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Why investors can use loan default rates to predict a recovery

Part 4
Why investors can use loan default rates to predict a recovery (Part 4 of 4)

Must-know: Why student loans are affecting the recovery

Student loans

“[Student loans have] got some unique qualities and risks that other loans don’t have,” says 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.”

Comparing loan default ratesEnlarge Graph

The industry’s attention, as outlined in the chart above, has focused on credit unions in the U.S., who are increasingly expanding sales of private student loans in their hunt for younger customers and higher returns. Little do these member-owned institutions realize the quantum of risk they’re undertaking.

Komyathy has rightly pointed out the main two characteristics of these loans:

  1. They are unsecured
  2. These students currently don’t have jobs

The rising costs of higher education, coupled with vanishing financial assistance, are putting the squeeze on middle-class students and students from low-income families. Moreover, 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.

According to the Federal Reserve Bank of St. Louis, private student loans have a default rate of about 12%, compared to 4% for car loans and 11% for credit card debt. In 2013, according to the Fed, more than 10% of student loans were considered delinquent—that is, with no payment made in the last 90 days—compared to a 7.6% delinquency rate five years earlier.

Despite warnings issued in December 2013 by the Federal agency to credit unions jumping into the student loan market, these unions have continued to extend loans to students, without any foresight as to the portfolio of bad debts or the total case of insolvency they could end up with.

Moreover, rising student loan defaults are damaging borrowers’ credit, making it harder for former students now starting careers to obtain mortgages, car loans, and other types of financing that boost consumer spending and fuel economic growth. Growing student-loan defaults are subtly weighing on a U.S. recovery that needs all the momentum it can get to break out of a historically sluggish pace.

Financial sector ETFs like the the SPDR S&P Bank ETF (KBE), and the SPDR Financial Select Sector Fund (XLF), which has its major holdings in banks like Wells Fargo & Co (WFC), JPMorgan Chase & Co (JPM), and Bank of America Corporation (BAC), may serve as important barometers of the health of the financial sector at any point of time.

To learn more about student loans and first-time home buyers, see Must-know: Why the first-time home buyer represents pent-up demand.

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