Discover Financial Services (DFS) in the next few months plans to enter the home equity lending business, a market where other banks have been scaling back amid crisis-related losses.

Because of rising mortgage rates, homeowners who until recently might have relied on a refinancing to extract equity from their property will now be more likely to take out a home equity loan, says Discover Chief Executive Officer David Nelms.

"And so we think the demand will be growing over the next few years," Nelms said in an interview Tuesday.

"The very recent vintages of home equity loans have performed well," he added. "We have the fortune of not having legacy portfolios from '05, '06, '07 that others are having to deal with."

Discover, based in Riverwoods, Ill., is best known for its credit cards, but it began wading into the mortgage business about a year ago. The company originated about $1 billion in mortgages last quarter and intends to keep expanding the business.

Discover's move into second mortgages comes at a time when some of the largest U.S. banks have been reducing their exposure. Wells Fargo (WFC) trimmed its home equity loan portfolio by 15% over the last two years. Bank of America (BAC) pared back its holdings by 19% during the same period.

Banks that were making home equity loans prior to the financial crisis have struggled to absorb the impact of bad loans. The percentage of home loan equity loans that are nonperforming has not come down significantly over the last few years, according to data supplied by

Moreover, the problems for long-standing participants in the home equity loan market could get worse before they get better.

Monthly payments on some of the most worrisome home equity loans, those originated between 2005 and 2007, will begin to rise in 2015, according to a recent report by Moody's Investors Service. Those loans typically allowed borrowers to pay only interest for their first 10 years before resetting to include both principal and interest payments.

The silver lining for lenders is that earlier stage delinquency rates on home equity loans have fallen, suggesting that newer loans are performing better. Across the industry, the 30-to-89 day delinquency rate fell from 1.23% in the third quarter of 2010 to 0.82% in the first quarter of this year, according to

Bill Moreland, a partner at, compares the market's digestion of troubled home equity loans to a snake's progress in swallowing a pig. It can be a slow and painful process, but eventually it will be completed.

"The pig's all in," he says. "And the pig is probably well along" the length of the snake.

Discover plans to begin offering home equity loans sometime in the third quarter of this year, according to a company spokesman. The product will be structured as a closed-end loan, rather than a line of credit, the spokesman says.

The foray into home equity lending reflects an industry-wide effort to pivot away from a reliance on refinancings, which have tailed off due to rising mortgage rates.

Nelms said that Discover's home equity loans will appeal to consumers looking to consolidate debt. The company already offers personal loans that are frequently used for debt consolidation.

Initially Discover plans to market home equity loans mostly to its existing customers, a strategy that the firm frequently uses with new products.

The second mortgage business makes sense for Discover, says Scott Valentin, an analyst at FBR Capital Markets, noting that the company also offers student loans in addition to credit cards, personal loans, and first mortgages. "I think it fits their business strategy of trying to serve the consumer through different channels," he says.

Discover is one of a several banks eyeing expansion in home equity lending. U.S. Bancorp (USB) is also looking to capture more market share as other banks scale back, according to recent comments by the head of the company's home lending unit.

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