The Long and Short

An improving credit profile, attractive spreads on Discover Financial

| February 11, 2022

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

The credit profile for Discover Financial Services has improved markedly over the past  few years despite the obvious operational challenges posed by the pandemic. DFS saw improved lending growth in the third and fourth quarters of 2021, and management is anticipating further normalization for the current year. With mid-to-high ‘BBB’ ratings at the bank operating company, the issuer offers attractive relative value and a good overall balance of risk and reward within the peer group and against the broader financial segment.

Graph 1. IG Consumer Lenders and Credit Card Processors

Source: Amherst Pierpont, Bloomberg/Barclays US Corp Index

DFS 2.7% 02/06/30 @ 113/10yr, G+113, 3.18%, $96.67

Issuer: Discover Bank (DFS)
Parent Holding Company: Discover Financial Services
CUSIP: 25466AAR2
Bank Ratings: Baa2/BBB/BBB+
Holding Co Ratings: Baa3/BBB-/BBB+
Amount Outstanding: $500 million
Global Deal

Discover Bank is the bank operating company of parent holding company Discover Financial Services (DFS). DFS is one of the nation’s largest standalone consumer lenders and credit card issuers with $108.5 billion in total assets, $89.5 billion in total loans and $72.7 billion in total deposits. Approximately $70 billion of the total loan balance is in credit cards, with an additional $10 billion in student loans, and the remainder in other direct consumer loans. The bulk of credit cards are issued under the well-known Discover franchise.

DFS is in an excess capital position as of the third quarter of 2021 with a Tier 1 Common (CET) ratio of 15.52% versus an internal target range closer to 10.5%. That number has increased from 11.23% at year-end 2019. The current total risk-based capital ratio is 18.52%. The additional capital provides plenty of capacity for the bank to fund shareholder incentives such as increased dividends and share repurchase programs. The bank paid $474 million in dividends and $1.5 billion in share repurchases in the first three quarters of 2021 under the current authorization for $2.4 billion through the first quarter of 2022.

DFS has vastly improved to a more stable funding profile over the past several years. The loan/deposit ratio has decreased to 123.25% as of the third quarter of 2021 from nearly 139% in 2017 as the bank has reduced its reliance on wholesale funding. Reliance on wholesale funding now stands at just under 35% from nearly 60% in 2017. Furthermore, emphasis on consumer deposits means the use of higher risk brokered deposits as a percentage of all deposits has decreased to 18% from just under 30% in 2019 and over 40% in 2017.

The bank’s credit quality in the existing loan book has improved significantly over the past several years, and management has set aside more reserves for loan losses. NPAs/Total Assets is roughly half the amount it was at year-end 2019 at just 1.93% as of the third quarter of 2021, down from 3.19%. The Texas Ratio, which measures total NPAs plus 90-day past due loans versus Tangible Equity and Loan Loss Reserves has improved substantially to its current level of 11.10% from a recent peak of 31.35% as of year-end 2019. Reserves held versus non-performing assets has quadrupled over that time to its current rate of just under 400%. Allowance for credit losses of total loans was approximately 7.7% as of the third quarter.

Dan Bruzzo, CFA
dan.bruzzo@santander.us
1 (646) 776-7749

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.

The Library

Search Articles