Where Banks Fear to Tread

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Discover Financial Services (NYS: DFS) has been exercising its expansion muscle lately, and investors are loving it. After a year of planning, the company has announced that it will offer home mortgages to existing customers through its website. Originally a credit card lending dynamo, this isn't the company's first move into non-card lending.

Discover has been offering more varied services lately through its online portal, including personal loans and, for the past few years, student loans. It began offering student loans in 2007 and purchased Citigroup's (NYS: C) student loan business in 2010. It went back for another bundle of Citi's student loans in 2011 and now boasts a portfolio of more than $7.5 billion. Discover also offers online savings, CDs, and money market accounts.

This new business sits on a solid platform of home loan assets that Discover purchased recently from Tree.com, an online mortgage originator. The purchase, which encompassed the entirety of Tree.com's mortgage unit, cost Discover nearly $46 million and immediately bulks up the home loan aspect of the company's service profile, much as the Citi acquisitions plumped its student loan portfolio.


Discover is sweetening the deal for customers who choose the company for their mortgage needs, tossing in a bonus of up to $2,000 in closing costs for those who return after the initial transaction to refinance or take out another mortgage with the company. In a nod to consumer concerns, Discover will also kick in another $1,000 toward closing costs if the loan doesn't close according to schedule. This last part seems a clever way to garner some positive PR for very little cost, and it's sure to be a hit with customers bruised by run-ins with mortgage departments at the big banks.

Indeed, the big banks seem to be slacking on the home mortgage-writing front, as former big lenders like Bank of America (NYS: BAC) , which has suffered more than any other big bank from the sting of home loans gone bad, cut back. Except for Wells Fargo (NYS: WFC) , the competition has waned, something that Wells, too, has been taking advantage of lately. The bank now originates fully one-third of all mortgages and is the clear front-runner in the industry. This fact obviously hasn't gotten past Discover, whose acute business sense has apparently alerted it to the fact that the loan-origination business, like nature, abhors a vacuum -- or, at least, a field with few players.

Discover has another weighty, non-traditional competitor in retail giant Costco (NAS: COST) , however, which has recently jumped into the mortgage business. Like Discover, Costco offers its service to members only, which should give it extra insight into customers' credit risk, and has been steadily expanding its menu of financial services over the past few years as well. With most of the big banks ignoring the sector, though, there should be plenty of business to go around.

Fool's take
Discover seems to have a keen eye for services that banks are neglecting but maintain high consumer demand. So far, its business plan has been paying off, resulting in bright quarterly reports with stellar numbers. Its stock value has increased 45% over the past year as well, as investors sanction the company's forays into what they consider to be lucrative, low-risk ventures. Once a mere purveyor of branded credit cards, Discover appears well on its way to being a dynamic financial powerhouse.

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At the time this article was published Fool contributorAmanda Alixowns no shares in the companies mentioned above. The Motley Fool owns shares of Citigroup, Bank of America, Wells Fargo, and Costco and has created a covered strangle position in Wells Fargo.Motley Fool newsletter serviceshave recommended buying shares of Costco and Wells Fargo and has adisclosure policy. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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