Discover Financial Services (DFS) plans to start offering loans that help college graduates consolidate and refinance their student debt sometime in 2014.
The Riverwoods, Ill., company is the second lender in recent weeks to announce plans to enter the long-moribund student loan refinancing market.
Until recently, only two of the country's seven largest private student lenders — Wells Fargo (WFC) and SunTrust Banks (STI) — offered a way for borrowers to refinance and consolidate their existing debt.
But earlier this month, RBS Citizens Financial Group announced that it would start offering such loans, and in an interview Thursday, Discover Chief Executive Officer David Nelms said his company is planning to follow a similar path.
"I do think it's likely that we’ll be launching a consolidation product later this year," Nelms told American Banker.
Both announcements follow a Jan. 9 meeting between top officials in the Obama Administration and representatives of the nation's largest private student lenders, including Discover and RBS Citizens, the U.S. banking unit of the Royal Bank of Scotland.
Though federal policymakers are more focused on the problems struggling borrowers face when they try to negotiate affordable repayment plans, officials from the Consumer Financial Protection Bureau have also lamented the lack of refinancing options for employed college graduates who are making their payments on time.
During the Jan. 9 meeting, private student loan refinancing was one of the topics discussed, according to a summary of the meeting provided by the Treasury Department.
At Discover, where credit cards account for 80% of all loans outstanding, a student loan refinancing product could enable the company to further diversify its revenue stream.
Discover originated more than $1 billion in private student loans last year, which was up from the two previous years. Student loans accounted for 13% of the firm's total loans outstanding at the end of last year.
Discover has also been ramping up its mortgage lending and its personal loans business. The company's portfolio of personal loans — such loans often go to consumers who are consolidating their credit card debt — grew by 27% over the course of 2013.
At the moment, only a handful of lenders refinance student debt. They include Darien Rowayton Bank in Darien, Conn., as well as nonbank startups Social Finance and CommonBond. That means there are limited relief options for college graduates who have steady incomes and have demonstrated their willingness to repay their debts.
For lenders, there is an opportunity to earn attractive returns in the refinancing market, argues Stephen Dash, founder of JoinStampede.com, which pools borrowers in an effort to renegotiate their interest rates collectively.
He notes that when college students initially borrow money to finance their education, they are often a risky bet. "Contrast that lending proposition with a graduate who has a degree, has a job, has an extended credit history," Dash says. "It's a much less risky proposition for a lender at that point."
But other observers say there are important barriers to the growth of student loan refinancing. For example, it can be expensive for lenders to peel off their competitors' customers. Marketing is pricey, and counter-offers from the existing lender can drive down profit margins.
In addition, private student lenders have little incentive to refinance their existing customers into lower-cost loans.
Although Nelms says that Discover is developing a refinancing option for borrowers, he also downplays the size of the company's opportunity. "We feel like it's probably only going to have limited interest," he said in Thursday's interview.
One reason the opportunity is limited, according to Nelms, is that it can be complicated to consolidate the debts of a borrower who owes money to numerous lenders.
Discover has not yet decided whether it will refinance only private student debt, or both federal and private loans, according to a company spokesman. The federal student loan market is much larger, but borrowers who refinance their federal debt into private loans lose important consumer protections, making such a transaction less attractive to the borrower.
Another reason for Discover's cautious outlook is the fact that many private student loans have variable interest rates, and the rates on those loans are quite low. "Frankly in a lot of cases, there's not a huge incentive to refinance," Nelms says.
A spokeswoman for Sallie Mae, the large private student lender, made the same point in an email Friday. But when asked whether Sallie has plans to introduce a refinancing product, she replied: "We're always looking at new options to serve our customers."