Updated from 10:57 a.m. EST
Discover Financial Services
surged 14% after the credit card payments firm returned to profitability during its fiscal fourth-quarter, fueled by a better-than-expected unemployment report.
The Riverwoods, Ill.-based Discover earned $432.3 million, or 89 cents a share, during the quarter ended Nov. 30, compared with a loss of $56.5 million, or 12 cents a share, during the year-ago period.
Analysts polled by Thomson Reuters, on average, forecast earnings of 13 cents per share for the quarter. Analysts' estimates do not always include gains and charges.
Discover's results were bolstered by an $863 million payment received as part of a $2.75 billion settlement of an antitrust lawsuit with
. The payment, received on Oct. 27, boosted profit by $535 million after taxes. Discover said it will receive the remaining funds in four $472 million installments quarterly in 2009. The lawsuit claimed MasterCard and Visa harmed Discover's business by preventing their member banks from issuing credit cards for Discover's network.
Despite its profitability in the quarter, Discover faces mounting card losses as more customers fell behind on payments. Many credit card lenders including
and large banks with significant credit card businesses such as
Bank of America
are also facing increasing losses as more customers fall behind on payments amid the ongoing recession.
CEO David Nelms said on a conference call this morning that a "sharp increase" in the unemployment rate has taken a toll on the consumer credit environment.
"We believe our consumer credit performance will continue to be among the industry leaders, but we are not immune" to the troubled environment, Nelms said.
"Payment rates have been declining," Nelms said later in the call. "November was a low point on payment rates."
The company expects consumer losses to top 6% next year, but Nelms said unemployment rates will determine loan losses next year.
Discover, like rival American Express, has applied to become a bank holding company and is seeking a federal investment through the Troubled Assets Relief Program, or TARP. Executives on this morning's conference call said they hope to have an approval of bank status in two weeks and for TARP funds in the first quarter. They declined to say how much capital they applied for.
Shares of Discover were up 12.7% to $9.67 also on news that the number of people who applied for
was lower than expected.
Discover's charge-off rate grew to 5.48% of total loans from 3.85% a year ago and 5.2% during the prior quarter. Charge-offs are loans written off as not being repaid.
SunTrust Robinson Humphrey analyst John Stilmar predicted earlier in the week that Discover would face peak charge-offs of 8.75% in the middle of 2010 based on a projected unemployment rate of 8.5%.
The delinquency rate for loans 30 days past due increased to 4.56% from 3.58% a year ago and 3.85% during the third quarter.
Because of the rising delinquency and charge-off rates, Discover continued to ramp up its provision for loan losses. The provision increased $521 million to $714.2 million during the fourth quarter.
Income from Discover's third-party payments business -- which processes ATM and debit transactions and other banks' cards -- rose sharply during the quarter to $20.6 million from $7.6 million during the final quarter in 2007. The boost was due to the addition of Diners Club International, which was acquired from Citigroup earlier in the year.
Discover's third-party payments business processed $34.04 billion in transactions during the quarter.
Average total loans during the quarter increased to $50.71 billion from $47.38 billion during the same quarter last year.
For the full year, Discover earned $927.8 million, or $1.92 per share, up from $588.6 million, or $1.23 per share, a year earlier.
Discover's larger competitors
, while not immune to the economic downturn, are more likely to tough out the difficult environment, given that they do not make consumer loans, and have come to rely -- Visa more than MasterCard -- on consumers using their debit cards for everyday purchases.
"We continue to favor Visa and MasterCard as credit risk-free, recession-resistant plays in the current environment (and beyond), and would avoid consumer lenders American Express and Discover due to consumer credit risk and their heavy dependence on capital markets for both short and long-term funding," writes John Williams, an analyst at Macquarie Research in a note earlier this week.
Discover's deposit base "leaves it much less dependent on publicly traded debt than American Express," Williams writes.
"Despite stable credit performance, a global growth slowdown will hurt, as
Discover is highly leveraged to the slowing domestic card market," he writes.
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