October 19, 2015

Student Loans: New Rules - New Concerns

The government has imposed new rules regarding student loans in the US.

Student loans have bankers and economists worried, considering the fact that the total amount of student loans in the US has been rising steadily, not to mention the total outstanding debt from such loans. In fact, they have doubled since the financial crisis in 2008.

As a result, the federal government has taken action and quickly taken over nearly the entire student-loan market since the crisis.

Government Takes Over Student Loans

According to the 2015 MeasureOne Private Student Loan Performance Report, the outstanding balance for the private student loan market is approximately $91.0 billion - or 7.2% of the $1.27 trillion in outstanding student loan balances in the country.

In comparison, the outstanding balance for the federal student loan market is $1,174.4 billion - or 92.8% of outstanding student loan balances.

This drastic difference illustrates the fact that the private student-loan market is collapsing. Years ago, it was the norm for college students to take out student loans at their local banks. But with the government stepping in, this 'norm' is becoming more of the exception to the rule.

Yet student loan performance metrics have steadily improved for the largest active private student lenders in the US. The six participants that were analyzed in this report represent roughly 70 percent of the private student loan market.

Delinquencies have continued a notable downward trend year after year in the private loan sector. In fact, the delinquency rates in 2014 were the lowest they've been since prior to the economic crisis in 2008. In addition, annualized charge-off rates dropped to 2.4 percent, a 22 percent change compared to the year before.

What this shows is that despite student loan delinquencies continuing to pose a real problem in this country, responsible private lenders don't have the high default rates that plague the government as a lender. Most of the student loan issues stem directly from Federally guaranteed loan programs that come with zero underwriting.

The federal government is, however, taking over the student-loan market in entirety. In fact, the government's financial-asset portfolio is increasingly being made up largely of student loans. In the early 1990s, federally-owned student loans were at zero. Today, almost 45 percent of asset portfolios held by the government are student loans.

Up until 2010, banks put forth capital for federally-backed student loans through the Federal Family Education Loan Program (FFELP). While the banks were the ones providing the funds, it was the government that was actually setting the terms and guaranteeing the loans.

Once students received the funds, banks would often package similar loans and sell them in a secondary market, somewhat like the secondary market for mortgages. Since the loans were guaranteed by the federal government, banks and investors were protected if a student borrower defaulted on their loan. This was generally considered healthy for the economy since it gives banks the liquidity needed to make more loans.

Private student loans actually have much fewer delinquencies in comparison to government-issued student loans.

In 2010, however, banks were forced out of the federal student loan program partly because of the liquidity crisis in the student-loan market. The global financial crisis resulted in a shrinkage in capital for lenders who were no longer able to come up with the cash needed to generate new student loans. The federal government ended up stepping in by providing this much-needed liquidity to help the market get started.

The US Education Department has since been providing all federal student loans. No longer are loans being made through the traditional system. However, billions of dollars in legacy outstanding loans are still being traded on the secondary market, many of which are suffering from poor performance issues. Many lenders are finding it nearly impossible to sell their old loans on the secondary market as a result of uncertainty of future payment rates causing price decline and a lack of capital.

Since the 1980s, the average tuition and fees for college and university has increased 1,100% - more than four times the rate of inflation. Because of the caps that the federal government loan programs place on student loans, they're often insufficient to meet the needs of many students. This is the reason why students have turned to private lenders to fill these gaps.

Private Lenders Have Much Fewer Loans in Default Compared to Those Issued by the Government

Because of the importance that private lenders place on solid underwriting and commonly using co-signers, private student loans have a relatively low default rate of 3.16 percent. These sound underwriting standards help ensure a borrower has the ability to repay their loan, as well as ensure that capable borrowers are awarded with responsible loans.

Approximately three-quarters of private student loans are in active repayment status, and not in default, forbearance or deferment, which demonstrates that many student borrowers seeking loans from the private loan sector are able to appropriately manage their repayment responsibilities.

On the other hand, the majority of the federal loan portfolio is not in such status, despite considerable income-based repayment plans.

Banks and credit unions that incorporate sound practices and integrate in-depth underwriting are precisely what students - and the economy - need. Responsible and savvy financial institutions are increasingly recognizing the positive return for student loans issued to responsible students, which has proven to be on par with other asset classes for the most part. Students and other borrowers need lenders who will provide a safer solution.

To discover how your financial institution can offer your clients private student lending products that will become profitable assets on your loan portfolio, get in touch with the professionals at Garnet Capital.

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