The value of outstanding student debt has exploded in recent years, and debt balances have now reached $1.3 trillion in face value, roughly the same size as the US high-yield corporate bond market according to a recent report from Goldman Sachs analysts Marty Young and Lotfi Karoui.
The student loan market may be the same size as the high-yield market, but its credit fundamentals couldn’t be more different. Indeed, according to Goldman’s analysts, the quarterly transition rate for student loans that falling into serious (90+ delinquency) is 9.6%. The transition rate for mortgages is 1.2%. In some cases the default rate is much higher:
“The Federal Reserve Bank of New York estimates that of students who left college in 2010 and 2011, 28% defaulted on their student loans within five years. Default rates rise to 42% for borrowers with below average family incomes attending private for-profit institutions, but are high (13%) even for borrowers from above average income families attending not-for-profit private schools.”
Student Loans Outstanding: The Treasury’s Problem
Student loan delinquency rates tend to be much higher than other types of debt because student lending programs ” have relatively looser underwriting, student loans are unsecured, and because non-performing student loans cannot be charged off even in bankruptcy,” the report notes.
High levels of student debt are negatively affecting homeownership rates as borrowers are struggling to both save and pay off creditors at the same time. However, even though high levels of student debt are having an impact on borrowers’ behavior, overall they don’t present systemic financial risks in the eyes of Young and Karoui.
That’s because most student debts are backstopped by the government and the risk of default is borne by the US Treasury:
“Of the >$1.3 trillion in SL loan debt outstanding, $190 billion is held in securitized format within asset backed securities, or ABS, of which $150 billion is associated with student loan programs such as FFELP in which the repayment of principal is guaranteed by the US government. Most of the remaining SL debt not in ABS format is provided to students by the US government through its Federal Direct lending program. Thus, in total, the substantial majority of student loan default risk is borne by the US Treasury.”