The key is to stay disciplined, community bankers say.
"We're still looking to see if it is something we want to stay in, but so far we've gotten good feedback," says Todd DeFee, the retail and student loan officer at Peoples State Bank in Many, La., which began making student loans for the 2011-12 academic year.
Peoples began making loans after clients asked for help sending their children to nearby Northwestern State University. "It piqued the interest of the higher ups," DeFee says, adding that the $497 million-asset bank is talking to bigger schools such as Tulane University and Louisiana State University.
Potential bankruptcy changes could cause trouble down the line for loans made now, but otherwise it's a good time for small banks to enter the business, says Kevin Moehn, a Reston, Va., consultant who works with community banks on student loans.
The market appears ready for new lenders, just two years after the federal government eliminated subsidies and became a direct lender. U.S. Bancorp (USB) late last month pulled out of the market, and JPMorgan Chase (JPM) sharply reduced its lending in the area. Small banks such as First Financial Bankshares (FFIN) in Abilene, Texas, have also exited the business.
Students continue to enroll in college, apply for loans and amass debt. Total outstanding student debt in the United States topped $1 trillion this year, Rohit Chopra, the CFPB's student loan ombudsman, said in March.
Shakeout from the government's decision to become a direct lender means market boundaries are clearly set for banks, Moehn says. The size of the federal loan market is about $100 billion annually, and the private loan market is about $9 billion and growing, he adds.
That's a huge amount of business, providing plenty of growth opportunities for community banks, says Moehn, who is also associated with Student Loan Finance, an Aberdeen, S.D., company that administers student loans for smaller banks.
Some smaller banks exited student loans in recent years because of the difficulty in securitizing the loans. Since there is no market for securitizations, banks that make student loans should be prepared for the long haul. "Banks should be looking at putting these loans on their balance sheets and keeping them there," Moehn says.
Changes notwithstanding, First Financial is not looking to reenter the market, says Bruce Hildebrand, the $4.1 billion-asset company's chief financial officer. "The profitability of those loans for us was taken out of the system," he says. "We were losing money every time we made the loans, so we got out of the business."
Other community bankers are also taking a pass, with some saying that student loans are best left to the very large banks.
"The law changes almost made it so that borrowers were really better off going through" SLM Corp. (SLM), says Brad Tidwell, the president and CEO of Citizens National Bank, a unit of Henderson Citizens Bancshares in Henderson, Texas. "We refer our customers to Sallie Mae or a private student loan originator."
There are other possible deterrents. A proposal by Sen. Richard Durbin would let borrowers discharge private student loans in bankruptcy. It is also unclear how the Consumer Financial Protection Bureau will regulate private student lenders.
Durbin has said he believes there is an opening to allow private student loans to be discharged in bankruptcy because the interest rate on federal student loans is set to double in July, to 6.8%, and some in Congress want to prevent the rate hike.
Private student loans offered by small banks, which are usually have variable rates, are not tied to the federal rate, Moehn says. Banks getting into the business also seem to be taking a more conservative approach to lending.
Peoples State has set aside $1 million for student loans, DeFee says, or an amount equal to less than 1% of its total loans at Dec. 31. The average loan is $3,500. The bank avoids lending more than the cost of tuition, eliminating cases where students could use part of a loan like a credit line.
"We make sure we know who we're lending to, we check the credit scores, and we have a co-signer," DeFee says. "We're not just giving them the money."
The Obama administration has so far declined to endorse Durbin's plan. Treasury Secretary Timothy Geithner has been non-committal about the legislation, though he suggested in a March 28 congressional hearing that he is broadly sympathetic with Durbin's concerns about the private student loan market.
If it becomes law, the bankruptcy proposal "would make private loans more expensive and less easy to obtain," Moehn says. "By definition, many of these students are bankrupt. These loans are intended to be made to people who cannot otherwise get a loan."
As a requirement of the Dodd-Frank Act, the CFPB must issue a joint report to Congress by July 21 with the Department of Education on the student loan market. The CFPB has authority over all private student loan issuers, and has a designated office to serve as an ombudsman on such issues.
Small banks welcome any calls from the CFPB for more disclosure of student loan terms, Moehn says. "We want to make sure students understand the deal they're getting."
"The way we're doing this, I can sleep well at night, and I don't feel like I'm the bad guy," DeFee adds.