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A Learning Curve For Debt Buyers: Charged-off student loans account for a mere sliver of the bad-debt sales market, but some collections executives sense a growing profit opportunity on campus.
Collections & Credit Risk December 1, 2005 | Daly, Jim The self-contained world of student loans is a jumble of agencies, programs, acronyms and regulations. Hence, unless your 18-year-old is talking with college recruiters, you might not know that FFEL stands for Federal Family Education Loan Program, formerly the Guaranteed Student Loan Program, or GSLP. And, unless you care about how Wall Street finances college loans, you probably are only vaguely aware of Sallie Mae, the giant aggregator of student loans.
Students and graduates collectively owe about $190 billion on their federally insured student loans alone, not to mention smaller amounts in private education loans. According to the U.S. Department of Education’s National Center for Education Statistics, bachelor’s degree financial-aid recipients in 1999-2000 were more likely than their 1992-93 counterparts to have borrowed to pay for their undergraduate education – 65% vs. 49% – and if they had done so, to have borrowed larger amounts – $19,300 vs. $12,100 in constant 1999 dollars, on average. This doesn’t include borrowing by parents. And then there’s the credit card debt students have racked up in the past two decades, but that’s another story.
Even though default rates have come down, they’re still running at about 4.5% a year on guaranteed loans, according to the Education Department (chart, page 29). That would indicate perhaps $9 billion a year in charged-off student loans going to collections agencies for recovery, and some of that potentially could be sold to third parties.
But debt buyers and broker executives say that, so far, they are not seeing many deals. Perhaps 3% of the $85 billion in chargeoffs that David Ludwig, president of Edwardsville, Ill.-based brokerage National Loan Exchange Inc., estimates will be sold in 2005 will be student loans (chart, page 30).
“We don’t see a lot of deal flow, and as a result don’t have a lot of experience serving student-loan paper,” says Michael Meringolo, senior vice president of NCO Group Inc., a Horsham, Pa.-based debt buyer and collections firm. “It doesn’t make sense for us to be venturing out into the unknown at this point.” Adds Dennis Hammond, executive director of the Santa Fe Springs, Calif.-based Debt Buyers’ Association: “That’s a small market area, a niche area.” Federally guaranteed student loan programs generally insure lenders against 98% of their losses. Most lenders and servicers involved with the federal programs either work troubled loans internally or use third-party agencies. Only a relative few charged-off student loans that originate under guaranteed programs head to the debt-sales market, and by then they may have lost their guarantees. go to website citi student loans
“There’s not been the volume in the market to justify us getting in,” says Tim Kirkpatrick, president of LoanTrade Inc., a Boca Raton, Fla.-based brokerage that concentrates on charged-off credit card, automobile, telecommunications and consumer loan receivables. “The origination volumes are not comparable to other types of consumer debt.” But some buyers sense the student bad-debt marketplace has growth potential and are undaunted by its esoteric structure. These buyers believe traditional stalwarts of the bad-debt market such as credit card loans are not growing fast enough to meet their earnings projections. “The credit card market is relatively mature, and these guys need to grow their business,” says Louis DiPalma, managing partner of New York City-based debt brokerage Garnet Capital Advisors LLC. “They need new avenues of growth. It’s really not that complicated.” The lowest-hanging fruit, though not necessarily the sweetest, is non-guaranteed bad debt from truck-driving schools. Somewhat higher-grade receivables come from business colleges and other private technical and trade schools.
“Right now there is lots of paper from private schools, that’s where the market is growing,” says DiPalma. in our site citi student loans
While recovery rates on debt from private trade schools are lower than those for four-year state or private degree-granting universities, chargeoffs from these schools have one thing in their favor. The newly enacted bankruptcy reform act removed the dischargeability provision from such loans, meaning graduates of trade schools can no longer file bankruptcy to avoid repayment. But it’s too soon to know the effect of the change on collections and sales of trade-school chargeoffs.
The force in student loans is Sallie Mae, formally the Student Loan Market Association. Founded in 1972 as a government-chartered entity to grow and bring liquidity to the student-loan market, Sallie Mae buys government-guaranteed and private loans from lenders and securitizes them – pools receivables and sells them as bonds, mostly to institutional investors. Sallie Mae securitized some $11.3 billion in student loans in 2005’s first half.
Sallie Mae today is the chief arm of Reston, Va.-based SLM Corp. SLM’s second-quarter balance sheet lists assets of $66.7 billion in federally insured student loans and $6 billion in private education loans.
Last year, SLM bought a controlling, 64% stake in the parent company of a top bad-debt buyer and collections company, Niles, Ill.-based Arrow Financial Services. The $165 million deal gave SLM access to cash flows from other types of receivables, and Arrow an edge on collecting on non-performing student loans. Exactly how much student debt Arrow buys or manages, and how the family-run firm works with its new owner, is unclear. Executives from Sallie Mae and Arrow passed on repeated CCR requests for interviews.
SLM was servicing $7.3 billion in defaulted student loans and another $2 billion in other loans, according to its second-quarter report. Observers say few of Sallie Mae’s non-performing receivables find their way to the third-party debt marketplace. NLEX handled several sales on behalf of Sallie Mae a few years ago, according to Ludwig.
One complicating factor in buying receivables originated under the federal guarantee programs is whether the guarantee remains in force if a non-performing loan is sold. Brokers generally say the guarantee goes away upon sale, but in some cases can be reinstated.
It’s no surprise then, given Sallie Mae’s dominant presence and the legal strings attached to guaranteed student loans, that the bad student loans that do sell tend to come from private trade schools and similar institutions. This is despite the fact that the overall volume of private education loans is much lower than the guaranteed loans.
Garnet’s DiPalma says market interest in such loans is slowly building, in part because of the aforementioned need for growth but also because of what he calls “a natural progression” in institutional knowledge about how to price, sell and collect on different loan types. “There is no seminal event,” he says.
Chargeoffs on trade-school loans can easily hit 9% or 10% of receivables, according to DiPalma, about twice the rate of federally guaranteed loans. Loans to graduates of the Ivy League and other elite universities default at even lower rates. The most reliable predictor of default is failure to graduate, he says.
Average balances on charged-off trade-school accounts run about $6,000 compared with $12,000 to $14,000 on junior/community college accounts and $24,000 to $26,000 for four-year institutions, according to DiPalma. But medical, dental and veterinary school loan balances can exceed $100,000.
The unique nature of the student-loan market manifests itself in pricing. The market apparently builds in a premium for education loans because of the nature of the debtor: A borrower may have defaulted on his loan, but at least he’s shown some gumption by the very act of going to school. There’s more hope for repayment than there is on an unsecured credit card account saddled with purchases of iPods and pizzas. “You look at the debtor – it’s someone trying to improve himself,” says NLEX’s Ludwig. “If it’s school they have completed, at some point they will be employable.” Ludwig estimates student loans garner a 20% premium over unsecured consumer loans.
Meanwhile, Garnet’s DiPalma describes recent pricing trends in education paper as “very good,” but adds that it’s hard to give meaningful ranges. “Every deal is so different,” he says, venturing that he’s seen paper go for 2 cents to 27 cents on the dollar. DiPalma expects his firm to have brokered about $50 million in student-debt deals during 2005, which he says is “about as much or more than anyone else.” While the brokers are hopeful about the student-loan chargeoff market, potential buyers remain wary. Some will enter the market as a sidelight to build business with current or potential loan-originator clients. Beaverton, Ore.-based receivables-management firm Genesis Financial Solutions Inc. did just that in October when it bought two pools of charged-off student loans with a total face value of $2.7 million. Genesis bought the receivables “to build a relationship” with a valued client, according to Brian Enneking, senior vice president of lending.
Enneking describes the volume of charged-off loans from private institutions as “very sporadic,” but adds, “I think it’s becoming a bigger dollar number.” Similarly, NCO Group’s Meringolo says his firm would dabble in student loans “to the extent we had a client who came to us … and if the deal were substantial enough.” What constitutes “substantial” is open to interpretation, but the volume of student loans seems likely to grow as tuition increases far outpace income growth and federal budget deficits create pressure to supplant tuition grants with loans. More loans will mean more chargeoffs, and with that may come more opportunities, however fitful, for the debt-sales market.