Discover to Introduce Checking Accounts in 2013

After enjoying strong growth in its credit card business in 2012, Discover Financial Services (DFS) is investing some of those returns in a more diverse range of products.

The Riverwoods, Ill., company, which reported net income Thursday of $551 million for the fourth quarter, described plans to expand its payments business and begin offering checking accounts early in 2013.

"What I would say is that we are generating some very impressive returns in the credit card business, and there's a limit to how much more growth we can get from that more mature business," Discover Chief Executive David Nelms said in an interview.

"So we are not only returning capital to shareholders," he added, "but also investing in faster growing lending and payments businesses."

The company's growth strategy has led to higher expenses — marketing expenses were up 33% over the same period a year ago, while employee compensation and benefits were up by 21%. But some stock analysts don't mind the added costs, as long as those costs are expected to yield future earnings.

"They have money to spend from an expense standpoint, and I think they are utilizing that advantage," said Sanjay Sakhrani, an analyst with Keefe, Bruyette & Woods. "I think it was a good quarter."

Not everyone saw it that way. Discover reported earnings of $1.07 per diluted share, which was an improvement from 95 cents per share in the same period a year earlier, but also fell short of investors' expectations. The average estimate of analysts surveyed by Bloomberg was $1.13 per share.

Shares in Discover were down by more than 3% in midday trading Thursday, to $38.34, though they are still up by nearly 60% from a year ago. Among the 81 financial services firms on the Standard & Poor's 500 Index, only Bank of America (BAC) has seen a bigger jump in its stock price this year, according to Bloomberg.

Discover's fourth-quarter earnings report showed revenue net of interest expenses at $2 billion, up 9.6% from the same period in 2011. That revenue growth was driven in large part by growth in Discover's credit card loan portfolio, which ended the quarter at $49.6 billion, up 6% from a year earlier.

"This is the fastest pace of growth for credit card loans since the financial crisis," analysts at investment bank Sandler O'Neill wrote in a research note.

The expansion in credit card lending comes at a time of relatively flat growth across the industry, suggesting that Discover has taken market share from competitors.

During a conference call with analysts, Discover executives attributed the growth partly to its increased marketing spending, and partly to customer response to a rewards package that will be scaled back in 2013.

Next month, Discover is planning a nationwide re-launch of its flagship credit card, which will also come with a strong marketing push. The new card will be called Discover It.

Nelms said that the new product will be a no-fee, cash-back card that builds on Discover's existing advantages in the card business. But it will also have a different look and feel than other credit cards, with the customer's personal information shown on the back of the card, he said.

"It's a very clean look on the front," Nelms said. "It doesn't look like the normal embossed card."

Regarding Discover's new checking product, Nelms did not offer many details, except to say that the company is launching it next quarter.

Over time, Discover hopes that the checking product will provide it a stable, low-cost source of funds, although Nelms said it will initially only be available to Discover's existing customers.

Also on tap for 2013 is the continued integration of a mortgage lending business that Discover acquired earlier this year. That business is originating about $1 billion of mortgages each quarter, and while Nelms did not forecast an uptick in 2013, he did suggest that growth may come later on.

"I think first foremost and fundamentally it's a new business for us," Nelms said on the call with analysts, adding that as Discover becomes more comfortable with the mortgage business, "you should look for it to become a more significant contributor."

Earlier this year, Discover entered into a partnership with PayPal that will allow consumers to use their PayPal accounts in retail stores. Nelms said Thursday that PayPal plans to introduce that service in the second quarter of 2013, and Discover has been working hard to make that happen.

Nelms also told analysts that he will keep looking for potential acquisitions in the payments business, but prices are high, so the company will also look for opportunities to partner with other payments companies.

"I think that is a more likely scenario to see, more partnerships as opposed to acquisitions," he said.