Reasons to be Cautious on Student Lending
This whacked-out, oft-censored, and certain-Canadian-export-loving Senior Research Analyst constantly heard from his parents in his formative years that having a higher education would translate into success later in life. The message was personally resonant and as a parent, such a message was communicated almost as a mantra to his scion. This “American Dream” message had particular meaning – the College Board has estimated that the lifetime earnings for those with a bachelor’s degree are 66 percent higher than those individuals with a high school diploma.
Today, higher education appears to be taking on a new meaning that is being precipitated by the rising cost of tuition, fees, room and board over the last decade. Such escalating costs have prompted higher-education aspirants to seek out financial support in the form of student loans. According to the Chronicle of Higher Education, approximately 20 million Americans attend colleges or universities each year and close to 12 million Americans – or 60 percent of the total – borrow annually to cover their academic costs.
Today, the amount of student-loan indebtedness is staggering. According to reports from the Federal Reserve Bank of New York (FRBNY) and the Consumer Financial Protection Bureau, there is respectively between $902 billion and $1 trillion in total outstanding student loan debt in the United States, which is second only to total home mortgage loan indebtedness and individually outpaces both total non-revolving credit dollar volume and home equity credit dollar volume. As of October 2012, the average student loan debt outstanding was $26,600, which is 1.7 times higher than it was in 2005. Further, the lion’s share of this indebtedness is being borne by individuals under 30 years of age that hold 32 percent of the student loan debt outstanding and individuals between 30 and 39 years of age that hold 34 percent of the debt.
Such debt loads have profound economic consequences. A recent Federal Reserve Bank of Kansas City (FRBKC) report entitled Student Loans: Overview and Issues (August 2012) observed that:
“Mounting student loan debt has placed a substantial financial burden on many U.S. consumers, especially young adults. High payments on the debt restrict discretionary purchasing power and may reduce access to other forms of credit. Especially burdensome payments frequently lead to delinquency and default, which present a host of problems to the individual borrower.”
In addition to the mounting student loan burden, repayment and default issues have become primary concerns. First quarter 2012 data from the FRBNY details that 10.6 percent of all student loan accounts were at least 30-days past due or delinquent, which is 3.4 times higher than the bank card delinquency ratio and 4.5 times higher than the composite ratio of closed-end installment loans 30-days past due. Further, as was we learned in the recent housing crisis, delinquency leads to default. The most readily available data (2009) on cohort student loan default rates comes from the U.S. Department of Education. It should be noted that the cohort default rate is the percentage of borrowers who enter repayment in a fiscal year and default by the end of the next fiscal year. The cabinet department detailed that this default rate was 8.8 percent at all institutions.
A contributing factor to the high student loan delinquency and default rates is our country’s unemployment rate. The economic dislocation that occurred in 2008 resulted in the loss of 8 million jobs. Currently, the official unemployment rate is 7.8 percent. However, this metric does not tell the whole story. The unemployment rate is really around 14.4 percent when discouraged workers who would like to work but have given up their job searches and part-time workers who would like to work full-time but are unable to find full-time work for economic reasons are counted. The point is that there are not enough jobs in the market place to employ graduates with student loans so they may have incomes to repay their debt obligations. In addition, the underemployment issue contributes to the malaise as graduates have accepted lower-skill level jobs that provide lower than expected pay scales from which “employed” graduates find it difficult to meet their debt obligations.
Sadly for our country’s ethos, higher education no longer ensures success later in life. The new reality suggests that a college degree ensures slim immediate employment opportunities and long-term indebtedness. The new reality also portends bleak prospects for our country’s economy growth as a new, net spender/borrower generation is being repressed.
Despite this dreary portrayal, demand for student loans in the short-term remains rather “robust” in comparison to other loans (See Following Chart). Community-based financial institutions looking to capitalize on this demand should understand that the market is made up of federal and “private” student loans. Today, federal student loans comprise 85 percent of total outstanding student loan debt, while “private” student loans comprise 15 percent of the total outstanding student loan debt.
Community-based institutions should also be cognizant of the fact that in July, 2010, the federal government stopped guaranteeing student loans made through private lenders and replaced the guarantee program with a direct loan program (This oft-censored Senior Market Research analyst will refrain from commenting on the appropriateness of our government serving as a personal lender in this post).
Further, institutions should realize that “private” student lending present new challenges with respect to pricing and more importantly, credit risk management. Lastly, firms should be aware that federal agencies are currently conducting probes into the “private” student loan business that may ultimately result in additional regulation.
What does all this mean for student lending? Here are a couple of key points to keep in mind. First, the student loan market eerily parallels what happened in the mortgage markets five to six years ago. There is far too much debt relative to income levels, and it could be argued that the ROI on a college degree is not what it once was. There is a good possibility that we could experience the same type of collapse in student lending as was seen in mortgage debt, although in this case the debt holder is primarily the federal government, so the impact would not be felt as directly by financial institutions. The dramatic increase in college education costs, coupled with a declining college age population, will spell trouble for many institutions of higher learning. Think hard before you decide to enter the arena of student lending. At the same time, however, the college population does represent the next generation of consumers, and establishing relationships with this group at a young age could help sustain your franchise. The largest banks have recognized the importance of Gen Y (the current generation that attends college) and have made significant inroads with this group, due to both locational convenience and technology. What this suggests is that the college-age consumer should not be abandoned, but student lending should be engaged in with great caution.| Comments (RSS) |