Discover Earnings: Strong Loan Growth Drives Higher Revenue, but Credit Costs Are Rising

Narrow-moat-rated Discover Financial DFS reported solid earnings as strong loan growth and rising interest rates drove net interest income higher, offset by higher credit costs. Net revenue increased 29% from last year to $3.75 billion. However, earnings per share fell 15% from last year to $3.58, which translates to a return on equity of 27%. The decline in earnings was due to a higher provisioning expense, which increased to $1.1 billion from $154 million last year. As we incorporate these results, we are maintaining our $146 per share fair value estimate for Discover and see the shares as undervalued.

Discover enjoyed another quarter of strong net interest income growth, rising 26% from last year to $3.1 billion. The increase was due to both impressive loan growth and net interest margin expansion. Average loans grew 21% from the prior year’s quarter and 3.7% sequentially to $112 billion. Growth was driven by Discover’s credit card receivables and personal loans, which grew 22% and 21%, respectively, while student loans only increased 3%. The bank’s net interest margin expanded to 11.34% from 10.85% last year and 11.27% last quarter as rising interest rates benefit its predominantly variable rate credit cards. That said, we expect that the bulk of margin expansion for Discover is behind us at this point and this tailwind for the firm’s results should diminish.

As we expected, net charge-offs increased meaningfully in the first quarter but remain in line to somewhat below the bank’s historical average. Net charge-offs rose 59 basis points from last quarter and 111 basis points from last year to 2.72%. Discover’s credit card net charge-off rate was even higher at 3.1%, already inside of its historical 3%-3.5% range. On a more positive note, the bank did narrow the top end of its 2023 net charge-off rate guidance by 10 basis points to 3.5%-3.8%, and the bank’s 30-day delinquency rate was more resilient, only increasing 0.84% from last year to 2.48%.