Welcome to the Senate Republican Press Search.

View Article Details

Print

State treasurer wants to refinance your high-cost student loan—with state money The House overwhelmingly passed a bill to permit the treasurer to allocate 5 percent of state cash to cut student debt. Can a broke state afford the risk?

Crain's Chicago Business

Monday, April 15, 2019  |  Article  |  Steve Daniels

Treasurer (92)

Few would deny that onerous student debt is a problem in the U.S., and an increasing number of states want to help. Can Illinois afford to?

State Treasurer Michael Frerichs says yes and is pushing legislation that would allow him to set aside up to 5 percent of the billions he invests on behalf of the state to refinance high-cost student loans for Illinoisans or to make relatively cheap loans to students. With $12 billion under his management, that means he could lend up to $600 million and help 10,000 to 50,000 students and graduates in Illinois.

More states around the country have launched programs in recent years to refinance high-rate student loans. They include Minnesota, which began offering re-fi loans in 2016, and Rhode Island. But virtually all those states are floating bonds backed by the state to finance the programs. Only Illinois is proposing to dip into funds it needs to pay the bills.

Frerichs' bill sailed through the House on March 29 on a 67-33 vote. The Senate has yet to act.

In an interview, Frerichs argues he would be generating higher returns than the 2 to 3 percent his office produces by investing in short-term and relatively safe fixed-income securities. At the same time, he would be meeting a pressing need to free up cash for younger workers, who then could potentially buy homes, keeping them in the state and helping fuel the economy.

The state already invests 5 percent of its portfolio in private-equity and venture-capital funds that finance Illinois startups and other firms. That portion of the portfolio generated 12.6 percent last year, he says.

Adding student loans to the mix would set aside up to $1 of every $10 the treasurer manages for investment in Illinois' economy, and the office can afford to do it, he says. He calls this "patient capital"—funds that aren't needed in the near term. These are dedicated to certain future payments and by law can't be accessed, for example, to pay down the state's billions in unpaid bills.

Still, student loans are anything but risk-free. Among even those who were required to begin paying back their federal-government loans as recently as 2015, 10.8 percent were in default last year, meaning they were at least 270 days behind on payments, according to the Department of Education. It was 11.5 percent and 11.3 percent, respectively, for those required to start making payments in 2014 and 2013. And that's in a decent economy.

In Minnesota, which has been making bond-financed student loans since 1984, the gross default rate hovers on average around 7 percent, according to Marilyn Kosir, student loan director for the state's Office of Higher Education. The net loss to the state, after collection efforts, is about 2 percent over time.

But those losses occur despite a highly conservative lending policy. For loans made to students in college, the state requires a co-signer—usually the parents. Without those co-signers, the losses surely would be significantly higher. For the new refinancings, the state won't lend to borrowers who didn't get their degree or who aren't currently employed (with an exception for people whose working spouse backs the loan).

One of the toughest problems with student debt today is the many borrowers who take on the loans but then don't finish school. If he gets approval, Frerichs is willing to refinance loans to those without degrees. "Ultimately, it would depend on the individual's creditworthiness," a spokesman says.

Frerichs allows that his office would be adding to the risk in its portfolio with this move. But he calls it "a risk with potentially big paybacks. I think this is a risk worth taking."

He foresees making loans of 10 to 20 years at an interest rate of 4 to 6 percent. Minnesota's refinancing program offers loans from 4.2 percent to 6.75 percent depending on the duration of the loan and whether the rates are fixed or variable. Pricing in Minnesota is not dependent on the credit profiles of those who qualify.

So one key question is how do loans refinancing existing student debt perform versus loans made to those in college? There's little data available.

Minnesota's program is too new. From January 2016 to January 2019, Minnesota has refinanced loans for 1,152 borrowers at a total amount of nearly $40 million.

Riverwoods-based Discover Financial Services, better known as a major credit card company, also is one of the country's largest private student lenders. Since April 2017, it's offered a student loan consolidation product that refinances existing debt and doesn't require a co-signer. But most borrowers do have co-signers because it lowers their rate, spokesman Robert Weiss says.

Net student loan charge-offs at Discover have averaged about 1 percent for the past three years, much better than the performance of the feds or most states. Discover's interest rates averaged 8.3 percent in the fourth quarter of 2018. Weiss says the company doesn't disclose how refinancings perform compared with in-school loans but says it likes how they've done.

Kosir says there's reason to believe refinancing loans could perform better than in-school borrowings, since borrowers are employed and have a credit history.

But, of course, all bets are off in a recession. Federal student loan defaults were in the single digits in the years leading up to the Great Recession but then ramped up to nearly 15 percent. They're still well above 10 percent.

So what percentage of defaults is the treasurer modeling? Frerichs declines to say other than to agree that it's below the 4 percent rate at which he's currently pegged the lowest-cost loans.