Discover Buys Citi's Student Loans on Astini News
, On Friday September 2, 2011, 6:30 pm EDT
Yesterday, Discover Financial Services (NYSE: DFS - News) made a Securities and Exchange Commission (SEC) filing for the purchase of $2.5 billion worth of private student loans from Citigroup Inc. (NYSE: C - News), the third largest U.S. bank. The purchase price is $2.48 billion, which translates into a discount of 1% on the outstanding balance and accrued interest.
The purchase deal is expected to be closed by September-end this year and Discover expects it to boost its 2012 earnings per share by 7 cents. Discover will use its liquid assets and available cash to fund the purchase.
Around 80% of the loans are in active repayment mode and a majority of the loans are co-signed. Loans to 4-year college and graduate students constitute 80% of the portfolio while other types of education loans like consolidation loans form the balance.
Student loans is a major part of Discover's direct banking business and the company is taking steps to expand its student loan portfolio, apart from increasing its home mortgage loans business and increasing its deposit base. The company is aiming to become the third largest lender of private students' loan by the end of 2011 by riding on rising education costs and increasing demand for student loans.
In September last year, Discover acquired student loans amounting to $4.2 billion as a part of a $600 million deal to purchase the 80% stake in Citigroup's private student loan business-Student Loan Corp. On the other hand, Citigroup has been trying to dispose the troubled assets of its Citi Holdings unit, valued at $308 billion, since the company received a bailout package of $45 billion.
The acquisition of Student Loan Corp. has helped in expanding the banking portfolio of Discover to a great extent. The student loans increased to $4.57 billion at the end of the second quarter of 2011, increasing by $820 million year-over-year, taking total loans to $52.51 billion. Income from loan fees increased to $81 million during 2011's second quarter, up 16% from the year-ago quarter.
We believe that the latest purchase should be profitable for Discover as student loans have better recovery rates than other types of loans. This is because students generally have a steady source of income after completing their education, enabling them to repay their loans. Additionally, student loans are generally co-signed, thereby increasing the chances of recovery and mitigating financial risk.
This is also reflected in Discover's declining loan write-offs. The company only wrote off 0.51% of its student loans in the second quarter of the year as compared to 2.88% of personal loans and 5.01% of credit card loans. Hence, the expansion of student loan portfolio bodes well for Discover's long-term growth.
Discover currently carries a Zacks 3 Rank implying a short-term Hold rating.
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