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Discover Beats Estimates by a Mile (Update 1)

  • Discover reports fiscal third-quarter EPS of $1.21, blowing past the consensus estimate of $1.03.
  • Average loans grow 3% sequentially, and 9% year-over-year.
  • Net interest income and margin increase; payment services income continues rapid increase.

Updated with market reaction and comments from Nomura analyst Bill Carcache.

NEW YORK ( TheStreet) -- Discover Financial Services (DFS - Get Report) on Thursday reported that is average loans grew by 3% during its fiscal third quarter, and 9% year-over-year.

The Riverwoods, Ill., card lender reported earnings of $627 million, or $1.21 a share, for its fiscal third quarter ended Aug. 31, soundly beating the consensus estimate of a profit of $1.03 a share, among analysts polled by Thomson Reuters.

In comparison, the company earned $537 million, or $1.01 a share, the previous quarter, and $642 million, or $1.18 a share, a year earlier.

Discover's shares were up 5% in afternoon trading, to $38.87.

The sequential earnings improvement reflected a $182 million release of loan loss reserves during the fiscal third quarter. During the previous quarter, the company released $110 million in reserves.

While earnings were down slightly from a year earlier, EPS was up, because of the company's share repurchases. Discover bought back roughly 10 million shares for $350 million during the fiscal third quarter. Total shares outstanding declined by 1.9% during the quarter.

Net interest income increased to $1.37 billion during the fiscal third-quarter, from $1.32 billion the previous quarter, and $1.24 billion a year earlier. The fiscal third-quarter net interest margin -- the difference between the average yield on credit card loans and investments -- was 9.44%, increasing from 9.31% the previous quarter, and 9.26% a year earlier, as declining funding costs more than offset a decline in portfolio yield.

Discover's credit card yield was 12.27% during the fiscal third-quarter, declining from 12.35% the previous quarter, and 12.46% in the year-earlier period.

The company reported that its payment services pretax income rose to $49 million in the fiscal third quarter, from $47 million the previous quarter, and $38 million a year earlier, "driven by an increase in higher margin point-of-sale transactions on the PULSE network."

Discover's revenue improvements were partially offset by an increase in expenses, which were up by $178 million or 29% from the prior year, "primarily due to a $94 million year-over-year increase in expenses for legal reserves," after the company agreed with the Federal Deposit Insurance Corp. and Consumer Financial Protection Bureau to issues refunds of up to $200 million to customers, related to the telemarketing of credit protection products, along with $14 million in fines.

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