JPMorgan Pulls The Plug On Its Student Loan Business

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JPMorgan Chase (NYSE:JPM) recently informed colleges that it will not be handing out any new student loans after October 12, making the diversified banking group the latest addition to the list of banking giants that have exited the once-lucrative student lending business. [1] This move was not entirely unanticipated as JPMorgan has only been accepting student loan applications from existing Chase customers since last July.

The student loans industry has shrunk considerably for private lenders since mid-2010 when federal government programs which used to provide student loans through the banks began giving out the loans themselves. There was also increased pressure from regulators to relax lending terms for such loans. The resulting margin pressures and increased default rates prompted U.S. Bancorp (NYSE:USB) to stage its exit last April (see U.S. Bancorp Expands Wholesale Business; Stops Student Loans). In fact, Bank of America (NYSE:BAC) predicted this situation way back in 2009 and planned its exit from the business then, followed by Citigroup (NYSE:C) which disposed of its student loan portfolio as a part of its reorganization plan in 2010. [2] With JPMorgan’s exit, Wells Fargo (NYSE:WFC) remains as the last banking giant to continue to offer student loans.

We maintain a $60 price estimate for JPMorgan’s stock, which is about 15% ahead of its current market price.

See our complete analysis of JPMorgan Chase here

The scenario for student loans began changing in late 2009, when the government expressed its intent to grant these loans directly instead of going through private lenders. Financial regulators also put increasing pressure on the lenders to ease the terms on which these loans are given. The lenders were forced to cut interest rates on these loans and also relax repayment schedules leading to lower margins as well as higher default rates. This drove lenders away from making student loans, with private lenders handing out just $8.1 billion in student loans for the academic year 2011-12, compared to $25.2 billion in 2007-08. [2]

A rather clear picture of the current scenario can be obtained from the fact that of the nearly $1 trillion in student loans outstanding, the government accounts for a near-85% share, with all private lenders making up the remaining 15%. And this ratio is only going to get more skewed with JPMorgan’s exit.

The table below shows the share of outstanding student loans in JPMorgan’s total loan portfolio and is compiled from the bank’s quarterly SEC filings.

(in $ bil) Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Q1 2013 Q2 2013
Student Loans 14.41 14.14 13.87 13.54 13.35 12.94 12.04 11.71 11.46 11.17
Total Loans 688.13 686.11 692.79 706.86 715.55 725.25 723.08 725.61 725.12 727.50
Percentage 2.09% 2.06% 2.00% 1.92% 1.87% 1.78% 1.66% 1.61% 1.58% 1.54%

As is evident from the table, JPMorgan has been steadily working its way through its student loan portfolio – adding fewer new loans than those being recovered over recent quarters. The bank reported just above $11.1 billion worth of student loans outstanding at the end of Q2 2013, which is a good 30% below the $16 billion figure for the bank in 2008 and 2009.

So what happens once JPMorgan discontinues new student loans this October? Firstly, the loan portfolio will continue to decline and that too at a faster rate than what has been seen over the recent past, till either all loans are repaid or charged off on JPMorgan’s books a few years down the line. But the more important impact would be a long term improvement in overall operating margins for JPMorgan’s retail banking business, as the student loans were a drag on the bottom line due to low profitability as well as high charge-off rates. You can understand the impact of an improvement in these margins on JPMorgan’s share price by making changes to the chart below.

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Notes:
  1. JPMorgan to stop making student loans: company memo, Reuters, Sept 5 2013 []
  2. J.P. Morgan to End Student-Loan Business, The Wall Street Journal, Sept 5 2013 [] []
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