[March 25, 2015]

Fitch: Private Student Lenders Get Little Boost in House Budget

The Federal budget outline put forward by Republicans in the US House of Representatives last week proposing limits on Pell Grants would provide little boost to private student loan demand, should the education proposals become appropriations later this year, says Fitch Ratings. We believe the larger impact would be to increase demand for loans originated through the US Department of Education's Federal Direct Loan Program (DLP).

Pell Grants, which are not loans and do not have to be repaid, are need-based grants to low-income students. Alternative sources of funding to Pell Grants have tended to be federal loans and not private student loans, mostly due to private lenders' focus on the opposite end of the borrower spectrum.

The House budget proposal, along with the Senate proposal also released last week, can indicate the direction of appropriation bills that will stipulate the precise spending for US programs in the federal fiscal year beginning Oct. 1.

Under the House proposal, the maximum Pell Grant award would be capped at the 2015-2016 academic year level of $5,770 over the 10-year budget window. While no specific changes to the Pell Grant's eligibility criteria were outlined in the proposal, eligibility considerations may be up for debate in the final education appropriations. Limiting or curbing appropriations for the Pell Grant program would mean that students would need to fund a greater portion of higher education expenses through other sources, including other grants and scholarships, individual contributions (e.g. parent and student income and savings), federal loans, and private loans, with the latter often being less preferable for many borrowers.

Sallie Mae, Discover and Wells Fargo (News - Alert), which account for the vast majority of all private student loan originations in the US, have focused on originating private student loans with high cosigner rates (typically 85%+) and to borrowers with high FICO scores (typically 700+). Factors that could be more meaningful drivers of private student loan growth include rising tuition costs, limited wage growth or failure of DLP lending limits to keep pace with tuition growth.

Historically, there has been an inverse relationship between the availability of federal program funds to students (such as Stafford Loans and Pell Grants) and private student loan originations, which can be seen in these charts.

Click here to view related charts.

The charts show a steep decline in private student loan originations from a peak of $23.7 billion in academic year 2007-2008 to $6.5 billion in academic year 2010-2011. Over the same period, funding for Stafford Loans and Pell Grants increased to $132.1 billion from $79.8 billion, while the number of Stafford loan borrowers increased to 17.8 million from 11.6 million and Pell Grant recipients increased to 9.3 million from 5.5 million. Other factors contributed to the decline in private student loan originations over the review period, including a reduction in lending to for-profit schools, tightened underwriting criteria, the exit from the business by several market players and dislocation in the capital markets.

Fitch expects regulatory, legislative and litigation risk within the private student loan industry to remain elevated over the near to intermediate term. Policymakers will continue to evaluate the potential benefits of a number of additional ideas. These include increasing the number of options available to distressed student loan borrowers, implementing programs to incentivize student loan borrowers to refinance existing loans, and enabling private student loans to be dischargeable in bankruptcy.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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