Discover says it could long face consequences of compliance problems

Discover’s risk and compliance costs have risen by more than $300 million between 2019 and this year. In 2023, the Illinois-based company expects to spend about $460 million in those areas.

Adobe Stock

Top leaders at Discover Financial Services are vowing to bolster the embattled consumer lender’s compliance framework, saying Thursday that the company, which faces new regulatory penalties, is suffering the consequences of its past shortcomings.

The firm’s update to investors was highly anticipated in the wake of the surprise announcement Monday that CEO Roger Hochschild was resigning. 

Investors appeared to give interim CEO John Owen a small vote of confidence, boosting Discover’s stock price some 2.3% on Thursday amid hopes that the credit card company can avoid a worst-case regulatory scenario.

But analysts are still warning it may take quite a while for the Illinois-based company to resolve its growing headaches.

Discover has yet to hire a permanent replacement for Hochschild, a 25-year company veteran who had been CEO since 2018. A consent order from the Federal Deposit Insurance Corp. over consumer compliance is still pending, and executives who spoke on a call with analysts Thursday didn’t rule out further regulatory actions.

Plus, overhauling a company’s compliance framework is never quick — or cheap.

“Obviously, the Board did not have confidence in the CEO,” said Kevin Barker, an analyst at Piper Sandler. “So it’s hard for shareholders and investors to get confidence in what is happening right now.”

The $138 billion-asset company is about to undergo a “reinvestment cycle,” Barker said, potentially leading to permanent structural expenses that will weigh on its profitability going forward.

Owen, a board member who stepped in as Discover’s interim head, said the company has made significant progress over the last 18 months but has a “fair amount of work to do.”

Discover is focused on “driving accountability and ensuring that we don’t put profits before compliance excellence,” said John Greene, the company’s chief financial officer.

“I’m not saying that that was an overt choice that the company made historically,” Greene said. “But we do need to make sure that we invest enough to achieve compliance and risk management excellence.”

The company “historically underinvested” in those areas, he said.

“And we’re paying the price right now,” Greene added. “So we’re going to make sure we don’t underinvest going forward.”

Those investments won’t come cheap. Greene said risk and compliance costs have risen by more than $300 million between 2019 and this year. Discover is eyeing spending of about $460 million on those issues in 2023. And while the company hasn’t finalized its budget for 2024, Greene said that he “wouldn’t expect” its risk and compliance costs to decrease.

The big concern among investors is that Discover will be stuck in a “prolonged compliance quagmire,” Brian Foran, an analyst at Autonomous Research, wrote in a research note.

Some analysts were relatively optimistic about the company’s compliance outlook.

Don Fandetti, an analyst at Wells Fargo, wrote that the “bear case” of prolonged regulatory pain doesn’t appear to be playing out.

“We wouldn’t be surprised if the stock recovers some of the steep losses,” Fandetti wrote in a research note. 

Still, Discover’s stock price “will have an overhang until we get FDIC clarity,” Fandetti wrote. Discover’s stock price has sunk roughly 24% since last month, when it disclosed the looming FDIC action — and also revealed that it overcharged merchants for 16 years.

Greene, the company’s CFO, said that an investigation into the overcharging of merchants “is nearing an end.” The FDIC consent order isn’t final yet, but will be public when the agency releases it, he noted.

The agency’s order is focused on prior years, Greene added, saying that “there could be other regulatory follow-ups” from the FDIC or other regulatory agencies.

Strategy-wise, Owen said he doesn’t expect major changes, and that Discover executives are “going to execute with the plan we have.” The company runs a payment network that looks to compete with Visa and Mastercard, and it also offers credit cards, student loans, personal loans and mortgages. Its online bank also has a growing deposit portfolio thanks to higher interest rates.

“For the most part, we’re going to stay the course,” Owen said. 

The team will also largely look the same — now that Discover has brought on new leaders in key roles as it looks to improve its regulatory standing. The company has a new chief information officer, a new general counsel and a new chief compliance officer. 

Owen said the firm has a “good balance” of Discover veterans who understand the business and “new talent that has dealt with the compliance issues at other companies.”

Discover has also added a new board member with significant industry and regulatory experience: former BNP Paribas USA Chairman J. Michael Shepherd, who was previously senior deputy comptroller of the currency.

The company has also hired more than 200 new compliance officers in recent months, who have experience at “other companies that have to deal with challenges similar to this,” Owen said.

Discover’s board is “acting with urgency” on finding a new CEO, working with an executive search firm to do so, he said.

“I think this is a great job,” Owen said, adding that the board has a “strong list” of internal and external candidates.

“I think we’ll get the right person in the role in a fairly quick manner,” he added.

Erika Najarian, a UBS analyst, said that Discover likely doesn’t want to compare itself with other banks that announced permanent CEOs at times when they needed major compliance overhauls.

That list, she said, includes Wells Fargo and Citigroup.

Leave a Comment