DBRS, Inc. (DBRS Morningstar) confirmed the ratings of Discover Financial Services (Discover, or the Company), including the Company’s Long-Term Issuer Rating of BBB (high). At the same time, DBRS Morningstar confirmed the A (low) ratings of its banking subsidiary, Discover Bank (the Bank). The trend for all ratings is Stable. The Intrinsic Assessment (IA) for the Bank is A (low), while its Support Assessment is SA1. The Company’s Support Assessment is SA3 and its Long-Term Issuer Rating is positioned one notch below the Bank’s IA.
KEY RATING CONSIDERATIONS
The ratings confirmation reflects the Company’s solid franchise in the credit card and payments industry, its resilient earnings generation capacity, proven credit risk management capabilities, diversified funding profile and sound capitalization. The ratings also consider the Company’s concentrated business model as well as the highly competitive landscape in the U.S. credit card, payments and personal loan space. Similar to other card issuers, we see Discover as poised to benefit from the expectations that a lifting of various pandemic mandates should lead to increased consumer spending by households on travel and other in-person experiences although should inflationary pressures in the economy be sustained these could be headwinds to the strength of household spending. Further, the steady reduction of consumers' excess liquidity built up during the pandemic over time should support growth in credit card balances.
The Stable trend reflects our expectation that Discover will continue to generate solid results accompanied with sound balance sheet fundamentals. The Stable trend also contemplates that asset quality metrics will gradually trend higher from the current historic low levels even though we expect favorable U.S. labor market conditions and healthy consumer balance sheets to be supportive of the loan portfolio’s credit performance. Nevertheless, further outbreaks of the pandemic, persistent inflationary pressures or a spillover from the current geopolitical developments in Europe could moderate our expectations.
Over the longer term, if Discover further diversifies its revenue streams by expanding its fee generating businesses while upholding similar profitability and risk profile the ratings would be upgraded. Conversely, a sustained deterioration in the Company’s earnings generation capacity or a significant degradation in credit fundamentals would result in a ratings downgrade.
Franchise Combined Building Block (BB) Assessment: Good / Moderate
Discover’s solid franchise is anchored by its entrenched and defendable market position as the sixth largest general purpose U.S. credit card issuer. The franchise also benefits from its position as a top tier private student loan lender and payment network provider. The Company’s franchise is supported by its strong brand recognition, a loyal customer base and a historical track record of innovative product offerings as well as value proposition enhancements that have aided it in achieving consistently top rankings in customer satisfaction studies. Additionally, Discover’s closed-loop network enhances its franchise by enabling it to better monitor and quickly implement new products or partnerships while strengthening its brand to consumers. Despite Discover’s widespread card acceptance which is largely in parity with the top payment networks, its market share as measured by U.S. credit card industry purchase volume has barely changed over the past several years. Nonetheless, Discover, through local partnerships, has methodically and consistently expanded its card acceptance in key markets globally.
Earnings Combined Building Block (BB) Assessment: Strong / Good
The Company’s strong earnings power is derived from its highly profitable and resilient business model that has enable it to withstand stressed economic environments. For 2021, Discover reported net income of $5.4 billion, substantially higher than the $1.1 billion earned in 2020, mostly benefiting from the sizeable reserve releases due to the improving economic outlook. Further, Discover delivered another year of strong profitability with income before provisions and taxes (IBPT)-to-average assets of 6.6% up from the prior year’s 5.7%. The Company has historically demonstrated sound cost control resulting in consistently lower operating efficiency ratios relative to the credit card bank industry peer average. Nevertheless, in 2021 total operating expenses (excl. one-time items) increased by 11% year-over-year (YoY), surpassing the 6% growth in revenues (excl. unrealized/realized gains/losses on equity investments) mainly as a result of the Company’s increased marketing spend and platform enhancement investments. For 2022, we expect minimal benefit to bottom line results from reserve releases, while spread-based revenue is poised to benefit from the expected high single digit loan growth and the continued strength in credit card spending with strong travel demand a key contributor. Longer-term, revenue generation should benefit from the continued shift to electronic forms of payment and the rapid growth of consumer spending through digital channels.
Risk Combined Building Block (BB) Assessment: Good / Moderate
Discover’s good risk profile is underpinned by its historically prudent approach in managing credit risk through economic cycles, which mitigates its concentrated business model that makes it more susceptible to household debt driven economic downturns. The Company’s credit risk is appropriately controlled with sound underwriting and a modest risk appetite as evident by the Company’s consistently low exposure to non-prime credit segments. Indeed, the portion of credit card balances associated with subprime accounts declined to 16% at December 31, 2021 (YE21) from 18% at YE20. Over the past year, Discover’s credit performance has remained solid across all loans portfolios. The credit card portfolio’s net charge-off rate reached historic lows at 2.1% in 2021, in-line with the peer average while the 30+ day delinquency rate of 1.7% at YE21 was near all-time lows. We anticipate asset quality metrics will gradually trend higher from the current historic low levels as 2022 progresses.
Funding and Liquidity Combined Building Block (BB) Assessment: Good / Moderate
The Company has a good funding profile supported by a strong liquidity position and a diversified funding base. Discover has a consistent presence across a diversified set of funding channels including deposits, asset backed securitizations and senior unsecured debt. The deposit funding accounts for nearly 80% of total funding. Over the past three years direct-to-consumer deposits, which we consider more sticky than brokered deposits, became the prominent funding source for Discover accounting for 67% of total funding at YE21, up from 47% at YE18. The Company has ample liquidity buffers to address its funding needs and near-term debt maturities. Discover has contingent liquidity capacity through its liquidity portfolio and undrawn credit facilities totaling $18.5 billion at YE21. Additionally, the Bank has access to the Federal Reserve’s discount window with an incremental capacity of $34.3 billion as well as liquidity access to the Federal Home Loan Bank of Chicago with $1.4 billion of total committed borrowing capacity. This available liquidity compares to long-term debt maturities of $5.2 billion and certificates of deposit maturities of $14.2 billion for 2022.
Capitalization Combined Building Block (BB) Assessment: Good
Discover’s sound capitalization is driven by its strong organic capital generation ability and loss absorption capacity as evidenced by its resilience during the 2008/2009 financial crisis as well as by its consistently solid performance under the Fed’s DFAST stress tests cycles. At YE21, Discover’s common equity tier 1 ratio (CET1) ratio was 14.8%, above its long-term target of 10.5% and firmly exceeding regulatory requirements. Further, the tangible common equity-to-tangible assets (TCE) ratio was sound at 11.0% at YE21. The Company has historically demonstrated a prudent and flexible capital management approach to bolster its capital position. Following the resumption of its share repurchase program in 1Q21, Discover repurchased $2.3 billion of common stock in 2021, while increasing its quarterly dividend by 14% to $0.50 per share. Given the Company’s commitment to return significant excess capital to its shareholders, we expect its capitalization metrics to trend lower over the coming quarters.
Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/394208.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.
All figures are in U.S. dollars unless otherwise noted.
The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (July 19, 2021): https://www.dbrsmorningstar.com/research/381742/global-methodology-for-rating-banks-and-banking-organisations.
Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021):
The primary sources of information used for this rating include Morningstar Inc. and Company Documents. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.
This rating was not initiated at the request of the rated entity.
The rated entity or its related entities did not participate in the rating process for this rating action. DBRS Morningstar did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
This is an unsolicited credit rating.
Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.
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