The Lessons Being Learned In Student Lending

As credit unions try to keep pace with the times, private student loans are an option to expand lending.

The decisive moment for this change of behavior was the credit crisis of 2008. Since then many lenders exited the student loan business while those that stayed in the market are using stronger underwriting.

The excesses of the past have largely been corrected and most of the bad actors have left the market. These were lenders who originated loans with loose underwriting standards and then sold them on the secondary market. When the market changed in 2008, those lenders relying on the capital markets were forced to exit the business.

Private loans offer an opportunity for income as well as the ability to further the cooperative mission. There has been, however, an abundance of misinformation in the media about student loans during the past few years.

This article is a synopsis of a new white paper from the CUNA Lending Council, "Demystifying Private Student Loans," that was also part of a panel discussion during the Council's recent annual meeting. The paper seeks to clear up some of the misconceptions as well as examine the portfolios of five credit unions that offer these loans.

Research Findings

The first two profiled, the University of Wisconsin CU and Notre Dame FCU, have records of annual delinquency and charge-offs going back to 2006 and 1999. The other three credit unions-University of Michigan CU, Members 1st FCU, and Core FCU-have more recent data. NCUA started to track private loans on their call reports at the beginning of 2011

Credit unions are new to the private student loan market-only 0.30% offered private loans in mid-2012. But examining the five credit unions and their private loan portfolios, it was found that:

  • Average student loan balances per borrower-private and federal combined-continue to surge, from $18,379 in 2007 to $23,829 in 2012, as the cost of higher education also increased.
  • Student loans are not a bubble about to burst analogous to the mortgage meltdown. The latter is a loan balance of $8.1 trillion and held by financial institutions while the former is $893 billion as of March 2012 and is mostly backed by the federal government. Student loan debt does not threaten the financial system as did the mortgage crisis.
  • Federal and private loans are different, but they are often lumped together by the media. Between 2007 and 2012, for example, loan delinquencies, measured on 90 days past due, increased 27% for federal loans while they dropped 2% for private loans over the same time period.
  • Private and federal loans can be discharged in bankruptcy, but debtors must prove "undue hardship," a difficult tactic, so it is rare for student loans to be discharged. Financial institutions should avoid promoting the non-discharge feature of student loans because it is inaccurate.

Private loans have performed well for the five credit unions profiled with low delinquency and charge-off rates. The two CUs with a history of data going back to1999 and 2006, Notre Dame FCU and UWCU, respectively, have strong portfolio performances.

Private loans tend to stick to the balance sheet longer than most consumer loans since the loans are typically deferred from one to four years while the student is in school. CORE FCU, an exception, requires students to pay a nominal amount while in school.

Yields range from 3% to 6% and loans are typically offered as variable rates. Most credit union loan policies limit private loans to 10% to 15% of the lending portfolio.

Data on wallet share of private loan recipients is unavailable at this time, but CORE FCU reports that 67% of its private student loan holders have checking accounts with it.

The After-Effects

The Health Care and Education Reconciliation Act of 2010 ended the federal guaranteed student loan program that used credit unions and banks as intermediaries.

The immediate effect of the Act and the federal government lending directly to students is that many institutions have left the student loan market. This departure is but one of a number of changes in the student loan environment. Schools now certify the student's financial needs and loans are paid directly to the college, which has curbed some of the abuses.

UWCU is an apt place to start with a discussion of private student loans. It is number two in the nation in volume with 10,438 private loans and almost $20 million projected to be disbursed for 2012.

UWCU's private loan performance has been impressive regarding loan delinquency and charge-offs as shown in the chart. Private loan delinquency dropped to 0.20% in 2008, reached a high of 0.80% in 2010 and was 0.64% at the end of 2011. The chart at lower left shows history of charge-offs.

One year at a private university is expensive, ranging from $40,000 to $60,000. Notre Dame FCU has a maximum student loan amount of $15,000 annually with a maximum of $75,000 for five years. The average borrowing per student for private student loans is $21,300.

At the beginning of the private loan program in 1999, NDFCU made about $1 million in loans. Since that time, there has been a steady increase in lending and the portfolio reached $16.5 million in 2011.

Loan delinquency and charge-offs were kept at low levels since the beginning of the program in 1999. There were no charge-offs until 2006. Private loan delinquency spiked to 2.30% but dropped to 0.60% in 2009 and reached 0.19 in 2011.

Marketplace Lessons 101

The private loan market is dominated by banks and other lenders. And that's unfortunate as Core FCU discovered that lenders were charging students and their parents 8% to 10% plus 4% to 10% origination fees.

By offering private student loans, there are rewards beyond monetary that echo the purpose and mission of the organization.

"We are here to help members and as an educational credit union, we are financing future leaders," said Notre Dame FCU's Rick Burden, chief lending officer and SVP.

Jim Jerving is a freelance writer based in Madison, Wis. For info: jim@jimjerving.com.