CORRECTED-UPDATE 2-Discover Financial worried over rival's new pricing

Tue Jun 19, 2012 6:13pm EDT

(Corrects percentage figure in paragraph one. Also corrects to say that Discover issues credit cards, not Diners Club cards)

* Q2 EPS $1.00 vs $1.09 last year

* Q2 provision for loan losses up 32 pct

* Total loans rise 9 pct

By Sharanya Hrishikesh

June 19 (Reuters) - Discover Financial Services reported a 11 percent drop in quarterly profit as the issuer of credit cards set aside more money to cover bad debts and legal costs, and said a "major competitor's" pricing actions were a big concern.

The new fee structure by the competitor took advantage of its 70 percent market share and created an uneven playing field, said Discover Chief Executive David Nelms on a conference call.

Visa Inc introduced a new fee structure in April called Fixed Acquirer Network Fee to push more transactions to its network that is likely to hurt other card processors.

Discover did not name the competitor.

The company said it set aside $232 million in the second quarter to cover future bad debts, up 32 percent from last year.

An increase in provisions does not necessarily mean that the company is expecting more people to fall behind on their monthly payments, FBR Capital Markets analyst Scott Valentin said.

Weak retail sales and a fall in hiring have been pointing to a shaky recovery in the United States, with the worsening Eurozone crisis adding to consumer fears.

Discover released $110 million from reserves for future losses in the quarter ended May, compared with $401 million a year earlier that helped double its profit.

"Last year, credit was increasing rapidly so there was more room to release reserves. Now we are getting near the end of that reserve release," Valentin said.

The company added $90 million to its legal reserves in the quarter, leading to an 18 percent increase in expenses.

It said in January it had been notified by the Federal Deposit Insurance Corp and the Consumer Financial Protection Bureau over its marketing practices.

Discover has been trying to shore up its other businesses like non-credit card lending after the financial crisis, as the industry struggled with weak consumer demand and higher delinquencies.

"Credit performance continues to be exceptional, but we continue to expect that we must be at or near the bottom," CEO Nelms said. "We are launching new products which will position us for revenue and asset growth in the future."

Earlier this month, Discover announced plans to launch a home loans business.

March-May profit fell to $537 million, or $1.00 per share, from $600 million, or $1.09 per share, last year.

Discover shares were up 3 percent at $33.78 in afternoon trade on the New York Stock Exchange. They have risen more than 35 percent year-to-date and touched their life-high in May. (Reporting by Sharanya Hrishikesh in Bangalore; Editing by Sreejiraj Eluvangal and Joyjeet Das)

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