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  • Credit cards are a trillion dollar industry.

  • In 2018, they were swiped nearly 45 billion times, paying for

  • products and services worth just under four trillion dollars.

  • Americans owe around one point one trillion dollars in credit card

  • debt, about five thousand seven hundred dollars each.

  • The US consumer is doing very, very well.

  • Strong consumer sentiment, strong retail spending, very low

  • unemployment. All of those things are great for the credit card

  • industry. Giants like MasterCard, Visa and Amex dominate the network

  • market. Chase, Citi, Amex and Capital One are the biggest issuers.

  • A quiet but a steady and perhaps lesser talked about competitor is

  • Discover. We're not one of the companies that's always out there

  • talking about how great we are.

  • The number one performing stock of all financials in the S&P for a 10

  • year period is not just an average company.

  • Discover has the 10th largest credit card portfolio in the world,

  • despite a smaller footprint outside of the U.S..

  • Still, there are 57 million Discover cards out there.

  • It's not really for the kind of people that want to fly first class

  • to the Maldives. Discover really is kind of for the masses.

  • When you think about the average consumer and likely where they

  • borrow and what their FICO scores are, I think that they're right

  • smack in the middle of all these issuers.

  • The Discover credit cards topped the J.D.

  • Power Customer Satisfaction Survey in 2019.

  • So how did they win over the American middle class?

  • To understand the credit card industry, it's important to know the

  • difference between a credit card network and an issuer.

  • The network is basically the digital rails on which transactions are

  • processed. A card issuer is the company who actually takes on the

  • credit risk. Discover and American Express are both an issuer and a

  • network. That gives them some diversity in their business model.

  • It also gives them a really stable source of revenue, at least from

  • the processing side.

  • Very different from the credit side of the equation where that could

  • be a lot more profitable if they're charging you 18, 20, 25 percent

  • interest. But there's also risk there.

  • And it's also less predictable in terms of the transactors and the

  • revolvers. You know, people who are paying their bills in full or

  • people who carry debt from month to month.

  • Forty percent of Americans are transactors.

  • 60 percent carry debt from month to month.

  • We spoke with Discover CEO Roger Hochschild over the phone.

  • Our model is lend focused.

  • We're looking for people and we make most of our money from people

  • who borrow money. American Express' model is much more spend focused.

  • For issuers American Express and J.P.

  • Morgan Chase interchange the top two slots on purchase volume and

  • outstanding debt.

  • Citibank, Bank of America and Capital One fill up slots 3 to 5.

  • Discover is sixth.

  • The Discover credit card was launched in 1986 by Sears Roebuck, the

  • largest retailer at the time.

  • Back then it was part of Dean Witter, which was part of Sears, and

  • they launched during Super Bowl Twenty.

  • They had this commercial back in early nineteen eighty six.

  • They talked about the dawn of Discover and they really pioneered two

  • main categories cashback and no annual fee.

  • Sears wanted to expand into financial services and decided to accept

  • only this year's Discover card at its stores.

  • Many merchants actually viewed them as a threat and they thought that

  • accepting a Discover card meant they were helping their rival Sears.

  • So that actually really led to a lot of hesitation and difficulty for

  • Discover establishing itself.

  • In 1993, Dean Witter Discovering Company became a publicly traded

  • company when it spun off from Sears.

  • Sears eventually filed for bankruptcy in 2018.

  • But that's another story.

  • In 1997, Dean Witter Discovering company merged with Morgan Stanley.

  • The mid 2000s were eventful for Discover and the barrier to entry

  • didn't end at Sears front door.

  • MasterCard and Visa were established in the industry and Discover

  • wanted in. In 2004, the Supreme Court upheld a ruling in Discover's

  • favor. Discover claimed that MasterCard and Visa had harmed its

  • business by preventing their member banks from issuing credit cards

  • from the Discover Network.

  • They did everything they could, including reaching out to merchants

  • to tell them that taking Discover would help S ears.

  • After the Supreme Court ruling Discover's business started taking

  • off. G Consumer Finance Wal-Mart and Sam's Club became card clients

  • and pulls a debit card network was acquired with more than 50 million

  • cardholders, the company had become a major player.

  • In July 2007, only six months before the Great Recession, Discover

  • severed ties with Morgan Stanley and started trading on the New York

  • Stock Exchange as DFS.

  • We just set up or our finance department our treasury function.

  • Luckily, we had a heritage that goes all the way back, the Sears are

  • being conservative lenders.

  • In the midst of the downturn t he company received welcoming news.

  • Visa and MasterCard paid Discover nearly $3 billion in damages after

  • finally settling the lawsuit.

  • Discover strategy remains simple charge no annual fee, offer simple

  • rewards like cashback, conduct all business online 24/7 u.s.-based

  • customer service and acquire and keep the customers who will revolve

  • a balance every month.

  • There is a relentless focus here at Discover on a limited set of

  • businesses. You compare us to most other banks that are big in credit

  • cards the've got commercial real estate , they have small business

  • lending. We're focused on consumers.

  • That consumer is a prime borrower.

  • 81 percent of Discover's customers have a FICO score of 660 and

  • above. Competitors like American Express caters to a more affluent

  • customer base with a higher average FICO score and Capital One serves

  • subprime borrowers with an average score below that of Discover's

  • customers. We might be more like Toyota and American Express, maybe

  • more like Mercedes.

  • I would say the typical Discover customer is probably a little bit

  • more likely to be middle class or even lower middle class, maybe more

  • likely to be a parent, maybe more likely to live in middle America.

  • You know, we're not necessarily talking about the affluent urban

  • professionals that are more likely to gravitate to, let's say, an

  • Amex card or a chase card.

  • According to the J.D.

  • Power Customer Satisfaction Survey, Discover has been voted number

  • one every year since 2014, except for in 2017.

  • It's very difficult in this stage of the game in the United States in

  • a very mature market to grow your business because so many people

  • already have a card.

  • But it's doing a really, really good job of keeping the customers it

  • has very satisfied with with the value proposition that it's

  • offering. I think sometimes these airline mile cards get a lot more

  • attention because that's just a sexier kind of redemption, right?

  • It's first class airport lounge, all that fancy stuff.

  • The fact is, though, we found that about two thirds of credit card

  • rewards chasers prefer cashback.

  • Discover's balance sheet, reflects the companies improving finances s

  • ince the 2008 recession.

  • The investors that are here looking for, you know, high capital

  • return, I mean, they've been roughly around that 70 percent plus

  • payout to investors through dividends, share repurchases.

  • And so it's about having a high R.O.T.C.E.

  • Having a very stable but growing business model,.

  • Maybe it's the Midwest heritage, we're not one of those companies,

  • that's always out there talking about how great we are.

  • And there are others who do much more of that.

  • But the last few years haven't stocked up for the Discover stock in a

  • one year and a five year comparison.

  • It underperformed that of the S&P 500 and multiple competitors.

  • On January 24, 2020, a day after the company's earnings call the

  • stock fell by 11 percent, the most it had done in 10 years.

  • It was announced that their share of high risk customers, something

  • called troubled debt restructurings, increased by nearly 50 percent,

  • something that has worried investors.

  • In an email to CNBC, the Discover CEO Roger Hochschild said the

  • market and individual stock prices can be volatile from time to time.

  • Our focus is on continuing to build the long term value of the

  • Discover franchise, which we believe will be reflected in a stock's

  • valuation over time.

  • Data show that younger generations aren't as enthused about credit

  • cards, and though people as a whole spend more and more on credit

  • cards, revolving debt has declined nearly every year in the past two

  • decades, potentially hurting companies like Discover, who depend on

  • finance charges.

  • If you want to continue to talk to your shareholders and give them a

  • successful story, you're gonna have to come up with something that's

  • going to look better than just steady as it goes.

  • It would not be surprising if in time we see Discover either making

  • an acquisition through merger with another credit card issuer or

  • being acquired by somebody bigger.

  • In this day and age, it's hard to know what's going to happen, but I

  • would say, we have a complete business model.

  • We're strong on both sides of the balance sheet, if you think about

  • our lending products, but also our deposit products.

  • So I feel very good about how Discover's positioned.

Credit cards are a trillion dollar industry.

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How Discover Won Over The U.S. Middle Class

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    joey joey posted on 2021/04/22
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