FSR Insights. Private Student Loans Market. Financial Instruments, Structured Products & Real Estate Insights September What s new?

Transcription

1 FSR Insights Financial Instruments, Structured Products & Real Estate Insights September 2013 Private Student Loans Market What s new? The amount of student loans outstanding today, currently exceeding $1 trillion, is larger than all other consumer ABS products. 1 The student loan market is segmented into two major disbursement channels: federal lending programs and privately originated loans, which represent 80% and 20% of the market respectively. Federally funded loans are backed by the U.S Government and are limited in both who qualify for these loans and the amount they can fund. Private student loans are originated through lending programs not affiliated with the federal government and are therefore not subject to federal eligibility standards and terms. As a result, private student loans are often used as supplemental funding by students in addition to any federal loans received. The private student loan market continues to evolve as it faces new challenges and offers new opportunities for growth. New regulations have played a significant role in the transformation of the overall Asset Back Security (ABS) Market. The private student loan sector is experiencing regulatory debate over the dischargeability of private student loans in a bankruptcy proceeding. Currently, student loan debt is not dischargeable in a bankruptcy; however, possible federal legislative developments could allow students in bankruptcy to discharge their student loan obligations along with the rest of their personal debt. If such legislation is passed, private student loan collateral pools may experience higher loses than currently projected. This scenario may cause student loan lenders to tighten underwriting standards and constrict available credit through raising interest rates. There has also been an increased focus on reporting, disclosure and enhanced consumer education and protection within the student loans product space. The Consumer Finance Protection Bureau is focused on protecting borrower s interests and has been actively reviewing the servicing and collection functions of different student loan issuers and lenders. As for investors, the SEC has undertaken initiatives focused on increasing the depth of financial disclosures to improve transparency. How we got here? Pre-credit crisis vs. post-credit crisis The private student loan lending and securitization industry has transformed over the past ten years, from a period of growth from to an abrupt halt in 2008 at the onset of the credit crisis. While other factors contributed to the contraction of the private student lending market, the credit crisis amplified the risks associated with investing in this asset class, increasing funding costs and ultimately decreasing demand and availability for this type of asset. 1 FRBNY Consumer Credit Panel/Equifax

2 Between 2001 and 2007 private lending grew from 11% of total student loans to 23%. The share of private loans has markedly contracted since Source: College Board, Trends in Student Aid 2012 Increased funding costs and reduction of margins has resulted in only 20 of the 93 private lenders during the credit boom of still remaining in the market today. 2 Private student loans vs. federal loans Private student loans have notable differences compared to federally disbursed loans. The primary difference is that private student loans do not have the benefit of a federal guarantee therefore credit risk management is paramount to lender profitability. Private student lenders have trended away from using simple eligibility criteria, such as FICO, and have begun to incorporate additional metrics, such as academic major and school, to evaluate potential credit risk as a component of the underwriting process. Private lenders have also increased the requirement for cosigners, spreading the risk of default, which allows for larger disbursements to students as the costs of education rises. The table below illustrates the positive trends in collateral performance of newer private student loans from Sallie Mae s 10-k, the largest private student loan issuer. 2 Continuing Education: A Review of Private Credit SLABS, Deutsche Bank PwC 2

3 FFELP vs Traditional Private Student Loans FFELP Traditional Private Student Loans (Dollars in millions) Balance % Balance % Balance % Balance % Balance % Balance % Loans in-school/grace/deferment $ 17, $ 22, $ 28, $ 5, $ 6, $ 8, Loans in forbearance 15,902 19,575 22,028 1,136 1,386 1,340 Loans in repayment and percentage of each status: Loans current 75, % 77, % 80, % 28, % 27, % 24, % Loans delinquent days 4, % 5, % 5, % 1, % 1, % 1, % Loans delinquent days % % % % % % Loans delinquent greater than 90 days 7, % 8, % 7, % 1, % 1, % 1, % Total Private Education Loans in repayment 90, % 94, % 96, % 31, % 30, % 27, % Total Private Education Loans, gross 124, , ,938 38,554 38,093 37,532 Private Education Loan unamortized discount Total Private Education Loans 125, , ,838 37,758 37,220 36,638 Private Education Loan receivable for partially charged-off loans ,347 1,241 1,040 Private Education Loan allowance for losses ,171-2,171-2,022 Private Education Loans, net 125, , ,649 36,934 36,290 35,656 Percentage of Private Education Loans in repayment 73.00% 68.90% 65.80% 81.70% 79.20% 74.20% Delinquencies as a percentage of Private Education Loans in repayment 16.80% 18.10% 17.20% 9.30% 10.10% 10.60% Loans in forbearance as a percentage of loans in repayment and forbearance 14.90% 17.20% 18.60% 3.50% 4.40% 4.60% Source: Sallie Mae 10K Elimination of the Federal Family Education Loan (FFEL) Program Under the FFEL Program, lenders would underwrite student loans, which were largely guaranteed by full faith of the U.S government. Prior to the elimination of the FFEL Program in 2010, the government significantly reduced the excess spread that is available to lenders who originated FFELP loans to the point that that it became uneconomical to continue underwriting FFELP loans. While many of the smaller issuers exited the market at this time, many larger underwriters remained due to the size of their FFELP portfolios. The FFEL lending program has been replaced by the Direct Lending Program in Under the Direct Lending Program, students could borrow directly from the Department of Education (DOE) through their selected university without any intermediary between the DOE and the borrower. 3 The university determines the amount of aid needed for each student, with a maximum lending limit of $31,000 over the 4 year period. Post-credit crisis Even as demand for consumer Asset Back Securities (ABS) increases, private student loan ABS issuances remain lower than precrisis levels. Issuance trends in other consumer ABS products are shown in the US ABS Issuance by Sector chart below. A number of hurdles exist for growth in the private student loan ABS market. These include: declining applications to graduate schools, such as law schools or MBA programs decreased demand for funding and reduced enrollment in For-Profit Educational Programs The decline in For-Profit Education comes at a time of increased government focus on the effectiveness of the sector and the potential to decrease grant availability to students seeking this type of education. 3 PwC 3

4 US: ABS Issuance by Sector US ABS Supply by Sector ($bn) YTD 2013 Projected 2013 Consumer Credit Cards Autos Student Loans Equipment Global RMBS Other Source: August23,2013 J.P. Morgan Global ABS/CDO Weekly Market Snap Shot.psf Even though post-crisis securitization volume has remained low, collateral quality has increased due to the improved underwriting standards. According to Sallie Mae 4, private student loans originated in recent years have outperformed loans previously disbursed, illustrated through a downward trend of charge-offs and losses. As of 2012, the average amount of cosigned loans within Sallie Mae s private student loan portfolios was 65% of all loans, while the average amount of cosigned loans in the portfolio originated in 2012 was 90%. Further, and the average FICO score was 748 the highest ever for an annual loan origination cohort. 5 While defaults are still highest in the initial repayment months, a TransUnion study indicated that the delinquency rates for private student loans originated between 2007 and 2012 decreased by 2%,while federal 4 Sallie Mae 10K 5 Sallie Mae 10K loan delinquencies for comparable vintages increased by 27%. This is reflective of increased efforts to improve underwriting quality and loan servicing by private student lenders. 6 Future of the student loans market While graduate and for-profit enrollment has slowed, undergraduate enrollment has continued to grow with expected enrolment rising to 20.6 million by The forecasted increase in enrollment, paired with the costs of education rising at a rate faster than both personal income and CPI, creates a unique opportunity for the private student loans lending market. This correlation is depicted below. 6 TransUnion Study Finds More Than Half of Student Loans in Deferment; High Unemployment Rates Put Loans at Risk, Jan 30, Continuing Education: A review of Private Credit SLABS, Deutsche Bank PwC 4

5 US Consumer Price Indices and Cost of Education (Jan 2000 = 100) 200 CPI Cost of Education Jan-92 Jul-92 Jan-93 Jul-93 Jan-94 Jul-94 Jan-95 Jul-95 Jan-96 Jul-96 Jan-97 Jul-97 Jan-98 Jul-98 Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Source: Bureau of Labor Statistics Average Annual Cost of Education (Tuition, Fees, Room and Board Charges) $45,000 $40,000 $35,000 $30,000 $25,000 $20,000 $15,000 $10,000 $5,000 Private Nonprofit Four-Year Public Four-Year $38,589 $17,131 $ Academic Year Source: The College Board, Trends in College Pricing 2011 PwC 5

6 Funding gap The funding gap is driven by supply and demand. While the demand for lending is increasing due to the higher costs of education, federal funding remains limited through the Direct Lending Program. Annual lending limits remain consistent while average annual costs of education increases at a rapid rate. For FY undergraduate students received on average $13, 218 in financial aid, of which only $5,056 was from federal loans. 8 Eliminating the cost of room and board (estimated at $5,000) the amount of aid provided will not cover a student s yearly educational costs. In addition, the amount provided though federal lending fell in FY 2011 and 2012, with a 2.8% decline driven by a drop in the amount of federal aid given resulting from a decrease in federal borrowing. 9 For these reasons, many students have and will continue to turn to private lenders to fill the gap between federally issued loans and grants and the cost of education. Underwriters: Decreased cost of funding As the market for private student loan securitization grows, there is an opportunity for issuers to improve marketability by adding additional structural enhancements and disclosures which may eventually lead to a decrease in the cost of funding 10. Structural enhancements and disclosures have improved 8 College Board Trends in College Pricing College Board Trends in Student Aid Cost of Funding Calculation Assumptions for Sallie Mae Trusts: 2006-C, 2010-B, 2012-A, 2013-B 1. Discount rates of 10%, 15% and 18% were selected to calculate a range of market values for the residual tranche. 2. Market value of each trust at issuance, we summed the projected par value of the issued notes and the residual class and subtracted the balance of the reserve accounts. 3. PwC derived a conditional default rate (CDR) is based on Moody s cumulative collateral loss projections at issuance for each trust. 4. Cost of funding is derived in Intex using market values under each discount rate scenario. leading to slight reductions in the cost of funding. As shown in the following table, we estimated the cost of funding for Private Student Loan ABS. The reduction in funding cost is due to market conditions and improvements made thus far such as, enhanced underwriting standards and increased disclosures. Cost of Funding 10% Residual Discount 15% Residual Discount 18% Residual Discount 2006-C 2010-B 2012-A 2013-B Issuers have the opportunity to further reduce the cost of funding by streamlining and increasing both what is disclosed initially at the time of closing the deal and periodically as part of the investor reports. In addition, structural enhancements to mitigate some investor concerns regarding changes in the private student loans market have the potential to further decrease the cost of funding. These improvements may initially reduce net proceeds received for issuance. Implementing these changes while the market is rebounding will likely have a positive effect on the demand for private student loan ABS in the future. What are potential road blocks? In order to rejuvenate investor confidence and demand in the private student loan ABS market, lenders should consider how to address the following investor concerns: transparency and risk of legislation. PwC 6

7 Transparency The lack of transparency stems from limited information available to investors regarding collateral and trust performance. As collateral information can be extensive, presenting the loan level data in a more useful form of conditional statistics benefits investor analysis and aids in the establishment of heuristics for the asset class. Heuristics or illustrations of mental shortcuts, that aid in processing information and are omnipresent throughout financial analysis of equities (beta), debt (duration), options (Greeks) and RMBS (liquidation ratios). Legislation Increased credit risk due to a potential change in bankruptcy laws is another major concern for investors and lenders. One piece of legislation, the Fairness for Struggling Students Act of 2013 (S. 114) 11, introduced by Senator Dick Durbin (D-IL) seeks to change the current dischargeability status. Supporters of the bill argue that private student loans resemble other consumer debt instruments and therefore should not be privy to additional protection. However, opponents argue that removing non-dischargeability would encourage moral hazard, increase borrower defaults and increase the cost of student loan funding. Dischargeability has been discussed in Congress before, most recently in the July 2012 Senate Committee on Banking, Housing and Urban Affairs on Financial Institutions and Consumer Protection. 12 Dischargeability has not been allowed for federal student loans since 1978 and while the debate over dischargeability for private student loans is likely to continue, the possibility of legislative action is still in doubt. While bankruptcy reform could benefit many borrowers struggling with repayment, if passed, higher loan charge offs may likely result in a tightening in underwriting standards, increased costs to consumers and originators, and an increase in interest rates Fuseaction=Hearings.Hearing&Hearing_ID=d31bafb 1-22cf-455e-8cd4-2b cec What s next in terms of possible solutions? The current environment provides an opportunity for lenders and investors in the private student lending market. With investors seeking higher yielding investments and consumers looking for educational funding, demand for new private student loan issuances is expected to continue to grow in the coming years. The following paragraphs outline some possible solutions to the road blocks discussed above regarding the expansion of the private student loans market. These solutions have the potential to help facilitate growth and consistency in this private student loan market. Options to enhance investor transparency Developing a framework of heuristics for the private student loan space like duration and convexity, presents issuers the opportunity to make private student loan credit analysis more available for a larger investor base. This will likely help investors to become less reliant on analysis provided by third party service providers and allow more market participants to develop an independent view on the different private student loan securities. Improvement in data analysis, disclosure, and consistent performance metric calculations presents increased transparency for investors. Issuers can develop historical performance metrics for different stratifications of loan collateral such that users can apply historic static pool data to the current portfolio to develop future expectations of performance. Additional collateral information disclosed by issuers could also include: Cohort default rates by school Borrower Major Updated FICO scores of the borrower and Co-signor on a more consistent and frequent basis, such as every reset cycle or annually whichever is earlier Break out of current geographic location of the borrowers PwC 7

8 Double stratification that illustrates multiple variables such as: local unemployment rate and the current geographic location of the borrowers By providing historical performance information for the static pools, investors will likely be more capable of conducting performance forecasting. Being able to independently forecast performance may reduce investor uncertainty, reliance on third party service providers and requirements to access loan level data. Providing streamlined performance metrics for different loan cohorts would allow investors to use conditional estimates such as Bayesian statistics to improve forecasting capabilities. With this type of analysis, investors can apply a number of forecasting approaches to loan cohorts, based on the stratification information, to improve the performance forecasting of the collateral pools. This ability will allow investors to use their own internal models to project future cashflows into and out of the trust, ultimately reducing the investor s reliance on rating agencies or other market participants. In addition to collateral stratification tables, creating an industry standard set of calculations and disclosures, such as default and prepayment metrics, recovery performance information, as well as other user friendly charts and analysis tools, would likely help spur investor demand and confidence. Structural options to enhance investor demand Creating a Fixed/Rate Reset maturity note (2-4 year) with the option to extend. This will help alleviate: - Credit risk for student loans that is typically higher when compared to other consumer ABS classes; and - Creating shorter notes with an option to extend will help to reduce the credit, interest rate and reinvestment risks associated with student loans. Under this alternative, if the collateral performs well, investors will likely have an option to hold on to the notes and reset spreads in a changing rate environment. Engaging a third party to act as a liquidity facility if early amortization is triggered. The proceeds from this facility could be used to pay off senior notes as quickly as possible. The Facility fee would cost a portion of the excess spread in the trust but would allow for tighter pricing of the senior notes; and if the pool performs as expected, the facility won t be drawn upon. This may enhance investor demand and confidence, given their concern over liquidity and the long duration of this asset class. Options to mitigate the effects of potential legislation Adding a repurchase option if Congress makes private student loans dischargeable in a bankruptcy proceeding This repurchase option could increase marketability by allaying investor concern over potential regulatory actions PwC 8

9 How PwC can help PwC can assist in helping you to improve your securitization platform and disclosures in the context of the ever changing market. We can help in advising with data, disclosures and analysis with regards to static pool information. Consult in the calculations of historical performance metrics and validate the accuracy of disclosures. Provide reviews and compliance checks which might include: quarterly thirdparty calculations and annual sample review after issuance. Provide insight on best practices with in the ABS reporting and disclosure space. Advising on different structuring options available for the issuers based on cash flow analysis etc. Provide insight on industry best practices on default and vendor management and loss mitigation strategies. PwC 9

10 Additional information PwC s FSR Group Yogesh Gupta Partner yogesh.gupta@us.pwc.com John Gibson Principal john.l.gibson@us.pwc.com Andy Hawley Principal andy.hawley@us.pwc.com Sandilya (Sandy) Hota Director sandy.n.hota@us.pwc.com Thomas Karwacki Manager thomas.j.karwacki@us.pwc.com Elizabeth Fireman Associate elizabeth.fireman@us.pwc.com PwC s FSR Group brings you: A unique combination of financial reporting, advisory, tax, finance, operational readiness, process and technology, and regulatory expertise, coordinated with specialized transaction and valuation services for securitizations, structured products, derivatives and real estate assets. In-depth knowledge and valuation expertise on virtually all asset classes, including debt and equity securities, derivatives, structured notes, residential and commercial mortgages, mortgage servicing rights, commercial loans and bonds, automobile loans and leases, trade receivables, credit cards, home equity loans, equipment loans and leases, student loans, manufactured housing loans, franchise loans, hospitality and leisure real estate, timeshare receivables, and mutual fund fees. A group of subject matter specialists who provide insights into developments in the capital, credit, derivatives and real estate markets, including but not limited to consumer and corporate credit, investment banking, transaction structures, investor reporting, technology, real estate asset monitoring and management, reorganization and insolvency, forensic accounting and hospitability and leisure services. Expertise in model development and risk analysis to assess your processes for valuing financial instruments, determine robustness of financial models and perform risk analysis, including evaluating sensitivity measures and stress testing methodologies for portfolio risk. Our team is multi-disciplined and diverse. We bring a unique approach to blending and managing services in today s dynamic and fast changing markets. PwC 10

11 FSR Insights Follow us on 2013 PricewaterhouseCoopers LLP. All rights reserved. PwC refers to the United States member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details. PwC refers to the US member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.