SLABs, and no we aren’t talking about the stuff of which patios are made, or the tiles that can be laid on kitchen floors. Nor, are we talking about some Silicon Valley laboratory firm. Let’s focus on Student Loan Asset Based securities. Yep, “securitized” assets – like mortgages, auto loans, credit card receivables, etc. We do remember the mortgage thing? Right?
SLABs were hot in 2013. [WSJ] In fact, see if you can make sense of the following description:
“Student loans are souring at a growing rate—and investors can’t seem to get enough. SLM Corp., the largest U.S. student lender, last week sold $1.1 billion of securities backed by private student loans. Demand for the riskiest bunch—those that will lose money first if the loans go bad—was 15 times greater than the supply, people familiar with the deal said.” [WSJ]
Why would investors be banging on the doors for those loans which are the most likely to go into default? I think we’ve seen this movie before, and the ending (2007 – 2008) wasn’t pleasant for anyone.
The Basic Materials
Once upon a time Sallie Mae or SLM, was a government sponsored lending firm specializing in student or educational loans. That was the case until 2004 when Sallie Mae went private and it’s now a publicly traded private sector corporation. SLM securitizes private education loan by selling them to the SMB Private Education Loan Trusts. The Loan Trusts (2014 and 2015) show “issuance details” online (here’s 2014-A) There was $382 million in the August 7, 2014 records; divided into five categories with varying rates of return. Scrolling down we find the ‘master servicer’ as Sallie Mae Bank, the sub-servicer as Navient Solutions, Inc., the indentured trustee being Deutsche Bank National Trust Company, and the underwriters Credit Suisse and the Royal Bank of Scotland. [SLM] Navient Solutions, Inc. is simply the name adopted in 2014 for Sallie Mae’s loan management, servicing, and asset recovery operation. [Bloomberg] An ‘indentured trustee’ is:
“A financial institution with trust powers, such as a commercial bank or trust company, that is given fiduciary powers by a bond issuer to enforce the terms of a bond indenture. An indenture is a contract between a bond issuer and a bond holder. A trustee sees that bond interest payments are made as scheduled, and protects the interests of the bondholders if the issuer defaults.” [Investopedia]
The underwriters, in this instance Credit Suisse and RBS, are the firms which act as sales personnel for the bonds bases on securitized private student loans. So, we have SLM issuing the bonds, Deutsche Bank National Trust acting as the agency responsible for bond registration, transfer, and payment of bonds, while Credit Suisse and RBS are the ones selling the bonds. Sounds impressive, however those private loans comprise only about 8% of the total student loan market – the remaining 92% are Federal Stafford and PLUS program loans. But – the numbers are still sufficiently high to interest SLM, Deutsche Bank, Credit Suisse and RBS, because there’s about $92 billion involved in the private student loan market. [PSL]
Slabs without much mortar
Recall for the moment what got Wall Street in major trouble during the Housing Bubble. Investment firms issued bonds, and then played with derivatives based on those mortgage based bonds, without being all that sure the loans were going to be paid off. Thus, it was extremely difficult, and in some instances impossible, to calculate what the bonds were actually worth. Enter the credit rating agencies who (for a nice fee) stamped AAA+++ on what should have been recognized as piles of garbage; the investors couldn’t get enough of these, so even more garbage piled up as the investment houses bet on whether or not the assets were worth anything. Enough garbage was included in the piles of paper that the whole pillar of paper crashed.
What’s saving us from the prospect of another bubble of epic proportions is that the market in private student loans is very small – that $92 million is a drop in a very large bucket of corporate and commercial debt. [Atlantic] Another bit of good news is that because of the Dodd-Frank Act there is more transparency required in dealings in asset based securities. [SEC] [WSJ] The bad news is that Republicans in Congress have been wailing for the repeal of the Dodd-Frank Act as “burdensome regulation” of the banking industry. Or, “make the SEC back off and let us get back to trading asset based securities like we used to in the Good Old Days.”
Who’s holding up the scaffolding?
Another bit of bad news is that while lenders are looking for new customers (students willing to take on private loans) we’re not tracking some important information about those loans. For example, the default rate for Harvard is less than 2%, while the default rate for the Arizona Automotive Institute is nearly 42%. [Bloomberg] Interestingly enough, there’s a long list of for-profit educational institutions with default rates higher than 28%. What we don’t need to see are more for-profit training schools encouraging more private student loan debt, debt which someone somewhere hopes will be hedged with private loans more likely to be paid off – because at bottom the funds to pay investors have to come from students paying off the loans.
Don’t panic yet, yes – there’s a hungry market for student loan asset based securities (perhaps in part because some old Federally backed loans were in the pipeline originally) and the market is relatively small albeit subject to some of the valuation mistakes of the Old Investment Houses – the ones who went bust in 2007-2008. There’s another reason for hope: The Consumer Financial Protection Bureau – the agency the Republicans can’t seem to wait to dismantle. [DB 7/30/14]
One of the provisions of the Dodd-Frank Act was the creation of an ombudsman for student loans which is part of the CFPB. In the 2014 annual report (pdf) it’s of interest to note that the biggest problem area was NOT repaying student loans but in getting financial institutions to cooperate with repayment programs and dealing with servicers and lenders (57%). If this sounds like a reprise from the Mortgage Meltdown Days it might be because some of the same actors are involved, at least in terms of complaint volume: JPMorganChase up 56% from 2013; Sallie Mae Navient up 48%; Wells Fargo up 8%. The annual report indicates problems in the following areas: (1) There is no clear path to avoid default. (2) Proactive outreach from borrowers was too often unsuccessful. (3) When repayment options are made available they are too often too little too late. (4) In some cases repayment options were allowed only after the loan went into default. (5) Short term forbearance options were often associated with processing delays, unclear requirements, and unaffordable fees. (6) Many lenders force a choice between staying in school and repaying the loans. There is a reason for the Ombudsman’s concern. The Sallie Mae Settlement.
The FDIC announced a settlement with Sallie Mae on May 13, 2014 in which Sallie Mae was charged with (1) inadequately disclosing its payment allocation methodologies to borrowers while allocating borrower payments across multiple loans in a manner that maximizes late fees; (2) misrepresenting and inadequately disclosing in its billing statements how borrowers could avoid late fees; (3) unfairly conditioning receipt of benefits under the SCRA upon requirements not found in the act; (4) improperly advising servicemembers that they must be deployed to receive benefits under the SCRA; and (5) failing to provide complete SCRA relief to servicemembers after having been put on notice of the borrowers’ active duty status.
As long as the private student loan market remains a small part of the total structure we can breathe a bit easier about its effect on capital markets. Secondly, the private student loan market has relatively low yields and thus doesn’t get included in most structured derivatives. Third, the old ‘recourse loans’ (for those with really low credit scores) are a thing of the past, most private loans now take higher scores into consideration. [Quora] What will continue to keep investors whole?
- Continued monitoring of the private student loan market by the CFPB so that loans taken out will continue to be loans paid off, even if this means some reduction in the revenue streams for the bankers.
- Continued oversight by the SEC and FDIC under the terms of the Dodd-Frank Act so that we don’t return to the Wall Street Casino of old should there be changes in the private student loan market.
- Improvement in the servicing of private student loans such that there are clear pathways to avoid default; effective and efficient communication between borrower and lender regarding repayment options; and, that this communication happens in a timely manner.
- Requiring lenders to make all the term of the private student loan clear at the outset including forbearance conditions, and any and all fees associated with deference, late payments or defaults.
From a Wall Street perspective private student loan asset based securities are a niche market, with some revenue potential – enough to keep the big banks interested – however, not with enough total clout to cause major financial displacement should the Quake happen. And yes, there are some institutions making nice fees for making student loans, selling student loans, securitizing student loans, servicing student loans, and collecting payments on student loans. Capitalism works, the trick is to keep free market capitalism from becoming casino capitalism and/or financialism.
A more existential question is how to maintain a system in which students are burdened with so much debt (Federal program/Private loan program) that they are deferring consumer purchases which would contribute to the growth of the overall economy. Deferred student loans can impact mortgage qualifications. [credit.com] We know this because the rate of homeownership among those with student debt is 36% below that of unencumbered home buyers, and we’re losing about $6 billion annually in new car buying capacity. [Forbes] And, this is not an inconsequential problem:
“Student loan debt is the only form of consumer debt that has grown since the peak of consumer debt in 2008. Balances of student loans have eclipsed both auto loans and credit cards, making student loan debt the largest form of consumer debt outside of mortgages.” [NYFed]
Given some of the trends reported by the NY Federal Reserve’s study of educational loans, how do we make sense of an economic system in which wages and salaries are stagnant while it is taking those from lower and middle income backgrounds longer to repay student loans? How do we sustain an economy when 29% of borrowers are paying off their loans, while 34% are making regular payments but the balance is increasing, and 20% have reported credit related problems, with another 6% delinquent and 11% in default?
These are not simply economic issues, they are also political as well. Is there the political will to make post secondary education more affordable for more people? Are we headed toward the privatization of our public institutions of higher education and post secondary training, and is this trend combined with the rising level of student indebtedness creating cracks in our economic foundations?