ABS analysts are saying Discover Financial Services would likely increase its ABS issuance and become an acquisition target if spun off from parent company Morgan Stanley. The unit, championed by Morgan Stanley CEO Phillip Purcell, has come under fire from shareholders and, more recently, a group of dissident former Morgan Stanley executives has called for Purcell's ouster in paid advertisements.

Discover will "likely become a more active issuer in the ABS market," as a result of becoming a stand-alone entity, noted one sell-side analyst who could not be named commenting on another firm's unit. Discover has approximately $4 billion in ABS due to mature in 2005, and is expected to return to the ABS market to refinance all of that volume. In addition, several of Discover's primary ratings have already been placed on watch for a possible downgrade by Moody's Investors Service. The already negative ratings news means Discover will find it less effective to issue unsecured debt, the analyst added, and will possibly turn to securitization more frequently for financing because of the attractive funding costs.

A spin off would make Discover a monoline credit card bank and put it in competition with issuers such as MBNA, which can issue Visa, MasterCard and American Express cards. In an announcement, Moody's cited competition as the main factor driving its angle on Discover. "The review of Discover Bank's ratings will focus on its position as a stand-alone competitor in the face of credit and charge card companies with greater scale and a more diversified set of product offerings, especially in the context of low overall industry growth," said Moody's in a report released last week.

Discover's position as a small fish in a big pond, as well as the solid performance of its trust, means the company is a juicy takeover target for a company looking to expand its credit card business. Discover currently has $47 billion in managed receivables, $33 billion of which is in its master trust. Charge-offs were at 5.5% in March, and excess spread was at 475 to 500 basis points. The monthly payment rate was at 19% "The stats have been strong and very stable," added the analyst. The Discover Card Master Trust has issued 22% of the total credit card ABS in 2005, making it the largest issuer in what has been a relatively slack year for the sector.

On the otherhand, Theresa O'Neill, ABS analyst with Merrill Lynch, said Discover's relationship with the stores that use its cards may limit the number of potential buyers. Visa and MasterCard are owned by their member banks, but they operate their own merchant networks. That is not the case with Discover. If a bank purchases Discover, it would have to also purchase and run the company's merchant network in order to offer the Discover brand. "If I'm a bank I have to make a decision whether I want to be in that business," O'Neill said. American Express also operates its own merchant network.

In the immediate term, O'Neill said the plan to spin off Discover has already started to put "downward pressure" on credit card ABS issuance volume, both from Discover and from the sector as a whole. O'Neill said companies typically slow the pace of securitization prior to the sale, or in this case spin off, of a credit card business or portfolio. O'Neill pointed to the sale of Sears' credit card portfolio to Bank One, as well as Bank One's subsequent merger with JPMorgan Chase as examples of that phenomenon.

Copyright 2005 Thomson Media Inc. All Rights Reserved.

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