Investing in a Time of Forgiveness and Forbearance

     Financial markets don’t like uncertainty (and neither do investors) and – whether that uncertainty is rooted in geopolitics, ongoing disruptions to global supply chains, inflation and the Fed’s response to it, or the upcoming midterm elections – worries over the state of the economy can have dramatic consequences on one's portfolio. As the Market has shown over the last few months, investors are nervous (just look at the VIX). This volatility also signals that investors are looking for alternative investments to balance their exposure to equity risk. 

So, what about diversifying your portfolio by investing in Student Loan Debt?

I can almost hear the outcry: "Are you crazy?!"

I get it; with extended forbearance, all the talk about potential loan forgiveness, delinquencies, and defaults, how could investing in student loans possibly be a good idea?” 

Now, before discussing the issues of forbearance, forgiveness, delinquencies, and defaults, let me reassure you:

• • • No, I’m not crazy.
    • It’s possible for this to be a good idea because not all student loan debt is created equal.

In fact, much of the existing student loan debt can prove to be a remarkably reliable investment for both institutional and individual investors. What’s more, investors interested in using their capital to create a positive social change in the lives of individuals, families, and communities – in addition to generating income for themselves – can use investments in high quality student loans to do just that. 

     So, let’s cut through some of the noise and confusion echoing across television cable channels and politician’s (re)election stump speeches, shall we? Specifically, let’s dispel three widespread myths that could dissuade your investment student loans. (Spoiler alert: they are myths.)

1. 1. 1. “Loan forgiveness” will apply to all borrowers and, if enacted, will wipe away all student loan debt.
      2. All student loans are inherently risky and have a high risk of default.
      3. Only the government is dumb enough to invest in student loans.

Here we go…

Loan Forgiveness for All?

    To begin, only Federal loans are under the purview of governmental control and subject to decisions made by either the President or Congress. The 'Myth' is that the Executive Branch has the will and the authority to forgive all $1.7T in outstanding student debt. The 'Truth' is that:

• • • Neither the President nor Congress has the power to forgive private student loans. 
    • Approximately 10 million American households hold $136 billion in private student loans. These 10 million households are not eligible for federal loan forgiveness.

The push-back to this (and another part of the myth that requires debunking) is that ‘The Left’ is exerting extreme pressure on the Administration to forgive as much as $50,000 per borrower. 

On April 28, 2022, however, President Biden unequivocally stated, “…I am not considering $50,000 in debt reduction…but I’m in the process of taking a hard look at whether or not there will be additional debt forgiveness…” So, what does the outline of additional ‘debt forgiveness’ actually look like?

• • • If there is to be any across-the-board forgiveness of federal indebtedness, it’s more likely to be on a more moderate scale of $10,000 per individual, and
    • During his 2020 campaign, Biden outlined two additional criteria in order to qualify: an individual that borrowed their undergraduate tuition must have attended a public college or university, a Historically Black College or University (HBCU), or other Minority Serving Institution (MSI), and had to earn less than $125,000 a year. 

While no definitive plans have been announced, these are the debt-forgiveness parameters that seem most probable, with only slight or moderate variations. 

Please note, these guidelines mean that not only are all private borrowers (again, 10M borrowers with $136B of debt) out of luck, but so are college graduates who took out federal loans to attend private colleges or graduate school. Federal borrowers are also out of luck if they’re professionals and earn more than $125K. Most doctors, lawyers, MBA’s, and engineers fall into this category, and often have the highest student loan burdens. I don’t need to tell you; grad school isn’t cheap…

This brings us directly to the second myth in need of debunking:

All Student Loans Carry a High Risk of Default

     I stated earlier that not all student loans are created equal and there are billions in loans that can be a reliable investment. That said, It’s risky to overgeneralize and the broader topic of overall default-risk has long been muddied by lack of nuance.

We’ve already established that private indebtedness cannot be forgiven by federal action, so let’s begin with what we know about private loan borrowers:

• • • “The average approved private student loan borrower in 2020 has a credit score of 748... higher than the average applicant credit score of 638,” according to data from LendEDU, and
    • “…[The fact that] most private student loans are cosigned…along with the economic recovery that followed the Great Recession of 2007-2009, helps explain why the number of private student loan borrowers who get behind on their loans is low and continues to fall.” (Undergraduate Private Loan Delinquency Rate: 1.48% and Graduate Loan Delinquency Rate: 0.78%, Credible)

It’s also important to keep in mind that, although highly educated professionals often accrue the highest debt burdens, they subsequently have tremendous earning potential. As a matter of fact, across both Federal and Private Loan holders, there appears to be an inverse relationship between the amount owed in loans and the risk of default: 

• • • A 2016 White House report reveals that borrowers owing less than $10,000 accounted for 66% of the defaults that take place in the first three years of loan repayment.
    • Conversely, those owing more than $40,000 accounted for only 4% of defaults over the same period, and only 1% of borrowers who owe $200,000 or more default on their loans. 

In addition, students who complete their degree have a far lower risk of default than those who borrow and do not complete their education. As a 2015 Federal Reserve analysis concluded, “Students who take out loans but don’t earn a degree are nearly six times as likely to default as those who earn a bachelor’s degree,” and the higher the degree attained, the lower the delinquency rate on the loans. 

By contrast – and at the risk of offending them – the data pertaining to for-profit institutions is clear. Students who incur debt to attend for-profit institutions run a significantly higher risk of defaulting within the first year of repayment than those who attend private non-profit institutions: 15.6% versus 7.1%, respectively.

     By adding more data and greater nuance to the conversation, we begin to get a better understanding that, “No! Not all student loan debt is at an equally high risk of default.”

On average, borrowers who hold private student loans have both good credit scores and lower rates of delinquency or default than federal loan holders. Students who complete their bachelor’s degree and those who earn an advanced degree, even if they hold higher loan balances, are at a much lower risk of delinquency or default than those who achieve only their associates degree or those who incur debt but do not complete their education. 

Two myths down, one to go:

Only the Government is be Dumb Enough to Invest in Student Loans

     Let’s word this myth a little more delicately: only the federal government has sufficient risk-tolerance to invest in student loans.

While it’s true that more than 90% of all student loans originate with the Federal government, we’ve already resolved the matter of the general creditworthiness of the $136B in private loans originated by banks, credit unions, and other institutions that originate loans. 

But, other than these entities, who else has been… sufficiently willing… to take the risk? 

The answer is: institutional investors such as insurance companies, fixed-income fund and pension managers, and others who have already invested billions in collateralized private Student Loan Asset Backed Securities (SLABS). In 2021 alone, $17.96B was invested in these private loans, and – as was reported on May 17, 2022  –  Navient issued a $714.6M SLAB. Of this securitized pool of loans, $678M were rated AAA, and the remaining 36.6M were rated AA. 

So, Now What?

You’ve noticed that, up until this point, I’ve avoided discussing one segment of the investing population. While major financial institutions and fund managers have been able to take advantage of this opportunity, there hasn’t been a mechanism for individual investors, family offices, or foundations to participate in the returns generated by high-quality and reliable student loan repayments.

This is the vehicle that Impact Capital Funds has developed to allow Socially Conscious & Impact Investors to participate.

The next few months of 2022 will be filled with a cacophony of divergent, strong (and loud) opinions. So just focus on these facts:

• • • Only federal student loans can be forgiven by the government and any forgiveness will likely be quite limited in scope.
    • Not all student loans are at high risk of default and many private loans, cosigned private loans, and even high balance loans held by graduate school alumni are far less risky than federal loans.
    • These same loans are (almost) infinitely less risky than low-balance loans held by students who did not complete their studies or attended for-profit institutions. 
    • Institutional investors, banks, credit unions, and other financial institutions are already profiting from their investments in student loan repayment. 

Through ICF’s Student Loan Impact Fund, accredited investors can make a significant impact in the lives of successful college graduates and young professionals while enjoying a reliable and stable source of income.

It’s a Win-Win—and that’s not a myth.