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Discover Financial Services Reports Third Quarter Net Income of $644 Million or $1.37 Per Diluted Share

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Discover Financial Services (NYSE:DFS) today reported net income of $644 million or $1.37 per diluted share for the third quarter of 2014, as compared to $593 million or $1.20 per diluted share for the third quarter of 2013. The company’s return on equity for the third quarter of 2014 was 23%.

Third Quarter Highlights

  • Revenue net of interest expense was up $128 million, or 6%, from the prior year to $2.2 billion.
  • Total loans grew $4.6 billion, or 7.4%, from the prior year to $67.4 billion.
  • Credit card loans grew $3.3 billion, or 6.6%, to $53.7 billion and Discover card sales volume increased 5.8% from the prior year.
  • Net charge-off rate for credit card loans increased 11 basis points from the prior year to 2.16% and the delinquency rate for loans over 30 days past due increased 4 basis points to 1.71%.
  • Payment Services pretax income was $28 million. Transaction dollar volume for the segment was $49.6 billion, up 2% from the prior year.

“I am very pleased with Discover’s results this quarter, which were driven by robust card loan growth, strong revenue growth and near historically low credit performance resulting in continued better than industry returns,” said David Nelms, chairman and CEO of Discover. “Our Direct Banking strategy continues to work as we grow consumer loans faster than our peers and return meaningful amounts of capital back to our shareholders.”

Segment Results:

Direct Banking

Direct Banking pretax income of $981 million in the quarter was up $63 million, or 7%, from the prior year.

Total loans ended the quarter at $67.3 billion, up 7.4% compared to the prior year. Credit card loans ended the quarter at $53.7 billion, up 6.6% from the prior year. Personal loans increased $835 million, or 20.9%, from the prior year and private student loans increased $369 million, or 4.5%, from the prior year. Excluding purchased student loans, private student loans grew $884 million, or 23.1%, from the prior year.

Revenue net of interest expense increased $129 million, up 7% from the prior year due to loan growth and net interest margin expansion.

Net interest income increased $129 million, or 9%, from the prior year, benefiting from loan growth, lower interest expense and higher loan yield. Net interest margin was 9.79%, up 14 basis points from the prior year. The increase in net interest margin reflects decreased funding costs and higher credit card and student loan yields. Credit card yield was 12.04%, an increase of 4 basis points from the prior year. The increase in credit card yield reflects a higher portion of customers revolving balances and lower interest charge-offs. Interest expense as a percent of total loans decreased 6 basis points from the prior year as the company continued to take advantage of available low rate funding.

Other income was flat year-over-year as higher interchange revenue and loan fee income were offset by lower protection products revenue and lower direct mortgage related income.

The delinquency rate for credit card loans over 30 days past due was 1.71%, up 4 basis points from the prior year and up 8 basis points compared to the prior quarter. Credit card net charge-off rate for the third quarter was 2.16%, up 11 basis points from the prior year and down 17 basis points from the prior quarter. The student loan net charge-off rate excluding PCI loans was 1.14%, down 19 basis points from the prior year. The personal loans net charge-off rate of 1.92% decreased by 9 basis points from the prior year.

Provision for loan losses of $356 million increased $23 million from the prior year. Net charge-offs increased $34 million due to several years of consistent loan growth and declining recovery dollars. The reserve build for the third quarter of 2014 was $32 million, $10 million lower than the prior year.

Expenses increased $43 million, or 6%, from the prior year due to increased employee compensation including higher headcount, increased professional fees and more investment in marketing, partially offset by lower other expenses.

Payment Services

Payment Services pretax income was $28 million in the quarter, flat to the prior year. Payment Services dollar volume was $49.6 billion for the third quarter of 2014, up 2% from the prior year. PULSE transaction dollar volume was up 3% year-over-year.

Share Repurchases

During the third quarter of 2014, the company repurchased approximately 10 million shares of common stock for $622 million. Shares of common stock outstanding declined by 2% from the prior quarter.

Conference Call and Webcast Information

The company will host a conference call to discuss its third quarter results on Tuesday, October 21, 2014, at 4:00 p.m. Central time. Interested parties can listen to the conference call via a live audio webcast at http://investorrelations.discoverfinancial.com.

About Discover

Discover Financial Services (NYSE:DFS) is a direct banking and payment services company with one of the most recognized brands in U.S. financial services. Since its inception in 1986, the company has become one of the largest card issuers in the United States. The company issues the Discover card, America’s cash rewards pioneer, and offers home loans, private student loans, personal loans, home equity loans, checking and savings accounts, certificates of deposit and money market accounts through its direct banking business. It operates the Discover Network, with millions of merchant and cash access locations; PULSE, one of the nation’s leading ATM/debit networks; and Diners Club International, a global payments network with acceptance in more than 185 countries and territories. For more information, visit www.discover.com/company.

A financial summary follows. Financial, statistical, and business related information, as well as information regarding business and segment trends, is included in the financial supplement filed as Exhibit 99.2 to the company’s Current Report on Form 8-K filed today with the Securities and Exchange Commission (“SEC”). Both the earnings release and the financial supplement are available online at the SEC’s website (http://www.sec.gov) and the company’s website (http://investorrelations.discoverfinancial.com).

This press release contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements, which speak to our expected business and financial performance, among other matters, contain words such as “believe,” “expect,” “anticipate,” “intend,” “plan,” “aim,” “will,” “may,” “should,” “could,” “would,” “likely,” and similar expressions. Such statements are based upon the current beliefs and expectations of the company’s management and are subject to significant risks and uncertainties. Actual results may differ materially from those set forth in the forward-looking statements. These forward-looking statements speak only as of the date of this press release, and there is no undertaking to update or revise them as more information becomes available.

The following factors, among others, could cause actual results to differ materially from those set forth in the forward-looking statements: changes in economic variables, such as the availability of consumer credit, the housing market, energy costs, the number and size of personal bankruptcy filings, the rate of unemployment, the levels of consumer confidence and consumer debt, and investor sentiment; the impact of current, pending and future legislation, regulation, supervisory guidance, and regulatory and legal actions, including, but not limited to, those related to financial regulatory reform, consumer financial services practices, anti-corruption, and funding, capital and liquidity; the actions and initiatives of current and potential competitors; the company’s ability to manage its expenses; the company’s ability to successfully achieve full card acceptance across its networks and maintain relationships with network participants; the company’s ability to sustain and grow its private student loan portfolio and mortgage loan products; losses as a result of mortgage loan repurchase and indemnification obligations to secondary market purchasers; the company’s ability to manage its credit risk, market risk, liquidity risk, operational risk, legal and compliance risk, and strategic risk; the availability and cost of funding and capital; access to deposit, securitization, equity, debt and credit markets; the impact of rating agency actions; the level and volatility of equity prices, commodity prices and interest rates, currency values, investments, other market fluctuations and other market indices; losses in the company’s investment portfolio; limits on the company’s ability to pay dividends and repurchase its common stock; limits on the company’s ability to receive payments from its subsidiaries; fraudulent activities or material security breaches of key systems; the company’s ability to increase or sustain Discover card usage or attract new customers; the company’s ability to maintain relationships with current merchants; the effect of political, economic and market conditions, geopolitical events and unforeseen or catastrophic events; the company’s ability to introduce new products or services; the company’s ability to manage its relationships with third-party vendors; the company’s ability to maintain current technology and integrate new and acquired systems; the company’s ability to collect amounts for disputed transactions from merchants and merchant acquirers; the company’s ability to attract and retain employees; the company’s ability to protect its reputation and its intellectual property; difficulty obtaining regulatory approval for, financing, closing, transitioning, integrating or managing the expenses of acquisitions of or investments in new businesses, products or technologies; and new lawsuits, investigations or similar matters or unanticipated developments related to current matters. The company routinely evaluates and may pursue acquisitions of or investments in businesses, products, technologies, loan portfolios or deposits, which may involve payment in cash or the company’s debt or equity securities.

Additional factors that could cause the company’s results to differ materially from those described in the forward-looking statements can be found under “Risk Factors,” “Business – Competition,” “Business – Supervision and Regulation” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the company’s Annual Report on Form 10-K for the year ended December 31, 2013 and under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2014, which are filed with the SEC and available at the SEC’s internet site (http://www.sec.gov).

DISCOVER FINANCIAL SERVICES
(unaudited, in millions, except per share statistics)
Quarter Ended

Sep 30,

2014

Jun 30,

2014

Sep 30,

2013

EARNINGS SUMMARY

Interest Income $1,926 $1,863 $1,787
Interest Expense 288 274 278
Net Interest Income 1,638 1,589 1,509
Discount/Interchange Revenue 599 595 550
Rewards Cost 304 268 274
Discount and Interchange Revenue, net 295 327 276
Protection Products Revenue 78 78 90
Loan Fee Income 85 80 78
Transaction Processing Revenue 46 46 46
Other Income 48 52 63
Total Other Income 552 583 553
Revenue Net of Interest Expense 2,190 2,172 2,062
Provision for Loan Losses 354 360 333
Employee Compensation and Benefits 320 301 292
Marketing and Business Development 182 168 174
Information Processing & Communications 87 87 81
Professional Fees 111 112 97
Premises and Equipment 23 22 21
Other Expense 104 107 118
Total Other Expense 827 797 783
Income Before Income Taxes 1,009 1,015 946
Tax Expense 365 371 353
Net Income $644 $644 $593
Net Income Allocated to Common Stockholders $630 $630 $579

PER SHARE STATISTICS

Basic EPS $1.37 $1.35 $1.20
Diluted EPS $1.37 $1.35 $1.20
Common Stock Price (period end) $64.39 $61.98 $50.54
Book Value per share $24.82 $24.46 $22.14

SEGMENT- INCOME BEFORE INCOME TAXES

Direct Banking $981 $984 $918
Payment Services 28 31 28
Total $1,009 $1,015 $946

BALANCE SHEET SUMMARY

Total Assets $80,596 $78,937 $75,544
Total Liabilities 69,295 67,556 64,942
Total Equity 11,301 11,381 10,602
Total Liabilities and Stockholders’ Equity $80,596 $78,937 $75,544

TOTAL LOAN RECEIVABLES

Ending Loans 1, 2 $67,366 $65,875 $62,738
Average Loans 1, 2 $66,481 $64,728 $62,110
Interest Yield 11.36% 11.42% 11.29%
Gross Principal Charge-off Rate 2.63% 2.82% 2.66%
Gross Principal Charge-off Rate excluding PCI Loans 3 2.79% 3.01% 2.86%
Net Principal Charge-off Rate 1.94% 2.08% 1.86%
Net Principal Charge-off Rate excluding PCI Loans 3 2.06% 2.22% 2.00%
Delinquency Rate (over 30 days) excluding PCI Loans 3 1.64% 1.56% 1.60%
Delinquency Rate (over 90 days) excluding PCI Loans 3 0.75% 0.73% 0.72%
Gross Principal Charge-off Dollars $440 $455 $416
Net Principal Charge-off Dollars $324 $337 $291
Net Interest and Fee Charge-off Dollars $85 $87 $79
Loans Delinquent Over 30 Days 3 $1,043 $964 $933
Loans Delinquent Over 90 Days 3 $476 $451 $421
Allowance for Loan Loss (period end) $1,644 $1,614 $1,598
Change in Loan Loss Reserves $30 $23 $42
Reserve Rate 2.44% 2.45% 2.55%
Reserve Rate Excluding PCI Loans 3 2.54% 2.56% 2.73%

CREDIT CARD LOANS

Ending Loans $53,699 $52,742 $50,360
Average Loans $53,130 $51,718 $50,017
Interest Yield 12.04% 12.10% 12.00%
Gross Principal Charge-off Rate 2.99% 3.22% 3.02%
Net Principal Charge-off Rate 2.16% 2.33% 2.05%
Delinquency Rate (over 30 days) 1.71% 1.63% 1.67%
Delinquency Rate (over 90 days) 0.82% 0.80% 0.78%
Gross Principal Charge-off Dollars $400 $415 $381
Net Principal Charge-off Dollars $289 $300 $258
Loans Delinquent Over 30 Days $920 $860 $843
Loans Delinquent Over 90 Days $440 $420 $395
Allowance for Loan Loss (period end) $1,388 $1,359 $1,393
Change in Loan Loss Reserves $29 $17 $33
Reserve Rate 2.58% 2.58% 2.77%
Total Discover Card Volume $32,091 $31,732 $30,275
Discover Card Sales Volume $29,609 $29,341 $27,989
Rewards Rate 1.03% 0.91% 0.98%

NETWORK VOLUME

PULSE Network $40,636 $41,500 $39,458
Network Partners 2,185 2,617 2,507
Diners Club International 4 6,777 6,733 6,549
Total Payment Services 49,598 50,850 48,514
Discover Network – Proprietary 30,577 30,342 28,880
Total $80,175 $81,192 $77,394

1 Total Loans includes mortgages and other loans

2 Purchased Credit Impaired (“PCI”) loans are loans that were acquired in which a deterioration in credit quality occurred between the origination date and the acquisition date. These loans were initially recorded at fair value and accrete interest income over the estimated lives of the loans as long as cash flows are reasonably estimable, even if the loans are contractually past due. PCI loans are private student loans and are included in total loan receivables

3 Excludes PCI loans (described above) which are accounted for on a pooled basis. Since a pool is accounted for as a single asset with a single composite interest rate and aggregate expectation of cash flows, the past-due status of a pool, or that of the individual loans within a pool, is not meaningful. Because the company is recognizing interest income on a pool of loans, it is all considered to be performing

4 Volume is derived from data provided by licensees for Diners Club branded cards issued outside of North America and is subject to subsequent revision or amendment

Note: See Glossary for definitions of financial terms in the financial supplement which is available online at the SEC’s website (http://www.sec.gov) and the company’s website (http://investorrelations.discoverfinancial.com).

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