Discover seen posting earnings drop amid weak credit

By Dan Wilchins - Analysis

NEW YORK (Reuters) - It's a tough time to be a credit card lender, as investors are likely to learn on Thursday, when Discover Financial Services (DFS.N) reports quarterly results.

The fourth-largest credit card network is expected to post second-quarter earnings of 37 cents a share, according to Reuters Estimates, a 26 decline from the prior year's quarter.

As American Express made clear on Wednesday, credit losses are rising. The third-largest credit card network said in a statement that "business conditions continue to weaken in the U.S., and so far this month we have seen credit indicators deteriorate beyond our expectations."

Credit concerns hit American Express' shares on Wednesday, pulling them down 2.8 percent, but Discover's shares dropped even more, falling 4.7 percent to $14.33.

Generally, a weaker credit environment could hurt Discover, which relies heavily on income from lending, more than it hurts American Express, which generates more of its revenue from fees, analysts said.

"Discover is more sensitive to the lending environment than American Express," said Sanjay Sakhrani, analyst at Keefe, Bruyette & Woods, adding, "We're definitely heading toward consumer credit quality deterioration."

American Express' clients tend to be wealthier than other credit card companies, which also helps insulate the company from the weaker outlook for consumer credit.

"Discover is more of a card for regular consumers, and American Express has a higher end client," said Steve Persky, chief executive at Dalton Investments.

Discover trades at about 9.4 times its expected 2008 earnings, compared with American Express' multiple of about 12 times.

BROADER DIFFICULTY

American Express and Discover both face unique difficulties, but credit card companies are broadly struggling with the weakening outlook for consumers. Unemployment in May rose to 5.5 percent, its highest level in more than 3.5 years, and U.S. consumer confidence is at a 16-year low.

"Gas prices are higher, people can no longer use their homes as a piggybank, the economy is weakening, and people are losing jobs," Dalton's Persky said, adding "There is stress on individual Americans."

Rising unemployment has historically correlated closely with rising credit card losses, and weakening consumer spending growth, analysts said.

A spokeswoman for Discover declined to comment.