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
Discover’s ratings reflect its solid franchise as a major credit card issuer and payment network owner, its earnings generation resiliency, disciplined credit risk management, diversified funding profile and sound capitalization. The ratings also consider the Company’s concentrated business model and the highly competitive business environment in the U.S. credit card issuing and payments space.
The Stable trend reflects our expectation that the Company will continue to deliver solid operating results despite the anticipated slowdown in credit card balances and spending growth, consistent with industry trends. The Stable trend also contemplates a continuing, yet manageable, deterioration in credit performance over the next several quarters.
Over the longer term, the ratings would be upgraded following further revenue expansion of fee generating businesses while sustaining risk-adjusted profitability metrics. Conversely, a prolonged weakening in the Company’s earnings power or a substantial deterioration in credit risk fundamentals would result in a ratings downgrade.
Franchise Combined Building Block (BB) Assessment: Good / Moderate
The Company has a solid franchise underpinned by its strong brand recognition and top tier presence as the sixth largest general purpose U.S. credit card issuer, a major player in the private student loan market and the fourth largest U.S. payment network provider. Discover’s franchise is also supported by its long track record of value proposition enhancements on its products as well as a loyal customer base, as indicated by continued top rankings in customer satisfaction surveys. Furthermore, the Company’s closed-loop network enhances its competitive advantage by enabling it to better monitor cardholder spending patterns and quickly implement new product offerings while reinforcing its brand to consumers. Even though Discover has achieved parity in merchant acceptance locations relative to other top payment networks, its card payment network market share in the U.S. has remained largely unchanged over the past several years. With that said, the Company has steadily and diligently expanded its card acceptance globally by partnering with local payment networks while at the same time making progress in broadening its network adoption in the B2B payment space.
Earnings Combined Building Block (BB) Assessment: Strong / Good
We view Discover’s earnings power as solid reflecting its highly profitable business model and proven resiliency in adverse economic environments. For 2022, Discover generated net income of $4.4 billion, down from $5.5 billion in 2021, despite positive operating leverage primarily due to higher provisions for credit losses as a result of reserve build compared to sizeable reserve releases in the prior year. Total net revenue (excl. realized/unrealized gains/losses) increased by 16% year-over-year (YoY), driven by strong growth in loan receivables and margin expansion while operating expenses increased by 9% YoY. As a result, the Company’s adjusted operating efficiency ratio improved to 39% in 2022 from 41% in the prior year, and remained below the credit card focused banks’ average ratio of 56%. For 2023, the Company’ expects low double digit loan growth, modest net interest margin expansion and improving operating efficiency partially offset by higher credit costs.
Risk Combined Building Block (BB) Assessment: Good / Moderate
The Company’s risk profile is supported by its strong track record of disciplined underwriting and credit risk management through various economic cycles. Nonetheless, its loan book composition makes the Company highly susceptible to the overall health of the consumer. Overall, Discover’s card lending exposure to non-prime borrowers is low, accounting for 16% of credit card balances at December 31, 2022 (YE22), in-line with the ten year average. The net charge-off (NCO) rate of the credit card portfolio was 2.05% in 2022, down slightly year-over-year and in-line with the industry average, while the 30+ day delinquency rate of 2.53% at YE22 has reverted to normalized levels. We expect the Company’s credit metrics in 2023 to reach or exceed the levels registered during the pre-pandemic period as a result of the portfolio seasoning due to the solid growth registered during the past two years as well as from the expected softening of the labor market.
Funding and Liquidity Combined Building Block (BB) Assessment: Good / Moderate
Discover’s funding profile is underpinned by diversified and reliable funding sources including deposits, asset-backed securitizations and senior unsecured debt. Direct-to-consumer deposits have become a major component of the Company’s funding comprising 63% of total funding at YE22 while brokered deposits remain a smaller contributor to funding accounting for 19%. Despite the rising interest rate environment, Discover’s consumer deposit balances have steadily grown over the past year. Of note, approximately 10% of the Bank’s deposits were uninsured at YE22, lower than banks in its asset range. The Company has sizeable liquidity buffers to meet its funding needs and debt obligations. At YE22, Discover’s primary liquidity portfolio comprised of cash and liquid investments ($19.8 billion) and undrawn credit facilities through private asset-backed securitizations ($3.5 billion). Furthermore, the Bank has another $42.3 billion in borrowing capacity at the Federal Reserve Bank’s discount window as well as liquidity access to the Federal Home Loan Bank of Chicago with $1.7 billion of total committed borrowing capacity. These liquidity sources compare to long-term debt maturities of $3.8 billion and certificates of deposit maturities of $18.0 billion for 2023.
Capitalization Combined Building Block (BB) Assessment: Good
The Company has sound capitalization driven by its dependable organic capital generation ability and strong profitability as well as by its historically flexible approach to capital management. Discover’s capitalization has demonstrated consistent resiliency in the Fed’s regulatory stress tests, as well as during prior economic cycles. At YE22, the Company’s common equity tier 1 ratio (CET1) ratio was 13.3%, higher than its long-term target of 10.5% and comfortably above the regulatory requirement of 7.0%, inclusive of the Fed’s stress capital buffer. In 2022, Discover repurchased $2.4 billion of common stock while increasing its quarterly dividend by 20% to $0.60 per share. We anticipate Discover’s capitalization metrics to trend lower over the medium term, given it is well above the Company’s long-term target capitalization levels.
Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/411648
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/ Social/ Governance factor(s) that had a significant or relevant effect on the credit analysis.
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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).
All figures are in U.S. Dollars unless otherwise noted.
The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 23, 2022): https://www.dbrsmorningstar.com/research/398692/global-methodology-for-rating-banks-and-banking-organisations.
In addition DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (May 17, 2022): https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings in its consideration of ESG factors.
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.
The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.
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