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Discover to be spun off from Morgan Stanley

Summary

Morgan Stanley has announced its plan to spin off the Discover card, allowing it to compete more independently.

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Morgan Stanley has announced plans to spin off credit card unit Discover, giving the Wall Street firm the ability to concentrate on its traditional securities businesses.  The decision means Discover will stand on its own for the first time in the credit card issuer’s 20-year history.  Morgan Stanley’s announcement came alongside its fourth-quarter earnings release.

Additionally, the move allows Discover to compete more independently with MasterCard, which in 2006 became a publicly traded company, and Visa, which recently indicated plans for a restructuring that includes going public.

Analysts expect that Discover could eventually be purchased by another firm after its stock is distributed tax-free to Morgan Stanley shareholders, scheduled for the third quarter of 2007.  Had Morgan Stanley sold Discover immediately, the parent company could have taken a sizable capital gains tax.

Discover is overshadowed size-wise in the credit card industry by network giants Visa, MasterCard and American Express.  According to SEC documents, Discover processed $56 billion in credit card transactions during the first half of 2006, while Visa processed $771 billion, MasterCard processed $411 billion, and American Express processed $195 billion.

Meanwhile, Discover also issues credit cards, and had about $50 billion in outstanding credit-card loans as of Nov. 30, 2006.  That is well below industry leaders Bank of America, Chase, and Citibank, which each have upward of $100 billion in credit-card loans.

For fiscal 2006, Discover saw its operating earnings climb 86 percent, which is double the growth experienced by the rest of the company, which jumped 40 percent, Morgan Stanley’s CFO noted in an interview.  The surge in Discover’s profits is partially due to the drop in consumer bankruptcies during 2006 following a spike in 2005, when bankruptcy law changed.

Merrill Lynch said Discover Card’s earnings growth should be restrained in 2007 as bankruptcy rates normalize.  Additionally, with consumer credit quality forecast to deteriorate, more bad loans will likely occur.

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