Discover Financial Services Q4 2024 Earnings Report

Discover Financial Services EPS Results

• Actual EPS: $5.11
• Consensus EPS: $3.13
• Beat/Miss: Beat by +$1.98
• One Year Ago EPS: N/A

Discover Financial Services Revenue Results

• Actual Revenue: N/A
• Expected Revenue: $4.40 billion
• Beat/Miss: N/A
• YoY Revenue Growth: N/A

Discover Financial Services Announcement Details

• Quarter: Q4 2024
• Date: 1/22/2025
• Time: After Market Closes
• Conference Call Date: Thursday, January 23, 2025
• Conference Call Time: 8:00AM ET

Discover Financial Services (NYSE:DFS), through its subsidiaries, provides digital banking products and services, and payment services in the United States. It operates in two segments, Digital Banking and Payment Services. The Digital Banking segment offers Discover-branded credit cards to individuals; personal loans, home loans, and other consumer lending; and direct-to-consumer deposit products comprising savings accounts, certificates of deposit, money market accounts, IRA certificates of deposit, IRA savings accounts and checking accounts, and sweep accounts. The Payment Services segment operates the PULSE to access automated teller machines, debit, and electronic funds transfer network; and Diners Club International, a payments network that issues Diners Club branded charge cards and/or provides card acceptance services, as well as offers payment transaction processing and settlement services. The company was incorporated in 1960 and is based in Riverwoods, Illinois.

Discover Financial Services Q4 2024 Earnings Call Transcript

Key Takeaways

• Discover reported full-year 2024 net income of $4.5 billion and EPS of $17.72, driven by average loan growth, deposit expansion, higher net interest margin, and the sale of its private student loan portfolio.
• In Q4, net income rose to $1.3 billion from $366 million a year ago, led by a $707 million reduction in provision expense, a $381 million gain from the student loan sale, and $162 million of net interest income growth.
• The net interest margin reached 11.96% (up 98 bps YoY), while average consumer deposits grew 10%, card receivables increased 1%, and direct-to-consumer funding reached 72% of total deposits.
• Credit trends improved as net charge-offs declined sequentially, 30+ day delinquencies held steady, and the allowance rate fell to 6.87%, supported by a stable consumer and resilient labor market.
• The pending merger with Capital One is on track with regulatory approval secured, the merger proxy filed with shareholders, and integration planning advancing to realize anticipated synergies.

Presentation

[Operator]

Good morning. My name is Madison, and I will be your conference operator today. At this time, I would like to welcome everyone to the Q4 2024 Discover Financial Services Earnings Conference Call. All lines have been placed on mute to prevent any background noise. Thank you.

[Operator]

I would now like to turn the call over to Ms. Erin Stiefer. Please go ahead.

[Erin Stieber, Investor Relation at Discover Financial Services]

Thank you, operator. I'll begin by referencing Slides 23 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 Q4 2024 earnings press release and presentation as well as the risk factors detailed in our annual report and other filings with the SEC.

[Erin Stieber, Investor Relation at Discover Financial Services]

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. However, the Investor Relations team will be available for any inquiries. It is now my pleasure to turn the call over to Michael.

[Michael Shepherd, Chief Executive Officer, President, Director at Discover Financial Services]

Thank you, Aaron. Good morning and welcome to today's call. 2024 was a good and transformative year for Discover. When assuming the role of Interim CEO last April, I shared that our top goals were operating the company profitably and safely, continuing to strengthen our risk management and compliance, sustaining our commitment to outstanding customer service and preparing for the successful completion of our merger with Capital One. I'm happy to report today that we have made considerable progress on each of these goals.

[Michael Shepherd, Chief Executive Officer, President, Director at Discover Financial Services]

We reported net income of $4,500,000,000 for the full year 2024 and earnings per share of $17.72 reflecting several factors. On a full year basis, we grew average loans, expanded our deposit base and benefited from a higher net interest margin. We also successfully completed the sale of our private student loan portfolio, which provided financial benefits and streamlined our business model. As we anticipated in our commentary, delinquency formation and net charge offs began to improve. And despite a modest slowdown in U.

[Michael Shepherd, Chief Executive Officer, President, Director at Discover Financial Services]

S. Card sales, overall network volume increased driven by growth in our Pulse business and demonstrating the strength of our payments network. We continue to invest heavily in risk management and compliance in 2024 and we are seeing meaningful improvements in our programs. Additionally, we've made progress on meeting regulatory requirements and toward fully resolving the card misclassification matter. Throughout the pursuit of these goals, we remain

[Michael Shepherd, Chief Executive Officer, President, Director at Discover Financial Services]

matter. Throughout the pursuit of these goals,

[Michael Shepherd, Chief Executive Officer, President, Director at Discover Financial Services]

we remain steadfast in our commitment to customers and employees, evidenced by the customer satisfaction and workplace award recognitions we have received. Each of these successes positions us well for our pending merger. Capital One received approval of the merger from the Delaware State Bank Commissioner and our definitive merger proxy has been transmitted to shareholders in connection with the upcoming shareholder votes. Integration planning efforts are progressing well in preparation for a smooth transition. We continue to firmly believe the merger will advance our company's shared mission to help our customers meet their financial goals, support the communities in which we operate and create value for our shareholders.

[Michael Shepherd, Chief Executive Officer, President, Director at Discover Financial Services]

With that, I'll now ask John Green to provide an update on our Q4 financial results.

[John Greene, Executive VP & CFO at Discover Financial Services]

Thank you, Michael. I'll start with our summary financial results on slide 5. In the Q4, we reported net income of $1,300,000,000 versus $366,000,000 in the same period last year. These results were driven by 3 main factors. First, provision expense declined by $707,000,000 This was largely from a reduction in our credit reserve balance compared to a reserve build 1 year ago.

[John Greene, Executive VP & CFO at Discover Financial Services]

2nd, as Michael mentioned, we successfully completed the sale of our student loan portfolio, which resulted in a gain of $381,000,000 The transaction in total provided an earnings benefit of 1,300,000,000 dollars including the reserve reduction of $869,000,000 recognized in the 2nd quarter. And 3rd, net interest income grew $162,000,000 from continued net interest margin expansion. In connection with finalizing the merger proxy, we restated financial results for the periods dated back to 2021, reflecting a reclassification of amounts related to the card tiering accrual. Furthermore, an independent review identified approximately $60,000,000 of incremental charges related to the card product misclassification and we increased our accrual for potential regulatory penalties by $90,000,000 in the 3rd quarter. Both are incorporated in our revised results.

[John Greene, Executive VP & CFO at Discover Financial Services]

Accounting for these updates, the cumulative impact on equity was a decrease of $151,000,000 Earnings for 2024 increased by $441,000,000 Back to the detailed results beginning with revenue on Slide 6. Our net interest margin ended the quarter at 11.96%, up 98 basis points from the prior year and up 58 basis points sequentially. Margin expansion was driven by product mix, investment of sales proceeds and a lower card promotional balance mix. Card receivables increased 1% year over year due to a slightly lower payment rate, partially offset by a decrease in sales volume. The payment rate declined around 10 basis points from last year, was down 20 basis points sequentially and is approximately 90 basis points above pre pandemic levels.

[John Greene, Executive VP & CFO at Discover Financial Services]

Over the past several quarters, payment rates have stabilized. Discover card sales were down 3% compared to the prior year. The decline in card sales is primarily due to credit tightening actions, which began in 2022. Holiday sales were strong and we currently see an opportunity to increase new account acquisition in the coming year. This is expected to provide a modest boost to 2025 sales with more substantial benefits expected in 2026.

[John Greene, Executive VP & CFO at Discover Financial Services]

Personal loans were up 5% from the prior year. Demand remains strong and we continue to take a conservative approach to underwriting. Total loans after adjusting for the student loan sale increased 3%. Average consumer deposits were up 10% year over year and 2% sequentially. Deposit growth driven by industry leading products, customer experience and our value proposition has enabled us to improve our funding mix.

[John Greene, Executive VP & CFO at Discover Financial Services]

Direct to consumer deposits now account for 72% of total funding, bringing us within our targeted range of 70% to 80%. We continue to manage deposit balances to meet our liquidity needs and anticipate a through the cycle beta of around 70%. Looking at other revenue on Slide 7. Non interest income increased $417,000,000 or 59%. Other income increased as a result of the successful student loan exit.

[John Greene, Executive VP & CFO at Discover Financial Services]

Net discount interchange revenue was up $45,000,000 due to increased cash back debit volume and lower rewards. The rewards rate was 135 basis points in the period, a decrease of 2 basis points driven by lower cash back match, which was largely offset by an increase in 5% rewards. Sequentially, the reward rate is down 9 basis points from changes in the promotional category. Moving to expenses on Slide 8. Total operating expenses were up $67,000,000 or 4% year over year.

[John Greene, Executive VP & CFO at Discover Financial Services]

Looking at our major expense categories, compensation costs increased $146,000,000 or 23%, primarily due to higher wages and benefits and proactive employee retention actions. Marketing costs declined $73,000,000 in the quarter due to timing of broad market advertising. Information processing increased as a result of technology investments and a twenty $2,000,000 write off pertaining to our student loan infrastructure. Professional fees were up $51,000,000 or 16%. This increase was driven by approximately $44,000,000 of merger and integration costs and loan sale expenses.

[John Greene, Executive VP & CFO at Discover Financial Services]

We recognized $588,000,000 of risk management and compliance expense in addition to card misclassification costs and $118,000,000 of merger and integration expense in 2024. Moving to credit performance on Slide 9. Total net charge offs were 4.64%, 53 basis points higher than the prior year and down 22 basis points from the prior quarter. On a full year basis, net charge offs ended at 4.8%, slightly better than our guided range. In card, net charge offs declined 25 basis points from the prior quarter and the 30 plus day delinquency rate was flat.

[John Greene, Executive VP & CFO at Discover Financial Services]

This marks the 3rd consecutive quarter the card net charge off rate has declined. The 2023 card vintage is maturing and is now expected to modestly outperform the 2022 vintage. We are seeing improvements across the portfolio. Personal loan net charge offs and delinquencies continue to be within historical norms. Increases reflect the seasoning of recent growth.

[John Greene, Executive VP & CFO at Discover Financial Services]

Our view on the consumer has not changed. We continue to observe a stable consumer supported by wage growth and a resilient labor market providing a foundation for sales and credit headed into 2025. Turning to the allowance for credit losses on Slide 10. Our credit reserve balance decreased $189,000,000 from the prior quarter. The reserve rate was 6.87 percent, down 31 basis points driven by our credit performance, improvement in household net worth and an increase in seasonal transactor balances.

[John Greene, Executive VP & CFO at Discover Financial Services]

Absent seasonal balances, the reserve rate would have declined by about 20 basis points. In terms of the macroeconomic outlook, our expectations for unemployment and GDP are relatively unchanged from last quarter. We now assume peak unemployment of 4.7%, up 10 basis points. Our GDP forecast remains in the 1% to 3% range. Looking at Slide 11.

[John Greene, Executive VP & CFO at Discover Financial Services]

Our common equity Tier 1 ratio for the period was 14.1%, up 160 basis points compared to the prior quarter supported by the student loan sale and core earnings generation. We declared a quarterly cash dividend of $0.70 per share of common stock. Including on Slide 12, given the pending merger, we will not provide numerical guidance. However, I'd like to provide some insights on trends for 2025. We anticipate loan growth to align more closely with pre pandemic norms.

[John Greene, Executive VP & CFO at Discover Financial Services]

Tailwinds from declining payment rates appear to have largely subsided. Sales and new account generation should play a larger role in driving growth than in the recent past. We expect net interest margin to remain relatively consistent with the 4th quarter level, although an increase in new account generation may create some margin pressure in the back half of the year. Mitigating factors include declining deposit rates and our improved funding mix. We have not contemplated any significant changes to our expense base prior to merger approval.

[John Greene, Executive VP & CFO at Discover Financial Services]

Previously, we had shared the expectation for net charge offs to peak and plateau. We are beginning to see a downward trend. To summarize, our strong 4th quarter results brought an excellent close to 2024. In 2025, we will continue to invest in actions that drive sustainable long term value and prepare for the consummation of our pending merger with Capital One. This concludes our remarks.

[John Greene, Executive VP & CFO at Discover Financial Services]

I'll turn the call back over to the operator.

[Operator]

Today's call has ended. The Discover Investor Relations team will be available for questions. Thank you for joining. You may now disconnect.

Participants

Executives

• Erin Stieber, Investor Relation
• Michael Shepherd, Chief Executive Officer, President, Director
• John Greene, Executive VP & CFO