Last night, the Senate finally negotiated and passed its amendments to Bill H. R. 1911 (see the full text here), which had already been approved by the House of Representatives, that would in effect tie student loans originated by the Department of Education to the 10-year Treasury Note. The bill is now headed to the White House.
First, a quick primer on the recent history and actual affects for individual student borrowers, then we will delve into how this might affect certain companies in the sector. The bill places the loans it's making into three different categories:
- Undergraduate Federal Direct Subsidized and Unsubsidized Stafford Loans (FDSL and FDUSL) are merged into one category with the same interest rate.
- Graduate Federal Direct Unsubsidized Stafford Loans (Grad FDUSL).
- Graduate Federal Direct PLUS Loans (Grad PLUS).
Historically, the rates for the FDSL had been 3.4% and 6.8% for the FDUSL, but since Congress had not done anything, the FDSL jumped up to the level of its unsubsidized counterpart on July 1, 2013, or 6.8%. The Grad FDUSL was also priced at 6.8% by the government. These two categories' main differences compared to the third category, the Grad PLUS, are that the dollar amount of the loan is capped for the FDUSL, FDSL and Grad FDUSL, but not for the Grad PLUS. Also, the Grad PLUS commanded the highest interest rate at 7.9%.
With the president signing off on this bill, though, the interest rates will now vary annually and therefore have a basis point premium on the last 10-year Treasury note auction held prior to preceding June 1, from when the student loan funds are dispersed. According to Treasury Direct, student loans for the fall 2013 and spring 2014 semesters will now be tied to the auction that took place on May 15, 2013, and yielded 1.8%. In line with the run-up in T-Note yields, this is well under the current market, which now sits at 2.6%.
Here's a table of interest rates for each segment of federal loans that are affected by this legislation:
Student Loan Rate
FDSL & FDUSL
Based off of the futures contracts for June 2014, it appears as if the following will be the case for the fall 2014 and spring 2015 semesters:
Student Loan Rate
FDSL & FDUSL
Note: Here's the link to the CME Treasury Futures Spreadsheet Calculator, where I arrived at the 3.02%.
All of these rates now have caps, should the T-Note go through the roof, and are as follows:
FDSL & FDUSL
These significant changes should affect two participants in the student loan sector: the originator/servicer and, on the other side of the coin, you have got the consumer or the for-profit universities.
To begin with, there are the originators. They might have a tougher time competing with government loans over the next year as their interest rates are now considerably lower for the upcoming two semesters. Their credit standards, which have risen considerably since 2008, have started honing in on mainly graduate degree programs -- which they rightfully found less risky and easier to undercut the Department of Education in interest rate pricing and origination fees (Grad PLUS has a 4% origination fee). Both graduate degree interest rates now average 5.9%, which is a significant fall from the average of 7.35%. That would be far easier of a price to beat for private lenders should this legislation not pass.
The largest player is Sallie Mae (SLM), which as of June 30, 2013, maintains a $146 billion student loan portfolio. Discover (DFS) and Wells Fargo (WFC) also are large players in underwriting and holding student loans. Discover's and Wells Fargo's student loan subsidiaries might be affected more by these depressed rates than Sallie Mae, however, as their business lines of origination make up the bulk of their business. Sallie Mae, on the other hand, has a much more balanced revenue stream in its student loan segment. Its revenue is spread out between servicing defaulted loans for themselves and for the federal government, origination and underwriting and servicing ABS on legacy FFELP loans that are no longer originated. Obviously, Discover and Wells Fargo have a much larger diversified business than just student loans, so I absolutely would assert that any effects to their businesses from this piece of legislation will most likely be a rounding error on either company's top- or bottom-line numbers as a whole.
The other sector affected is the for-profits, or proprietary universities. Their public holding companies will seemingly benefit from this change in the near term, or at least over the next year. In total there are 15 publicly traded for-profit education companies; however, Kaplan, Inc., is owned by Washington Post and therefore is the only non-pure play. They are as follows:
Publicly Traded Company
American Public Education, Inc.
Apollo Group, Inc.
Bridgepoint Education, Inc.
Capella Education Company
Career Education Corporation
Corinthian Colleges, Inc.
Education Management Corporation
Grand Canyon Education, Inc.
ITT Educational Services, Inc.
Kaplan, Inc. (Washington Post)
Lincoln Education Services Corporation
National American University Holdings, Inc.
Strayer Education, Inc.
Universal Technical Institute, Inc.
According to the HELP Senate Committee report conducted last year (see the executive summary here) on these companies (which all of the above companies were included in), on average they received "86% of revenues from taxpayers." Why only 86%, you ask? Well, that's because there's a federal mandate that no for-profit university can receive more than 90% of its revenue from federal student loans.
So you can pretty much generalize that the for-profits have almost all of their students going into government sponsored debt to attend their schools. Rent-seeking organizations that almost solely rely on the government to generate and price the financing of nearly all of their prospective customers will surely be affected by any major interest rates moves like the ones in this legislation. A significant decrease in the interest rate pricing of loans will be a big boost to these companies' marketing pitches to prospective students and might lead to a higher number of students and, in turn, revenue. Of note is that the 15 publicly traded companies spend roughly 22.7% of all revenue on marketing and recruiting.
In the end, tying these interest rates to a market index over the next year should generally be 1) neutral for originators with other business lines that include servicing the government's student loan portfolio, 2) positive for companies that rely on cheap government loans to finance the majority of their customer volume, and 3) negative for any business trying to provide a cheaper alternative to federal student loans. Mind you, this is just for the upcoming year. All bets are off as to where the 10-year T-note and therefore student loan financing costs might be next year, when student loan interest rates are auctioned off by the Treasury in the days before June 1, 2014.