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There’s a gift for student lenders in the education bill

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After the 2016 elections, there were high hopes that student lenders (and servicers) would benefit from a more favorable environment regulatory environment and expanded lending opportunities.

Until recently, however, there was not much to show in either respect. While the industry cheered the Department of Education’s decision in August to stop sharing servicing data with the Consumer Financial Protection Bureau, higher education did not appear to be a high priority for the Trump administration.

Now it appears that private lenders could play a much larger role in financing higher ed, and Congress, not the White House, is the catalyst. The House is reportedly preparing legislation that aims to change how Americans pay for college. Industry participants and observers say that almost all of the measures in the Promoting Real Opportunity, Success and Prosperity through Education Reform Act, which were reported by The Wall Street Journal this week, would benefit lenders and servicers.

But the introduction of limits on federally guaranteed loans to graduate students, instead of letting them borrow whatever schools charge, would be the biggest plum for the industry — potentially creating a multibillion-dollar opportunity for the likes of Sallie Mae, Wells Fargo, Discover and Citizens Bank.

“Ultimately what it means is either people won’t go to more expensive schools, or they will simply borrow more from private lenders,” said David Klein, CEO of CommonBond, which offers both in-school and consolidation loans. “The degree to which any of that happens depends on where the level of the cap is set.”

All private student lenders stand to benefit from reductions in lending under the Grad PLUS program. But no one is in as better position than the market leader, SLM Corp., also known as Sallie Mae. It was already planning to expand lending to graduate students, with six new products targeting professional degrees that will be rolled out next year: Business schools, legal, medical, dental, health professionals and a general graduate loans.

Sallie Mae and other private lenders originate some $1 billion in loans to graduate students in the 2016-17 school year, while Grad PLUS originations totaled $9.6 billion.

Michael Tarkan, an analyst at Compass Point Research & Trading, says that private lenders are in a strong position to compete with Grad PLUS by offering lower interest rates to the strongest borrowers, even if federally guaranteed lending remains uncapped.

In a report published this week, he noted that Grad PLUS loans carry a 7% fixed interest rate plus a 4.3% origination fee, which equates to an annual percentage rate of 7.1% to 7.9%, depending on the term of the loan. And those rates are the same, regardless of the student‘s personal credit, the degree or school attended.

Sallie Mae, by comparison, does not charge origination fees. Nor do most private student lenders. It currently offers graduate fixed-rate loans at an all-in APR as low as low 5.5%, though borrowers can pay as much as 8.3%. All-in APRs on variable-rate loans range from 3% to 8%.

“Sallie Mae is going after that market [grad students] regardless of what happens,” Tarkan said in an interview. “It has already built the infrastructure. If federal lending is capped, that makes it easier … though it may also attract more competition” from other private lenders.

Right now, he said, “I don’t get the sense that it’s the same aggressive, competitive environment.”

Of course, private lenders will not replace every dollar that the federal government lends.

“There will be a segment of [graduate] borrowers the private lenders will not necessarily want to lend to, but it’s much smaller versus the undergraduate market,” the analyst said.

And it remains to be seen how much of this additional lending might be funded in the securitization market. Sallie Mae has said it will be reducing its reliance on securitization; Wells Fargo and Discover, the No. 2 and No. 3 lenders, keep most of their student loans on balance sheet.

A spokesman for Sallie Mae declined to comment, except to say that the company “supports the goal of providing access to an affordable college education and we expect to continue responsible participation in a student loan marketplace that will continue to feature both federal and private student loans.”

Caps on PLUS lending could be positive for investors in private student loan bonds, according to Pedro Sancholuz-Ruda, a senior analyst at Moody's Investors Servce. That's because lenders who rely on securitization for funding would presumably use higher proportions of these loans, which tend to be stronger credits, to their pools of collateral.

The Prosper Act would reportedly preserve an option known as “income-driven repayment,” which ties borrowers’ monthly bills to their earnings, but it would eliminate the ability of borrowers to have balances forgiven under them. At the margin, this could benefit marketplace lenders like CommonBond, SoFi and Earnest (which is being acquired by the servicing giant Navient) that refinance the student debt of borrowers who have graduated with advanced degrees and have high-paying jobs.

A few banks, including Citizens and Darien Rowayton Bank, target this market as well; with the exception of Citizens, all of these refinance lenders tap the securitization market regularly for funding.

Currently, borrowers can make payments of as little as 10% of their discretionary incomes and have remaining balances forgiven after 20 or 25 years. Under the bill, borrowers would reportedly pay 15% of discretionary incomes for as long as it took to cover the amount they would have paid under a 10-year standard repayment plan. Current participants in both programs would be grandfathered in.

The thinking is that some borrowers may avoid refinancing federal student loans with private lenders because they do not want to lose access to income-based repayment options. So any changes that make IBR less attractive would mean borrowers have less to lose by refinancing with a private lender.

Klein said that curtailing IBR could also affect the way people think about what to do after college to pay off their loans. “They might choose a major in college that tends to lead to a higher-paying job," such as in science, technology, engineering or math, he said.

Of course, any changes to IBR could impact the performance of bonds backed by federally guaranteed student loans. Moody’s view is that income based repayment affects Federal Family Education Loan securitization in two ways: On one hand it can help reduce defaults; on the other, the low monthly payments also mean that loans amortize more slowly.

Whether eliminating loan forgiveness under income base repayment impacts FFELP securitizations depends in large part of who is grandfathered, however. If it remains an option for all borrowers who are currently eligible, then there is likely to be little impact. But if it remains available only for borrowers currently in the program, there could be a larger impact, according to Sancholuz-Ruda.

The Prosper Act would also reportedly end loan-forgiveness programs for public-service employees, who currently can make 10 years of payments and then have their remaining debt forgiven, tax-free. However, this is less likely to affect demand for private student loans than it is to reduce the number of people interested in public interest work, according to Klein.

The bill would overhaul more than a federal student aid programs. It would also roll back regulations on for-profit colleges and introduce greater accountability for all schools by revamping information provided to prospective students and mandating that schools would repay a portion of federal loans when students default. It is likely to face strong opposition and undergo changes.

“Given the complexity of this, the expectation is that this will be a multimonth, 2018 development with lots of changes in the making,” Henry Coffey, an analyst at Wedbush, said in a research note published this week. “The good news here is that now we finally have something to focus on.”

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Student loan ABS Student loans Policymaking Discover Citizens Bank SoFi Wells Fargo CommonBond Darien Rowayton Bank