Shares of Discover Financial Services (DFS) dropped over 8% in after-hours trading on Wednesday following the company’s announcement of better-than-expected quarterly earnings, but also revealing an ongoing investigation by the Federal Deposit Insurance Corp. (FDIC) and accounting errors dating back several years.
Strong Quarterly Earnings with Some Complications
In the second quarter, Discover reported earnings of $901 million, or $3.54 per share, compared to $1.1 billion, or $3.93 per share, in the same period last year. Despite the decline, revenue saw a 21% increase to $3.9 billion, in line with analysts’ expectations from FactSet. However, analysts had predicted EPS of $3.67.
Accounting Misclassification and Corrective Measures
The company disclosed that it had “incorrectly” classified certain credit-card accounts into the highest merchant pricing tiers since mid-2007. Although this did not impact cardholders directly, it did affect pricing for specific businesses. While this misclassification did not materially affect financial statements, Discover has rectified the error. It estimated a liability of $365 million for potential refunds to affected merchants, although the final amount is difficult to ascertain due to various merchant agreements, changes in network terms, and insufficient historical data. An external law firm is currently conducting an investigation into the matter, and discussions with regulators are underway.
FDIC Proposed Consent Order and Additional Supervisory Actions
In addition to the accounting missteps, Discover also disclosed receiving a proposed consent order from the FDIC regarding consumer compliance issues. However, this order does not pertain to the card product classification matter. Discover stated that there may be potential additional supervisory actions related to this issue.
Despite these complications, shares of Discovery ended the regular trading day with a marginal increase of 0.1%.
