Discover dabbles with two types of delinquency
NEW YORK, July 21 (Reuters Breakingviews) - In the credit card business, delinquency means not paying on time. In the real world, it means behaving badly. Discover Financial Services (DFS.N), a large U.S. credit card issuer, is dabbling with a bit of both, and it’s a double concern for shareholders.
Discover’s stock plunged 16% on Thursday amid a deluge of bad news. The company said that it had overcharged merchants and their banks due to misclassifying some cards. The financial impact is a trifle. But it came alongside the revelation that regulators have proposed serving Discover with a punitive “consent order,” for other undisclosed shortcomings. To cap it off, Discover paused stock buybacks - a big deal for a company that repurchased 50% of its shares over the past decade.
Boss Roger Hochschild has tangled with watchdogs before. Discover received a consent order from the Consumer Financial Protection Bureau in 2020, as punishment for disobeying another order from 2015. In 2022, the company suspended buybacks as it launched a probe into its student lending practices. The stock fell 9% in a day.
But investors were forgiving: shares recovered in under a month. Understandably, too. As with its peers, Discover’s rich 26% return on equity in the second quarter shows that regulatory scrapes aren’t necessarily an impediment to an enormously lucrative credit-card business. Just look at Bank of America’s (BAC.N) consumer division, which was fined earlier this month and is similarly profitable. Or JPMorgan (JPM.N), charged a $250 million penalty in 2020 over a nebulous “pattern of misconduct.”
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The danger comes when a firm becomes defined by its gaffes, and regulators’ punishment for them. Call it the “Citigroup (C.N) threshold”: the bank trades at a big and growing discount to peers thanks to a history of mistakes and regulatory fouls that have become material because Citi is having to invest heavily to clean up. Wells Fargo (WFC.N), too, fits in this category. Five years ago, the Federal Reserve capped its assets a certain level. The shares never recovered.
As the post-Covid era of pristine credit ends, the risk of crossing that threshold grows. Some 2.9% of Discover card loans were overdue at the end of June, back where they ended 2019. There’s still plenty of profit to go around, but higher provisions against bad debt quickly eat into generous earnings. Eroding earnings further through unnecessary missteps would be an easy way to strain shareholders' good graces to the breaking point.
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CONTEXT NEWS
Discover Financial Services' stock plunged 16% on July 20, after it said it was talking with regulators about deficiencies in its corporate governance and risk management.
The U.S. credit card issuer said it had accidentally set up some cards in a way that meant merchants and their banks were charged higher fees, starting in 2007. It said that cardholders were unaffected, and that the total amount of retained earnings that would be wiped out as a result was $255 million.
Discover also said that the Federal Deposit Insurance Corp had proposed serving the bank with a consent order – a kind of regulatory censure that usually involves a curb on certain behaviors related to alleged wrongdoing.
Editing by Jonathan Guilford and Thomas Shum
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Source: Reuters.com
