How Negative Student Loan Trends Could Affect Auto Lending Market

By Nick Zulovich, Editor
January 30, 2013

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CHICAGO and SAN JOSE, Calif. — As CNW Research noticed subprime auto loan approvals rising year-over-year by at least 40 percent yet again this month, TransUnion and FICO Labs spotted potential trouble on the horizon for lenders and dealers working with customers who absorbed significant debt to fund higher education.

A recent TransUnion study revealed that more than half of student loan accounts are in deferred status where the repayment of the principal and interest of the loan is temporarily delayed. Analysts said deferred loans now represent 43.5 percent of all student loan balances.

The study also found that reported student loan balances increased by 75 percent between 2007 and 2012 with the average student loan debt per borrower increasing 30 percent to $23,829.

And new findings from FICO Labs are even more unfavorable.

As a group, FICO Labs determined individuals taking out student loans today pose a significantly greater risk of default than those who took out student loans just a few years ago. The situation is compounded by significant growth in the amount of debt that new graduates are carrying.

FICO Labs indicated the delinquency rate today on student loans that were originated from 2005–2007 is 12.4 percent. The comparable figure for student loans that were originated from 2010–2012 is 15.1 percent, representing an increase in the delinquency rate by nearly 22 percent.

While the delinquency rate is climbing, the average amount of student loan debt is increasing even faster, according to FICO Labs.

In 2005, the average U.S. student loan debt was $17,233. By 2012, it had ballooned to more than $27,253 — an increase of 58 percent in seven years.

By contrast, analysts said the average credit card balance and the average balance on auto loans owed by U.S. consumers actually decreased during the same period.

In a related finding, FICO's quarterly survey of bank risk managers conducted in December found that nearly 60 percent of respondents expected delinquencies on student loans to increase during the next six months. The same respondents expected delinquencies on all other types of consumer loans to decrease, putting the pessimism around student loans in sharp relief.

"This situation is simply unsustainable, and we're already suffering the consequences," said Andrew Jennings, FICO's chief analytics officer and head of FICO Labs.

"When wage growth is slow and jobs are not as plentiful as they once were, it is impossible for individuals to continue taking out ever-larger student loans without greatly increasing the risk of default. There is no way around that harsh reality," Jennings continued.

"As more people default on their student loans, their credit ratings will drop, making it harder for them to access new credit and help grow the economy," Jennings went on to say. "Even people who stay current on their student loans are dealing with very large debts, which reduces the money they have available to spend elsewhere. The stakeholders in the student lending industry have to take a hard look at the terms and repayment rules for student loans, and the industry may have to develop a new lending model to prevent a bad situation from getting completely out of hand."

For now, carriers of large amount of student loans who might be considered a subprime auto loan candidate are having decent success in getting the vehicle contract bought by a lender or buy-here, pay-here dealer.

CNW noted that subprime approvals this month are 41 percent higher than January of last year. Despite that solid year-over-year gain, the momentum is slowing.

December's year-over-year climb came in at 43.2 percent. In November, the jump in subprime loan approvals was 44.6 percent while the industry produced a 47.8-percent rise in October. September marked the strongest spike of the year-closing string at 62.5 percent.

Orchestrators of TransUnion's study noted that deferments of student loans may continue to become a consumer issue because more than half of college graduates under the age of 25 are either unemployed or underemployed — the highest rate in 11 years, according to an analysis of government data. They said this construct is exacerbated by the increases in both student loan balances and deferred balances.

"With the economy either in recession or slowly coming out of it during the study period, we had expected that student loan balances might increase as consumers frustrated with the job market went back to school to work toward a different career path," said Ezra Becker, vice president of research and consulting in TransUnion's financial services business unit. However, the rate of growth we observed was truly eye opening."

Between 2007 and 2012, balances of reported deferred loans jumped from $228 billion to $388 billion. In that same period, average student loan balances per borrower across all risk spectrums increased from $18,379 to $23,829.

"It is especially noteworthy that more than half the student loans in our study were in deferment, and with unemployment rates remaining high, particularly among recent graduates, the repayment of these loans remains a concern," Becker said. "Students can defer their loans for only a certain period, often up to three years. After that, these students can find themselves in a difficult position financially."

The TransUnion study also highlighted the disparity between federally backed student loans — those guaranteed by the government — and private student loans, which are issued by private lenders and are most often used to cover the gap between funds made available by government loans and actual tuition rates.

TransUnion indicated federal loans made up 92 percent of all student loan accounts and 86 percent of overall balances. Between 2007 and 2012, federal loan balances jumped 97 percent while private loan balances only rose 4 percent.

As billions of dollars were added to student loan balances between 2007 and 2012, TransUnion also pointed out delinquency rates also increased. Yet the distinction in performance between federally backed student loans and private student loans was material, according to the firm.

From 2007 to 2012, federal student loan delinquencies rose 27 percent while private loan delinquency rates actually dropped 2 percent in that same timeframe. The 90-day delinquency rate for federal loans was 12.31 percent as of March, compared to 5.33 percent for private loans.

"It's important to highlight that both federal and private student loan delinquency rates are higher than most other credit products such as mortgages, home equity lines of credit, credit cards and auto loans," Becker said.

"While the focus in recent years has been on the mortgage market, lenders will need to keep an eye on student loan portfolios — and on customers who have student loan debt — as the high delinquency rates among these borrowers can spell trouble across multiple products," Becker concluded.

Nick Zulovich can be reached at nzulovich@subprimenews.com. Continue the conversation with SubPrime Auto Finance News on LinkedIn and Twitter.

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