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High interest rates may have cut into net interest income (NII) across the banking industry in Q3 as higher funding costs created a headwind again, but the opposite rang true for Discover Financial Services (DFS). After the close last night, the credit card company reported upside Q3 results, comfortably exceeding EPS estimates, fueled by a 10% increase in NII to $333.0 mln. Thanks to those high interest rates, DFS's net interest margin was up 43 bps yr/yr to 11.38%.

• As some may recall, Capital One (COF) announced back in February that it intends to acquire DFS in an all-stock transaction that was valued at just over $35.0 bln at the time. However, as expected, this deal is receiving plenty of scrutiny from both regulators and consumers, so we view the closing of this merger as questionable, at best. There are certainly compelling aspects to that proposed merger, including COF gaining hold of its own in-house credit card issuing business, but DFS is also operating quite well on a standalone basis at the moment.
• On a yr/yr basis, EPS jumped by 42% to $3.69, bolstered by the aforementioned NII increase, a 4% yr/yr increase in total loans to $127.0 bln, and a decrease of $229 mln in provision for credit losses to $1.5 bln. On the last point, credit card net charge-offs improved a bit from last quarter, dipping by 27 bps to 5.28%, while 30-day delinquencies remained in line with seasonal trends at 3.84%.
• The company is also making good progress on its effort to divest its student loan portfolio, disclosing that it has completed the first of four student loan sale closings. To quickly rewind, DFS announced on July 17 that it planned to sell its private student loan portfolio to funds owned by Carlyle Group (CG) and KKR (KKR), estimating that the deal would generate up to $10.8 bln in proceeds. In addition to the influx of capital, the divestiture would enable DFS to simplify its operations, enabling it to better focus on its core credit card and personal loan businesses.

DFS's solid results set the stage for fellow credit card companies American Express (AXP), Mastercard (MA), and Visa (V) to deliver solid results when they report earnings later this month. AXP is the next one up with its earnings report set to be released tomorrow morning, followed by Visa on October 29 and MA on October 31.