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Discover CEO Sees More Growth in Private Student Lending

Discover Financial Services agreed to buy Citigroup Inc.’s Student Loan Corp. in a deal valued at $600 million to become the third-biggest U.S. provider of private student loans.

Discover, the No. 4 U.S. payment-card network, will pay $30 a share for Stamford, Connecticut-based Student Loan Corp., the companies said today in separate statements. The price was about 40 percent higher than the closing value yesterday on the New York Stock Exchange.

Legislation backed by the Obama administration eliminated private lenders from the federal student loan program this year, so students seeking government loans now must borrow directly from the Department of Education. They can still borrow privately through businesses such as Student Loan Corp., as well as SLM Corp., the biggest provider, and No. 2 Wells Fargo & Co.

“Private loan demand is growing, and contrary to some perceptions out there, done right it actually has very low loan losses and risks compared to other unsecured loans,” Discover Chief Executive Officer David Nelms, 49, said in an interview.

Citigroup expects to take an after-tax loss of $500 million on the transaction that will be recorded in the third quarter, the bank said in a statement. Shannon Bell, a Citigroup spokeswoman, said that the deal would be “slightly accretive” to Tier 1 capital and Tier 1 common capital.

Photographer: Tim Boyle/Bloomberg News

David Nelms, chairman and chief executive officer of Discover Financial Services. Close

David Nelms, chairman and chief executive officer of Discover Financial Services.

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Photographer: Tim Boyle/Bloomberg News

David Nelms, chairman and chief executive officer of Discover Financial Services.

Private Loans

Discover will acquire $4.2 billion of Student Loan Corp.’s private loans for 8.5 percent below face value, along with $3.4 billion of securitized loans. SLM, known as Sallie Mae, will separately purchase $28 billion of securitized federal student loans and related assets from Student Loan Corp. Sallie Mae is paying $1.2 billion for the assets, said Matt Snowling, an analyst with Arlington, Virginia-based FBR Capital Markets.

Citigroup will keep $8.7 billion of federal and private loans, the companies said. Sallie Mae is one of four companies allowed to continue servicing federal loans.

Student Loan Corp.’s net income was $20.8 million at the end of June, compared with $70.5 million three years earlier. The deal is expected to boost Discover’s earnings per share by 9 cents in 2011, Riverwoods, Illinois-based Discover said in the statement.

“We feel very good about the risk and the immediate benefit to our shareholders,” Nelms said in the interview.

Discover fell 22 cents, or 1.4 percent, to $15.57 in composite trading on the New York Stock Exchange at 4:15 p.m. Student Loan Corp. rose $8.72, or 41 percent, to $29.87, and Citigroup dropped 2 cents to $3.95.

Job Cuts

It’s too early to determine whether there will be job cuts among the 230 Student Loan Corp. employees who are expected to join Discover, Nelms said.

“One of the things we really like is the experience of the employee base, so we’ll probably be more focused in the near term that we retain the talent,” he said.

Nelms declined to say whether the acquisition would preclude a stock buyback or dividend increase by Discover, which is scheduled to report fiscal third-quarter results on Sept. 20.

“We will be actually detailing that on Monday when we announce earnings,” Nelms said.

Discover has less than $1 billion of private student loans, so the deal “significantly increases our private student loan businesses,” Nelms said. “It’s a key part of our direct banking strategy.”

New Customers

Discover will acquire 300,000 customers and the website studentloan.com in the transaction. More than 70 percent of the loans are insured, Nelms said.

Discover may be able to make more credit-card loans by introducing its brand to customers of its expanded student-loan business, Nelms said.

“We do expect over time these students and their parents will appreciate the great value we’re providing in student loans, and we hope to certainly attract some of them to credit cards,” he said.

New loans haven’t been made through the Federal Family Education Loans, or FFEL, program since July 1, said Mark Kantrowitz, publisher of FinAid.org, a website that provides information on financial aid, in an interview. As a result, he said, companies that hold such loans face growing administrative costs as expected repayments decrease.

“If you’re an entity like Sallie Mae, you want to acquire FFEL portfolios because you’re the 800-pound gorilla,” Kantrowitz said. “You have the best volume, the best economies of scale. For any lender that has $2 billion or less in volume, they can’t stay the same size. They have to sell their portfolio or buy another portfolio to get bigger in size.”

Asset Quality

Sallie Mae “pursued what made sense for us in terms of new customers, asset quality and potential return,” spokeswoman Martha Holler said in an e-mailed statement.

Student Loan Corp. will sell $4.7 billion in federal student loans to the U.S. Department of Education.

The firm was one of at least 21 Citigroup businesses tagged for sale in the wake of the New York-based bank’s $45 billion bailout in 2008. CEO Vikram Pandit has shifted these assets into the bank’s Citi Holdings division.

“We expect that once this divestiture is completed in the fourth quarter, total assets in Citi Holdings will be less than 20 percent of our balance sheet as of year-end,” Pandit said in the statement.

Barclays Plc’s Barclays Capital unit is advising Discover on the transaction, with Sidley Austin LLP was legal counsel. Citigroup is getting advice from its own investment bankers. Moelis & Co. is advising a special committee of Student Loan Corp.’s board, and Gleacher & Co. provided an opinion. Proskauer Rose LLC is providing legal counsel to the special committee. Goldman Sachs Group Inc. is advising Sallie Mae.

To contact the reporters on this story: Donal Griffin in New York at Dgriffin10@bloomberg.net; Peter Eichenbaum in New York at peichenbaum@bloomberg.net

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