Discover's 4Q Hurt by Mortgages, Rewards Policy Change

Earnings at Discover Financial Services plunged by 33% in the fourth quarter, largely due to a charge tied to the firm’s mortgage business and a previously announced revision to its flagship credit card program.

The Riverwoods, Ill.-based firm reported quarterly net income of $404 million, which was down from $602 million during the same period a year earlier. Adjusted net income, which excluded nonrecurring items, was $553 million, or 8% lower than the previous year.

Discover announced its fourth-quarter earnings shortly after the stock market closed Wednesday. By 5 p.m. ET, shares in the company had fallen by about 3% in after-hours trading.

Discover cited three nonrecurring factors as drivers of its lower earnings. First, the company took a $178 million charge related to its decision to make it easier for credit card holders to redeem their cash rewards. Those changes were announced last year, so the one-time charge was anticipated by investors.

Second, Discover said that it took a $27 million impairment of the goodwill that was realized with its acquisition of the Discover Home Loans platform.

Discover launched its mortgage business in 2012 after acquiring assets from Tree.com. Last October, Chief Executive Officer David Nelms acknowledged that the move had not gone according to plan. He attributed the struggles to higher regulatory costs and the steep industrywide decline in mortgage financing.

Third, Discover said that it took a charge related to its classification of a payment network that it owns, Diners Club Italy, as held-for-sale.

In Discover’s credit card business, results were stronger. At the end of the fourth quarter, credit card loans were $56.1 billion, which was up 5.6% from the same period a year ago. The delinquency rate on credit card loans was 1.73%, which was up by a single basis point compared with a year earlier.

Companywide, net interest income totaled $1.67 billion, up 7% from the fourth quarter of 2013. Net interest margin was 9.77%, which was down five basis points from a year earlier. Discover attributed the decline to higher funding costs.

Nelms said in a news release Wednesday that the company’s fourth-quarter performance was “solid.”

Discover’s operating expenses were $932 million in the fourth quarter, up 11% from a year earlier. The company cited higher marketing costs, professional fees and compensation, among other factors, as contributors to the increase in expenses.

Looking ahead, Discover said that it expects “modest” compression this year in its net interest margin, a 2.5% rise in its provision for loan losses, and a $3.5 billion increase in operating expenses.