Student Loans Come Due

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Just as the Federal Reserve raises rates and inflation hits a 40-year high, Americans with federal student loan debt will start making payments on the debt after a two-year pause. On Aug. 31, the Department of Education will require 41 million people with student loans to begin paying again. 

According to the Federal Reserve, about one in five Americans have federal student loan debt and they saved $5 billion per month from the forbearance. It’s safe to say that a lot of people are going to struggle to restart those payments again and some of them work for banks.

The good news is that there are new employee programs that can help. One CARES Act provision allowed companies to pay up to $5,250 toward an employee’s student loans without a negative tax hit for the employee. Ally Financial, Fidelity Investments, SoFi Technologies, and First Republic Bank are a few of the many financial companies offering this benefit to employees. First Republic launched its program in 2016, after its purchase of the fintech Gradifi, which helps employers repay their employees’ loans. These programs typically pay between $100 and $200 a month on an employee’s loans, and usually have a cap.

The 2020 Bank Director Compensation Survey shows that 29% of financial institutions offered student loan repayment assistance to some or all employees. Many of those programs discontinued when the student forgiveness program started. In the anticipation of government forbearance coming to a close, now is a good time to think about restarting your program or even developing one. 

Americans now hold $1.59 trillion in student loan debt, according to the Federal Reserve. How did we get here? College got more expensive— much more expensive. 

Earlier this summer, the Federal Reserve and Aspen Institute had a joint summit to discuss household debt and its chilling effect on wealth building. The average cost of college tuition and fees at public 4-year institutions has risen 179.2% over the last 20 years for an average annual increase of 9.0%, according to EducationData.org.

At the same time, wages have not shown much inflation-adjusted growth. ProPublica found in 2018 that the real average wage of workers, after accounting for inflation, has about the same purchasing power it did 40 years ago. And inflation in 2022 has far outpaced wage increases. Some economists speculate that any pandemic-era wage increases are effectively nullified by this rapid inflation.

Not all borrowers are equally impacted. Sixteen percent of graduates will have a debt-to-income ratio of over 20% from their student loans alone, according to the website lendedu.com, while another 28% will have a DTI of over 15%. The 44% of graduates with that level of debt exiting school will face a steep climb to meaningful wealth building. The students that didn’t graduate will have an even harder climb.

Those graduates who struggle with their student loans will be less likely to buy a home or more likely to delay home ownership. They will be less likely to take on business debt or save for retirement. Housing prices have risen in tandem with education prices. The “starter home” of generations past has become unattainable to many millennial and Gen Z debt holders.

More than half of borrowers owe $20,000 or less. Seven percent of people with federal debt owe more than $100,000, according to The Washington Post. Economists at the Federal Reserve say borrowers with the least amount of debt often have difficulty repaying their loans, especially if they didn’t finish their degree. Conversely, people with the highest loan balances are often current on their payments. It’s likely that people with higher loan debt generally have higher education levels and incomes.

The Aspen Institute published a book known as “The Future of Building Wealth: Brief Essays on the Best Ideas to Build Wealth — for Everyone,” in conjunction with the Federal Reserve Bank of St. Louis. It illuminates long-term solutions for financial planning, focusing on policies and programs that could be applied at a national scale. 

In the absence of these national solutions, some employers are taking the matter into their own hands with company policies designed to help employees with student debt. Those banks are making a difference for their own employees and are part of the solution. 

Five Steps to Mitigate the Risk of HELOC Delinquencies

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8-11-14-Sutherland.jpgOver the next three years, 60 percent of home-equity lines of credit (HELOCs) are coming due, setting the stage for a new wave of potential credit losses for banks and other lenders. The majority of these loans—opened at the height of the housing bubble when underwriting standards were less stringent than they are today—will reach the 10-year mark between 2015 and 2017. Roughly $30 billion in outstanding home equity loans are due to reset by the end of this year, according to the Office of the Comptroller of the Currency.

As these HELOCs mature, and borrowers must begin to pay interest and principal versus interest alone, many consumers will see their payments as much as triple. A recent report from Moody’s Investors Service illustrates the payment shock in dollars: A homeowner with a $40,000 line of credit balance and a $210,000 mortgage at 4 percent interest could face a 26 percent increase of almost $300 more per month. More shock waves will ripple among borrowers with home equity lines that require a balloon payment; they will owe the balance in full.

Here are five steps banks should take immediately to mitigate the impending HELOC credit risk:

Take a Close Look at the HELOC Portfolio
Banks have a tendency to focus on first mortgages. But now is the time to zero in on the HELOC portfolio and conduct a thorough analysis for potential risks. Look at your borrowers’ credit history. Identify customers who are likely to default. Reach out to these individuals and make sure they know exactly what’s happening and how much they owe.

Be Proactive, not Reactive
Reach out to borrowers whose loans are nearing a reset in payment. Notify borrowers immediately if the bank is going to extend the interest rate. If the payment will jump, tell them when and by how much. Assess the borrower’s current monetary circumstances. Has there been a job layoff or loss of income in recent years? Have household expenses increased due to college tuition or the birth of another child?

Develop Loss Mitigation Programs
Explore flexible, viable alternatives to avoid defaults and reduce losses. Does the borrower have enough equity in his or her home today to refinance out of the HELOC? Develop loan modification programs aimed at HELOC consumers. Be creative and design programs that fit their current financial situations.

Consider Outsourcing
Given the heavy load of impending mitigation issues, it may be tough to handle everything in-house. There are several reasons why banks should consider outsourcing all or part of their mortgage and HELOC operations:

  • Now more than ever, banks need to focus on their core work. Outsourcing HELOC activity will enable them to address home equity issues and allow for a continued focus on core functions.
  • Regulators are encouraging banks and lenders to get ahead of the HELOC issue—a good outsource provider with experience and licenses can handle this swiftly.
  • Regulatory burdens such as the SAFE Mortgage Licensing Act of 2008 and the Dodd-Frank Act of 2010 have squeezed profit margins due to rising compliance costs, making it tougher for banks to be profitable.
  • Rising compliance costs and net interest margin pressure continue to impact banks as they search for ways to streamline processes and cut expenses.

Choose the Right Provider
Many bank executives worry that outsourcing will negatively affect the customer experience. Conversely, the right provider will support and strengthen banking relationships. Here are three key attributes to look for:

  • Domain expertise: Find an outsourcing provider with demonstrated experience in the banking/mortgage industry. You need a provider that understands the complexities of products like HELOCs and mortgages, as well as how cycle times affect the customer experience.
  • Geographical location: Particularly critical for regional banks and lenders, select a BPO with a strong onshore presence to ensure streamlined, timely service to domestic customers.
  • Pricing flexibility: While the traditional Business Process Outsourcing pricing model is calculated based on the cost of employees, consider a provider that can offer transactional or outcome-based pricing, which is most beneficial for banks in terms of cost savings.

For more information on this topic, see Sutherland’s videos on “The Risks and Opportunities of Home Equity Loans” and “Mortgage Outsourcing: Benefits Beyond Cost Savings“.

What Falling Home Prices Mean for Banks

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skydive.jpgThe most recent S&P/Case-Shiller Home Price Indices declined 4.2 percent in the first quarter of 2011 on top of an earlier 3.6 percent drop in the fourth quarter of 2010. “Nationally, home prices are back to their mid-2002 levels,” according to the report.

If you are a connoisseur of home price data—and the countless expert predictions since the market’s collapse in 2007—you know that the housing market should have bottomed out by now and been well into its long awaited recovery. There was a slight rebound in housing prices in 2009 and 2010 due to the Federal Housing Tax Credit for first-time homebuyers, but that rally pretty much died when the program expired on Dec. 31, 2009. Now, housing prices are falling again like a skydiver without a parachute.

Recently I called Ed Seifried, Ph.D., who is professor emeritus of economics and business at Lafayette College and a partner in the consulting firm Seifried & Brew LLC in Allentown, Pennsylvania, to talk about the depressed housing market and its impact on the banking industry. Seifried is well known in banking circles and was a keynote speaker a few years ago at our Acquire or Be Acquired conference.

“We’re pretty close to a structural change in housing,” Seifried says. You, me and just about everyone else (including, apparently, former Federal Reserve Chairman Alan Greenspan) was taught that home prices always go up—sometimes by the rate of inflation, sometimes more—which made it a pretty safe investment. “That dream has pretty much been shattered,” Seifried continues. “The Twitter generation is looking at the European (housing) model, which is smaller and more efficient. Your home shouldn’t be a statement of your wealth.”

A broad shift in housing preferences could have important long-term implications for the U.S. economy, since housing has been one of our economy’s engines of growth for decades. What is absolutely certain today is that a depressed housing market is hurting the economy’s recovery after the Great Recession, and that has broad implications for the banking industry.

A depressed housing market translates into a depressed mortgage origination industry, which has significant implications for the country’s four largest banks—Bank of America, J.P. Morgan Chase, Citigroup and Wells Fargo—which have built giant origination platforms that might never again churn out the outsized profits they once did. In fact, I wouldn’t be surprised to eventually see one or two of them get out of the home mortgage business if Seifried’s structural change thesis is correct.

Community banks that lent heavily to the home construction industry during the housing boom are either out of business or linger on life support. But even those institutions that did not originate a lot of home mortgages, or lent heavily to home builders or bought lots of mortgage-backed securities are being hurt because housing’s problems have become the economy’s problems.

In a recent article, Seifried points out that for the last 50 years housing has contributed between 4 and 5 percent of the nation’s GNP. In the 2004-2006 period, that contribution rose to 6.1 percent.  In 2010, housing accounted for just 2.2 percent of GDP—and dropped to 2.2 percent in the early part of 2011. Seifried also estimates that the housing market accounts for 15-20 percent of all U.S. jobs when “construction and its peripheral impacts are weighed.”

“It’s difficult to imagine an overall economic recovery that can generate sufficient jobs to return the U.S. economy to full employment without a return of housing to its historical share of GDP,” he writes.

In our interview, Seifried told me of a recent conversation he had with a bank CEO who thought his institution was reasonably well insulated from the housing market’s collapse because it had made relatively few construction loans. But that bank still experienced higher than expected loan losses because of all the other businesses it had lent to that ended by being hurt by the housing downturn.

Indeed, virtually no bank in the country is immune to the housing woes because banks—even very good and very careful ones—require a healthy economy to thrive. The U.S. economy needs a strong and growing housing market to thrive, and that doesn’t seem to be anywhere on the horizon.