College loans have always been a stable portion of a bank's portfolio. But now an incremental shift away from state and federal government funding toward private sector lending is making student loans more profitable than ever.
The steep rise in college costs spearheaded the trend. But the shift gained steam with the coming of a new administration to the White House. While President Clinton pushed for more government spending for education, the Bush Administration is counting on the private sector to help students deal with the rising cost of college.
The possibilities are enormous. Just as the banking industry used the efficiencies of technology and the secondary markets to extend credit to lower-income families, the industry now seems poised to do the same for students.
The bundling of student loan debt by secondary market companies for sale to third-party investors has added liquidity to the marketplace and can make lending to students a virtually risk-free endeavor. Meanwhile, the current interest rate environment has brought private sector student loan rates closer to low federal direct rates.
The constant need for student loans makes them an important long-term asset for banks, especially during times of economic stress, by providing a steady stream of income. The loans provide a robust hedge against future economic downturn because repayments are often delayed while students finish college, and students entering the working world properly credentialed by and largely make excellent repayment prospects.
Currently, the sector is witnessing all-time low default rates. In fact, the market is so inviting that some banks are keeping more of their student loans on their balance sheets instead of sending them to secondary market institutions like Sallie Mae.
Students up, funding down
College lending has become a $57 billion business annually (compared with $40 billion in 2002) with about $50 billion in federally guaranteed loan programs and another $7 billion in other private sector loans. That's no match for the $2 trillion annual home-mortgage market. But it's nothing to scoff at either, and the experts say the student loan business is likely to trend upward (see chart).
A growing need for student loans has been spurred by several factors, especially an escalating demand for skilled workers. In the current decade 40% of this demand will be for jobs that require college degrees and experts agree that in the not-too-distant future, four out of five jobs will require degrees or equivalent training. Moreover, much of today's workforce will need to be retrained, in many cases, just to retain current jobs.
Other factors fostering a need for more private-sector lending include a growth in the number of people seeking to enter college, tuition increases, and fewer public dollars available for student loans. Tuition is rising as private-school endowments shrink, and as the states, beset with budget problems, cut back the money they usually earmark for public colleges and universities.
"Certainly the demographics are favoring the product," says Doris Grose, president of Educaid, the student lending division of Wachovia. "The number of students is increasing dramatically, tuitions are going up and state funding is being cut--and so parents and students are looking for a way to pay the bills."
A spike in college enrollments comes from both traditional college-aged students as well as older people who are under-employed or recently unemployed. While most states have actually increased their education budgets slightly, the extra money is going for primary and secondary education while college programs are being curtailed.
"The amount of financial aid hasn't really kept pace with the cost of college," says Carl Krueger, a policy analyst with the Education Commission of the States (ECS), a non-partisan, Denver-based watchdog agency. …