The Student Loan Picture Is Getting Worse. What Does It Mean for This Lender?

Photo credit: Flickr/Kalamela68

It seems like every day a new story comes out about the difficulty people are having repaying student loans. And that's probably for good reason: According to U.S. News & World Report, student loan defaults have risen six years straight.  

In the wake of these difficulties, several large lending institutions that used to be major players in student loans have gotten out of the game or reduced their exposure in recent years. JPMorgan Chase  (NYSE: JPM  ) announced in September that it would no longer accept any student loan applications. In 2010, Citigroup  (NYSE: C  ) also decided to get out of student loans and sold its portfolio to a financial company charging hard in the opposite direction and into student lending.

Swimming against the tide
Discover Financial Services (NYSE: DFS  ) , mostly known for credit cards, has spent the last several years building up the student loan portion of its business. Acquiring some of Citigroup's portfolio was just the beginning.

In 2011, Discover made another large purchase, acquiring some of the assets of the Student Loan Corporation in an effort to expand its student loan offerings . With all the uncertainty and risk around student lending, how is Discover performing in this area? Did student loans increase? Are they actually getting paid back? Luckily for us, Discover's fourth quarter earnings report allows us to perform a checkup on this aspect of its business.

Loan Growth
CEO David Nelms said on the earnings conference call that increasing student loans  was a priority, and Discover succeeded in that goal. The student loan book grew from $7.8 billion to $8.1 billion  between the fourth quarter of 2012 and the end of 2013. That slice now accounts for nearly 13% of Discover's entire loan portfolio.

Discover is clearly not deterred by other lenders' reluctance to lend to students and is earning business. However, I don't want to congratulate Discover too much for successfully giving out money. Lending to people who will pay you back and adjusting the interest rate to account for risk are the true tests of a lender.

While Discover succeeded in lending more money, getting paid back on existing loans was more of a challenge. The rate at which Discover was charging off student loan debt rose from 1% to 1.41% year over year and up from 1.33% from the previous quarter.

These three data points establish a trend that is clearly going in the wrong direction. In addition to charge-offs increasing, the 30-day delinquency rate rose quarter-over-quarter and year-over-year.

Does that mean that it's time to panic? Not necessarily. I checked Wells Fargo's (NYSE: WFC  ) student loan results from its quarterly report to compare repayment rates. Wells Fargo's fourth quarter charge off rate came in at 1.36%, right in line with Discover's. Wells Fargo actually had a worse 30-day delinquency rate, coming in at 2.27%, which was also up from what they reported in the third quarter. Discover's results line up with Wells Fargo's, suggesting higher delinquencies may be an industry problem and not an issue specific to Discover. 

Interest Rates
While loans performing worse is never a good thing, Discover investors can take solace in the fact that the average rates they are receiving on student loans is increasing. Discover's average interest rate for student loans rose from 6.48% in the fourth quarter of 2012 to 6.63% at the close of this past quarter.

I compared the interest rate numbers at Discover to the rates for the granddaddy of all student lending companies, the Student Loan Marketing Company, better known as Sallie Mae or SLM Corp.  (NASDAQ: SLM  ) . Sallie Mae's fourth quarter average rate for student loans was  6.42% compared to 6.35% from the fourth quarter prior.  Discover is once again ahead of a competitor with rates 20 basis points higher than Sallie Mae. 

Foolish final thoughts
The fourth quarter provided a mixed bag for investors checking up on Discover's student loans. Rising rates are encouraging, but rising delinquencies are discouraging.

Overall though, Discover seems to be performing well in comparison to rivals Wells Fargo and Sallie Mae. It may be too early to tell if Discover has spotted a golden opportunity to establish itself in the industry, or if former rivals, like Citigroup and JPMorgan, are acting wisely by shrinking away from student lending. At 12% of Discover's portfolio, student loans won't make or break the company. But, Discover needs to avoid trying to grow simply for growth's sake and focus on quality loans. 

For now, I'm staying patient and will be checking up on Discover's progress next quarter.

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Comments from our Foolish Readers

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  • Report this Comment On February 01, 2014, at 1:26 PM, Craigie7 wrote:

    Student loan defaults actually did not rise during 2007-2011. It only appeared that way because the 2003-2006 rates were skewed artificially-low due to pre-repayment ("in school") consolidations quietly permitted by the Bush Administration that had the side effect of cramming hundreds of thousand of borrowers into the denominator prior to their actual graduation (or drop out) year and also leaving 2007-2010 calculations filled with high-risk borrowers who were unwanted by the consolidation lenders.

  • Report this Comment On February 01, 2014, at 3:15 PM, icydemons wrote:

    Sign this petition to make all student loan payments tax deductible.

  • Report this Comment On February 01, 2014, at 4:01 PM, macarthur1 wrote:

    Student loans should not be susceptible to bankruptcy. I have over $100,000 in student loans and can't find a job, but I believe I should have to pay it back, even if it takes my entire life to do so, I agreed to take on the debt and pay it back.

    Maybe what they could do is put a cap on and freeze interest capitalization after a certain amount for those in economic troubles, in order to help these graduates catch up on their payments and so the principle doesn't start growing exponentially and out of control - and also extend the repayment deadline.

    The root of the out of control cost problem is lack of discipline. The schools continue to inflate costs WELL BEYOND the rate of inflation, and the government continues to go along with it, dolling out more money. Policies need to be put in place so that school cannot go on a party spree increasing tuition costs 15% per year, even though the number of students, staff and staff salaries remain the same while inflation is set at only 1%. Something needs to come to a head.

  • Report this Comment On February 01, 2014, at 8:10 PM, czanclus wrote:

    Much like for unemployment benefits, a person (former student and student loan borrower) should be able to claim eligibility for frozen interest rate during the time of legitimate unemployment. The students that are under-employed (this is a simple mathematical ratio in terms of income currently earned to income generally earned in a profession that the degree was directed towards) should have payments and interest rates adjusted towards their current income.

    The students took on loans in good faith that their education will enable them better jobs than selling fries at a local fast food joint, only to find that they emerged post-graduation into an economic recession and joblessness caused by major over-seas outsourcing of labor and automatization of services. They could not be held at fault for failing to anticipate a global economic crisis. This responsibility should fall on the shoulders of lenders (ie. banks), at least as far as the timeliness of payments and the interest accrued during that time is concerned.

    This is the change that we must demand. Bring jobs back to United States, or at the very very least actively disseminate accurate and up to date information in easily digestible form for a typical 18 year old.

  • Report this Comment On February 03, 2014, at 2:04 AM, ChrisWalczakSD wrote:


    Whether the number of years defaults have been rising is 6 or 3 doesn't change the thesis of the article. Credit metrics for banks lending to students is getting worse. If you own these banks, keep an eye on it.

  • Report this Comment On February 03, 2014, at 1:44 PM, MrMadmax wrote:

    "Schools is for fools, look at me."

    Great article!

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