Author Topic: DFS - Discover Financial Services  (Read 12524 times)

Spekulatius

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Re: DFS - Discover Financial Services
« Reply #30 on: March 17, 2020, 03:04:55 PM »
The loan losses could be staggering in the short term though.

Why do you think that? What would be your estimate for loan losses?

Edit:
Looking at this, it was not bad in 2008-2009: https://www.sec.gov/Archives/edgar/data/1393612/000119312511014919/d10k.htm

Do you expect it to be (much) worse this year? If so, why? And how much worse?

The general argument is they've been reaching for yield with riskier borrowers. At least to a greater extent than they were in 08.

What screwed DFS up in 2008 wasnít the loan losses, but the fact that their off balance sheet  vehicles (securitization) needed to come back on the balance sheet, making the healthy equity cushion appear much weaker. They had to raise equity as I recall.

Roughly looking at the numbers, Their loan loss provision would need to more than double to eat up their  profit, a scenario which I think is possible. With a ~10% NIM, they do have a lot of earnings power to compensate for loan losses.

No position currently, but this is one I am interested owning. Owning this at book value is more interfering than owning a bank at book value, imo.
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mjohn707

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Re: DFS - Discover Financial Services
« Reply #31 on: March 17, 2020, 03:18:06 PM »
The loan losses could be staggering in the short term though.

Why do you think that? What would be your estimate for loan losses?

Edit:
Looking at this, it was not bad in 2008-2009: https://www.sec.gov/Archives/edgar/data/1393612/000119312511014919/d10k.htm

Do you expect it to be (much) worse this year? If so, why? And how much worse?

The general argument is they've been reaching for yield with riskier borrowers. At least to a greater extent than they were in 08.

What screwed DFS up in 2008 wasnít the loan losses, but the fact that their off balance sheet  vehicles (securitization) needed to come back on the balance sheet, making the healthy equity cushion appear much weaker. They had to raise equity as I recall.

Roughly looking at the numbers, Their loan loss provision would need to more than double to eat up their  profit, a scenario which I think is possible. With a ~10% NIM, they do have a lot of earnings power to compensate for loan losses.

No position currently, but this is one I am interested owning. Owning this at book value is more interfering than owning a bank at book value, imo.

Worth a position in a basket of indiscriminate panic buying of similarly situated names I think
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Foreign Tuffett

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Re: DFS - Discover Financial Services
« Reply #32 on: March 17, 2020, 07:45:09 PM »
I know almost nothing about this business, but DFS is known for issuing cards to lower income folks, right? Sort of the anti-AMEX.

"The market" is probably thinking that alot of those folks are about to get laid off (hotel workers, bartenders, waiters, etc) and not be able to pay their bills.

Jurgis

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Re: DFS - Discover Financial Services
« Reply #33 on: March 17, 2020, 09:00:12 PM »
I know almost nothing about this business, but DFS is known for issuing cards to lower income folks, right? Sort of the anti-AMEX.

I'd say wrong.
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samwise

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Re: DFS - Discover Financial Services
« Reply #34 on: March 21, 2020, 01:13:26 PM »
All card issuers have been declining much more rapidly than the market and iíve been buying.

So what is the market seeing that I am not? What is going to happen here.
Everyone stays home doesnít pay their credit card bills? Depositors pull money to spend and there is a bank run. 20% unemployment and depression. How can a 25% ROE business sell a 3 times peak earnings.

I do expect the future to look similar to the past once we are past this epidemic.
What will the epidemic cost? Depends on depth of losses, and stability of funding.
Isnít it safer to pay by credit card now, and shop online? Wonít people use the $1000 to pay their credit card bills? Iíve heard of restrictions like landlords canít foreclosure, utilities canít cut you off, but is there a restriction on card issuers managing their credit limits?

What if DFS gave a 2 month need based payments holiday. Would that kill the equity?

Their clients are prime, btw. CEO owns a lot of stock and is aligned. Only issue currently is the depth of current losses and if funding is stable. Would love to hear anything people have seen or heard about stresses here. The only thing I know is google searches for unemployment are back at 2010 levels. DFS survived that.

Spekulatius

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Re: DFS - Discover Financial Services
« Reply #35 on: March 21, 2020, 04:55:35 PM »
I know almost nothing about this business, but DFS is known for issuing cards to lower income folks, right? Sort of the anti-AMEX.

I'd say wrong.

It’s all relative, I have a Discover card too. They had decent standards in the last, typically 700+ scores. ADS, COF (spending on cards), SYF Target lower income folks. Amex is higher income and scores than DFS.

I think most issues have slacked off on the credit quality in recent years after being really tough after the GFC for a couple of years. The business has been just to damn profitable not to do so. DFS also reduced their equity from 13% CETC to ~10.5% CETC ratio with buybacks, which also could end up biting them. I think they have to rebuild their equity ratios a bit. SYF did likewise.
« Last Edit: April 05, 2020, 09:32:37 AM by Spekulatius »
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Spekulatius

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Re: DFS - Discover Financial Services
« Reply #36 on: April 05, 2020, 09:42:24 AM »
I agree. But it looks like for now Americans are using those savings to pay down their credit cards. Totally not what I was expecting. Not in line with 10% charge offs on credit card portfolios either. I know it's still the early innings and it can change rather abruptly. But it's encouraging for now at least.
Listed below are some of the references used to formulate this post.

I would say this is nothing new, just perhaps an accentuation of a previous trend, although it looks like a reversal. Since the GFC, there has been a marked shift in credit card usage. Consumers have deleveraged. The absolute balance is back to where it was before but it's still way down once adjustments are made for population and GDP growth. There is potentially an obvious contributing factor: the compensatory (and more) growth in the balance of the 'consolidated' credit card. It's reasonable to expect a net down effect on the credit card balance when circumstances force people to pay down and when the 'consolidated' credit card account explodes to the upside as people, in the aggregate, are not always stupid (think of the permanent income stuff that Mr. Milton Friedman, of Nobel fame, talked about). I would submit that the consequences of the growth of the 'consolidated' credit card account are hard to handicap and are certainly not covered by present-day stress tests (for BAC and others).

https://wallethub.com/edu/cc/credit-card-debt/25533/
https://www.philadelphiafed.org/-/media/consumer-finance-institute/payment-cards-center/publications/discussion-papers/2016/dp16-01_what-happened-to-revolving-credit-card-balances-2009.pdf?la=en
The second link deals with the revolving component but is relevant nonetheless.

TL;DR version: If people continue to adapt their savings rate to the growth of the 'consolidated' credit card balance, they will eventually be able to spend more wisely but the interim period may be difficult for banks.
https://fred.stlouisfed.org/series/PSAVERT

Personal bias: I wonder if a beautiful deleveraging is possible.

This is of interest here (and I am more interested in CC issues than BAC, so I am replanting this here. it also is of relevance for SYF and AXP or ADS.

Today we have an unique situation of both a demand shock and an economic shock mostly related to  the service sector . What is going to happen to existing CC issues in terms of income as well as defaults.

The work from the Philadelphia Fed looking at what happened to the CC balances in 2009 is pretty interesting. I noticed the headline numbers of 27.8% balance reduction by defaults. that’s a pretty high number and I think we could easily see  similar numbers today based on the suddenness of the economic shock.

DFS CETC1 ratio is 10.5% and DYF is ~14.1% can they remain solvent? Looks a bit questionable to me, of course a lot depends on the speed of default, and their reoccurring income (which will also go down because customers  will spend less ). Both companies and AXP are not part of the stress test any more, which could give some insight what is expected to happen during a severe economic shock unfortunately.
« Last Edit: April 05, 2020, 09:47:23 AM by Spekulatius »
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HJ

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Re: DFS - Discover Financial Services
« Reply #37 on: April 05, 2020, 06:23:14 PM »
That's an interesting statistic to look at, 27.8% charge off.  But I would point out the following: 1) it's over 4 years from March 2009. So it's 2 years of ~10+% charge off followed by 2 years of closer to normal charge off rates.  2) These cards charge interest rates of 12+% to start.  While these companies earn something like 3% pretax on the card balances, there's significant marketing and operational spend that can be dialed back in negative macro environment like today.  3) Today's accounting already require them to book all the loans on balance sheet, and have some amount of forward loan losses provisioned on the books.  Compared with pre crisis, substantially all of the receivables were off balance sheet going into the crisis, and had no loan loss provisions booked against them to start. 

This is certainly a hugely negative event.  But if it's only a replay of '08/'09, these companies should have little problem going through it.  The question of course, is if it will turn out to be significantly worse than '08/'09 over the next 3-4 years, which only time will tell.