UPDATE: Discover Shares Fall As 4Q Loan Balances Shrink

Discover Financial Services (DFS) reported a fiscal fourth-quarter profit of $350 million as improving credit trends allowed the company to free up funds in reserves and cardholders spent more.

But investors, disappointed by Discover's shrinking book of loans, drove the company's shares down 4.1% to $18.34. Discover's results underscore the sliding revenue trend that is plaguing the card industry, which is facing shrinking loan balances.

The company's profits from lowering its loss reserves reinforce the trend observed earlier this year in companies, including Capital One Financial Corp. (COF) and American Express Co. (AXP), whittling down their reserves amid improving credit trends.

For the fourth quarter, the Riverwoods, Ill., company reported a profit of $349.6 million, or 64 cents a share, down 1% from $352.5 million, or 60 cents a share, a year earlier. The results from a year ago were bolstered by an after-tax gain of about $285 million related to an antitrust settlement. Analysts polled by Thomson Reuters forecast, on average, earnings of 43 cents a share for the latest quarter.

Discover's net revenue, on an adjusted basis, declined 8% from a year ago to $1.6 billion. Average credit card loan balances dropped 6% to $44.7 billion during the same period. In coming quarters, investors will continue to examine the proportion of profits coming from an actual increase in revenue--a sign of growth--and the bump in profits from lenders releasing reserves as credit trends improve. Discover's fourth quarter got a boost from a $414 million reserve release.

Unlike most other card companies, which either issue plastic or process the transactions, Discover and bigger rival American Express do both. Therefore, in addition to the interest Discover earns on its credit card loans, a chunk of its revenue comes from fees it charges banks and merchants, such as grocery stores or gas stations, to process card payments.

The more times consumers use Discover-branded cards and the more they charge on them, the more the company earns in fees. Discover customers spent $23 billion on their cards, a 6% jump from a year ago.

Discover reported lower delinquencies and charge-offs, or loans that the company doesn't expect to collect on. Charge-offs for the fourth quarter totaled 6.58%. The write-off rate remains elevated but is lower than the 8.43% a year earlier and the 7.18% in the third quarter.

Loans at least a month past their due payments totaled 3.89%, down from 5.31% a year ago and 4.16% in the prior quarter. The delinquency rate is important for issuers because higher delinquencies force them to put away capital to reserve for potential losses; ultimately, companies must write off loans if customers can't pay up.

Discover's provision for credit losses, at $383 million, fell 70% from a year earlier, on an adjusted basis.

In September, the company agreed to acquire private student-loan operations of Student Loan Corp. (STU) for $600 million and $4.2 billion of the company's assets for 91.5 cents on the dollar. Discover has been ramping up its business in personal and private student loans, seeking revenue growth. The acquisition will add nine cents to earnings per share in 2011, Discover said at the time.

-By Aparajita Saha-Bubna, Dow Jones Newswires; 617-654-6729; [e-mail]

(Matt Jarzemsky contributed to this report.)