Private Student Loans Could Graduate into Major New Debt Market

As more students go to college, the amount of student loan debt continues to climb. Total enrollment increased by as much as 15 to 20 percent between 2002 and 2004, according to the National Center for Education Statistics, setting the stage for significant growth within the student loan collection market.

Several factors will play prominent roles in the upward trend in student loan defaults, but the major contributor will be the ever increasing cost of education. The combined costs of tuition, fees, and room and board have increased 31 percent in the last decade at private four-year colleges and 42 percent at public four-year institutions, according to the National Association of Student Financial Aid Administrators.

These rising costs, combined with the economic fallout from the credit crunch and the mortgage crisis, is sending education loan defaults higher ("Student Loan Defaults Rising," Dec. 14). United Student Aid Funds Inc., the largest loan guaranty agency, reported a 22 percent increase in default claims in its fiscal 2007 year ending in September.

Much has been made of recent initiatives by a select few colleges and universities to provide more financial assistance to lessen costs for their students. But such initiatives are unlikely to become commonplace because schools are limited by their resources, thereby limiting these financial aid programs to institutions whose endowments are large enough to support them (e.g., Harvard, Princeton, Stanford and other well-heeled schools).  

As education costs have soared many would-be college students have turned to private student loans to bridge the funding gap between their federally funded loans and their college expenses.

Though private student loans constitute the smallest segment of the student loan market, it is widely recognized as the fastest growing. From 1995 to 2005 private loans grew from 5 percent to 19 percent of the market, and generated $19 billion in lending in 2005, according to the Institute for Higher Education Policy.

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Unlike federally-backed student loans – whose interest rates are capped – private loans carry fees and interest rates that are often variable and as much as three times higher then their federally back counterparts. This leaves private student loans more susceptible to downward turns in the economy.

The largest student loan player, Sallie Mae, acknowledged charge-offs in its private loan portfolio had reached $110 million for the third quarter of 2007, double the charge-off amount from the third quarter of the previous year. Sallie Mae’s private student loans were reported as totaling $28 billion by The Wall Street Journal.

Structured securities backed by student loans have come into vogue over the past several years and have been stung by rising defaults, much like securities constructed using residential mortgages.

A recent example of these developments can be seen in First Marblehead Corp., a leading player in the packaging of student loans into structured securities. Seventeen months after First Marblehead arranged in 2005 a package of student loans, 2 percent had already defaulted. A comparable package arranged in 2006 by First Marblehead had a default rate of 3.98 percent after seventeen months.

These rising defaults within the loans backing such securities devalue the investment and scare off investors. First Marblehead reported early this month it would not be arranging any securities offerings for the fourth quarter of 2007. 

The banks that work with the First Marbleheads, including JPMorgan Chase and Bank of America, to securitize private student loans are now in a difficult situation. It’s plausible that these banks will be selling off more student loan debt to mitigate the affects of deterioration in the market.

As the credit crunch turmoil continues to produce negative affects across a wide array of sectors, and banks continue to retrench, those looking to enter or expand within the student loan collection market may have found an opportunity.

Dimitri Michaud analyzes trends in strategic receivables management within the consumer finance sector, including the banking, credit card and mortgage markets.  He conducts research, writes publications and hosts a regular blog on insideARM.com for Kaulkin Media.