As 2018 dawns, Discover Financial Services finds itself a leader in an unfamiliar category: bad credit-card loans.
Probably not coincidentally, the Riverwoods-based credit-card company is growing its credit-card balances at twice the rate banking giants like JPMorgan Chase and Bank of America are.
Discover has gone in a year from nearly best-in-class in terms of customers who stay current on their credit cards to nearly worst-in-class.
Among the major card issuers, only Capital One will be expected to have higher charge-offs. But that's because Capital One lends to subprime borrowers unlike Discover.
Discover lends only to prime-rated borrowers and even then in the past was conservative relative to peers.
To be sure, Discover's card-loan write-offs aren't at alarming levels. It posted charge-off rates of 3 percent in October and 3.1 percent in both November and December, according to a Jan. 16 Securities and Exchange Commission filing. But those numbers are 0.5 percentage points above the same time frame the year before. No other major issuer that's posted fourth-quarter results so far has shown such an acceleration in bad loans.
Discover investors appear a bit unsettled. The company's stock has fallen 2.8 percent since the Jan. 16 filing. For the first two weeks of 2018, Discover's stock price is up 1.7 percent while rivals Capital One Financial, Chase, Bank of America and Citigroup all have risen anywhere from 3.9 percent to 5 percent.
Discover will report fourth-quarter earnings next week, and credit quality is sure to be top of mind for analysts quizzing CEO David Nelms. A Discover spokesman declined to comment.
Discover's card loans have outpaced its rivals as well. Card loans as of Dec. 31 stood at $67.3 billion, 9 percent above $61.5 billion the year before.
Meanwhile, Chase posted loan growth in the fourth quarter of 5 percent, Bank of America 4 percent and Citi 7 percent. Capital One has yet to report for the fourth quarter.
Capital One reported 10 percent year-over-year loan growth in the third quarter. But, at the same time, its charge-off rate fell 0.5 percentage points from the quarter before. There are some analyst expectations that Capital One will look to slow its torrid card-lending growth rate.
Discover increasingly looks like the one major player in the credit-card field with its pedal to the floor. Economic growth is picking up, and the overall health of the U.S. consumer is stable.
But, with cash readily available both from credit-card companies and newer online consumer lenders, even Discover executives themselves have cautioned that some consumers are taking on too much debt from multiple providers and getting themselves in trouble.
Nevertheless, Discover has gone all-in on the type of consumer who uses their card to finance substantial investments and then pays it off over time, incurring interest expense. By contrast, Chase and Citi, in particular, have engaged in an expensive rewards-based battle aimed at consumers who use their cards liberally but pay off their balances each month.
Discover, the company that invented cash-back rewards in the 1980s, ironically has decided that arms race is too costly. That leaves catering more to card users who need the money—and the credit risk that comes with lending so actively.
So far, Discover has profited from that approach. But, with credit losses on the upswing, it increasingly looks like Discover's losses will top those of a lot of rivals when the wave crests.
That's unfamiliar territory for the traditionally cautious lender. So long as that wave isn't the kind of tsunami that bludgeoned the industry in the wake of the financial crisis, Discover should be able to surf it.
But investors may have to avert their eyes a few times along the way.