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 (NYS: USB) stopped accepting student loan applications in late March, and JPMorgan Chase (NYS: JPM) will entertain such loans only for its customer base starting next month. Smaller banks such as First Financial Bankshares (NYS: 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 (NYS: 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 (NYS: 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.

At the time thisarticle was published Fool contributorAmanda Alixowns no shares in the companies mentioned above. The Motley Fool owns shares of JPMorgan Chase and has adisclosure policy. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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