Defending against the spread of credit problems from the mortgage market has become a leading goal for Discover Financial Services.
Though the company said practices it put in place years ago offer substantial protection from such fallout, on Thursday it outlined several additional steps it is taking.
The measures “include changing underwriting criteria for applicants with certain mortgages, suppressing credit line increases on accounts with high-risk mortgages, investing in a high-risk unit that focuses on review and proactive contact with certain customers, even those who remain current,” David W. Nelms, Discover’s chief executive, said during a conference call on results for its fiscal fourth quarter, which ended Nov. 30.
Mr. Nelms said the Riverwoods, Ill., card company has also been closing long-inactive accounts to reduce its “contingent loan exposure.”
“We’re continuing to refine and in some cases, yes, tighten” lending standards, Mr. Nelms said.
He said Discover moved “five years ago to have higher cutoffs and to reduce marketing to certain metropolitan areas which are at the moment experiencing the greatest stress,” because of its view of risk in markets “that have high average debt versus income levels.”
But despite such measures, Discover has had “more of an increase in” credit problems “in some of the markets that are most stressed with housing and mortgages, such as Florida, California, as well as states that have higher unemployment, such as Michigan,” Mr. Nelms said.
“We do have customers in all those markets and would expect to be affected, which is reflected in our numbers,” he said.
The chargeoff rate in Discover’s managed portfolio rose 14 basis points from the previous quarter but fell 15 basis points from a year earlier, to 3.84%.
The share of receivables that were more than 30 days delinquent climbed 43 basis points from the previous quarter and 20 basis points from a year earlier, to 3.59%.
Though Mr. Nelms said the company is “heading into a more challenging phase of the credit cycle,” he described its current numbers as “strong.”
“While we recognize that there is a broader set of housing and mortgage-related issues that some customers are experiencing, we have relatively low exposure to consumers whom we believe are most exposed to these problems,” he said.
For example, “only about 1% of our customers have adjustable nonprime mortgages.”
Mr. Nelms said Discover’s portfolio is also protected because 78% of its loans are to accounts that are over five years old.
“A key part of any credit performance is how long someone has been with you and paid you on time,” the CEO said.
“Tenure and experience” are “probably more important” than credit scores.
He also said that as credit conditions have deteriorated the company has observed among competitors “some … moderation in the increase we’ve seen over a number of years, and in some cases some pullback, in mail volumes and some increases in pricing.” That trend has translated to an improvement in response rates to Discover’s marketing efforts for “the first time in a while,” he said.
Mr. Nelms said the company continues to target “growth in U.S. card receivables in the range of 4% to 8%” but the goal is subject to change.
“If we see significant opportunities because of pullback from competitors and modest changes in unemployment rates … we would be more aggressive,” he said.
“Conversely, if the environment deteriorated more than expected, we would certainly take that into account.”
Roy A. Guthrie, Discover’s chief financial officer, said that currently “the capital markets are clearly a challenging place to fund, particularly with consumer assets as collateral.”
But he said, “It’s our expectation that the credit card [asset-backed securities] markets will begin to normalize early next year, albeit at significantly higher risk spreads.”
“We have a good balance between bank deposit sources of funds and capital markets sources,” Mr. Guthrie said.
Discover lost $84.1 million, or 18 cents a share, in its fourth quarter, compared with earnings of $202.2 million, or 42 cents a share, the previous quarter and $186.5 million, or 39 cents a share, a year earlier. The loss was driven largely by a $279 million after-tax impairment associated with its U.K. card-issuing unit, which has been rocked by sharp credit losses and funding problems.
