Discover Financial returns to profitability in 4Q

Discover Financial Services said Thursday it returned to profitability in its fiscal fourth quarter, thanks to a legal settlement, but it is nevertheless trying to get funding from the government. Its shares rose nearly 8 percent.

Without the lawsuit settlement gain, the credit card lender would have had a loss due to rising defaults and delinquencies. Nearly all lenders are seeing more customers stop making their monthly payments as home prices tumble and unemployment surges.

Because the credit climate keeps deteriorating with no end in sight, Discover - like its larger counterpart, American Express Co. - is applying to become a bank holding company and get government funding to support its lending efforts, the card issuer said Thursday.

"We will continue to operate in a very difficult environment in 2009," CEO David Nelms said during a conference call with investors, noting that next year's unemployment rate will largely determine consumer loan losses.

Discover decided to apply for government funding to take the most "conservative approach," Nelms said, and to give the company "additional liquidity, additional options, and maximum participation in government programs."

If Discover, which already has deposits, is approved as a bank holding company, it could get between $400 million and $1.2 billion in government financing - or 1 to 3 percent of $40 billion in risk-weighted assets, officials said. Discover would pay the government a 5 percent rate, plus warrants.

"Taxpayers will benefit from our stock price performance," Nelms said in an interview with The Associated Press. "I very much view this as an investment by the taxpayers that we will pay back with interest, and it will be a great investment for taxpayers."

Riverwoods, Ill.-based Discover earned $432.3 million, or 89 cents per share, during the quarter ended Nov. 30, compared with a loss of $56.5 million, or 12 cents per share, during the year-ago period.

Discover's results were bolstered by an $863 million payment, or $535 million after taxes, received as part of a $2.75 billion settlement of an antitrust lawsuit with Visa Inc. and MasterCard Inc. Discover will receive the remaining funds in four quarterly $472 million installments in 2009. The lawsuit claimed MasterCard and Visa harmed Discover's business by preventing their member banks from issuing credit cards for Discover's network.

Analysts polled by Thomson Reuters forecast earnings of 13 cents per share, on average, for the quarter. Analyst estimates often do not include gains and charges. Citigroup analyst Donald Fandetti said the company's core results were worse than he anticipated, particularly the company's loan loss provision.

Discover's provision for loan losses increased $521 million, or 89 percent, to $714.2 million.

Still, shares of Discover rose 68 cents, or 7.9 percent, to close at $9.26.

Discover's charge-off rate grew to 5.48 percent of total loans from 3.85 percent a year ago and 5.2 percent during the prior quarter. Charge-offs are loans written off as not being repaid. Discover expects the charge-off rate to rise above 6 percent in the first quarter.

The delinquency rate for loans 30 days past due increased to 4.56 percent from 3.58 percent a year ago and 3.85 percent during the third quarter.

Average total loans during the quarter rose to $50.71 billion from $47.38 billion during the same quarter last year.

Discover is primarily a credit card lender, but it also offers money market funds, certificates of deposits and IRAs. Total deposits rose 15 percent during the third quarter to $29 billion.

Nelms said Discover does not have any current plans to acquire banks, but said applying to become a bank "gives us more flexibility to do so if we decide to do so."

He added that about half the company's funding is already through deposits, and that Discover is prepared to fund the whole business with deposits for as long as the securitization market remains dried up. The securitization market is where companies sell repackaged loans to other investors.

Meanwhile, income from Discover's third-party payments business - which processes ATM and debit transactions and other banks' cards - rose sharply during the quarter to $20.6 million from $7.6 million. The boost was due to the addition of Diners Club International, which Discover acquired from Citigroup Inc. earlier this year.

For the full year, Discover earned $927.8 million, or $1.92 per share, up from $588.6 million, or $1.23 per share, a year earlier.

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AP Business Writer Stephen Bernard contributed to this report.