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Rating Action:

Moody's affirms Discover Financial's ratings (Baa3 long-term senior unsecured), outlook remains stable

05 May 2020

New York, May 05, 2020 -- Moody's Investors Service (Moody's) has affirmed the ratings of Discover Financial Services (DFS) and its bank subsidiary, Discover Bank, following the affirmation of the baa2 standalone baseline credit assessment (BCA) of the bank subsidiary. DFS' senior long-term unsecured debt is rated Baa3 and the bank subsidiary has long-term senior unsecured debt ratings of Baa2 and long-term deposit ratings of A2. The Baa1(cr)/Prime-2(cr) Counterparty Risk Assessments and the Baa2/Prime-2 Counterparty Risk Ratings of the bank subsidiary were also affirmed.

The outlooks on Discover and its bank subsidiary remain stable.

Affirmations:

..Issuer: Discover Financial Services

....Pref. Shelf, Affirmed (P)Ba1

....Pref. Shelf Non-cumulative, Affirmed (P)Ba2

....Senior Unsecured Shelf, Affirmed (P)Baa3

....Subordinate Shelf, Affirmed (P)Baa3

....Pref. Stock Non-cumulative, Affirmed Ba2 (hyb)

....Senior Unsecured Regular Bond/Debenture, Affirmed Baa3, Stable

..Issuer: Discover Bank

.... Adjusted Baseline Credit Assessment, Affirmed baa2

.... Baseline Credit Assessment, Affirmed baa2

....ST Counterparty Risk Assessment, Affirmed P-2(cr)

....LT Counterparty Risk Assessment, Affirmed Baa1(cr)

....ST Counterparty Risk Rating (Foreign Currency), Affirmed P-2

....ST Counterparty Risk Rating (Local Currency), Affirmed P-2

....LT Counterparty Risk Rating (Foreign Currency), Affirmed Baa2

....LT Counterparty Risk Rating (Local Currency), Affirmed Baa2

....LT Issuer Rating, Affirmed Baa2, Stable

....LT Bank Deposits, Affirmed A2, Stable

....ST Bank Deposits, Affirmed P-1

....Subordinate Regular Bond/Debenture, Affirmed Baa3

....Senior Unsecured Regular Bond/Debenture, Affirmed Baa2, Stable

Outlook Actions:

..Issuer: Discover Financial Services

....Outlook, Remains Stable

..Issuer: Discover Bank

....Outlook, Remains Stable

RATINGS RATIONALE

The baa2 BCA reflects Moody's assessment that DFS's business is heavily skewed towards the US general-purpose credit card market and is heavily reliant on net interest income, making it vulnerable to a deterioration in asset quality and therefore economic shocks, as well as regulatory risks. Nevertheless, Moody's believes that DFS has countered these threats with prudent underwriting and ongoing initiatives to broaden its business. These initiatives include the development of its direct banking presence through ancillary lending and deposit products, as well as DFS' payment services business, which enhances its brand recognition, merchant acceptance and fee-based revenues.

Moody's believes that DFS's sustainable market position drives its strong profitability, one of the highest amongst Moody's-rated US banks with a return on assets averaging well above 2.0% since 2011. The company's strong profitability also provides additional support for the firm's solid capital levels, as measured by tangible common equity to risk-weighted assets of 11.1% as of 31 December 2019. Loan growth over the last several years has been above the industry average and a driver of increasing net charge-offs, which have risen over the last two years to over 3.0% from historic lows. However, the company's charge-offs remain around industry average, demonstrating disciplined underwriting along with good risk management.

DFS has an above peer-average reliance on confidence-sensitive wholesale funding despite ongoing diversification of its funding profile via internet deposits. However, Moody's believes that refinancing risk stemming from the firm's above peer-average portion of wholesale funding is partially mitigated by a high proportion of insured deposits, which Moody's views as a stable funding source even in adverse market conditions. DFS's good liquidity management includes a large portfolio of cash and cash equivalents and investment securities, as well as contingent liquidity of $6 billion of asset-backed conduit lines, as of 31 December 2019.

The rapidly deteriorating economic environment in the US will result in a material weakening of the bank's asset quality and in turn profitability. However, the stable outlook reflects Moody's assessment that the DFS will maintain asset risk and profitability profiles compatible with the baa2 BCAs of its bank subsidiaries, which are positioned two notches below the a3 median BCA of Moody's US-rated regional banks. The baa2 BCAs incorporate the risks to creditors stemming from DFS' elevated exposure to economic shocks as a result of its focus on unsecured consumer loans.

The spike in unemployment above the 10% level reached in the 2007-08 global financial crisis is a clear credit negative, but the severity of deterioration in loan performance will depend on how long unemployment remains so elevated. For example, if unemployment falls to below 8% by early next year and continues to improve, Moody's expects credit card charge-offs will likely peak in 2021 at around 6.0% to 7.0% from today's 2019 average of around 3.25% to 3.50%. However, if unemployment remains around or above 10% into next year, Moody's expects credit card performance will deteriorate substantially, possibly approaching the peak 9.0% to 10.0% 2009 average charge-off levels during the 2007-08 financial crisis.

DFS' solid profitability as measured by net income to average assets, was 2.7% in 2019 reflecting its very high net interest margin. The strong profitability exceeded the 1.2% median for regional bank peers, and will help DFS weather the current economic downturn, in Moody's view. Similarly, when profitability declined materially during the 2007-08 financial crisis, DFS's performance was stronger than that of peers. DFS only reported a loss in just Q4 2007 of $57 million, driven largely by a $279 million impairment related to its UK credit card business.

Due to the rapidly deteriorating economic environment, DFS reported a loss of $61 million for Q1 2020 due largely to a large increase in loss provisions to $1.8 billion up from $0.8 billion in Q4 2019. Pre-tax, pre-provision income was $1.73 billion in Q1 2020 versus $1.76 billion in Q4 2019. Common Equity Tier1 was 11.3% as of 31 March versus 11.2% as of year-end 2019.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

Given the deteriorating economic environment and the uncertain duration, an upgrade is unlikely at this time.

Upward rating pressure could emerge when the risks associated with the coronavirus pandemic outbreak abate, accompanied by the firm again achieving its historically strong profitability and solid capital levels. In addition, continued growth of its direct deposits reducing its reliance on wholesale funding and brokered deposits, would be positive for the ratings.

The bank subsidiary's baa2 BCA could be downgraded if capitalization weakens materially, such as tangible common equity to risk weighted assets falling below and expected to remain below 8.0%. In addition, the BCA could be downgraded in the event that asset performance is weaker than Moody's currently expects, given the current economic environment, or if liquid resources decline materially, making the firm vulnerable to market shocks. A lower BCA would likely lead to rating downgrades.

The principal methodology used in these ratings was Banks Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1147865. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Warren Kornfeld
Senior Vice President
Financial Institutions Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

M. Celina Vansetti-Hutchins
MD - Banking
Financial Institutions Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

No Related Data.
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