1. 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
1 FRBNY Consumer Credit Panel/Equifax
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 2003-2007 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.
FSR Insights
Financial Instruments, Structured Products & Real Estate Insights
September 2013
Private Student Loans Market
2. FSR Insights September 2013 www.pwc.com/fsr
PwC 2
Increased funding costs and reduction of
margins has resulted in only 20 of the 93
private lenders during the credit boom of
2001-2007 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
2 Continuing Education: A Review of Private Credit
SLABS, Deutsche Bank
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 co-
signers, 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.
Between 2001 and 2007 private lending grew from 11% of total student loans to 23%. The share of private loans has
markedly contracted since 2008.
Source: College Board, Trends in Student Aid 2012
3. FSR Insights September 2013 www.pwc.com/fsr
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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 2010.
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
$31,000 over the 4 year period.
3 https://studentloans.gov/myDirectLoan/index.action
Post-credit crisis
Even as demand for consumer Asset Back
Securities (ABS) increases, private student
loan ABS issuances remain lower than pre-
crisis levels. Issuance trends in other
consumer ABS products are shown in the US
ABS Issuance by Sector chart below.
A number of hurdles exist for growth in the
private student loan ABS market. These
include:
• declining applications to graduate
schools, such as law schools or MBA
programs
• decreased demand for funding and
reduced enrollment in For-Profit
Educational Programs
The decline in For-Profit Education comes at
a time of increased government focus on the
effectiveness of the sector and the potential to
decrease grant availability to students seeking
this type of education.
FFELP vs Traditional Private Student Loans
(Dollars in millions)
Balance % Balance % Balance % Balance % Balance % Balance %
Loans in-school/grace/deferment 17,702.00$ 22,887.00$ 28,214.00$ 5,904.00$ 6,522.00$ 8,340.00$
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 75,499 83.20% 77,093 81.90% 80,026 82.80% 28,575 90.70% 27,122 89.90% 24,888 89.40%
Loans delinquent 31-60 days 4,710 5.20% 5,419 5.80% 5,500 5.70% 1,012 3.20% 1,076 3.60% 1,011 3.60%
Loans delinquent 61-90 days 2788 3.10% 3438 3.70% 3178 3.30% 481 1.50% 520 1.60% 471 1.70%
Loans delinquent greater than 90 days 7,734 8.50% 8,231 8.60% 7,992 8.20% 1,446 4.60% 1,467 4.90% 1,482 5.30%
Total Private Education Loans in repayment 90,731 100.00% 94,181 100.00% 96,696 100.00% 31,514 100.00% 30,185 100.00% 27,852 100.00%
Total Private Education Loans, gross 124,335 136,643 146,938 38,554 38,093 37,532
Private Education Loan unamortized discount 1436 1674 1900 -796 -873 -894
Total Private Education Loans 125,771 138,317 148,838 37,758 37,220 36,638
Private Education Loan receivable for partially charged-off loans 0 0 0 1,347 1,241 1,040
Private Education Loan allowance for losses -159 -187 -189 -2,171 -2,171 -2,022
Private Education Loans, net 125,612 138,130 148,649 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%
Traditional Private Student Loans
2010
FFELP
2012 2011 2010 2012 2011
4. FSR Insights September 2013 www.pwc.com/fsr
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US: ABS Issuance by Sector
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 Mae4, 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 2021.7 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, 2013
6 Continuing Education: A review of Private Credit
SLABS, Deutsche Bank
0
10
20
30
40
50
60
70
80
90
100
110
2008 2009 2010 2011 2012 YTD 2013 Projected
2013
US ABS Supply by Sector ($bn)
Consumer Credit Cards Autos Student Loans Equipment Global RMBS Other
5. FSR Insights September 2013 www.pwc.com/fsr
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US Consumer Price Indices and Cost of Education (Jan 2000 = 100)
Source: Bureau of Labor Statistics
Average Annual Cost of Education (Tuition, Fees, Room and Board Charges)
Source: The College Board, Trends in College Pricing 2011
135.0
196.0
50
75
100
125
150
175
200
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
CPI Cost of Education
$38,589
$17,131
$0
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
$35,000
$40,000
$45,000
1981-82
1982-83
1983-84
1984-85
1985-86
1986-87
1987-88
1988-89
1989-90
1990-91
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
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1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
Academic Year
Private Nonprofit Four-Year Public Four-Year
6. FSR Insights September 2013 www.pwc.com/fsr
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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 2011-2012 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 funding10. Structural
enhancements and disclosures have improved
8College Board “Trends in College Pricing 2012”
9 College Board “Trends in Student Aid 2012”
10 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
2006-C 2010-B 2012-A 2013-B
10%
Residual
Discount
5.08 6.42 6.22 4.75
15%
Residual
Discount
5.56 7.95 7.90 5.86
18%
Residual
Discount
5.78 8.70 8.64 6.34
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.
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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.
11 http://thomas.loc.gov/cgi-bin/query/z?c113:S.114:
12http://www.banking.senate.gov/public/index.cfm?
Fuseaction=Hearings.Hearing&Hearing_ID=d31bafb
1-22cf-455e-8cd4-2b8121209cec
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
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• 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.
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
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.
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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 third-
party 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.
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Additional information
PwC’s FSR Group
PwC’s FSR Group brings you:
A unique combination of financial
reporting, advisory, tax, finance, operational
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measures and stress testing methodologies for
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Our team is multi-disciplined and
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blending and managing services in
today’s dynamic and fast changing
markets.
Yogesh Gupta
Partner
202 414 1354
yogesh.gupta@us.pwc.com
John Gibson
Principal
202 414 4691
john.l.gibson@us.pwc.com
Andy Hawley
Principal
617 803 5993
andy.hawley@us.pwc.com
Sandilya (Sandy) Hota
Director
202 414 4516
sandy.n.hota@us.pwc.com
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Manager
202 346 5082
thomas.j.karwacki@us.pwc.com
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Associate
202 346 5021
elizabeth.fireman@us.pwc.com
