Discover Financial Services is going into the new year in a relatively stronger position than it was a year ago, helped by the improving economy and by recent key strategic moves it has made, a new report suggests.
But the improving health of Discover’s credit card portfolio and its increasingly robust card-acceptance network also make it more vulnerable to takeover, according to a Dec. 20 outlook report from New York-based equity firm Keefe, Bruyette & Woods.
On the issuing side, Discover has a “simpler” balance sheet than some of its competitors do, with credit card receivables comprising some 86% of its total loan portfolio. Discover also weathered the recession well, and the credit quality of its loan portfolio is improving, the analysts note.
Keefe, Bruyette & Woods also applauds Discover’s diversification this year into the student-loan market. Student loans now comprise about 9% of Discover’s total loan portfolio, of which 82% were acquired from Citigroup Inc. and “are 70% insured by the bank for losses,” while personal loans made primarily to credit card customers make up the remainder of Discover’s portfolio, the analysts note.
Discover’s increasingly broad third-party credit and debit card acceptance network, with dozens of new global card-acceptance agreements signed within the past couple of years, has strengthened its value as a transaction-processing network, the analysts say (see story).
Besides integrating its Diners Club International subsidiary into its network along with its Pulse PIN-debit network, Discover within the past year has achieved the “technical ability” to provide credit card acceptance at 95% of merchant locations that accept Visa and MasterCard.
Because of these efforts, Discover’s credit and debit card networks could be worth as much as $2 billion to a potential buyers, Keefe, Bruyette & Woods estimates.
The analysts also suggest Discover’s credit card portfolio could be attractive to prospective buyers as a separate asset.
“Card receivables will be one of the most-profitable asset classes within a bank’s portfolio and, therefore, should be sought after when capital levels rebound for larger banks,” the analysts note regarding Discover’s potential acquisition value to another bank.
Discover also gained some positive attention this year through its formation of a partnership with AT&T, T-Mobile and Verizon Wireless for Isis, a national mobile payment and commerce network announced in November with Discover acting as the exclusive payments network (see story).
Although details about the business model remain hazy, the Isis announcement has “opened the flood gates for mobile-payments movement,” the analysts contend.
“We believe Discover Financial is one of the few large, low-risk and very profitable business models that could be available,” the analysts write. A large bank buying Discover could “extract cost savings from refinancing the balance sheet over time and there would also be synergies on the operating cost side,” the analysts note.
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