Soaring debt burdens among students financing their higher education has been receiving increased press coverage as of late and has emerged as an important presidential campaign issue. The average cost of attending a four-year private university has nearly tripled since 1990 and is fast approaching median household income in the United States, so it’s not surprising that the issue is in focus . A recent Chart of the Week by Jennifer Ripper highlighted how student loan debt was changing spending habits and home ownership rates among Millennials.
Performance for the student loan asset-backed security (ABS) market has been challenged by increasing delinquencies and defaults, slower repayment rates associated with income-based repayment plans and potential rating agency downgrades. Student loan ABS was the worst performing sector of the securitized fixed income markets during 2015.
A research report published last year by the Federal Reserve, “A Trillion Dollar Question: What Predicts Student Loan Delinquency Risk”, identifies a number of variables which help predict future student loan delinquencies. The study’s findings identify three well-understood predictors:
- delinquency rates among students who don’t graduate is significantly higher than those who do,
- graduates from for-profit schools (with or without a degree) have disproportionately greater risk of future delinquency relative to both public and not-for-profit private institutions, and
- a borrower’s credit score is highly predictive of future delinquencies.
The most surprising finding in the study is that student loan balances are a poor predictor of future delinquencies despite the “popular narrative that frequently link borrowers with high student debt burdens (and often advanced degrees) to student loan repayment difficulties.” Data in the table above depicts average student loan balance and delinquency rates by the level of degree attained, supporting this finding.
Key Takeaway: Valuations today within the student loan ABS market have been negatively impacted by market fears regarding the sustainability of student debt burdens. Despite these fears, pockets of opportunity exist for investors who can successfully identify securities backed by loans with specific borrower characteristics and ample credit support.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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