Carlyle and KKR vie for Discover’s $10bn portfolio of US student loans

Carlyle and KKR have emerged among the final bidders for a $10bn US student loan portfolio from Discover Financial, according to people familiar with the matter, as private investment firms step into a lending void left by the retreat of traditional banks.

The two asset managers are working together on their bid for the portfolio, a deal that would feed their growing appetite for credit as they expand far beyond their private equity roots and lend against assets such as rooftop solar power, credit card receivables, mortgages and rail cars.

Discover has agreed to sell itself to rival Capital One for $35.5bn, one of the banking industry’s largest mergers, and has launched a disposal process for the student loan portfolio as part of the deal.

Carlyle and KKR are among a handful of finalists in the process to buy the Discover student loan book, which has drawn interest from across the private credit industry. Ares, Blackstone, Brookfield, Fortress and Oaktree all studied bids, people familiar with the matter said. One person briefed on the matter said the auction was likely to conclude later this month or in early July.

Discover, Carlyle, KKR, Ares, Blackstone, Brookfield, Fortress and Oaktree declined to comment.

Private credit’s interest in so-called asset-backed finance has been supercharged by the industry’s fast-growing insurance operations, which principally invest in highly rated debt. And their insurance clients have been drawn to the higher returns on offer.

The cash flows from these asset-backed loans offer stable payouts, which are a boon to insurers managing policies that can stretch for decades into the future. Private credit managers often split the loans into different tranches, providing lower-risk investments to their insurance clients and hiving off the riskier but higher-yielding elements to institutional investors.

Credit investment shops have become an increasingly important provider of capital since the financial crisis, when more stringent regulation prompted banks to pull back from the kinds of traditional asset-backed lending they had long engaged in.

That shift has accelerated once more since a handful of US regional banks, including Silicon Valley Bank and First Republic, collapsed last year. Other lenders are now looking to raise capital by selling the billions of dollars of loans they have on their books.

Earlier this year, Blackstone agreed to buy $1.1bn of consumer credit card debt from Barclays. That came weeks after KKR and investment manager Kennedy Lewis clinched a deal to buy about $7bn worth of loans on recreational vehicles from the Bank of Montreal. Last June, Ares bought a $3.5bn portfolio of consumer and small-business loans from PacWest.

The Federal Reserve’s decision to lift interest rates has boosted the appeal of this corner of the market, making the yields on investment-grade debts more attractive.

“We see opportunity to continue to scale our asset-backed finance offering, a trend that may persist for years as market participants increasingly look to partner with firms like Carlyle to address their capital solutions,” Harvey Schwartz, Carlyle’s chief executive, said on the company’s earnings call in May.

Carlyle has been building its presence in student lending, earlier this year acquiring a $415mn portfolio from US bank Truist and investing in provider Monogram, which manages about $7bn. The private equity firm has said it is looking to fill the gap left by traditional lenders exiting the student lending business, which is dominated by the US government.

Since 2008, banks including Citigroup, Bank of America and JPMorgan have halted their offerings of student loans, which have higher default rates compared with other types of debt. Wells Fargo, one of the last banks still left furnishing finance for education, sold about $10bn worth of student loans to private equity firms Apollo Global Management and Blackstone in 2020.

Discover, one of the last private lenders still targeting the sector, has long been under regulatory scrutiny over its lending practices. It agreed to pay $35mn to the Consumer Financial Protection Bureau watchdog over its debt collection practices and billing statements in 2020 after an initial consent order five years earlier.