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It was bound to happen.
So-called alternative financing sources for student loans have been popping up all over the place. Some take a peer-to-peer (P2P) approach, where individuals with a few bucks to spare and hopes of a better-than-market return lend to others who are looking for a good deal on a loan.
P2P companies serve as matchmakers of sorts. The firms pair pre-screened applicants with investors who set the credit and pricing ground rules for the loans they’re eager to make. The fees that the P2Ps earn may come from arranging the match and babysitting (servicing) the offspring (loans) over time.
The more traditional alternative lenders are somewhat less paternalistic.
A number of high-powered professional investment companies—including private equity and hedge fund firms—are backing a string of nonbank lending operations that are busy staking out market positions in a variety of business sectors.
Higher education is one of these.
The reason for the interest is obvious: More than $1 trillion worth of student loans, a portion of which will make its way into the private market at some point. For example, some borrowers may require additional financing after maxing out the amount they can get from federal programs. Others may need to combine and refinance their government and private student loan debt later on.
What’s less obvious is the lenders’ control over the selection process, and the fact that even if a bad deal were to slip through anyway, all student loans—government and private alike—continue to be virtually impossible to discharge in bankruptcy.
The selection process is attracting a bit of attention these days. Some lenders are seeking to improve upon their already good repayment odds by exclusively marketing to those students who are pursuing historically high-paying areas of study at premier colleges and universities. As for the rest, their rates are typically higher and their loans may need to be co-signed by deep-pocketed parents or other close relatives.
To paraphrase Orwell, all students are equal, but some are more equal than others.
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Meantime, there’s news that the first of these alternatively-originated loans are ending up in securitizations.
Fundamentally speaking, this form of structured finance serves two key purposes: It broadens lending capacity by recycling previously originated loans, thereby freeing up the lenders to grant new credit. It also locks in the originating lender’s profit, which is typically expressed in terms of the difference between the interest rates that borrowers are charged and those that are paid to investors to whom the loans are ultimately sold through one of these complex transactions.
The integrity of the investors’ rate of return depends on three things: an originally agreed-to payment stream that will not change, a loan value that can be expected to amortize as it was intended and a repayment term that will also remain intact.
Reduce the payment amount, forgive a portion of the loan value or extend the duration and the investor’s rate of return could get hammered—which explains the strong reluctance on the part of their agents (loan servicers) to meaningfully restructure or permanently modify securitized loans for distressed borrowers, whether for home mortgages or education debt.
So, as securitizations and other forms of structured-finance transactions begin to crank up in the education-loan sector, what should be done differently this time around?
As long as Congress continues to do nothing about the free pass in bankruptcy court that education lenders and investors enjoy today (including the feds), lawmakers should, at the very least, mandate two things.
First, that the governing documentation for all after-the-fact financing transactions (securitizations, in particular) makes it clear to all concerned that troubled debts will be promptly restructured or modified in a manner that is consistent with the student-loan relief programs the government has in place at the time.
Second, that everyone that’s involved in this financial conga-line — lenders, investors and loan servicers alike — will be held equally accountable for that as well.
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This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its affiliates.
Image: Robert Churchill
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