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student debt

A $1.3 Trillion Quandary

If you’re looking for pockets of risk (and you should always be looking for pockets of risk as it’s a good way to both avoid losses and find good opportunities to profit from speculative excess and/or stupidity), one good place to dig around is in the growing pool of student debt.

America’s student debt problem is a bit of a strange bird. Most of the $1.3 trillion (and no that’s not a typo) outstanding is guaranteed by the government, but there are of course private lenders as well and don’t think P2P isn’t on the scene vying for a slice of the growing pie. Consider the following from a Reuters piece out earlier this month:

Social Finance seized the recent risk-on wave for consumer-related debt by dramatically pulling in pricing on Thursday on its latest student loan securitization.

The online startup priced the biggest part of its new US$561m bond at 45bp, or 10bp tighter than its prior broadly syndicated deal, according to bankers.

“I think they are really starting to make a name for themselves,” said Jason Merrill, a structured analyst at Penn Mutual Asset Management.

SoFi’s CFO Nino Fanlo said the new deal attracted more than US$4bn of orders and the participation of about 40 accounts, or double the investor base in SoFi deals sold a year ago.

The new trade also came with the added cache of being the first to carry S&P’s top Triple A ratings.

Where other online lenders have stumbled, SoFi has built up a platform with a strong bond buyer following.

It has now completed a total of 14 private student loan ABS transactions, according to Moody’s Investors Service, which pegged its delinquencies and defaults at just a handful.

Now bear in mind, this would be the very same SoFi that went full retard about a year ago with an idea to create a hedge fund just to buy its own loans. Via WSJ:

One of the largest online lenders thinks it has found a prescription for the sector’s growth problem: launching a hedge fund.

Social Finance Inc., the San Francisco startup focused on student loans, in recent weeks opened a credit fund that will buy its loans and some from its competitors.

The unusual move by SoFi, as the company is commonly known, is an attempt to get around waning investor interest that is threatening online lenders’ growth.

That was from March 2016 and I don’t think I have to tell you how absolutely ridiculous that idea is, but note that market sentiment around risk assets has changed dramatically since then which probably accounts for the tight spreads on the new SoFi deals.

As the Reuters piece goes on to note, essentially what SoFi is doing now is siphoning the best credit risks from the pool of borrowers with outstanding government-backed student loans:

The US government provides a backstop for a huge chunk of the roughly US$1.3trn of outstanding US student loans – and SoFi has seized on refinancing its top earners.

SoFi’s new bond deal refinanced only workers earning an average of US$170,000 annually and with roughly US$7,000 of free cash flow each month after paying their bills, according to DBRS.

The obvious question there is who the f*ck are all these people with $7,000/month in unencumbered cash flow that are somehow still in debt? And, relatedly, what do the prepayment models on these deals look like?

So make of that what you will and I’ll have more on the P2P and private label student loan ABS story in the days ahead.

For now, I want to simply bring to your attention the state of the overall market. Via Bloomberg:

Outstanding loans taken out for higher education have doubled since 2009, data show. No other form of household debt has increased by as much since then. In fact, of the six major categories of consumer debt tracked by the New York Fed, only student loans and auto debt have increased since year-end 2008 (total auto loans are up 46 percent). Total household debt has fallen by 1 percent.

studentdebt2

Close to one-quarter of student debtors whose bills have come due are either in default or at least 90 days late on their required monthly payments, New York Fed data suggest. Delinquencies have remained stubbornly high, despite attempts by the former Obama administration to make loan payments more affordable. The federal government owns or guarantees more than 90 percent of all student debt.

Obviously that has all kinds of implications for consumer spending and household formation. And, in turn, those considerations have implications for the US economy.

Consider all of that with the following excerpts from a Goldman note out earlier this month and draw your own conclusions.

Via Goldman

The significant growth of the student loan debt market has been accompanied by an increase in delinquency rates. Among all types of consumer debt, student loans now have the highest delinquency rate, as shown by Exhibit 25. The high delinquency rates among student loans is partly due to the fact that non-performing student loan debt cannot be discharged through bankruptcy, whereas much of the mortgage debt that went into default during the recent recession has since been charged off.

studentdebtgs

While the deterioration of credit quality in the student loan market is concerning, the vast majority of student loans outstanding are guaranteed by the federal government, and the sector is thus unlikely to pose a threat to financial stability. These guarantees have been made directly by the US government via the Federal Direct program since 2010. Federal Direct loans are long-duration, fixed-rate liabilities and thus are not sensitive to interest rate shocks. A relatively small number of private student loans have been originated with floating interest rates. These loans tend to go to high credit quality borrowers for whom the private lender can offer a lower rate than is offered in the government loan market, which does not have risk- based pricing. For example, for recent floating rate private student loan ABS transactions, the average borrower incomes at the time of origination have been above $150K and the average credit score above 750.

That said, the large amount of student debt and the high delinquency rate will likely continue to constrain the ability of young households to take out mortgages and buy homes. In fact, student loans have already disproportionately affected young households. As shown by Exhibit 26, the non-mortgage debt to income ratio of the 25-34 year old households more than doubled from the early 1990s to 2013, and student loans account for almost all of the increase.

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