Credit card interest rates waver in past week

Discover credit card company seeks a piece of the bailout pie

by
Jan 20, 2009

The Riverwoods-based issuer of the Discover credit card is trying to tap into more than a billion dollars in federal funds by virtue of its imminent transition to a bank holding company. But Discover Financial Services LLC insists that this is no bailout, for it remains healthy and is merely looking to boost its already strong capital.

Discover Financial already has been approved by the Federal Reserve Board as a bank holding company and has received preliminary approval to participate in the U.S. Treasury’s Capital Purchase Program, which was launched in October by the government as a way to encourage financial institutions to build capital and in turn make loans to businesses and consumers.

According to Securities and Exchange Commission filings, Discover is seeking to sell to the Treasury shares of preferred stock and warrants to purchase shares of common stock for an aggregate price of about $1.2 billion.
The preferred stock would pay a cumulative dividend of 5 percent annually for the first five years and then jump to a 9 percent annual rate.

Becoming a bank holding company not only allows Discover to apply for the federal funds, it opens up new business possibilities. A bank holding company may own more than one kind of bank, noted Jon Drummond, senior manager of corporate public relations. The company already owns two subsidiary banks in Delaware, Discover Bank and Bank of New Castle. Now it wants to acquire more consumer and business deposits, and, Drummond observed, it could purchase more banks as a way to accomplish that. But he cautioned that the company has not made any statements on what it is planning to do.

However, Michael Kon, an analyst at Morningstar Inc., said he doesn’t think the company is in the market to purchase a bank because growth in deposits could be achieved through its existing banks, utilizing its strong online platform.

The Riverwoods company primarily operates as a credit card issuer, but also services third-party payments and offers other loan products. In 2008 the company had net income of $927.8 million, or $1.92 per diluted share, up from $588.6 million, or $1.23 per diluted share, in 2007. The 2008 results included a $135.2 million loss from discontinued operations. Discover sold off Goldfish, a U.K. credit card business, to Barclays Bank PLC in March.

Discover takes deposits at its banks including money market accounts and certificates of deposit. Additionally, the company offers installment loans such as personal and student loans. At the close of 2008 it had $49.7 billion in loans, up 4.9 percent from $47.4 billion in 2007.

Revenue generated from bank deposits are used to finance Discover's credit card and installment loan businesses. At the close of the fourth quarter, which ended Nov. 30, the company had deposits of $28.5 billion. Additional funding for business activities comes from the process of asset securitization, according to the company.

Though profit for full year 2008 was up from 2007 it is still below the level of 2006, which saw net income of $1.1 billion, or $2.26 per diluted share.

Most analysts who follow Discover are advising investors to buy or hold the stock, although there are also two sell ratings. The stock closed Tuesday at $7.01, down 95 cents or 11.9 percent. Financial stocks were hit hard by investor reaction to the government's revised bank bailout plan.

Discover's stock 52 week high was $19.87, its low $6.59.

Kon of Morningstar says the stock has a fair value of $30. He recommends investors consider buying shares at $15 and consider selling them at $60. The stock has Morningstar’s highest rating of five stars.

The company is “making the right decisions and I think they are going to perform well once the economy improves,” Kon said in a phone interview.

“They made good decisions before this downturn,” he noted.

Among those good decisions, Kon said, was staying away from certain geographic areas, such as California and Florida, which have seen the worst of the housing crisis.

Nevertheless, its loan losses increased last year, and Discover greatly augmented its loss reserve.

By the end of 2008 the reserve increased to $1.4 billion, up 81 percent from $759.9 million a year earlier. Net charge-offs for 2008 totaled $981 million, up 44 percent from $677.9 million in 2007.

“The next year will probably see continued increase in loan losses,” Kon said. “The environment is deteriorating and they are facing a lot of economic head winds. Credit card volumes are under pressure with the slump in consumer spending.”

However, the company’s debit card portfolio should remain strong as debit volumes are growing faster than credit cards, he said.

Discover’s participation in the federal Capital Purchase Program will strengthen the company’s capital position, officials said, while pointing to the company's already-strong balance sheets.

According to the company’s SEC filing, Discover Bank and Bank of New Castle exceed the capital requirements of the Federal Deposit Insurance Corp.

On Nov. 30 Discover Bank had total capital to risk weighted assets of $4.3 billion, or a 12.9 percent ratio, in excess of the required $2.7 billion or 8 percent. The smaller Bank of New Castle had $15.5 million, or more than 400 percent compared with the required $279,000, or 8 percent.

The parent company's year-end stockholder equity was $5.9 billion, or 15 percent of average total assets.

The added capital from federal funds can be used to replace the company’s previous dependence on the securitization market, which has stalled in the current credit crisis.

Applying for government money makes good business sense in a difficult market, according to some analysts.
Christopher Brendler, of Stifel Nicolaus, said Discover is a prime candidate for government support.

“It doesn’t hurt to have extra capital on hand to handle losses,” he said.

Other credit card companies, such as Capital One Financial Corp. and American Express Co., have already become bank holding companies, Brendler said.

Shifting to a bank holding company is not expected to alter the company’s operations, Discover’s Drummond said, but will merely bring in different regulations and bring the company under the oversight of the Federal Reserve.

The Chicago Federal Reserve Bank, which oversees the Midwest seventh district, will supervise Discover as a bank holding company. The Chicago Fed already oversees 975 bank holding companies, said Doug Tillett, vice president of public affairs.

Chicago Fed officials look at a company’s risk management, the board and senior management oversight and policies and procedures. Federal regulators will also monitor the holding company’s financials such as asset quality, capital, liquidity and earnings, Tillett said.

Receipt of Capital Purchase Program funds will not be the first infusion of federal dollars for the company. Discover Bank has already been to the Fed’s discount window and borrowed $1 billion over the course of two visits, once in November and once in December.

However, analysts at Fitch Ratings Ltd. are more reserved in their opinions of a non-banking financial firm’s converting to a bank holding company, especially because, they say, stricter Fed regulations may be coming.

“Fitch does not view BHC status as a panacea for the current economic and credit cycle,” the firm reported recently. “While BHC status may provide additional protections in the current environment such as capital boosts and debt guarantees, these firms will remain challenged by weakening economic conditions and business model changes.”

Published February 27 2009
Citigroup reaches aid deal with government
Citigroup Inc. said this morning it reached a deal that will give the government an increased stake in the struggling bank. The company also said it recorded a goodwill impairment charge of about $9.6 billion due to deterioration in the financial markets. The government, along with other private investors, will convert some of their preferred stock in Citi to common shares.
By: Stephen Bernard, Associated Press

RELATED CONTENT
Add a comment (0)
NEW YORK — Citigroup Inc. said this morning it reached a deal that will give the government an increased stake in the struggling bank.

The company also said it recorded a goodwill impairment charge of about $9.6 billion due to deterioration in the financial markets.

The government, along with other private investors, will convert some of their preferred stock in Citi to common shares. The Government off Singapore Investment Corp., Saudi Arabian Prince Alwaleed Bin Talal, Capital Research Global Investors, Capital World Investors are among the private investors that said they would participate in the exchange.

The increase in government ownership will not require additional taxpayer money. The government currently holds about an 8 percent stake in Citi.

As part of the agreement, Citi will suspend dividends on both its common stock and preferred shares.

Citi will also reshape its board of directors, Richard Parsons, the bank's chairman, said in a statement. The board will have a majority of new independent directors as soon as possible, Parsons added.

One of the hardest hit banks by the ongoing credit crisis, Citi has already received $45 billion in cash from the government and guarantees protecting it from the bulk of losses on $300 billion of risky investments.

The goodwill charge was added to Citi's 2008 results along with a $374 million impairment charge tied to its Nikko Asset Management unit. The charges resulted in Citi revising its 2008 loss to $27.7 billion, or $5.59 per share.

Shares of Citi rose 3 cents to $2.49 in premarket trading.

Copyright 2009 The Associated Press.