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Citizens Bank Becomes An Unlikely Student Loan Leader

This article is more than 8 years old.

In 2009, most banks were desperately trying to survive the financial crisis. The typical large bank was busy shrinking its balance sheet, tightening risk management policies, increasing pricing, firing staff and exiting products. But in the midst of the crisis, Citizens Bank made a contrarian move. The bank, at the time a subsidiary of the troubled Royal Bank of Scotland , decided to enter the student loan market. This surprising bet seems to be paying dividends. Today, Citizens has built a portfolio of more than $2 billion. If you are looking to finance your education, Citizens is now a leading issuer of loans in the country. And if you are looking to refinance, Citizens is competing with Silicon Valley start-ups SoFi and Earnest for market dominance.

Why was Citizens Bank willing to take this bet, when so many other banks decided to leave the private student loan market completely? According to Brendan Coughlin, President of Consumer Lending at Citizens, the reason was twofold. First, Citizens was responding to consumer demand. In 2009, many customers of the bank decided that going to back to school would be a good way to manage the crisis. Recently unemployed, many professionals decided that getting an MBA or law school degree would be a great way to ride out the recession. However, they struggled to find financing, and were equally frustrated when Citizens Bank did not have a product to offer.

The second reason Citizens Bank was able to enter the market is that, according to Brendan, “we did not have the legacy issues of other banks. We did not have to clean up our shop from poor underwriting of the past, and had the opportunity to build a new more customer centric approach from scratch.”

The student loan market has experienced significant regulatory change. Before, the federal government would provide principal protection for private student loans, so long as banks would follow federally mandated criteria. Banks like Citibank became very active in the business, and it generated excellent returns. If the students made their payments on time, Citibank would make money. If the students defaulted, the banks would get their money back from the government. Because the business was government-guaranteed, it required very little capital. Once the government removed the federal guarantee, most banks just exited, including Citibank. And the poor underwriting that characterized the era made banks nervous to enter the business without a guarantee.

Citizens Bank decided to take another approach. Rather than making underwriting decisions based upon future earning potential, Citizens wants to make sure that the parents can afford to make the payments today. More than 95% of Citizens loans are co-signed by parents.  In order for the parents to qualify as co-signers, they need to prove their income and creditworthiness. This is very different from traditional student lending, where the federal government is making a bet on the ability of a student to earn enough money in the future. Because of Citizen’s more conservative approach, their default rate is below 1%.

The Citizens Bank promise is relatively simple. If you are a creditworthy parent with sufficient income, you should be able to get a lower interest rate than a federal loan. Citizens is trying to give people with good credit a better deal. In traditional student loans, their biggest competitors in this space are Sallie Mae and Wells Fargo. Citizens has expanded, by entering the refinance market, where very different competitors have been active.

Student loan refinancing went mainstream thanks to SoFi, a well funded Silicon Valley startup. The premise of a student loan refinance is simple. When the federal government makes a loan, it has no idea how much money you are going to make in the future. As a result, there is no risk-based pricing. Everyone receives the same interest rate, which can be high.

However, if you are a college graduate with an excellent job and a high credit score, you may be frustrated by the high interest rates that you are paying. Enter student loan refinancing. According to market data from MagnifyMoney (my website), interest rates are now as low as 1.90% variable, and 3.50% fixed for borrowers. The savings, given the size of student loans, can be dramatic. At SoFi, the average borrower saves $14k by refinancing. At Citizens, the average borrower sees a 150 bps reduction in their interest rate.

Student loan debt continues to grow rapidly. Given the more than $1.2 trillion of debt outstanding, opportunities exist for people with excellent credit risk profiles to save money with lower interest rates. Citizens Bank looks smart, and has a leadership role in an asset class that was largely ignored by private banks. However, competition will increase as Silicon Valley startups and other banks, like DRB in Connecticut, expand in this space. In addition, regulators and lawmakers are paying close attention. Senator Elizabeth Warren wants the federal government to offer refinancing to all students. President Obama has introduced income-based repayment programs. And as the system overall becomes more confusing, default rates of federal loans continue to increase.

While the future remains unclear, the present opportunity remains dramatic. And that counter-intuitive decision in 2009 looks like it is paying off for Citizens.

Nick Clements is the author of the Forbes eBook, How To Crush Credit Card Debt, available on Amazon