College, the American Dream, and Wall Street
Marie is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In an effort to achieve the “American Dream,” college students are amassing student loan debt at an alarming rate. So, the student loan business is booming. And, the Fed’s Zero Interest Rate Policy (ZIRP) has brought life to the student loan asset backed securities (SLABS) market.
Since new legislation in 2010, the government has been lending directly to students. The government now oversees about 90% of all student debt, which is helping raise U.S. student loan volume to record levels. What’s more, unlike private loans, government loans aren’t securitized. That’s good, right? Not necessarily.
Federal loans don’t have credit standards and nearly any student can obtain a loan. Moreover, many federal loans have high caps. Take for instance the Stafford loan, which accounts for 75% of all government loans. An undergrad provided a Stafford loan can borrow up to about $58,000.
As if the bone-chilling thought of a 20-something year-old, with no credit to his name, borrowing $58,000 wasn’t scary enough, some students use the borrowed money to buy clothes, go on vacation, or even repay credit-card debt. However, what’s most daunting is that these loans are guaranteed by the government. Essentially, in the event of a mass default by students, tax payers could end up footing the bill.
Such a risk begs an obvious question: Why did the government change the rules so it could lend to students directly? The Congressional Budget Office estimates that for 2013, interest income from student loans was about $48.6 billion. For perspective, that’s roughly the combined 2012 net income of the four largest U.S. banks.
The rest of the $1.1 trillion student loan debt is managed by private lenders.
The largest originator of federally-insured student loans is SLM Corporation (NASDAQ: SLM), otherwise known as Sallie Mae. In the fourth quarter of 2012, Sallie Mae sold $13.8 billion worth of SLABS, a 12.5% increase over the previous year. According to an article published by The Wall Street Journal, in the last week of April 2013, Sallie Mae sold $1.1 billion of securities backed by private student loans. Interestingly, demand for the riskiest tranche was 15 times higher than supply. Apparently, investors were willing to purchase higher risk loans in exchange for a higher yield.
Still, Sallie Mae isn’t the only company benefiting from increasing student loan debt. The less-known, Nelnet (NYSE: NNI) is the second largest holder of Federal Family Education Loan Program (FFELP) loans. In 2005, Nelnet had its most profitable single student loan asset backed securities offering, generating $862 billion.
Student Loan Corp., once a subsidiary of Citigroup, used to be the third largest buyer of FFELP loans until it was sold to Sallie Mae and Discover Financial Services (NYSE: DFS) in 2010 for $600 million. Discover's student-loan portfolio ended the fourth quarter of 2012 at $7.7 billion. That’s up almost 5.5% from a year earlier. Alleged strict credit checks and increased student loan underwriting is helping Discover’s stock rise to record highs. Discover’s stock is up about 32% year-to-date.
What’s the big deal?
Student Loan ABS generated sales of $135 billion in 2006 and 2007. Compared to other assets, such as residential mortgage-backed securities, demand for SLABS was slow to pick up after the financial crisis. However, in 2012, student loan ABS generated $25 billion in sales as debt buyers scoured the marketplace for yield. Albeit small, the uptick is worth noting.
According to a Fed report, federal and private student loan borrowing totaled $966 billion at the end of the fourth quarter, up 11% from a year earlier, and up 51% since 2008. And, according to asset-backed security publication, Asset-Backed Alert, SLABS generated $5.6 billion in sales in January and February 2013. That’s a 30% rise year-over-year.
However, for once, size isn’t the main issue. The most critical (and potentially damaging) issue is the increasing delinquency rate on student loans.
Investors are rushing into SLABS head first. I’m fearful that to satisfy demand lenders may repeat the same mistakes they made pre-financial crisis and go bottom feeding. Equifax reported that banks wrote off $3 billion of student loan debt the first two months of 2013. That’s an increase in write-offs of more than 36% from the previous year. Of course those loans were far past due, but the market isn’t that big – after all, weren’t SLABS sales only $5.6 billion those same two months? In other words, SLABS sales growth underperformed write-offs by 6%.
The size of student loan debt is by no means comparable to the 2007 mortgage market. But, increasing delinquencies in a major market is a problem. And as long as would-be college students finance dreams of grandeur with debt from Uncle Sam or private lenders, Wall-Street will ensure that the student loan asset backed securities market flourishes.
Tax increases that took effect at the beginning of 2013 affected nearly every American taxpayer. But with the right planning, you can take steps to take control of your taxes and potentially even lower your tax bill. In our brand-new special report "How You Can Fight Back Against Higher Taxes," the Motley Fool's tax experts run through what to watch out for in doing your tax planning this year. With its concrete advice on how to cut taxes for decades to come, you won't want to miss out. Click here to get your copy today -- it's absolutely free.
This article was written by Santiago Rodriguez and edited by Chris Marasco. Chris Marasco is Head Editor of ADifferentAngle. Neither has a position in any stocks mentioned. Marie Palumbo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!