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Discover Keeps Cooking With 27% Return on Equity (Update 1)

Updated from 9:40 a.m. ET, with late morning market action, information about Discover's share buybacks, and comment from FBR analyst Scott Valentin.

NEW YORK ( TheStreet) -- Discover Financial Services (DFS - Get Report) continues to bring home industry-leading earnings, and investors looking for long-term growth should pay attention.

The credit card lender, based in Riverwoods, Ill., on Tuesday reported a first-quarter return on equity of 27%, which is a fabulous number, underlining the case for a long-term commitment by investors.

Discover's first-quarter net income allocated to common stockholders of $659 million, or $1.33 a share, increasing from $530 million, or $1.06 a share, in the fourth quarter, and $644 million, or $1.22 a share, in the first quarter of 2012. The main factor in the sequential earnings improvement was a decline in the quarterly provision for loan losses to $158 million in the first quarter from $370 million in the fourth quarter. The first-quarter provision was up from $84 million in the first quarter of 2012.

A major highlight for Discover during the first quarter was the continuing growth of its credit card portfolio, which runs counter to the industry trend, as U.S. consumers continue to deleverage. Average card loans were $49.3 billion in the first quarter, increasing from $49.2 billion the previous quarter, and $46.6 billion a year earlier.


That's a 6% year-over-year growth rate for credit card loans, which is better than the growth rates for most other major card lenders. Looking past sequential growth rates because of seasonal declines in the first quarter, here's how other big credit card lenders have fared:

  • Bank of America's (BAC - Get Report) credit card loan balances averaged $91.7 billion during the first quarter, declining from $98.3 billion in the first quarter of 2012
  • For JPMorgan Chase (JPM - Get Report), average credit card balances declined to $123.6 billion in the first quarter from $127.6 billion a year earlier
  • U.S. Bancorp (USB) reported first-quarter average credit card loans of $16.5 billion, declining from $16.8 billion a year earlier
  • Wells Fargo (WFC - Get Report) reported first-quarter average credit card loans of $$24.1 billion, increasing 9% from $22.1 billion in the first quarter of 2012
  • For Citigroup (C - Get Report), average card loans increased to $146.2 billion in the first quarter from $141.7 billion in the first quarter of 2012, for a year-over-year growth rate of 3%
  • American Express (AXP) reported average loans of $62.8 billion in the first quarter, increasing 3% from $60.7 billion a year earlier
  • Capital One's (COF) average portfolio credit card loans increased to $78.4 billion in the first quarter from $61.5 billion a year earlier, however, the company acquired roughly $27 billion in card loans from HSBC last year, and transferred its $7 billion Best Buy card portfolio to held-for-sale in the first quarter. The sale of the Best Buy portfolio to Citigroup is expected to be completed in the third quarter.

Among the seven companies listed above, the only one with first-quarter performance coming close to Discover was American Express, with a return on average equity of 23.2%.


Why is Discover's credit card loan growth so important? The biggest reason is that credit card lending is so profitable, because of the higher net interest margins. Discover's first-quarter net interest margin -- the spread between the average yield on loans and investments and the average cost for deposits and borrowings -- was 9.39%, compared to 9.40% in the fourth quarter and 9.09% a year earlier. It's not a fair comparison, because of Discover's focus on credit cards, but the Federal Deposit Insurance Corp. reported that the consolidated fourth-quarter net interest margin for all U.S. banks during the fourth quarter was 3.32%.

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