Compliance woes dominated Discover Financial Services' Thursday earnings call, as the institution faces a potential FDIC consent order regarding consumer compliance while juggling regulatory fallout from an earlier student loan servicing investigation. The credit card giant also admitted to overcharging merchants for almost 16 years.
"Beginning around mid-2007, we incorrectly classified certain card accounts into our highest merchant and merchant-acquiring pricing tier," Roger Hochschild, Discover's president and CEO, told investors Thursday when discussing second-quarter results.
Discover's stock fell 18% to $102 per share after the firm released news of its regulatory and merchant-fee pricing issues on Wednesday. The company also said it's halting its share repurchase program due to these issues.
Hochschild declined to provide details about the FDIC's draft consent order, which he said is separate from the merchant-fee error.
Discover has previously received
The merchant fee-pricing error was uncovered internally, and Discover is conducting an independent investigation to assess its effect, Hochschild said. Discover plans to reimburse affected merchants and acquirers, and the total compensation amount is likely to represent less than 1% of Discover's merchant revenue and less than two basis points of what merchants typically pay to accept Discover's credit cards, he said.
Discover informed regulators about the misclassification of merchant card-acceptance fees, Hochschild said, noting: "It doesn't mean that the misclassification may not result in further regulatory action, but I don't want to speculate on that."
Card network merchant fees have been a hot topic this week, with Square's parent
Analysts were dismayed by Discover's compliance headaches, although one noted that regulatory issues are becoming increasingly common across the financial services industry.
"Regulatory issues are a big disappointment, but consent orders from the FDIC are not uncommon these days as there were 10 consent orders in the month of April and Wells Fargo itself is currently under 10 separate consent orders," said Robert Napoli, a partner with equity research firm William Blair, in a Thursday note to investors.
In part due to escalating compliance issues, Discover's operating expenses spiked 15% during the quarter ended June 30, driven by new investments in compliance management systems, said John Greene, Discover's chief financial officer. Compensation costs rose by $73 million, or 14%, due to increased headcount. The company's compliance costs will increase this year altogether by about $300 million, Greene said.
The strong loan growth Discover experienced through the first quarter is slowing. Discover's credit card sales volume grew 2.5% in the second quarter over the same period a year earlier, but this month loan growth has slowed to about 1%, Green told analysts.
Total loans grew 18.7% during the quarter to $118 billion from $100 billion during the same period a year earlier, with personal loan volume up 27% and student loan growth up by 2%.
The loan-loss provision expense was $1.3 billion at the end of the quarter, about even with the same period a year earlier, and the company said outlook for losses is improving, with net charge-offs now forecast to be in the lower range of 3.4%-3.6% for this year versus the company's earlier projection of 3.5%-3.8%.
Discover's payment services volume for the second quarter was $89.3 billion, up 8% over the same period a year ago. Pulse debit volume rose 10% during the quarter and Diners Club charge card volume rose 18% compared to a year ago, reflecting higher corporate travel spending.
Deposits rose 4% in the second quarter as Discover continues on its mission to become a major
Total revenue for the quarter ended June 30 was $3.87 billion, up 21% from $3.2 billion during the same period a year ago. The credit card charge-off rate jumped to 3.22%, up 142 basis points from a year earlier and net income declined 18% to $901 million.
Despite its regulatory setbacks, Discover's balance sheet is healthy, said John Hecht, an equity analyst with Jefferies, in a Thursday note to investors. "Fundamentally, the business has not changed, given second-quarter results were OK and the guide update was in line with expectations," Hecht wrote.
