Discover Financial Services sees the future — and it's not just in plastic.
Seeking revenue growth, the card issuer and payments network company is ramping up its business in personal and private student loans. That's why, in the six months through the end of June, Discover was the second highest mailer of non-credit-card loan offers among issuers of plastic, behind larger card lender Citigroup Inc., according to Mintel Comperemedia, which tracks credit card mail offers.
Discover hopes these consumer loans, which are emerging as a central plank in Discover's business strategy, will help offset lower credit-card income as sweeping legislation curbs card fees and interest rates. In a post-crisis world, where Americans can no longer easily tap home equity loans, personal loans provide a cheaper funding source than credit cards.
"This is an area of focus for the company. Diversifying our revenue stream is very important for us," says Carlos Minetti, an executive vice-president and head of Discover's consumer banking and operations. "We want to be more than a credit card company."
The push into personal and private student loans comes as Discover and its peers are struggling to grow their business. They have put the worst of the credit losses from the Great Recession behind them. But the card lending business is shrinking, a function of tougher lending standards, written-off debt and less borrowing by stressed consumers. According to the Federal Reserve, revolving credit lines — mainly card balances — fell by about $4.5 billion in June, or at an annualized rate of 6.5%, to $826.5 billion. Since the end of 2008, these balances have been cut by about $131.6 billion.
Discover said income decreased $7 million in the second quarter from a year ago primarily due to the elimination of fees paid when customers go over their credit limits. The Riverwoods, Ill.-based company also said restrictions on fees for late payers will reduce Discover's income before taxes by $80 million to $90 million over a 12-month period.
Discover, spun out of Morgan Stanley in 2007, is the smallest of the major U.S. card issuers. Unlike most other card companies, which either issue plastic or process the transactions, Discover does both. Discover cardholders charged $100.4 billion on their plastic in 2009, according to the Nilson Report, a newsletter that tracks the payments industry.
While Discover has pitched personal loans since 2008, it has sharply increased such lending and expanded it to non-Discover customers as well. The loans, marketed as a means to consolidate credit-card debt, carry interest rates ranging from 7.99% to 18.99%. They carry a maximum term of seven years and a limit of up to $25,000. Interest rates on these unsecured loans are on average four percentage points lower than rates on credit cards. The catch: the loans are invitation-only, with Discover pre-screening potential borrowers. The personal loans are aimed at consumers with reasonably strong credit histories, with the average FICO score on borrowers at 740.
As of Discover's first quarter ended Feb. 28, the latest quarter for which numbers are available, the volume of personal loans at Discover totaled $1.5 billion, up 25% from a year earlier and a more than three-fold jump from $400 million in the first quarter of 2008. Private student loans at Discover totaled $800 million in the quarter ended Feb. 28, up from $300 million a year ago and less than $100 million in the third quarter of 2008.
Discover's credit-card business, with average loans totaling $45.3 billion as of May 31, dwarfs the volume of personal and private student loans. Its book of card loans fell 8% in the second quarter from a year ago. Discover expects the rapid growth in consumer loans to continue.
"This business isn't going to catch up to credit cards overnight," says Discover's Minetti. Still, he says, "This year they will have positive contribution to Discover's results."
Moshe Orenbuch, an analyst at Credit Suisse, says Discover's expansion carries "a degree of risk. It's always easier for people to take money from you than to pay it back." Scott Valentin, an analyst at FBR Capital Markets, says, "It makes sense for Discover to apply what it has learned in credit-cards to other areas of consumer lending."
Discover's shares recently traded at $14.39, down 2.57% on the day, amid broader declines in the financial services sector.
