David Nelms is going on an African safari this winter. An
adventurer who enjoys power boating, scuba diving and piloting
planes, Nelms should find that trip a lot more predictable than
running a consumer credit and payment company. The chairman and
CEO of Discover Financial Services has faced many challenges
since the financial crisis shook his industry.
With a market capitalization of $13 billion, Discover
is the sixth-largest U.S. credit card issuer; one in four U.S.
households uses its plastic. Its also the No. 2 U.S. card
company with its own network, after American Express Co. But
Riverwoods, Illinoisbased Discover almost didnt
make it after spinning out from Morgan Stanley in the third
quarter of 2007, just ahead of the Bear Stearns Cos.
More recently, the 11,000-employee firm has contended with
increased regulation thanks to the Credit Card Accountability
Responsibility and Disclosure (CARD) Act of 2009, which aims to
protect consumers from predatory lending practices.
But Nelms, who was named CEO in 2004 and chairman in 2009,
has much to celebrate. The Discover card is turning 25 with the
highest sales and lowest delinquency rates since its 1986
launch by Dean Witter Financial Services Group, then a division
of Sears, Roebuck and Co. In the third quarter of 2011, card
sales volume reached a record $26.3 billion, up 9 percent
from the same period in 2010. Meanwhile, credit card loans more
than 30 days past due hit an all-time low of 2.43 percent.
Nelms, 50, joined what is now Discover as president and COO
in 1998, the year after Dean Witter, Discover & Co. merged
with Morgan Stanley Group. The St. Petersburg, Florida, native,
who has an MBA from Harvard Business School, had previously
been vice chairman of credit card company MBNA America
Nelms helped to diversify Discovers business by
expanding into other banking areas, such as personal and
student loans, prepaid cards and deposit products. He also
acquired the Pulse debit and ATM network in 2005 and the Diners
Club International credit card network when Citigroup spun it
off in 2008. Diners Club gave Discover cardholders
entrée to millions of merchants in 185 countries and
Discover has a distinctly different business model from
MasterCard and Visa, both of which process payments made by
consumers using bank-issued cards that run on the banks
networks. Both a network and a direct bank, Discover issues its
own cards. Like American Express, the other major vertically
integrated card company, it holds all customer debt itself. If
that debt offers greater earning potential, it also makes
Discover more sensitive to economic shocks.
Before the financial crisis, Nelms took a conservative
approach to the subprime credit card market, then a key source
of growth for banks affiliated with MasterCard and Visa. During
the meltdown, the industrys account write-offs peaked at
12 percent in August 2009; Discovers high was between 9
and 10 percent. In 2008, Discover won a $2.75 billion
settlement from a 2004 antitrust lawsuit against MasterCard and
Visa for blocking banks from issuing cards on the Discover
Discover signs merchants to its network rather than leaving
the task to banks or other entities. Ironically, the credit
crunch made this job easier. During the past few years, as
Discover worked to increase so-called merchant acceptance,
competing card issuers closed more accounts than it did while
raising their interest rates. In 2006, Discovers merchant
acceptance was only 76 percent of MasterCards and
Visas; today its almost equal.
Earnings have followed. In the third quarter of 2011,
Discover earned $649 million, compared with
$261 million during the same period in 2010, a year when
total net income was $765 million. Revenue before credit
loss provisions was $6.7 billion in 2010, versus
$4.8 billion in 2009.
Jason Arnold, a consumer finance analyst at RBC Capital
Markets in San Francisco, is impressed with Nelmss
leadership skills and calls Discover a strong buy. David
manages the business like a long-term investor, Arnold
says. After dropping to $4.73 in March 2009, the companys
stock regained 2007 levels this past July by climbing above
$27; in early December it was about $24 a share.
As he looks ahead, Nelms must boost card member spending.
Discovers transaction volume, which includes purchases
and cash advances, totaled only $114 billion in 2010,
compared with $852 billion for Visa, the No. 1 credit card
company. To meet this challenge, Nelms has ventured into mobile
apps through Discovers Zip and Google Wallet. We
think that the phone will increasingly become the access device
for the credit card account, he says.
Senior Writer Frances Denmark recently spoke with Nelms
about the Morgan Stanley spin-off, the credit crisis and new
Institutional Investor: What was it like to spin off
Discover just before the financial meltdown?
Nelms: We came out almost right at the peak in financial
stock prices, so our price was a lot higher than we expected it
to trade at the outset. We didnt raise any money. We were
a dividend to shareholders, but it quickly traded off.
After that all heck broke loose with Lehman Brothers,
Countrywide, AIG and the rest. We went through quite a roller
What were your top challenges in running a newly
The first two Bear Stearns funds failed within two months of
our becoming a public company. Then things quickly
deteriorated. Had we not gone public when we did, we could not
have gotten the funding and completed the spin-off. We
didnt have a big balance sheet standing behind us.
Another challenge was building functions like treasury, human
resources and some of the legal functions from scratch. On the
other hand, we were able to do the right thing for Discover
without being distracted by some of the other problems that the
parent company had to deal with after we left.
What helped get Discover through the financial
First, we had a very experienced and stable management team.
I had been running the company for more than a decade before
the spin-off, and most of my team had been with us during that
entire period. Second, we had been pretty conservative on
credit going into the crisis. We had actually given up some
market share because we didnt participate in some of what
we considered at the time to be too-aggressive lending, so our
credit customer base was very sound as we entered. Third, we
had been fairly conservative in how we capitalized the company,
how we funded it and the amount of leverage we had. We were
starting from a solid foundation. Interestingly, some of the
biggest challenges for us were changes that happened at the
same time as the crisis or came out of it.
What challenges were those?
Everyone talks about Dodd-Frank or the health care bill, but
the CARD Act affected us more significantly. The act and
regulations flowing from it had hundreds of pages of new rules
that required the credit card industry to make fundamental
changes to many of its business practices, including marketing,
pricing and billing.
What were some of the costs of complying with these
To some degree, we went back to how credit cards used to
work in the 1990s, before risk-based pricing and promotional
rates. So it wasnt the end of the world, but it was a
huge adjustment, and there are some things that are gone. As an
example, we cant charge over-limit fees anymore, so maybe
we have to be a little more careful about who we allow in to
take a card. There was a lot coming at us. But the good news
is, we reinvented our strategy.
How did you do that?
A lot of people recommended that we buy a bank and have
branches and stable deposits. We considered and rejected that.
We came to the conclusion that direct banking is the future,
not going backward and getting branches. When you get branches,
you do pick up a good source of deposits, but you also pick up
a lot of expense. You also have to be in all the products. The
direct model is less expensive. My feeling is that ATMs
essentially are the branches we needed, so during the process
we built a global ATM network; its got about 800,000 ATMs
around the world. You dont have to have a branch. We can
offer a better value to consumers. Were open 24 hours a
day, moving to the Internet.
How is that playing out?
We said were going to focus on direct banking and
payments. One of the great things about our model is that we
can pick and choose which products we think will be profitable
and serve customers well. We got into student loans just as
some others were getting out of them. We got into personal
loans to help consumers consolidate their debt and pay it down,
taking advantage of the deleveraging that so many consumers are
focused on. And we got really big in direct deposits. We had
$3 billion worth of certificates of deposit and money
markets as we spun out of Morgan Stanley. We now have
$25 billion; thats our single largest source of
funds. Securitizations are a much smaller part of our