As college becomes less and less affordable, private student loan companies are originating more loans, then securitizing those loans to yield-hungry investors, the Wall Street Journal reports. Sallie Mae, which is the largest U.S. student loan lender, sold more than $1 billion in securities backed by private student loans last week and demand outstripped supply for the highest yielding securities by 15 to 1.
The story goes on to report that Second Market Holdings today rolled out a trading platform so that lenders can issue these securities directly to investors.
What’s driving increased borrower interest is that student loan securities carry higher yields than many other types of fixed income securities. In an interest rate environment where the Federal Reserve is committed to keeping rates low through next year, investors are reaching for yield in different sectors, student loans being the latest.
The caveat is because of fairly high unemployment and underemployment among young people, these securities carry a fair amount of risk. Some of these borrowers are finding it increasingly difficult to stay current on their student loans. In fact, the story reports that 31 percent of borrowers are at least 90 days late as of Dec. 31, 2012; those rates include Federal student loans, which are securitized, and private loans. Sallie Mae says that only 4.6 percent of loans in repayment are more than 90 days past due as of Dec. 31, 2012, down from 4.9 percent in the fourth quarter of 2011.
Here are the take-aways I see:
- If you’re an investor looking for yield, don’t put too much of your bond allocation into higher-yield, riskier securities such as private student loans. Diversify your bond portfolio with either individual securities or mutual funds that have differing maturities and credit quality.
- The securitization market for riskier assets is alive and well. Just how accurately these securities are being rated and what their actual underlying risk profile will prove to be over time isn’t something we can know right now, but it bears watching. We learned all too well in the last financial crisis what a bad marriage loose credit rating standards and securitization run-amok is. Fortunately, the securitization market for student loans is much, much smaller than that of mortgages. Still, the market bears watching for signs of a bubble and other problems that could potentially destabilize the financial markets and financial institutions.