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.
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.
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.
Fool contributor Chris Walczak owns shares of Discover Financial Services. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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