Discover Financial Services(DFS) - 2025 Q1 - Quarterly Report

Part I FINANCIAL INFORMATION Financial Statements Q1 2025 financial statements report net income of $1.1 billion and diluted EPS of $4.25, with total assets at $147.9 billion Condensed Consolidated Statements of Financial Condition (Balance Sheet) | (dollars in millions) | March 31, 2025 | December 31, 2024 | | :--- | :--- | :--- | | Total Assets | $147,914 | $147,640 | | Net loan receivables | $109,295 | $112,795 | | Total deposits | $108,220 | $107,009 | | Long-term borrowings | $14,538 | $16,253 | | Total Liabilities | $128,951 | $129,714 | | Total Stockholders' Equity | $18,963 | $17,926 | Condensed Consolidated Statements of Income | (dollars in millions) | Q1 2025 | Q1 2024 | | :--- | :--- | :--- | | Net interest income | $3,558 | $3,487 | | Provision for credit losses | $1,244 | $1,497 | | Total other income | $693 | $673 | | Total other expense | $1,563 | $1,544 | | Net income | $1,104 | $851 | | Diluted EPS | $4.25 | $3.25 | Condensed Consolidated Statements of Cash Flows | (dollars in millions) | Q1 2025 | Q1 2024 | | :--- | :--- | :--- | | Net cash provided by operating activities | $2,132 | $1,843 | | Net cash provided by investing activities | $3,006 | $358 | | Net cash (used for) provided by financing activities | ($802) | $514 | | Net increase in cash, cash equivalents and restricted cash | $4,336 | $2,715 | Note 1: Background and Basis of Presentation Discover, a digital banking and payment company, is proceeding with a $35.3 billion merger with Capital One, expected to close by May 2025 - On February 19, 2024, Discover entered into a merger agreement with Capital One Financial Corporation in an all-stock transaction valued at $35.3 billion[28] - The merger with Capital One received all required regulatory approvals as of April 18, 2025, and is expected to close on or around May 18, 2025[29] - The company completed the sale of its private student loan portfolio during the fourth quarter of 2024[27] Note 3: Loan Receivables Total loan receivables decreased to $117.4 billion, with a $215 million allowance release due to improved credit quality and seasonal declines Loan Receivables Composition (in millions) | Loan Type | March 31, 2025 | December 31, 2024 | | :--- | :--- | :--- | | Credit card loans | $99,027 | $102,786 | | Personal loans | $10,096 | $10,314 | | Home loans | $8,223 | $7,963 | | Total loan receivables | $117,403 | $121,118 | | Allowance for credit losses | ($8,108) | ($8,323) | | Net loan receivables | $109,295 | $112,795 | Allowance for Credit Losses Roll-Forward (Q1 2025, in millions) | Description | Amount | | :--- | :--- | | Balance at Dec 31, 2024 | $8,323 | | Provision for credit losses | $1,244 | | Net charge-offs | ($1,459) | | Balance at Mar 31, 2025 | $8,108 | - The $215 million release in the allowance for credit losses was primarily driven by a seasonal decline in receivables and improved credit quality in the credit card portfolio, partially offset by changes in macroeconomic forecasts[52] Delinquency Rates (30+ Days Past Due) | Loan Type | March 31, 2025 | December 31, 2024 | | :--- | :--- | :--- | | Credit card loans | 3.66% | 3.84% | | Personal loans | 1.68% | 1.69% | | Home loans | 1.22% | 1.23% | Note 11: Capital Adequacy DFS and Discover Bank met all Basel III capital requirements as of March 31, 2025, with DFS reporting a 14.7% CET1 ratio Capital Ratios as of March 31, 2025 | Ratio | Entity | Actual | Minimum Requirement | Well-Capitalized Requirement | | :--- | :--- | :--- | :--- | :--- | | CET1 Capital Ratio | DFS | 14.7% | ≥4.5% | N/A | | | Discover Bank | 11.9% | ≥4.5% | ≥6.5% | | Total Capital Ratio | DFS | 17.1% | ≥8.0% | ≥10.0% | | | Discover Bank | 14.1% | ≥8.0% | ≥10.0% | | Tier 1 Leverage Ratio | DFS | 12.8% | ≥4.0% | N/A | | | Discover Bank | 9.7% | ≥4.0% | ≥5.0% | - The company's three-year phase-in for the regulatory capital impact of the Current Expected Credit Losses (CECL) methodology ended on December 31, 2024[105] Note 13: Litigation and Regulatory Matters The company addresses a $1.246 billion card product misclassification liability, with $250 million in regulatory penalties and ongoing SEC investigation - The counterparty restitution liability for the card product misclassification was $1.246 billion as of March 31, 2025[135][136] - In April 2025, the FDIC and Federal Reserve assessed combined civil money penalties of $250 million related to the card product misclassification, fully accrued as of September 30, 2024[136] - The company is cooperating with an SEC investigation into the card product misclassification matter and believes additional losses are probable but cannot be reasonably estimated at this time[137] - The estimated range of reasonably possible losses for all legal and regulatory proceedings, in excess of accrued amounts, is up to $60 million as of March 31, 2025[128] Note 16: Segment Disclosures The Digital Banking segment reported $1.35 billion in Q1 2025 pre-tax income, while Payment Services generated $91 million Segment Income Before Income Taxes (in millions) | Segment | Q1 2025 | Q1 2024 | | :--- | :--- | :--- | | Digital Banking | $1,353 | $1,037 | | Payment Services | $91 | $82 | | Total | $1,444 | $1,119 | - The Digital Banking segment includes Discover-branded credit cards, personal loans, home loans, and deposit products[170] - The Payment Services segment includes the PULSE network, Diners Club, and the Network Partners business[170] Note 18: Subsequent Events Subsequent events include $250 million in regulatory penalties assessed in April 2025 and the Capital One merger receiving final regulatory approval - On April 16, 2025, the FDIC assessed a $150 million penalty, and on April 18, 2025, the Federal Reserve assessed a $100 million penalty, both fully accrued as of September 30, 2024[175] - On April 18, 2025, the Federal Reserve and the OCC approved the pending merger with Capital One[176] Management's Discussion and Analysis (MD&A) MD&A highlights a 30% net income increase to $1.1 billion, driven by lower credit loss provisions, improved loan quality, and strong liquidity Q1 2025 vs Q1 2024 Performance Summary | Metric | Q1 2025 | Q1 2024 | Change | | :--- | :--- | :--- | :--- | | Net Income | $1.1B | $851M | +30% | | Diluted EPS | $4.25 | $3.25 | +31% | | Provision for Credit Losses | $1.24B | $1.50B | -17% | | Net Interest Income | $3.56B | $3.49B | +2% | - The increase in net income was primarily driven by a lower provision for credit losses and decreased interest expense, partially offset by lower interest income from a smaller average loan portfolio[214][217] - The company has paused share repurchases through the completion of the merger with Capital One, in accordance with the merger agreement[289][306] Regulatory Environment and Developments The company navigates evolving regulatory changes, including Basel III and long-term debt requirements, with capital plan adjustments due to the Capital One merger - Proposed amendments to Basel III rules could significantly revise risk-based capital requirements for banks with assets over $100 billion, including DFS[186] - A separate proposal would require DFS to maintain minimum levels of outstanding long-term debt[187] - Due to the pending merger with Capital One, the company resubmitted its capital plan and must receive prior approval from the Federal Reserve for capital distributions[190][282] Critical Accounting Estimates Allowance for credit losses is a critical estimate, with sensitivity analysis showing a $487 million increase under the most adverse economic scenario - The allowance for credit losses is a critical accounting estimate due to the significant judgment involved, particularly in selecting macroeconomic forecasts[207][209] - The Q1 2025 allowance was based on a macroeconomic forecast projecting a weighted average unemployment rate peaking at 4.88% in Q2 2026 and real GDP growth of 1.69% in 2025[230] - Sensitivity analysis indicates that using the most adverse economic scenario would increase the allowance for credit losses by approximately $487 million[211] Loan Quality Loan quality improved in Q1 2025, with credit card net charge-off rates decreasing to 5.47% and delinquency rates falling to 3.66% Net Charge-off Rates (Annualized) | Loan Type | Q1 2025 | Q1 2024 | | :--- | :--- | :--- | | Credit card loans | 5.47% | 5.66% | | Personal loans | 4.21% | 4.02% | Delinquency Rates (30+ Days) | Loan Type | March 31, 2025 | Dec 31, 2024 | | :--- | :--- | :--- | | Credit card loans | 3.66% | 3.84% | | Personal loans | 1.68% | 1.69% | - The provision for credit losses decreased to $1.24 billion in Q1 2025 from $1.53 billion in Q1 2024 (excluding unfunded commitments adjustment), driven by improved credit quality in the credit card portfolio[228][233] Liquidity and Capital Resources The company maintains strong liquidity with $84.6 billion in total sources and a 14.7% CET1 ratio, pausing share repurchases due to the merger Liquidity Sources (in billions) | Source | March 31, 2025 | Dec 31, 2024 | | :--- | :--- | :--- | | Liquidity portfolio (Cash, Investments) | $30.2 | $27.3 | | Private asset-backed securitizations (undrawn) | $3.5 | $3.5 | | FHLB of Chicago (undrawn) | $4.9 | $4.7 | | Federal Reserve discount window (undrawn) | $46.0 | $46.5 | | Total Liquidity Sources | $84.6 | $82.0 | - Primary funding sources include $92.4 billion in direct-to-consumer deposits and $15.8 billion in brokered deposits[243] - The Board of Directors declared a quarterly cash dividend of $0.70 per common share, but Discover common stockholders are expected to receive the Capital One dividend instead due to the expected merger closing date[286] - Share repurchases have been paused through the completion of the merger with Capital One[289] Quantitative and Qualitative Disclosures About Market Risk The company's primary market risk is interest rate risk, with a 100 basis point rate increase estimated to raise net interest income by $52 million Estimated 12-Month Impact on Net Interest Income from a Parallel Rate Shift | Basis Point Change | At March 31, 2025 ($M) | At Dec 31, 2024 ($M) | | :--- | :--- | :--- | | +100 | $52 | $52 | | -100 | ($50) | ($25) | - The company's primary market risk exposure is from changes in interest rates, which affect net interest income[291] - The company uses interest rate swaps to manage the repricing characteristics of its assets and liabilities[293] Controls and Procedures Management concluded that disclosure controls and procedures were effective as of March 31, 2025, with no material changes to internal controls - The CEO and CFO concluded that the company's disclosure controls and procedures were effective as of the end of the reporting period[300] - No material changes to internal control over financial reporting occurred during the quarter[301] Part II OTHER INFORMATION Legal Proceedings Legal proceedings are detailed in Note 13 of the condensed consolidated financial statements - For a description of legal proceedings, see Note 13: Litigation and Regulatory Matters to the condensed consolidated financial statements[304] Risk Factors No material changes to risk factors were reported from the prior Annual Report on Form 10-K - No material changes to risk factors were reported for the period[305] Unregistered Sales of Equity Securities and Use of Proceeds Share repurchases are paused due to the Capital One merger, with 144,509 shares withheld for employee tax obligations - Share repurchases have been paused through the completion of the merger with Capital One[306] Employee Transactions (Q1 2025) | Description | Total Shares Purchased | Average Price Paid Per Share | | :--- | :--- | :--- | | Employee transactions (tax withholding) | 144,509 | $200.78 | Other Information No directors or executive officers adopted or terminated Rule 10b5-1 or non-Rule 10b5-1 trading arrangements during the quarter - No directors or executive officers adopted or terminated a Rule 10b5-1 or non-Rule 10b5-1 trading arrangement during the quarter[312]