Private Student Lending Gets a Boost from Job Market

Private student lending is enjoying something of a recovery, and it appears to have a lot to do with the improving market for college graduates.

SLM Corp., known as Sallie Mae and the nation's largest private student lender, boasts a growing portfolio of new loans, and they are far healthier than those it originated in previous years, Chief Executive Albert Lord said at a conference in Miami on Wednesday.

"We expect credit losses of 1% or less annually," Lord said, of his company's new loans. "It's Sallie Mae's future. It's a wonderful business."

Behind the improving loan outlook is the brightening outlook for college graduates themselves. The unemployment rate among recent college graduates fell to 7.7% in 2012 from 9% between 2009 and 2011, Moody's Investors Service noted in a recent report.

"The rate will likely continue to improve gradually in 2013-14, in line with our forecast for a gradual improvement in unemployment for the overall population," Moody's says. "Unemployment is a key driver of student loan delinquencies and defaults."

The upbeat news on jobs comes as private lenders are feeling less pain from defaults on pre-crisis private loans. Standards for private student loans have tightened considerably since 2008. Average credit scores are up, and more than 90% of new loans are being underwritten with a parent or other co-signer backing up the student-borrower.

"The credit quality of loans that are being originated today is very strong," says Moshe Orenbuch, an analyst with Credit Suisse.

The improving outlook aside, investors and analysts remain cautious. Sallie Mae's Lord lamented the fact that his company's stock price is hovering near $18 per share, which is far short of his $30 target. Sallie's bond rating has sagged as well and stands just below investment grade.

The fast-rising cost of a college education is one factor hurting perceptions of Sallie Mae and other private student lenders, including Discover Financial Services (DFS), Wells Fargo (WFC) and SunTrust (STI).

"The problem is they face a seemingly unsustainable dynamic: college costs are rising faster than U.S. salaries," Standard & Poor's concluded in an August 2012 report.

The risks faced by private lenders are closely tied to the federal government's actions. College students generally turn to private lenders only after they've hit limits for lower-cost federally guaranteed loans. That helps explain why private lending accounts for only about 15% of the $1 trillion in total student debt.

Private lenders say they hold borrowers to higher standards than does the federal government. The Consumer Financial Protection Bureau appears to agree.

"Nearly all American students are eligible for some form of federal student loan, without regard to traditional creditworthiness criteria," it concluded recently.

Overall, the outlook remains gloomy for the entire student loan sector, public and private, argues Frederic Hunyh, senior principal scientist for Fair Isaac Corp. The still tepid job market and high cost of education are the main culprits.

One bright spot for the private lender are their relatively tight standards. Private lenders "may not be seeing the same prominent increases in student loan delinquency rates," Hunyh adds.

More broadly, the dynamics of private education lending are unsustainable, Adom Rosengarten, an S&P analyst, concluded in a research note last year. He pointed in part to a 2010 law that prevents private lenders from originating federally guaranteed loans, which formerly had represented a growing business for banks.

"That left private lenders with a shrinking, riskier business: making unsecured consumer loans that students and their families historically had used to fill the gap between federal education loan limits and total education costs," Rosengarten wrote.

Private lenders also must contend with the continuing damage from loans made prior to the financial crisis. An estimated 55% of private student loans had co-signers in 2005, a far lower than the rate today, and credit scores were significantly worse, according to data compiled by the CFPB.

Because students are typically not responsible for loan repayments until after they graduate, the underwriting mistakes of the past have a delayed effect on delinquency rates.

Annual defaults on private loans as a percentage of repayments were around 4% in 2012, according to Moody's data. That figure is low compared to 2009, but it's high in the context of what happened prior to the financial crisis.

Another concern for private lenders is that Congress might amend the law to permit educational borrowers to discharge loans by declaring bankruptcy. That idea, championed by Democratic Sen. Richard Durbin, has drawn strong opposition from private student lenders.

Last March, U.S. Bank (USB) pulled out of the private student loan market. JPMorgan Chase (JPM) has said that it's limiting its lending to existing customers, amid industry fears about increasing regulatory scrutiny. Those fears have eased somewhat recently.

But even signs of improvement in the employment picture come with caveats. Tracy Rice, a Moody's analyst, notes that students are carrying higher debt levels, and some graduates are settling for lower-paying jobs.

"Unemployment is one of the key drivers of performance of student loans, but it's not the only driver," she says.