March 28, 2013

Taking risk, credit unions push student loans

Interest rates, default level high

Credit unions, in the hunt for younger customers and higher returns, are rapidly expanding sales of private student loans and grabbing the attention of regulators worried about the increased risks these member-owned institutions are taking.

Many credit unions in Massachusetts are among those entering the market, even as some of the nation’s biggest commercial banks are leaving, partly because of the growing risks of default as college students take on higher levels of debt, only to graduate into a labor market with few jobs.

“It’s got some unique qualities and risks that other loans don’t have,” said JeanMarie Komyathy, director of risk management for the National Credit Union Administration, the industry’s primary regulator. “It’s an unsecured loan to somebody who doesn’t have a job.”

In December, the federal agency warned credit unions to take care before jumping into the student loan market, worried that the institutions could end up with a portfolio of bad debt that could threaten their solvency — or cost their members. While private student loans may be a good fit for some credit unions, regulators said, they need expertise in this type of lending.

Student loans have a default rate of about 12 percent, compared with 4 percent for car loans and 11 percent for credit card debt, according to the Federal Reserve Bank of St. Louis.

The entry of credit unions into the private student loan market should provide families with more options, but they should first maximize federal loans, which have rates nearly half those of private loans, according to consumer advocates.

Many credit unions argue they are helping their members to finance college educations. Federally guaranteed student loans, which carry lower interest rates than private loans, are limited and insufficient for most families to cover the costs of higher education, credit union officials say.

They add they take steps to ensure that neither students nor credit unions take on debt that can’t be repaid, requiring high credit scores and parents to co-sign. “Credit unions exist to do loans,” said Paul Gentile, president of the Massachusetts Credit Union League, a trade group in Marlborough.

Credit unions are nonprofit financial cooperatives established to benefit the community and their members by providing lower-cost loans. Most provide basic consumer products to help members buy homes and cars. Massachusetts has almost 200 credit unions, with more than 2 million members.

Private student loans have become attractive to credit unions during a period of low interest rates that have squeezed the revenues of lenders everywhere. Interest rates on private student loans can range as high as 12 percent, compared with about 4 percent for a car loan and 4.5 percent for a home loan.

With increased revenues, credit unions say, they can offer members better rates on all loans. In addition, offering private student loans helps credit unions to attract new, younger members, since borrowers must join and open an account.

“It’s been a great opportunity for our credit union and our members,” said John LaHair, a spokesman for Digital Federal Credit Union in Marlborough. “It has opened the doors for people who may not have known about it.”

Nationwide, private student loans held by credit unions have jumped 25 percent from the end of 2012, to $2.5 billion in the third quarter of last year, according to the National Credit Union Administration.

In Massachusetts, private student loans at Digital Federal, the state’s largest credit union, with more than 460,000 members, jumped to $115.5 million in September from $4 million in 2008. Two years ago, Jeanne D’Arc Credit Union of Lowell held less than $300,000 in student loans; last year its student loan portfolio topped $12 million.

Massachusetts, with its many universities, is fertile ground for private student loans, and it makes sense for credit unions to want a piece of that business, said Perry O’Grady, a partner with Silver Sword Capital Partners, a sales and marketing firm in Newton. But collecting on these loans can be a challenge, he said, pointing to several big banks that are getting out of the business.

JPMorgan Chase of New York, the country’s largest bank, scaled back its student lending as federal regulators increased scrutiny of rising student debt, pegged at $1.1 trillion last year, and investors, fearful of rising defaults, backed off of buying the loans. Minneapolis-based US Bank stopped accepting new student loan applications after 2012.

Many credit unions have entered the private student loan industry by contracting with third parties, called credit union servicing organizations. These for-profit businesses provide credit screening and collection services for credit unions that don’t have the money and staff to do it themselves.

The servicers have varying degrees of control over the loans, depending on their contracts. In some cases, they determine the creditworthiness of borrowers and essentially approve the loans; in others they just process payments. Federal credit union regulators have no direct oversight of the loan servicing businesses.

Workers Credit Union of Fitchburg did not have the staff to process and collect loans, so it hired a servicing organization, said Thomas Gray, senior vice president of lending. Workers Credit Union, however, determines who qualifies for the loan and the rates they’ll pay.

Workers Credit had $30 million in student loans last year, with about 6 percent delinquent for more than two months. “The last thing we want to do is to get any member to get into a loan that they couldn’t afford,” Gray said.

Credit unions also are starting to refinance student loans, a way for borrowers to consolidate debt and lower rates. But borrowers should be cautious about refinancing federal and private loans together, said Rohit Chopra, the federal Consumer Financial Protection Bureau’s student loan ombudsman.

Federal loans come with protections, including income-based payments and forgiveness if a student becomes a teacher. If federal loans were consolidated with private loans in refinancing, those protections would be lost, Chopra said.

“It’s important for the borrower to look at everything,” he said.

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