improved average receivables and an expanded net interest margin. Net interest margin improved 25 bps year over year to 11.05%.

Payment Services Segment

The segment reported a pretax income of $53 million in the third quarter against the prior-year quarter’s loss of $114 million. The segment’s performance gained on an unrealized equity loss of $167 million reported in the third quarter of 2021. Better PULSE and Network Partners volumes also contributed to the quarterly results.

Payment Services volume of $84.1 billion rose 10% year over year. While PULSE dollar volume increased 6% year over year in the quarter under review on the back of higher debit transaction volume, Diners Club volume witnessed a 34% year-over-year climb. Network Partners volume advanced 15% year over year, thanks to growing AribaPay volume.

Financial Position (as of Sep 30, 2022)

Discover Financial exited the third quarter with total assets of $121.9 billion, which grew 12% year over year. The liquidity portfolio (comprising cash and cash equivalents and other investments but excluding cash-in-process) dropped 20% year over year to $16 billion.

Borrowings stood at $20.2 billion at the third-quarter end, up 9% year over year. Total liabilities climbed 13% year over year to $107.6 billion. Total equity of $14.3 billion increased 8% year over year.

Capital Deployment

DFS suspended its stock buyback program in July 2022 due to an internal investigation of its student loan servicing practices. The suspension stays.

Shares of common stock outstanding dipped 0.7% sequentially.

The board of directors announced a quarterly cash dividend of 60 cents per common share, which will be paid out on Dec 8, 2022, to Discover Financial’s shareholders of record on Nov 23.

2022 Guidance

Management anticipates loan growth to be in high teens, up from the prior estimate of low teens’ growth. The average net charge-off rate is projected in the 1.8-1.9% range, down from the previous view of 1.9-2.1%.

Operating expenses are predicted to grow in high-single digits this year, up from the prior estimate of a rise in mid-single digits. Though the guidance for net interest margin is reiterated, the metric is likely to stay fairly above the upper end of the earlier projected range.

Zacks Rank

Discover Financial currently carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Other Finance Sector Releases

Of the Finance sector players that have reported third-quarter results so far, the bottom-line results of Bank of New York Mellon Corporation BK, State Street Corporation STT and MarketAxess Holdings Inc. MKTX beat the respective Zacks Consensus Estimate.

BNY Mellon’s third-quarter 2022 adjusted earnings of $1.21 per share surpassed the Zacks Consensus Estimate of $1.10. The bottom line represents a rise of 11% from the prior-year quarter’s number. Total revenues grew 6% year over year to $4.28 billion. The top line outpaced the Zacks Consensus Estimate of $4.18 billion. On a fully taxable-equivalent (FTE) basis,  BK’s net interest revenues were $929 million, up 44.3% year over year.

State Street’s third-quarter 2022 adjusted earnings of $1.82 per share outpaced the Zacks Consensus Estimate of $1.79. The bottom line was 9% lower than the prior-year level. The total revenues of STT were $2.96 billion, decreasing 1% year over year. Also, the top line missed the Zacks Consensus Estimate of $2.98 billion. The net interest margin rose 35 basis points year over year to 1.11%.

MarketAxess reported third-quarter 2022 earnings per share of $1.58, beating the Zacks Consensus Estimate by 6%. The bottom line improved nearly 4% year over year. Total revenues of $172.1 million rose 6% year over year in the quarter under review but fell short of the consensus mark by a whisker. MKTX’s commission revenues of $153.2 million climbed 7.2% year over year.

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