Discover Financial Falls After Disclosing Regulatory Review, Suspends Buybacks

Discover Financial Services fell the most in more than three years after the lender disclosed that it was in discussions with regulators over how it misclassified some of its credit cards.

(Bloomberg) — Discover Financial Services fell the most in more than three years after the lender disclosed that it was in discussions with regulators over how it misclassified some of its credit cards. 

The stock was the worst performer in the S&P 500 on Thursday, tumbling 16%, the biggest decline since March 2020. A day earlier, the company said in a statement that it will suspend buybacks while it begins an internal review of compliance, risk management and corporate governance. 

Discover said that it misclassified certain credit-card accounts into its highest pricing tier, starting in 2007, meaning merchants were charged more than they should have been to accept the cards for payment. The resulting incremental revenue amounted to less than 1% of its cumulative interchange income — the money it collects from merchants each time a consumer swipes a card at checkout. 

The lender said it’s discussing the matter with regulators and warned it could face future regulatory actions. Additionally, Discover said it received a proposed consent order from the Federal Deposit Insurance Corp. for a consumer compliance issue that’s separate from the misclassification matter.

“We are actively enhancing our governance and oversight structures and are making significant investments in our compliance management system,” Chief Executive Officer Roger Hochschild said in the statement. “We remain deeply committed to achieving excellence in all these areas.”

Internal Investigation

It’s the second time in a year that the company had to suspend share repurchases over compliance concerns.

Last year, Discover temporarily paused stock buybacks after it started an internal investigation into practices within its student-loan servicing business. Four months later, it started buying shares again after completing that review, noting it would continue to communicate with regulators about the unit’s practices.

Discover said its management team would prepare a program to compensate merchants affected by the misclassification issue, setting aside $365 million to provide refunds to retailers and payment processors. 

“Given differences in individual merchant agreements, changes in network terms, and availability of historical data, it is difficult to determine the final amount of potential refunds at this time,” Riverwoods, Illinois-based Discover said in the statement, noting that its board has retained a law firm to work on the matter.  

The firm warned it would spend more on improving its internal systems for compliance. Discover now expects full-year expenses to jump by a percentage in the “low double digits” compared to 2022, up from a previous forecast that costs would rise less than 10% for the year. 

Discover’s board hired an outside law firm to investigate the issue. 

“It really is focused on why this was not escalated and addressed more quickly,” Hochschild said Thursday in a phone interview. “One of the things we try to do when something goes wrong is not just fix it but also try to learn from it. So it is a little more broad in terms of looking at our processes and what happened.”

Profit Slide

Discover’s second-quarter profit, meanwhile, dropped 18% to $901 million. While that topped Wall Street estimates, Discover set aside $1.31 billion in provisions for souring loans as write-offs surged in the period. That figure was larger than analysts predicted. 

In May, the firm relaunched a debit card that offers users cash back for their purchases. The company opened 30,000 new accounts in the weeks since its debut and plans to increase marketing for the offering in coming months, Hochschild said. 

Discover, which operates as both the issuer and the network for its cards, is exempt from legislation that limits how much banks can charge merchants each time consumers use their debit cards. 

“We are pleased with the usage,” Hochschild said. “The key thing that you want is to make sure people are using it as their primary account. That’s where, I would say, some direct banks have gone astray. The economics won’t work.”

(Updates with closing share price in second paragraph.)

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