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