UPDATE 3-Discover Financial worried over rival's new pricing

Tue Jun 19, 2012 6:39pm EDT

* 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 for fee-based protection products, such as balance protection.

Since the financial crisis, Discover has been boosting its reliance of deposit funding, and diversifying its lending to areas like student loans.

"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 launched a mortgage business, which makes home loans and packages them into bonds to sell to investors.

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

Discover shares, which have risen nearly 37 percent year-to-date and touched their life-high in May, closed up 2 percent at $33.57 on the New York Stock Exchange on Tuesday.

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