The new economics of educational lending under the ihelp program

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1 The new economics of educational lending under the ihelp program Finally, a private student loan program that makes financial sense for community banks and their customers. Students- still a great investment In its recent report Education Pays 2010 the College Board, the nation s foremost expert on trends in Higher Education confirmed once again that the economic benefits of higher education for individuals, society at large and the communities in which they reside are substantial. Although colorful and unfortunate anecdotes are often highlighted in the media, the evidence is clear. Even during the recent recession, the College Board saw evidence that unemployment rates for college graduates were less than half of those with only high school degrees 4.6% compared to 9.7%. A full 86% of the college graduates in the study earned more than high school only graduates. The report went on to suggest that median earnings are $39,000 for high school only graduates vs. $65,800 for college grads. The report concluded that even if fully funded by student loans, and considering 4 years in school rather than in the labor market, by about age 33 these higher earnings should result in the financial break even point for the typical student. Naturally, there are wide variations and different individual results. These impressive economics aside, the value to society and to the local communities in which these students reside after graduation is also improved. A part of the benefit to the community certainly is financial as college graduates will likely be an upper income resident of the community, but also these graduates will contribute to the quality of that community s collective life. Securing a student loan will be many young people s first major financial transaction. Community banks are in a perfect position to help these students start out on the right financial track. The terms and conditions of the ihelp loan program were developed specifically for students and their unique needs. ihelp s

2 single rate and simple cost structure will serve community banks well and will represent one of the most affordable college financing options in today s market. Colleges and Universities critical tuition revenue The economics to the Colleges and Universities of being able to rely on a responsive private loan program for their students is critical. As tuitions increase and federal and state funded scholarship and grant programs are challenged in these tough economic times, schools look to outside sources for student aid. While federally sponsored loans help finance a college s tuition, these loans are limited in the amount a student can borrow and many students will need additional support from a private loan. The downturn in the economy has put additional pressure on endowment funds normally used for capital campaigns, not student aid. A program like ihelp is viewed as a key source of tuition revenue for these cash strapped colleges and will be embraced by colleges for the support it provides to their students. This is why so many schools are excited about ihelp s development and are including the program as the school s financial aid office counsels students on how to pay for college. Community Banks- key economics Overview - In the past, providing a loan program designed specifically for local students and their families was very difficult for a community bank. The potentially modest net return coupled with the administration and compliance issues for a program of limited or unknown size was prohibitive. However, most banks still want to serve their customers and their communities. The ihelp program effectively performs all the back room work for the bank. From underwriting to origination to servicing to collections, a 10 year ICBA Preferred Service Provider handles all the administration and compliance. In addition, the loans are insured by a licensed regulated insurance company whose management has over 20 years of experience in insuring over $12 Billion in student loans. This arrangement should appeal to state and federal regulators as it demonstrates that the program provides a proven, repeatable and uniform process for managing individual loans and a bank s student loan portfolio each and every day.

3 What is left for the bank is to market the program to its customers and community and to enjoy a solid return on a secure asset. Economics Originating Lenders fee income Within each State, generally only one ICBA member bank will serve as that State s ihelp Originating Lender for the State. The Originating Lender is the lender of record and will actually own legal title to the loans. The Originating Lender will then participate out the economic interest in some or all of the loans to a Participating Bank. In return for being the Originating Lender and loan s title holder, the Originating Lender will receive as fee income: $12.50 for each loan originated paid at the time of disbursement. As an example, if 2,000 loans were originated, the fee income would be $25,000 and;.125% (12.5 basis points) annualized and paid monthly of the loans principal balance while the loan is outstanding. On a $10,000,000 portfolio (2,000 loans of $5,000 each), this would yield $12,500 in the first year of the program and will yield additional revenue each year while these loans are outstanding. These two sources of revenue would provide fee income to the Originating Lender of $37,500 in the first year of a $10,000,000 loan portfolio containing 2,000 loans. Other than some legal review in setting the program up, the Originating Lender should incur no out of pocket or other expenses. Banks interested in generating fee income are generally interested in becoming an Originating Lender. Most Originating Lenders also choose to keep a portion of the loans on their balance sheets and not participate out all of the loan portfolio s economics to a Participating Bank. Keeping a portion of the portfolio s economics will also yield margin income on the volume of loans the Originating Lender keeps on its books as described below.

4 Participating Banks margin income Most ICBA banks will participate in the ihelp program as a Participating Bank. A Participating Bank owns 100% of the economics of the loan (receiving all income and paying all expenses), but does not own legal title to the loan. The legal title remains held by the Originating Lender. The loans in which a Participating Bank owns the economic interest can be loans made to the Participating Bank s customers or to a broader market of college students within its state. An Originating Lender can keep the full economics of some of the loans it originates and all Originating Lenders are holding some loans. Participating Bank will receive as income; A variable interest rate equivalent to the 3 month LIBOR plus 6.00% adjusted quarterly. In today s market this gross yield is about 6.40%. A $10,000,000 ihelp Participating Bank s portfolio should have a gross yield of about $640,000 in the current interest rate environment. Participating Bank s Expenses a) Servicing fees prior to repayment of $1.50/ month b) Servicing fees during repayment of $4.37/month c) Loan delinquency charge of $2.00/month d) Management and Originating Lender fees of.25% e) An annual fee of $1.50 for 1098 statements sent to borrowers Currently loans are averaging about $7,500, although to be conservative in computing the fees, we will assume a loan size of $5,000 as we did above. For a $10,000,000 participation, at an average loan size of $5,000, about 2,000 loans would be in the portfolio. Assuming 1,500 the loans would be in school and the other 500 would be in repayment and 10% of those in repayment are delinquent at any time, the Participating Bank s annual expense on that 2,000 loan $10,000,000 portfolio would be about:

5 a) 1,500 x $1.50 x 12=$27,000 b) 500 x $4.37 x 12 = $26,220 c) 50 x $2.00 x 12 = $1,200 d) 10,000,000 x.25% = $25,000 e) 2,000 x $1.50 = $3,000 Total annualized fees = $82,420 These expenses of $82,420 would then reduce the gross income on the loan portfolio from $640,000 to $557,580 and reduce the gross margin income from 6.40% to 5.57%. That should be a very attractive return in today s market. As the loans are insured, there should be no credit losses on the portfolio. Most banks interested in generating margin income for their bank will become ihelp Participating Banks. Additional economic considerations may include: Risk Based Capital Requirements Even if insured by a State licensed and regulated insurance company as ihelp loans are, these loans will likely fall into the 100% risk rate category for determining risk-weighted assets. Allowance for Loan and Lease Losses Properly underwritten, as ihelp loans also are, they should fall into the general allocation required under the Statement of Financial Accounting Standards Number 5 (SFAS No.5) The general allocation percentage requires the smallest reserve for ihelp loans on a per dollar basis except for the portion of loans secured by cash, cash equivalents and/or federal guarantees which ihelp loans do not carry.

6 Internal cost of funds Some banks will identify a specific liability within the bank to use as a funding vehicle (e.g. deposit accounts or CDs). Other banks may have a set pool of funds against which they will identify a blended allocation of loan capital costs. This cost of funds needs to be subtracted from the gross income. General Overhead In addition to the cost of funds, a bank may allocate a set amount of its general overhead and operating costs to any loan it makes or in which it holds an economic interest. This is also necessary in the profitability computation. ihelp is committed to delivering a safe and secure loan type to be added to a community bank s overall loan portfolio. The net return the ihelp loan offers should be an attractive one for at least a portion of the bank s overall retail or consumer loan portfolio. There is no doubt the ihelp loan will help a bank attract new customers and serve existing customers while meeting a growing community need. Educational lending is an outstanding community service that benefits not only the individual students and the families investing in their future, but the community in which they reside. As schools and students are beginning to look at next fall s financing options early in 2011, the time is fast approaching for community banks to decide to participate in the ihelp program. For answers to your questions or more information on the ihelp private student loan program, contact Ann Anderson at (303) or [email protected].