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We have retained our Neutral recommendation on Discover Financial Services Inc. (DFS - Analyst Report) as rising expenses and high competitive pressure are likely to weigh on company positives. This direct banking and payment services company currently carries a Zacks Rank #3 (Hold).

Why the Reiteration?

Discover Financial has been consistent in launching new and innovative products to cater to the growing demand of the payments industry. Its introduction of Discover it card, Discover Cashback CheckingSM and three new loan products for law students so far in 2013 are worth mentioning. These efforts coupled with acquisitions to diversify its product portfolio are expected to be accretive to the top line improvement going forward.

Discover Financial is also working hard to establish a foothold in the international card market. The company has taken up initiatives to expand into the Republic of Ecuador, India, China, Russia, Nigeria and other Middle-Eastern countries. The PayPal agreement and the initiative with Ariba are also expected to bolster Discover’s global clientele base, enhance the brand value and competitive strength.

Discover also boasts of a strong capital position that is boosted by equity and debt offerings. Additionally substantial improvement in delinquency and net charge-off rates and moderation in interest expenses have been aiding bottom line growth  over the past several quarters. We expect the benefits from capital management to continue to support the operating leverage and earnings in the upcoming quarters.

On the tepid side, increased competition has led Discover to witness rising expenses for the past few years and the first half of 2013 was no exception. Moreover Discover’s agreement with the Federal Deposit Insurance Corporation (FDIC) and Consumer Financial Protection Bureau (CFPB) increased its already high expenses thereby moderately affecting the cash position and balance sheet. Also the net interest margin has been a drag and with the decline in credit card yield and addition of lower rate student loans margin is likely to fall further.

Discover Financial’s earnings for the second quarter of 2013 came in at $1.20 per share, surpassing the year-over-year earnings by 21.2% and the Zacks Consensus Estimate by 3.4%.

Other Stocks to Consider

Among other financial services companies that are worth considering are SLM Corporation (SLM - Analyst Report), Encore Capital Group Inc. (ECPG - Snapshot Report) and Tree.Com Inc. (TREE - Snapshot Report). All these stocks carry a favorable Zacks Rank #2 (Buy).

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