Student Loan Risk Assessment

How are the changing economic, political and consumer environments affecting student loan asset backed securities?

Evolving sentiment toward the rising cost of higher education and growing student loan debt balance is resulting in new market opportunities and challenges. The charts provide instruction on how industry practices and other factors are impacting risks for lenders and investors.

Risk Level

As of Sept 2018

HIGH MED LOW 2012201320142015201620172018
The Student Loan Risk Assessment shows the risk of battles over loss allocation.

LOW RISK

HIGH RISK

Lending Practices and Factorsi

Private lending and refi’s have benefited from stringent underwriting, but competition could lead to looser underwriting; deferments and forbearances are skewing delinquency rates; latent risks exist, such as loans for unaccredited programs and for-profit schools.

LOW RISK

HIGH RISK

ABS Practices and Factorsi

Private and Refi deals continue to benefit from pools of higher quality loans; FFELP deals should continue to benefit from the government guarantee.

LOW RISK

HIGH RISK

Underlying Market Risksi

Education costs, the average student loan debt burden and the aggregate student loan balance all continue to climb, spurring debt-relief programs, proposed legislation and bankruptcy reform, and a growing body of borrower-friendly decisions.

current Status

2018 may be the beginning of the end of an education finance system that has resulted in overburdened students and families struggling to pay back loans that were too high at their inception relative to the reasonable income potential of the degree earned. Change won’t come overnight, but potential solutions should be put in motion this year, mainly aimed at relieving the student loan debt burden.

Below are a few touchstones for change that would signal the beginning of the end of the current student debt cycle.

New Laws

Under the proposed Promoting Real Opportunity, Success and Prosperity through Education Reform Act (the PROSPER Act), Congress is poised to take unprecedented steps to alter the current market dynamics, from capping the amount that can be borrowed for tuition to making colleges responsible for a portion of federal student loans after borrowers default. Overall, the biggest winners could be for-profit and trade schools – a target of the Obama Administration and criticism generally – which would be granted equal treatment with non-profit schools in terms of being benchmarked against the economic success of its graduates and limits on federal aid.

Market Trends

If for-profit schools are to benefit from the PROSPER Act, many will likely need to show greater responsibility for quality of education and post-grad success in order to overcome recent criticisms and negative press for the industry. On a long-term basis, if for-profit options grow and attract more students, it could have an impact on investor expectations of performance because expenses related to such education may not satisfy the standard of “qualified educational expenses” to be safe-harbored from discharge under the Bankruptcy Code.

Legal Challenges for Servicers

On the heels of government and class action litigation against Navient for allegedly improper servicing of student loans, a recent letter by House Democrats to some of the nation’s largest servicers could foreshadow greater regulatory efforts to curtail certain servicing conduct – such as failing to advise borrowers of repayment options and consequences – that can contribute to defaults.

Paradigm Shifts

New movements to help students directly – such as efforts to buy and then forgive student debt, donations made to students rather than to universities and states luring graduates to their economies with promises of tuition repayment – may start to gain momentum and improve loan performance.

Private Loan Market May Benefit

Although the recently reported delinquency rate of 13% of the outstanding student loan debt far exceeds delinquency of auto loans and mortgages, there are specific opportunities in the private student loan asset-backed securities (ABS) market, such as refi’s backed by borrowers with strong credit. Further, the private student loan segment may grow overall if the House of Representative’s efforts to pass the PROSPER Act are successful. Although restrictions on borrowing could translate into tuitions being lowered to meet lower loan amounts or even less demand for more expensive schools, more realistically, both education costs and demand will remain relatively constant, forcing borrowers to place greater reliance on private loans.

There Are No Guaranties

But, undeniably, the market is entering a state of flux that makes performance across the board less certain. Some untested ideas, such as those that favor for-profit schools, may actually wind up causing more harm than good to consumers. Whatever the outcome, creating a solution to the student loan crisis will require some destruction of current market dynamics. The transformation could change the way lenders view the market and price their loans, and ultimately where ABS investors find opportunities and risk.

James Serritella, a partner in the Insolvency, Creditors’ Rights & Financial Products Practice Group of Davis & Gilbert, contributed to this post.