Credit unions have shown a growing interest in offering private student loans in recent years. In addition to advancing the credit unions’ mission of serving their members and communities, private student loans offer relatively high yields, an opportunity to diversify the balance sheet, and a means to attract new members, especially among Millennial and Gen Z borrowers. According to SNL data, as of March 2018, credit unions held more than $4.4 billion in student loans, up 14 percent from the previous year.
Credit union involvement in the student lending business started in 2009, shortly after the Great Recession as a way to recapitalize an industry and provide alternative education funding sources for their members. As in any new asset class, risk was a major concern, and the use of credit default insurance became popular in those early days. As experience and performance history accumulated, many credit unions began offering uninsured student loans, relying on the fact that the private student loan asset class has historically performed well from a credit quality perspective.
As interest in education lending has increased, new credit union entrants find there are several other “non-insurance” options available to properly tailor a program based on their institutions’ risk tolerance. They can choose to “sell”, by originating student loans and subsequently selling them to an institutional investor; “invest”, by purchasing participation interests in student loans and spreading their exposure; or “hold”, by keeping 100% of the loans that they originate.
For credit unions that wish to serve their members’ needs for student loans, or who hope to use the offering to attract new members, originating loans for sale is a way to gradually enter the market while learning the dynamics of the asset class. Under a forward sale program, the credit union originates loans that it later sells to investors in secondary market transactions. The originating credit union lender initially funds 100 percent of the loan, but achieves liquidity upon sale to the secondary market, freeing up the balance sheet for further lending while mitigating credit risk. Furthermore, the originating lender maintains the member relationship, and has an opportunity to cross-sell other products and services to the member.
Alternatively, credit unions that wish to allocate some capital to student loans, while diversifying their assets, can invest in this asset class by joining a participation network and purchasing participation interests in the student loans. Such networks enable as many as ten lenders to combine their resources to make loans under mutually agreed upon underwriting and pricing criteria. The originating lender retains a 10 percent ownership stake, while the participating lenders independently review each loan file before purchasing proportional participation interests of the remaining 90% of the loan. Since each lender holds 10 percent shares in a variety of loans across the U.S., the participation network can improve the credit unions’ balance sheets by reducing the concentration risk potentially associated with lending in a small geographic region.
Finally, credit unions that wish to commit a greater level of capital to student lending have the option of tailoring a custom program and holding 100 percent of the loans on their balance sheets. The originating lender can specify its own underwriting and pricing parameters, and has the opportunity to brand and market the student loan products as it wishes. While credit unions overall are making increasingly effective use of their balance sheets, (the national loan-to-share ratio is currently around 80.7 percent) there is clearly room for many credit unions to deploy their balance sheets more efficiently in higher yielding asset classes such as student loans. A custom program is a means to achieve this goal.
Credit unions need to determine how best to serve and attract members, manage their balance sheets, and maintain appropriate risk exposure. As this asset class continues to expand, so will the opportunity to capture prime millennial borrowers at the beginning of their credit journey. Choosing the right level of commitment – sell, invest or hold – allows a credit union to find a solution that meets its objectives, while providing access to the education financing students need to realize their dreams.
