Invest in Gen Y
Careful underwriting and due diligence can make private student loans a valuable asset.
If Gen Y represents the future of your loan portfolio, wouldn’t it be wise to offer the types of products and services these younger members need? One of the Gen Y products to consider is private student loans.
Some lenders would contend that private student loans are too risky and not profitable enough to warrant consideration. If other loan options are more profitable and less risky, they say, why even consider private student loans, especially when it could be a year or more before realizing significant returns? And after considering the rising risk of default, these lenders pass on the idea.
But where some lenders see problems, others see potential. They contend that private student loans perform well and are loans that college-age members—and their parents—desperately need. And, when it comes to credit union philosophy and balance sheet performance, many credit unions say it’s important to step into the gap and find ways to make these loans responsibly.
A changing landscape
A major turning point for student lending took place in 2010 when the Health Care and Education Reconciliation Act terminated the Federal Family Education Loan Program (FFELP). This program allowed financial institutions to originate and hold federal loans guaranteed by the U.S. government.
Another significant regulatory change occurred in 2007, when the government phased out the loan securitization market. Private student loans had been highly securitized. Without a secondary market, many of the existing lenders either reduced their origination volume or simply left the market entirely. Suddenly, lenders that had accounted for an estimated $20 billion in private student loans annually were no longer making those loans.
In addition, many states were passing similar legislation, including New York’s Student Lending, Accountability, Transparency, and Enforcement (SLATE) Act. The wave of new legislation and regulation prompted a lot of lenders to pull back even further from their relationships with college financial aid offices.
Credit unions have only a sliver of the private student loan market—$2.3 billion of the entire $150 billion in private student loans outstanding, or about 1.5% as of midyear 2013. About 600 credit unions, or approximately 9.1% of all credit unions, have private student loans on their books, according to Mike Schenk, CUNA’s vice president of economics and statistics.
Total (private and federal) student loans outstanding in the U.S. is estimated to be about $1.1 trillion, and approximately $850 billion of that are federal loans guaranteed by the U.S. government. The government provides these guaranteed loans, which aren’t initially underwritten, based on need. Federal student loans sometimes require significant restructuring based on the borrower’s income and ability to repay. Delinquency and charge-offs on these loans can be cause for concern.
Comparing federal loans to private loans is like comparing apples to oranges. Students receive private student loans after they reach the limit on federal loans, and these loans go through rigorous underwriting. The majority of private loans are co-signed, typically by parents, and most have variable rates.
Because of these significant differences, private loans are performing much better than their federal counterparts, industry experts say.
“Private student loans, when underwritten correctly, will perform quite well and are an excellent way to build relationships with Gen Y,” says Vince Passione, CEO of LendKey, a CUNA Strategic Services alliance provider. LendKey manages a private student loan portfolio for credit unions in excess of $500 million.
NEXT: Loan performance
You don’t have to convince Mike Long that private student loans can perform well. Long, who is executive vice president/chief credit officer at $1.7 billion asset UW Credit Union in Madison, Wis., took part in a panel discussion on student lending during the 2013 CUNA Lending Council Conference. Long also heads up CU Campus Resources—a credit union service organization (CUSO).
Nearly half (45%) of UW Credit Union’s student loans are in repayment, with a charge-off ratio of only 0.2% and a return on assets in the 5.5% to 6% range. This level of performance prompts Long to ask his credit union colleagues, “What are you waiting for?”
Jon Jeffreys, president of Credit Union Student Choice and also a panelist at the conference, echoes Long’s enthusiasm. “We have about 42,000 private student loans right now and I’d say well more than half of those have brought in new members,” he says. Credit Union Student Choice, a CUSO, was formed in 2008.
Jeffreys points to a recent study by the credit reporting agency TransUnion that shows federal student loan balances jumped 97% between 2007 and 2012, while private loan balances increased only 4%. The TransUnion report also showed delinquencies on federal student loans rose 27% during that period while delinquency rates on private student loans actually dropped 2%.
“We believe the numbers show this is a reasonably safe asset class,” says Jeffreys. “You can price for risk, and it’s a way to serve existing members and attract new ones.”
Another credit union finding success with its private student loan portfolio is the $196 million asset First Financial Credit Union of Wall, N.J. First Financial is earning a 4.5% net return on its private student loan portfolio and charge-offs are at 0.2%, according to Alice Stevens, First Financial’s chief operating officer. The variable rates on these loans range from 4% to 7%.
“These loans are fully underwritten with consideration to members’ credit histories, income, ability to pay, and their year in school,” says Stevens. “We also take a close look at the federal repayment history of each school when creating our eligible school list. The three-year Federal Cohort Default Rule, published by the government, provides insight on risk by institution. Over 85% of these private school loans are co-signed.”
First Financial requires students who are still in school to make minimum monthly payments of $25 on their student loans. “This says to the student that you have to be responsible,” says Stevens. If the student borrower fails to meet the $25 monthly payment or if the loan is in forbearance, First Financial won’t lend the student any more money.
The monthly payments help students build their credit histories and establish the discipline of making monthly payments. It also gives young members practical experience in financial literacy. Students set up checking accounts, and they can apply for credit cards.
Stevens also serves as chair of Member Student Lending LLC. The CUSO uses LendKey’s underwriting and pricing platform.
To date, Member Student Lending has originated roughly 22,600 loans, totalling $440 million. About 98% of the portfolio is current, with only 1.01% more than 60 days delinquent. The portfolio’s default rate is just 0.34%.
One of the CUSO’s services matches graduates with participating credit unions so they can refinance their private student loan debt with a consolidation loan. This practice of consolidating debt into consolidation loans has become popular with both graduates and parents, according to Stevens.
Consolidation loans can help borrowers combine multiple student loans into one, often reducing the interest rate and monthly payments, making the consolidated loan much more manageable.
Like private student loans, consolidation loans perform well when underwritten correctly. UW Credit Union launched a student loan consolidation product in 2013 in response to member demand. “Regulators are open to this as long as borrowers understand they’ll be giving up some benefits as they switch from a federal to a private student loan,” says Mike Long.
NEXT: A Gen Y strategy
A Gen Y strategy
More than 80 million strong, Gen Y (born between 1982 and 2002) represents about 25% of the U.S. population. In seven years, Gen Y consumers will represent 40% of the U.S. workforce.
Gen Y also represents the future of your credit union’s loan portfolio. These young people are coming to the conclusion they’ll need college degrees and graduate degrees to find their way in this postrecession economy. And they’ll need help paying for those degrees.
Student loans help credit unions achieve their mission of educating members, and they help college students and their parents meet a financing need. Most parents understand the importance of a college education and won’t hesitate to co-sign loan documents to help their children get that diploma.
And many credit unions see student lending as an opportunity to meet a host of future borrowing and investment needs from students and their parents.
“If you expect to have a relationship with Gen Yers,” says Passione, “you’re going to have to deal with some part of their student loan debt.”
NCUA advises credit unions to consider all risks associated with private student loans before entering the market. And, with delinquency rates expected to increase in the years ahead, NCUA cautions credit unions engaged in private student lending to be aware of various risks.
Those risks include loan concentration and repayment risk. NCUA advises credit unions to maintain proper concentration limits. In response to repayment risk, more borrowers now require co-signers. Only about 55% of private student loans had co-signers in 2005. By 2011, 91% had co-signers, according to the Consumer Financial Protection Bureau.
Another consideration is the compounding interest that occurs during the deferral period, which results in the borrower owing more than the original principal amount. The variable rate can also inflate loan payments, making it more difficult for borrowers to make those monthly payments.
NCUA also encourages credit unions to mitigate some of the risk associated with these loans by including private insurance. And the agency requires credit unions to perform due diligence on all parties involved in their private student lending programs. Consult NCUA’s Supervisory Letter No. 13-13 for all the details.
For more from Jeffreys, Long, and Stevens—recent panelists at the 2013 CUNA Lending Council Conference—see “Student loan CUSOs exhibit class,” p. 44.
CUs have only a sliver of the private student loan market—$2.3 billion of the entire $150 billion in private student loans outstanding.
By 2011, the percentage of private student loans with co-signers had grown to 91%.