NEW YORK (CNN/Money) -
While Morgan Stanley's banking profits have soared with the recovering stock market, its credit card unit has become a blight -- but the firm may "discover" a card up its sleeve with the network that processes those transactions.
The Discover unit was the only one of Morgan Stanley's four operating segments to report a drop in third-quarter profit, and Wall Street is starting to take notice.
"In an ideal world, I wish they didn't have [the Discover card]," said Jeff Harte, analyst with Sandler O'Neill & Partners. "It gave the bank some support during the stock market downturn, but now it's lagging behind."
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| Source: Morgan Stanley |
Although the credit card unit is plagued with falling revenue and rising bad debt, the division could see a turnaround following a court ruling that could send more traffic to its Novus network that processes Discover card transactions.
Credit card users have been feeling the effects of a weak economy. In Morgan Stanley's third quarter, the percentage of credit card debt the company could not collect jumped to 6.9 percent from about 6.1 percent a year earlier.
The company attributed an 11 percent drop in third-quarter credit revenue and the increase in bad debts to "sustained high levels of U.S. bankruptcy filings and unemployment," as well as a change in how it accounted for late payments.
"Discover card has higher charge-offs than any other prime lender," said Reilly Tierney, analyst with Fox-Pitt, Kelton. "The only reason people have it is for the cash-back feature, and other cards, like American Express, are beginning to copy that."
The cash-back feature gives a small percentage of the overall monthly balance, up to 1 percent, back to cardholders.
Morgan's Discover unit posted a third-quarter profit of $185 million, down 11 percent from a year earlier, on revenue of $834 million.
Will it Discover a buyer?
The struggling card unit, which accounted for about 16 percent of Morgan Stanley's (MWD: Research, Estimates) third-quarter revenue, has left some company watchers wondering it will do to improve the business, including a possible sale.
"They could sell it, but I'm not sure anyone would give them what it's really worth," said Sandler O'Neill's Harte.
A sale would follow some other companies with under-performing portfolios that have exited the credit card business recently.
In one of the biggest sales, Sears, Roebuck and Co. sold its $29 billion card portfolio to Citigroup for a pretax profit of about $6 billion, or about 21 percent of the total portfolio's value.
On that same percentage level, Morgan Stanley could see a pretax profit of about $10.5 billion for its $50 billion portfolio.
"It's not the greatest franchise," Tierney said. "It might struggle finding a buyer. It's still there because [Morgan Stanley CEO Philip] Purcell likes it."
A Morgan Stanley spokeswoman would not comment on the company's plans for the division, citing a quiet period before the brokerage reports fourth-quarter results Thursday.
A novel chance for Novus
Although analysts doubt Morgan could get fair value for the struggling credit card unit, they see a developing opportunity for its Novus network that processes Discover card transactions.
"The Novus network has potentially become more valuable and the more interesting story in regards to what has been going on in the industry," Tierney noted. "It may be a way to get some growth out of the business without having to sell the whole thing."
What's been going on in the industry is a proposed merger between two of the biggest credit card transaction-processing firms, First Data (FDC: Research, Estimates) and Concord EFS (CE: Research, Estimates), and recent problems with heavyweights Visa and MasterCard.
In September, a U.S. appeals court ruled that Visa and MasterCard, which are joint ventures owned by their member banks, violated antitrust laws by enforcing a rule that prevented their banks from issuing American Express and Discover cards.
Having more banks issue Discover cards means more transactions will be processed over Morgan Stanley's Novus network, which only processes Discover card transactions.
"Previously, smaller networks like Discover's Novus network had to charge higher fees to make money," said Standard & Poor's equity analyst Scott Kessler, who covers First Data. "That's why not every merchant accepts it."
"Now with Visa and MasterCard losing some power, it allows these smaller networks to compete."
If Morgan Stanley does decide to expand the Novus network and take on the larger players, it's a space where there's some money to be made.
In its third quarter, First Data, which also owns the money transfer firm Western Union, reported an operating profit of $215 million in its merchant services business, which includes credit card transaction processing.
"It's no question there's an opportunity for Novus, it just depends on whether it's worth pursuing for Morgan Stanley," said Kessler.
--None of the analysts interviewed own shares of Morgan Stanley, nor do their firms have investment banking relationships with the company.
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