Banks Are Backing Away From Student Loans

The heavy debt burden many college students shoulder in the United States has been a front-and-center story lately, particularly as a grim jobs picture makes paying off onerous student loans look less and less likely. As cumulative student debt reaches $1 trillion and the New York Fed estimates that approximately 27% of student loans are currently in arrears, big banks are reading the writing on the wall and getting out while the getting's good.

American Banker reports that US Bancorp (NYSE: USB  ) stopped accepting student loan applications in late March, and JPMorgan Chase (NYSE: JPM  ) will entertain such loans only for its customer base starting next month. Smaller banks such as First Financial Bankshares (NYSE: FFIN  ) have also shuttered their college loan departments.

What's going on here?

More risk and regulation, less profit
When the federal government backed student debt, these loans were much less risky for private banks to originate. Federal guarantees ended two years ago, however, while the default rate shot up to nearly 9% last year. As if that's not enough to sour banks on student loans, the new Consumer Financial Protection Bureau has been collecting complaints about these loan products and is thinking about placing more stringent controls on lenders.

While college students may borrow up to $31,000 in federal Stafford loans, the average cost of a four-year college education keeps going up: Estimates put the cost at more than $32,000 per year for the 2009-2010 school year. Obviously, a Stafford loan isn't going to cut it, so students turn to private lenders. Banks generally charge higher interest rates and fees for these loans, but higher default rates make these loans much less attractive to lenders. Possibly adding to lenders' jitters is legislation being proposed by Sen. Richard Durbin (D-Ill.), which would allow such loans to be erased through bankruptcy -- something that is currently not allowed.

This is on top of a recent move by the Obama administration that starting in 2014 will allow students to limit monthly payments to 10% of their income after basic expenses as well as forgive remaining debt after two decades or sooner. The plans will be paid for by reducing middleman subsidies to private lenders.

Fool's take
Both JPMorgan and US Bancorp say the portion of student loans they write is so small that it's just not a profitable venture, while First Financial noted the lack of profitability and difficulty moving such loans off its books. It seems possible to me, though, that these banks see a storm brewing over student debt and decided to cut and run.

Not everyone is leaving the scene, however. Discover Financial Services (NYSE: DFS  ) joined the industry in late 2010, when it purchased a chunk of the Student Loan Corporation's loan portfolio. Since then, it has acquired more of these loans and has begun writing loans as well. SLM (NYSE: SLM  ) , better known as Sallie Mae, bought up a large portion of Student Loan Corporation at the same time as Discover and has made a nice living on lending money to college students, though not without turmoil. The private lender was sued last year for tacking fees of 25% onto student loans before sending them to debt collectors.

As more banks exit the business, students will have fewer options to secure financing for college, possibly making these loans even more expensive than they are right now. Unfortunately, the future doesn't look bright for either lenders or borrowers, which is probably why the smart money is getting out.

It is, however, refreshing to see that banks are beginning to take steps to avoid activities that could put their profits at risk. If you love banks but are still concerned about risky lending practices, I invite you to take a look at this free report, which outlines some very stable banking investments. You'll quickly discover why Fool experts have called them The Stocks Only the Smartest Investors Are Buying.

Fool contributor Amanda Alix owns no shares in the companies mentioned above. The Motley Fool owns shares of JPMorgan Chase and has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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  • Report this Comment On June 05, 2012, at 8:12 PM, devoish wrote:

    The real cost a student pays for college is less than the $32,000 average list price. There is always a "sale", then you get loans.

    <<NAICU doesn’t collect dollar amounts, just percentage increases and decreases, but other organizations do, even if the data are a little old. The College Board reports that tuition and fees at private colleges and universities averaged $27,290 in 2010-11, while net tuition (after grant aid from all sources and federal tax benefits are factored in) averaged $11,320. Over five years, the net inflation-adjusted cost of tuition and fees at private colleges actually declined by 11.2 percent, according the College Board>> - http://www.businessweek.com/bschools/blogs/mba_admissions/ar...

    But you cannot be seriously writing this article. Banks were getting a free ride from the Gov. who would lend them the money to lend at higher cost to students and then gaurantee the loan against default.

    Putting an end to that free ride was and always will be the right thing to do, and if it means that students have "fewer choices" but the remaining choice of a direct to the student Government loan is 3% less expensive to the student, then good. It is the way it should have been done in the first place, instead of subsidizing more costly private loans.

    Best wishes,

    Steven

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