TEXT-Fitch affirms Discover Financial Services at 'BBB/F2'

Fri Jun 22, 2012 10:51am EDT

June 22 - Fitch Ratings has affirmed the long- and short-term IDRs of
Discover Financial Services (Discover) and Discover Bank (DB) at
'BBB/F2. The Rating Outlook is Stable. Approximately $43.5 billion of unsecured
debt, subordinated debt, and deposits, are affected by these actions. A full
list of ratings is detailed at the end of this release.

The ratings affirmation reflects the strength of Discover's credit and debit
card franchise, superior asset quality, solid liquidity, and strong capital
levels. Ratings remain constrained by a lack of meaningful revenue diversity,
limited funding flexibility, and heightened legislative and regulatory scrutiny
of consumer products.

Net charge-offs hit record lows in 2011, and fell further to 2.66% in second
quarter-2012 (2Q'12), down 203 bps from a year ago. Losses on the credit card
portfolio were 2.79% in 2Q'12 and 3.07% in 1Q'12. This compared to an average 1Q
loss rate of 4.15% for the top five card issuers in the industry. Credit
performance of personal loans and student loans remained solid. However, Fitch
believes the student loan portfolio has yet to season as a large portion of the
portfolio is not in repayment status. While Fitch believes full-year 2012 credit
metrics will outperform 2011, the loss rate is expected to rise before year-end.

Earnings rose nearly threefold in 2011, to $2.2 billion. The increase was driven
by strong credit trends, higher spend, an increase in processing volume, modest
NIM expansion, and portfolio growth, partially offset by higher operating
expenses. Similar trends were evident in first half-2012 (1H'12). Still, Fitch
expects provisions to become more of a headwind as the year unfolds with credit
metrics beginning their mean reversion. Discover released $1.1 billion of
reserves in 2011 and another $336 million in 1H'12, which is expected to
moderate as the loan portfolio expands.

Capitalization continues to be a rating strength. Discover posted a Tier I
common ratio of 14% in 2Q'12. This was well-above the long-term target of 9.5%
and compares favorably to similarly rated financial institutions. In 1H'12,
Discover raised its quarterly dividend by $0.04 to $0.10 per share, while also
announcing a $2 billion share repurchase program. Fitch expects Discover to
migrate toward its long-term capital target over time, balancing organic growth
and acquisitions with dividends and share repurchases. Even with the higher
dividend, the payout remains well within the Federal Reserve's comfort level, at
approximately 9.2% in 1H'12.

Discover's liquidity profile is solid, with approximately $27.6 billion of
contingent liquidity. This consists of an $11.3 billion liquidity portfolio,
$7.3bn of ABS conduit capacity, and $9 billion of discount window availability.
This compares to $5.4 billion of ABS maturities and $11.6 billion of deposit
maturities over the next 12 months (as of Feb. 29, 2012). Parent company
liquidity is solid, with no debt maturities until 2017 and more than two years
coverage on interest and dividend payments.

The Stable Outlook reflects the expectation for earnings consistency, moderate
portfolio growth and peer-superior asset quality. Also factoring into the Stable
Outlook is the maintenance of strong liquidity and risk-adjusted capitalization.
While Discover will reduce capital ratios to its targeted range over time, Fitch
expects the bank to do this in a prudent manner.

Increased revenue diversity, proven competitive positioning and credit
performance in non-card loan categories over time may support positive ratings
momentum. Other factors supporting positive rating actions include enhanced
funding flexibility and/or further clarity on regulatory and legislative issues
(particularly as it relates to the student loan sector).

Conversely, negative rating action could be driven by a decline in earnings
performance, resulting from a decrease in market share or credit deterioration,
along with a weakening liquidity profile. Negative rating momentum may also
result from significant reductions in capitalization, and legislative and/or
regulatory changes that alter the earnings prospects of the credit card and
student loan businesses.

Negative rating momentum could also be driven by an inability of Discover to
maintain its competitive position and earnings prospects in an increasingly
digitized payment landscape. While the company is focused on strategic
acquisitions and alliances to expand its online and mobile capabilities,
competition from technology companies and social networks, with access to
significant consumer data, is expected to intensify.

Discover is a leading credit card issuer and electronic payments company that
authorizes, processes, and guarantees the settlement of cardholder transactions
on the Discover, PULSE, and Diners Club networks, and extends credit on a
revolving basis to Discover cardholders. The company had $57.1 billion in
receivables at May 31, 2012 and its stock is listed on the NYSE under the ticker
symbol DFS.

Fitch has affirmed the following ratings with a Stable Outlook:

Discover Financial Services
-- Long-term IDR at 'BBB';
-- Short-term IDR at 'F2';
-- Viability Rating at 'bbb';
-- Senior debt at 'BBB';
-- Support at '5'; and
-- Support Floor at 'NF'.

Discover Bank
-- Long-term IDR at 'BBB';
-- Short-term IDR at 'F2';
-- Viability Rating at 'bbb';
-- Short-term Deposits at 'F2';
-- Long-term Deposits at 'BBB+';
-- Subordinated Debt at 'BBB-';
-- Support at '5'; and
-- Support Floor at 'NF'.

Additional information is available at 'www.fitchratings.com'. The ratings above
were solicited by, or on behalf of, the issuer, and therefore, Fitch has been
compensated for the provision of the ratings.

Applicable Criteria and Related Research:
--'Global Financial Institutions Criteria' (Aug. 16, 2011);
--'Bank Holding Companies' (Aug. 16, 2011);
--'Finance and Leasing Companies Criteria' (Dec. 12, 2011).
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