- The U.S. Government issues federal loans, while private loans are issued by non-government entities such as a bank, credit union, state agency, or school.
- To service this portfolio, the Government contracts with private entities. The entities collect loan payments, advise borrowers, respond to customer inquiries, and perform other administrative tasks on behalf of the U.S. Department of Education (NYSE:ED).
- The ED has changed substantially under President Trump. One of the more significant changes involves the Trump administration’s plan to stop using DMCS contractors for overdue student loans and give that responsibility to student loan servicers.
- Impacted companies include for-profit colleges (CECO, ATGE, CPLA, LAUR, LOPE) and student loan servicers (SLM, NNI, NAVI).
Read the Full Report Below
U.S. EDUCATION & STUDENT LOAN INDUSTRIES
There are two types of student loans: federal and private. The U.S. Government issues federal loans, while private loans are issued by non-government entities such as a bank, credit union, state agency, or school. Total outstanding federal and private loans were $1.4 trillion and $64.2 billion¹ respectively as of Q1 2018. Based on these numbers, the U.S. Government issues ~95% of all student loans.
To service this portfolio, the Government contracts with private entities. The entities collect loan payments, advise borrowers, respond to customer inquiries, and perform other administrative tasks on behalf of the U.S. Department of Education (ED). As of 2015, the contracts paid the companies $2.85 per month per borrower that is current and between $1.05 and $2.11 for each month a borrower is behind or delaying repayment. After 270 days of being behind, the loan is considered in default and handed off to another set of ED contractors, the Debt Management Collection Services (DMCS) team. DMCS contractors earn (1) $1,740 per borrower that resumes payments, or (2) 2.75% of the total balance if the borrow consolidates loans. They also receive 14-16% of the payments made through wage garnishment.
DEPARTMENT OF EDUCATION MANDATES
The ED has changed substantially under President Trump, with change being implemented across government agencies. One of the more significant changes involves the Trump administration’s plan to stop using DMCS contractors for overdue student loans and give that responsibility to student loan servicers. In addition, the ED has reduced the size and scope of a team that investigates abuses by for-profit colleges.
Outside of the ED, the Consumer Financial Protection Bureau (CFPB) recently removed ‘Student Loan Servicing’ from its Spring 2018 Agency Rule List. In addition, the CFPB team focusing on for-profit college and student loan servicing abuses, including the pending agency action against Navient, was merged into the consumer information unit.
The move is widely seen as an attempt to dismantle the consumer watchdog and refocus the mandate away from consumer finance enforcement toward providing consumers with information about legal rights and remedies.
Within the education industry, there are for-profit colleges and student loan servicers. Below is a quick summary of impacted companies:
- For-Profit Colleges: Career Education (CECO), Adtalem Global (ATGE), Capella Education (CPLA), Laureate Education (LAUR), and Grand Canyon Education (LOPE) are each for-profit educational companies. They offer a mixture of online and in-person educational programs.
- Student Loan Servicers: Sallie Mae (SLM) and NelNet (NNI) are two of the student loan servicers contracted by the ED. Since spinning out NAVI, SLM has rebranded to offer additional services such as savings accounts. NNI is also a loan servicer, but not a pure play servicer as it operates a communications segment providing fiber optic service under the ALLO Communications brand.
Navient (NAVI): NAVI is a student loan servicer, but we want to highlight it separately because it frequently gets categorized as a student lender². While the company services student loans, it doesn’t issue loans. Below are five key points:
- The company was spun out of SLM in 2014 and services a portfolio consisting of ~78% federal loans and ~22% private loans. Due to prior settlements, the company cannot issue new federal or private loans until 2019.
- The federal loans serviced by NAVI are issued under the Federal Family Education Loan Program (FFELP), which was discontinued in 2010 by President Obama. NAVI buys outstanding FFELP loans, which are still subject to the program, and services the portfolio, making the company the de facto servicer overseeing the FFELP program runoff.
- Management has indicated FFELP loans have a low loan loss provision because the company generally bears a maximum 3% loss exposure on defaults. The FFELP loans also generate steady cash flow, with net interest margins (NYSE:NIM) averaging 0.75-0.80%.
- NAVI’s private loans make up ~40% of its profit despite being only ~22% of its loan portfolio. They generate higher NIMs, typically +3%, but come with increased default risk.
- As both the federal and private loan portfolios shrink, NAVI returns cash to shareholders through a buyback program and dividends. The next evolution of the company may be whether it re-enters the student loan issuance market in 2019 and beyond. The alternative would be to let the current loan portfolio runoff.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: Sources
1. Federal Student Loan Portfolio
2. Navient 2017 10-K
Active Weighting Advisors LLC ("AWA") is an SEC-registered investment adviser that manages ETFs under the brand name EventShares Funds. Mr. Phillips is the Chief Investment Officer of AWA. The views expressed are subject to change, and no forecasts can be guaranteed. The comments may not be relied upon as recommendations, investment advice or an indication of trading intent. AWA is not soliciting any action based on this document. In preparing this document, the author has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources. Investing involves risk, including the possible loss of principal and fluctuation of value. Mr. Phillips and AWA disclaim responsibility for updating information. In addition, Mr. Phillips and AWA disclaim responsibility for third-party content, including information accessed through hyperlinks. For more information about EventShares, contact us by calling 877.539.1510 or visit our website at www.EventShares.com.