DBRS Assigns Discover Financial Services Long-Term Issuer Rating of BBB (high); Stable Trend

DBRS, Inc. (DBRS) assigned ratings to Discover Financial Services (Discover, or the Company), including Long-Term Issuer and Long-Term Senior Debt ratings of BBB (high). At the same time, DBRS assigned Long-Term Issuer, Long-Term Senior Debt and Long-Term Deposits ratings of A (low) to its banking subsidiary, Discover Bank (the Bank). The trend for all ratings is Stable. The Intrinsic Assessment (IA) for the Bank is A (low), while its Support Assessment is SA1. The Company’s Support Assessment is SA3 and its Long-Term Issuer Rating is positioned one notch below the Bank’s IA.

KEY RATING CONSIDERATIONS
The ratings reflect the Company’s solid franchise in the credit cards and payments industry, as well as in personal and student lending. Additionally, the ratings consider Discover’s resilient earnings generation capacity, strong credit risk management, sound funding profile and solid capitalization. The ratings also consider the inherently competitive environment in the U.S. credit card and payments space, the Company’s product concentration and lack of international diversification.

The Stable trend reflects DBRS’s expectation that Discover’s financial results will remain supportive of the ratings in the near to intermediate term. The Stable trend also contemplates that credit costs are likely to continue increase modestly over the near-term to intermediate-term as a result of loan growth and portfolio seasoning. Nonetheless, a healthy U.S. labor market and solid wage growth bode well for credit losses remaining very manageable through 2019.

RATING DRIVERS
DBRS views Discover as comfortably placed within its current rating category. Over the longer term, positive ratings implications could arise if the Company were to grow its fee-based businesses leading to further diversification of its revenue generation. Conversely, a diminishing competitive position of the Company’s credit card business resulting in substantial market share erosion and sustained weakening in its earnings power could have negative ratings implications. Furthermore, a meaningful deterioration in credit performance reflecting an increased risk appetite or aggressive capital management could result in downward ratings pressure.

RATING RATIONALE
Discover’s solid franchise is an important factor in the ratings. The franchise is anchored by the Company’s core card business and benefits from high customer loyalty and satisfaction, as well as a long track record in product innovation. DBRS considers Discover's top rankings and industry outperformance in customer satisfaction as indicative of its loyal customer base, strong value proposition and customer service. The Company’s closed-loop network adds flexibility and further enhances its competitive advantage all of which underpin the franchise. The closed-loop network enables the Company to provide competitive pricing, to better monitor and evaluate consumer spending, and to quickly implement new products or partnerships while reinforcing its brand to consumers.

Discover’s solid earnings generation capacity is derived from its highly profitable business model. Earnings have also proven to be resilient as demonstrated by the Company’s ability to generate annual profits through the 2008/2009 financial crisis. However, revenues are predominately comprised of net interest income with a lower contribution from fee-related income, which serves as a modest ratings constraint. Positively, Discover has a sound cost control culture with satisfactory ability to manage costs over time as evidenced by its historically low operating efficiency ratios relative to its peers. Most recently, Discover reported FY18 net income of $2.7 billion, resulting in a ROA of 2.6% and an ROE of 25.1%. DBRS notes that the Company has consistently demonstrated solid key profitability and returns on both assets and capital metrics.

The Company’s conservative risk management culture underpins its good risk profile. Credit risk is appropriately managed with sound underwriting and a modest risk appetite as evident by the Company’s low exposure to non-prime customers. Moreover, the Company has demonstrated sound servicing and collection capabilities. Discover’s well-managed credit risk is also evident by the fact that the credit performance of its credit card portfolio has been consistently better than the industry average. Indeed, Discover’s 2018 credit card net charge-off rate was 3.26%, better than the industry average of 3.64%, according to the Fed’s data. Historically, the Company has demonstrated a disciplined and effective credit risk management by acting swiftly in adjusting its credit underwriting approach throughout the credit cycle.

Discover has a good funding profile benefitting from diverse funding sources and a strong liquidity position, both of which support the ratings. Discover maintains a meaningful presence in each of its three primary funding channels, including deposits (direct-to-consumer and brokered deposits), private and public asset backed securitizations, as well as senior unsecured debt. The Company’s solid direct-to-consumer deposit gathering capability has grown over the past several years to become a key component of its funding profile at nearly 47% of total funding. The Company has strong liquidity to address its funding needs and debt obligations. Specifically, Discover’s liquidity portfolio and undrawn credit facilities totaled $21.4 billion at YE18, including cash and cash equivalents of $12.8 billion and investment securities of $3.1 billion. This compares to term debt maturities totaling $6.5 billion and certificates of deposit maturities of $15.3 billion for 2019. Moreover, the Bank has access to the Federal Reserve’s Discount Window.

DBRS considers the Company’s capital position as sound. As of December 31, 2018, the Company’s common equity tier 1 ratio (CET1) ratio was 11.1% under the Basel III fully phased-in approach, and comfortably in excess of regulatory requirements. Discover’s capitalization is supported by its sustainable organic capital generation and its inherently high profitability. DBRS views Discover’s capital management activities as prudent, including proactively adjusting its dividend policy following the financial crisis. Moreover, Discover is a top performer under the Comprehensive Capital Analysis and Review program, and its capital plans have received no objections from the Fed.

The Grid Summary Grades for Capital One are as follows: Franchise Strength – Good; Earnings Power – Strong/Good; Risk Profile – Good; Funding & Liquidity – Good; Capitalisation – Strong/Good.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Global Methodology for Rating Banks and Banking Organisations (July 2018), which can be found on our website under Methodologies.

The primary sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating was not initiated at the request of the rated entity.

The rated entity or its related entities did not participate in the rating process for this rating action. DBRS did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is an unsolicited credit rating.

For more information on this credit or on this industry, visit www.dbrs.com.

DBRS, Inc.
140 Broadway, 43rd Floor
New York, NY 10005 USA