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Wells Fargo can upend student refis, but will it?

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With cheap funding and plenty of marketing muscle, Wells Fargo has the potential to shake up the student loan refinance business.

But does it really want to?

Wells is the second biggest underwriter of private student loans, which are used to finance the cost of higher education over and above what federal student loans cover. It is now looking at offering loans that will not just consolidate private student debt, but also repay federal loans.

Refinance loans take advantage of the lack of underwriting done by the federal government, offering better rates to borrowers who have obtained advanced degrees and high-paying jobs. These borrowers are highly coveted, but they represent a small corner of the $1.4 trillion student loan market, and the competition is growing.

In addition to fintech lenders such as Social Finance and CommonBond, a number of smaller banks, including Citizens Financial, Laurel Road and SouthEast Bank, as well as many state student loan agencies, also offer refinance loans.

Since 2013, SoFi and others have bundled some $18 billion of refinance loans into collateral for bonds, according to DBRS. This figure excludes whole loans that were financed by being sold to investors or held on balance sheet.

“It feels like a lot of the low-hanging fruit has already been taken out of the refi market,” said Robert Kelchen, assistant professor of higher education at Seton Hall University.

Kelchen noted that SoFi, for example, started out targeting students in certain programs at a small number of elite universities. SoFi has since expanded the number of schools and programs, but that means it is reaching students with somewhat more risk of not repaying their loans. And as this market broadens, the interest rate on refinance loans has begun to approach the rates for many existing private loans as well as federal loans for graduate students. This makes refinancing less attractive to many students in this broader pool.

Another reason the refinance market is so modest is that, even for the best borrowers, it generally only makes sense to use these loans to repay federally guaranteed loans to graduate students or parents, which pay rates of over 7%. Federally guaranteed undergraduate loans only pay around 5.5%.

“So the question is,” Kelchen said, “can Wells Fargo potentially poach some of the low-hanging fruit, or is the goal to get people who have some private loans and some federal loans to refinance their federal loans with the company they already have private loans with?”

Michael Tarkan, an equity analyst at Compass Point, thinks the bank’s goal is relatively modest. “My guess is they’ve had requests from existing [student loan] customers to refinance [federal student loans] and they want to have that capability,” Tarkan said.

“Wells Fargo has a lot experience in student lending, so this is a logical step, but I don’t get the sense it’s intended to really drive a lot of volume or that it will significantly move the needle for Wells Fargo,” he added.

A Wells spokesman would not comment on Wells' plans or analysts' speculation but wrote in an email that the bank "is continuously evaluating the marketplace to better serve customers."

Unlike SoFi, CommonBond and some other refi lenders that rely on securitization and whole loan sales for funding, Wells Fargo holds the student loans it makes on balance sheet. Its student loan portfolio was $11.9 billion at the end of the second quarter. That was just a fraction of the bank’s $441 billion consumer loan portfolio and an even smaller fraction of its total $944 billion portfolio of consumer and commercial loans.

Wells Fargo may be losing existing borrowers to refinance lenders “at the margin,” Tarkan said, but not nearly as much as it likely lost during a big refinancing wave in 2017.

Jon Riber, senior vice president of U.S. asset-backed securities at DBRS, is skeptical that Wells Fargo would try to compete by going down the credit spectrum.

“I’d assume they’d go after the same types of borrowers" as refi lenders like SoFi and CommonBond "because they are a bank that will most likely hold their loans on balance sheet,” he said. “They won’t lend to non-super-prime borrowers, and potentially get into trouble down the road.”

Even if the refinance market is too small to make a big impact on Wells Fargo’s balance sheet, the bank could have a big impact on existing lenders. Certainly, Earnest has picked up the pace of origination since being acquired by the student loan servicing behemoth Navient in the fourth quarter of 2017; so far this year, it has completed three securitizations totaling over $1.2 billion, more than it did for all of 2016 and 2017. Navient’s bigger balance sheet and strong servicing record also earned a higher credit rating on the deals, lowering its funding costs.

“It’s a little too early to tell if Wells can be more competitive in the refi market, but presumably it could drive higher consolidation for lenders,” Tarkan said.

“A new product with name recognition is certainly a concern" for existing refi lenders, "but at least some of the bigger refi lenders already out there have pretty good name recognition and relationships with colleges,” Kelchen said. While relationships with colleges are not quite as important for refinance lenders as for undergraduate in-school lenders, “refi lenders want to get students fairly soon after graduation.”

Another potential advantage for Wells, according to Kelchen, is the bank's existing relationships with borrowers through its in-school lending program, though he said this advantage seems to be fairly modest.

“Wells Fargo is a large bank, and their cost of funds is probably lower than everyone else, and that could be an issue, as the other lenders won’t be happy if Wells offers a lower rate,” Riber said.

He said the bank’s marketing muscle is also a potential advantage. “Acquisition costs in the refi space — meaning the marketing cost to acquire borrowers — have increased because of the competitive nature of the refi market. SoFi has spent a lot on expensive Super Bowl ads, which Wells could easily do. For the other lenders, this is not an option.“

On the other hand, Riber said, “the refinance market could shrink if interest rates rise more than expected, because the incentive for a student loan borrower to refi goes down as the difference between their current loan rate and the new refi loan rate gets smaller.”

Of Wells Fargo’s two biggest competitors in in-school lending, only Discover offers refinances loans, and the company declined to provide origination volume for the product, which has been offered to all of its customers since March 2017. SLM Corp., better known as Sallie Mae, has repeatedly downplayed the threat of refinance lenders, despite the fact that student lending is by far its biggest line of business — and refinance lenders are cherry-picking some of its best borrowers.

Sallie Mae executives reiterated on the company’s second-quarter earnings call that margins on refinance lending are thin and eroding, noting that lenders have started to raise their interest rates. The amount of loans originated or serviced by Sallie Mae that were refinanced (or “consolidated,” in the company’s own lingo) by other lenders fell by $3 million, or 1%, in the second quarter to $221 million.

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Student loans Student loan ABS Wells Fargo Social Finance CommonBond