(Bloomberg) — Discover Financial Services has fallen the most in more than three years after the lender revealed it was in discussions with regulators about how it could misclassify some of its credit cards.
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The stock fell 17% to $101.36 at 11:49 a.m. in New York, the biggest intraday drop since March 2020 and the worst performance for the S&P 500. On Wednesday, the company said in a statement that it will suspend buybacks while it begins an internal review of compliance, risk management and corporate governance.
Discover said it misclassified some credit card accounts at their highest pricing tier, starting in 2007, meaning merchants were being charged more than they should have been for accepting cards for payment. The additional revenue generated amounted to less than 1% of its cumulative interchangeable income – the money it collects from merchants each time a consumer swipes the card at checkout.
The lender said it was discussing the matter with regulators and warned that it could face regulatory action in the future. In addition, Discover said it received a proposed approval order from Federal Deposit Insurance Corp. The issue of consumer compliance is separate from the issue of misclassification.
“We are actively strengthening our governance and oversight structures and are making significant investments in our compliance management system,” CEO Roger Hoschild said in the statement. “We remain deeply committed to achieving excellence in all of these areas.”
internal investigation
It’s the second time in a year that the company has had to put share buybacks on hold due to compliance concerns.
Last year, Discover paused stock buybacks after it launched an internal investigation into practices within its student loan servicing business. Four months later, it began buying the stock again after completing that review, stating that it would continue to communicate with regulators about the unit’s practices.
Discover said its management team will set up a program to compensate merchants affected by the misclassification problem, with $365 million set aside to provide refunds to retailers and payment processors.
“Due to differences in individual merchant agreements, changes in network terms, and the availability of historical data, it is difficult to determine the final amount of potential refunds at this time,” Riverwoods, based in Illinois, said in the statement, noting that its board has retained a law firm to work on the matter.
The company warned that it would spend more on improving its internal compliance systems. Discover now expects full-year expenses to jump by percentage in the “low double digits” compared to 2022, up from a previous forecast that costs would rise less than 10% for the year.
Discover’s board hired an outside law firm to investigate the issue.
“She’s really focused on why we shouldn’t escalate this and address it more quickly,” Hochschild said Thursday in a phone interview. “One of the things we try to do when something goes wrong is not just fix it but also try to learn from it. So it’s a little bit broader in terms of looking at our processes and what happened.”
profit slice
Meanwhile, Discover’s profit in the second quarter fell 18% to $901 million. While that beat Wall Street estimates, Discover took $1.31 billion in non-performing loan provisions as writedowns rose in the period. This number was larger than analysts expected.
In May, the company relaunched a debit card that offers users cash back on their purchases. Hoschild said the company opened 30,000 new accounts in the weeks after it debuted and plans to ramp up marketing for the offering in the coming months.
Discover, which acts as an issuer and network for its cards, is exempt from legislation that limits how much banks can charge merchants each time consumers use their debit cards.
“We’re happy with this use,” Hochschild said. “The main thing you want to do is make sure that people use it as their primary account. This is where, I would say, some of the direct banks have lost their way. The economy is not going to work.”
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