Improving economic conditions helped drive up net profits at Discover Financial Services during its fiscal second quarter, with higher cardholder spending, lower delinquencies and chargeoffs and a significant reversal in loan-loss reserve requirements.

The company expects continued improvement because many consumers affected by long-term unemployment have already moved through the delinquency and chargeoff stages, David Nelms, Discover's chairman and chief executive, said on a conference call Thursday.

The "inflow" of newly unemployed consumers has slowed, he said in an interview, which is helping credit conditions improve despite ongoing high unemployment, Nelms said.

The Riverwoods, Ill. card company posted net income of $258.1 million for the quarter ending May 31, up 14.2% from a year earlier.

Net income attributable to common stockholders was $184.6 million, or 33 cents per diluted share, compared with $206.4 million, or 43 cents per share, a year earlier.

Discover in April redeemed $1.2 billion in preferred stock it had issued to the government to repay funds it received under the Troubled Asset Relief Program, reducing earnings by 13 cents.

Discover's shares closed at $14.08 Thursday, up 0.5% from Wednesday's close.

Analysts were pleased with the results.

"I think largely it was the first time in a couple of quarters that Discover posted a clean, within-expectations quarter that's consistent … with the economics of the business," said John Stilmar, a director with SunTrust Robinson Humphrey in Atlanta.

Major credit card issuers have reported declines in delinquencies and chargeoffs in recent months, citing gradually improving economic conditions.

Discover's rate of loans more than 30 days delinquent was 4.52%, an improvement of 56 basis points from a year earlier and 53 basis points from the previous quarter.

Its net chargeoff rate was 7.97%, a year-over-year increase of 18 basis points and a quarter-over-quarter decrease of 54 basis points. The rate was slightly better than the 8% to 8.5% range the company previously forecast. It expects a net chargeoff rate for the current quarter in the range of 7.5% to 8%.

"I expect our credit is going to continue to improve," Nelms said.

Earnings also were helped by the release of $277 million in loan-loss reserves during the quarter, a major shift from a year earlier when Discover added $299 million to reserves.

The improvements come as Discover and other credit card companies continue adjusting their businesses in light of new regulations under the Credit Card Accountability, Responsibility and Disclosure Act of 2009.

The implementation of changes under the CARD Act "is now largely behind us," Nelms told analysts during the conference call but he said the impact of the rules limiting penalty and other fees that take effect Aug. 22 are not clear yet.

Nelms said Discover expects an annual net pretax revenue impact resulting from the late-fee rules of $80 million to $90 million.

"I think really from here on out what Discover faces and what others do as well in the industry is not so much changes" in the regulatory front "but, rather, the risk tolerance that the competition is willing to accept."

The effect of the financial reform bill that Congress is debating should be smaller than that of the CARD Act, he said.

That bill includes a proposal to give the Federal Reserve authority to set debit interchange rates and prohibit issuers and networks from limiting the number of networks on which a debit transaction can be processed.

That benefit Discover, Nelms said, by encouraging competition.

"If interpreted in a pro-competition way" the provision "would maybe undermine the strategy" Visa Inc. and MasterCard Inc. "have had on locking up their debit cards with their signature and their PIN debit network only."

Discover's total purchase volume, including from its Pulse debit network, third-party issuers, Diners Club International and its own network, was $60.7 billion, up 3.4% from a year earlier.

 

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